By the Numbers
Pandemic risk dissipates while refi risk rises
Mary Beth Fisher, PhD | October 28, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Fannie Mae’s multifamily delinquency rates are not yet back to pre-Covid levels, but the bulk of loans that entered forbearance have already cured and defaults have so far been modest. The bigger risk is arguably the upcoming maturity wall. More than 10% of Fannie Mae’s existing multifamily portfolio matures over the next three years and virtually all of it will need to be refinanced at considerably higher rates.
Progress on multifamily credit
Despite heightened recession fears, most commercial real estate loan performance has continued to gradually improve from the pandemic-driven peaks of delinquencies and defaults. Agency multifamily loan performance benefitted tremendously from the government-sponsored forbearance programs. Delinquency rates at Fannie Mae surged from less than 0.1% before the pandemic to 1.3% at the peak in late 2020 and early 2021 (Exhibit 1). This was nearly twice as high as peak delinquency rates of almost 0.8% in 2010 in the wake of the housing-led financial crisis.
Exhibit 1: Fannie Mae multifamily historical delinquency rates
Loans that were put into Covid-19 forbearance were marked delinquent at Fannie Mae but were allowed to cure over time after exiting forbearance. Beginning in early 2021, those loans began to exit forbearance and enter repayment. The bulk of the loans that entered forbearance gradually cured over time and returned to performing status. Currently $1.6 billion across 143 loans, or 0.38% of the unpaid principal balance (UPB) of Fannie’s multifamily portfolio, is delinquent (Exhibit 2). About half of that is still in repayment after exiting forbearance. The other half of the delinquent loans are in some stage of workout, most of which never entered forbearance.
Exhibit 2: Fannie Mae multifamily current delinquency status
Some portion of the loans in repayment, $830 million or 0.20% of the outstanding principal balance, will likely ultimately default and enter workout. Worst case scenario might assume all 143 loans comprising 0.38% of outstanding and currently delinquent UPB ultimately default. Compared to the historical default rates and losses primarily incurred due to the financial crisis, those incremental defaults would be rather modest. Assuming a historical loss severity of 31%, that 38 bp of defaults would generate 12 bp of losses. That’s less than the cumulative losses from the 2009 vintage alone, which was the best performing vintage of the first decade of the 2000s. The overall performance of Fannie Mae’s portfolio has been quite strong (Exhibit 3). The pandemic crisis in agency multifamily looks like it has been largely resolved and contained.
Exhibit 3: Fannie Mae multifamily performance summary
A wall of refinancings
One of the primary concerns in commercial real estate going forward is that maturing loans will need new financing, and that financing is largely going to be at considerably higher rates. That’s true for agency CMBS as well. Nearly 11% of Fannie Mae’s outstanding multifamily portfolio matures over the next three years (Exhibit 4). The average note rate on the existing loans is 4.5%, which is roughly 100 to 150 bp below current DUS 10/9.5 rates, depending on property tier and other credit factors.
Exhibit 4: Upcoming multifamily maturities at Fannie Mae
The upside is that the maturing loans have benefitted from up to 10 years of exceptionally strong property price appreciation. Existing borrowers should be able to refinance relatively easily at the higher rates, even if they need to do so at a lower loan to value (LTV) in order to maintain an acceptable debt service coverage ratio (DSCR). Those owners who wish to sell the property may find the environment less favorable. Commercial real estate prices generally have already started to decline modestly month-over-month, and that trend is expected to continue well into next year. New investors are going to demand higher cap rates given the higher cost of financing, which will put more pressure on sellers.
On the upside, the fewest properties mature in 2023, and those already have the highest average existing note rate at 4.75%. The benefits of accumulated price appreciation and the lowest average jump in financing costs should limit any potential wave of delinquencies. By 2024 or 2025 the Fed could be in an easing cycle and rates could be roughly flat to those of maturing loans, though prices could also be at a local trough. Even in a recession scenario of higher rates and lower prices, the maturity wall in agency CMBS is unlikely to result in a pile-up of delinquencies and defaults, but some speed bumps due to local losses are to be expected.