By the Numbers

Rising multifamily defaults but limited losses

Mary Beth Fisher, PhD | August 18, 2023

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.

Freddie Mac’s multifamily portfolio stands on solid ground these days when it comes to credit. The portfolio shows only modestly elevated losses mainly from its most sensitive sectors: seniors housing and small balance loans. Based on history, Freddie Mac’s multifamily default rates for the vintages most heavily affected by pandemic will likely reach those of the worst years of the housing crisis. But cumulative losses will probably remain much lower due to the concentration of losses among small balance loans.

Strong performance despite overhang of loans in workout

An overall summary of Freddie’s multifamily performance through the first quarter of 2023 includes a few highlights (Exhibit 1):

Freddie reports 141 defaulted loans that have completed workout since 1994.
The average default rate over the past 30 years has been 0.45%, not including the vintages since 2020. Default risk has varied significantly across funding years, with some vintages experiencing default rates as low as 0% to 0.14%, while the vintages of 2006 through 2009 affected by the housing crisis had default rates of 1.0% to 1.6%.
Workouts of troubled loans take a long time, and there is an overhang of mostly pandemic era defaulted loans still in the resolution process. The average workout period for Freddie multifamily loans is 47 weeks.
There were 129 non-current loans at the end of the first quarter of 2023, most of which were in special servicing and in some stage of workout.
Updated projections of default rates, losses, and cumulative loss rates across vintages are shown in the three rightmost columns (highlighted in green). This assumes all of those non-current loans default and complete the workout process, with a loss severity equal to the long-term average of 27.2%.
The vintage projected to be the most heavily impacted by the pandemic is, not surprisingly, the 2018 vintage. There are 55 non-current, 2018 vintage loans, which would bring the total number of defaulted loans for that year to 84. The projected default rate for 2018 would rise to 1.51%, similar to that of the peak housing crisis years, but with projected cumulative losses of only 10 bp. That is much lower than the 22 bp to 42 bp of peak cumulative losses for the housing crisis vintages.

Exhibit 1: Freddie Mac multifamily performance summary through Q1 2023

Note: The projected default rate and projected losses assume that all non-current loans default and complete workout, with a loss severity equal the long term average severity of 27.2%. Data through first quarter of 2023. Non-current loans are those 60+ days delinquent, in foreclosure or real estate owned as of the end of the first quarter. Source: Freddie Mac, Santander US Capital Markets

One of the reasons for the lower projected cumulative losses is that 93 of the 129 non-current loans (72%) are from the small balance (FRESB) program (Exhibit 2). There are about 10,000 small balance loans currently outstanding, totaling about $25 billion of unpaid principal balance (UPB) outstanding. Comparatively there are over 15,000 loans securitized in various Freddie K-series (FHMS) deals, totaling about $325 billion of UPB.

Exhibit 2: Breakout of non-current loans

Note: Data as of first quarter 2023.
Source: Freddie Mac, Santander US Capital Markets

Of the other 36 non-current loans, 22 of them are seniors housing or assisted living centers. This subsector of multifamily housing experienced the worst distress due to the Covid pandemic and has been among the slowest to recover. Eighteen of the 22 non-current seniors housing loans are from portfolios securitized in the KS06 and KS09 deals (KS for senior housing K-deal).

A few caveats to otherwise strong performance

The loans for senior living properties in workout could potentially have higher than average loss severities, depending on the stability of the market and resolution process. This would obviously raise the cumulative loss projections modestly.

Freddie’s multifamily performance database does not identify loans that are current but have been transferred to special servicing. There are an additional 50 to 60 of such small balance loans as of the latest tape date (7/1/2023). Many of these loans contain watchlist commentary that notes the borrower is current on the loan but in some sort of distress, or in a stage of bankruptcy. These loans could also eventually default and enter workout, raising the default rate and increasing losses.

Mary Beth Fisher, PhD
marybeth.fisher@santander.us
1 (646) 776-7872

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.