By the Numbers
Rip currents emerge in small balance multifamily CMBS
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. This material does not constitute research.
Agency multifamily CMBS has seen delinquency rates rise in tandem with the broader market, but overall performance continues to be better despite some undertow in the small balance sector. A surge in delinquencies in Freddie Mac’s small balance loan (FRESB) program still does not reflect a large portfolio of loans lingering in special servicing. The bulk of those troubled but mostly performing loans appear to be on rent-regulated New York City buildings. It’s unclear if these troubled loans will migrate to non-performance. If so, the workout times are likely to be longer than average and loss severities higher. The result would primarily effect FRESB B-piece investors and those with securities trading away from par and consequently sensitive to the timing of involuntary prepayments.
Caught in the rising tide of delinquencies
Delinquencies surged at the end of 2023 across all multifamily sectors, and the FRESB program did not escape it (Exhibit 1). The delinquency rate across FRESB collateral jumped from 1.45% in November to 2.25% in December. Long-term delinquencies actually fell as some loans completed workout, but 30-day delinquencies rose from 0.09% to 1.06%.
Exhibit 1: A sharp rise in FRESB delinquency rates
Note: Data is monthly through January 2024.
Source: Freddie Mac, Bloomberg, Santander US Capital Markets
Data through January 2024 indicate the delinquency rate held at 2.24%, with nearly all 30-day delinquent loans in December transitioning to 60-days delinquent in January. This is likely in part due to a portfolio of properties from a common borrower transitioning towards workout, as apparent in nearly identical delinquency commentary across many of the 56 loans ($240 million UPB) in the 60-day bucket. The two deals with the largest exposure to these 60-day delinquent loans are FRESB 2019-SB63 and FRESB 2019-SB68 (Exhibit 2). The bulk of the properties backing the delinquent loans are in New York City, often above 96 Street, and likely include rent-regulated units.
Exhibit 2: FRESB deals with exposure to 60-day DQ bucket
Note: Data through January 2024.
Source: Bloomberg, Santander US Capital Markets
In an encouraging sign, there was not an additional build of new delinquencies, as the 30-day delinquency rate declined from 1.06% in December to 0.16% in January.
Why New York is the epicenter of new delinquencies
The value of rent regulated buildings in New York have been plummeting since a 2019 rent law was passed. An excellent overview of the law and the projected impact on landlords is in New York Landlords in a Financial Bind from New Rent Law, a 2019 article in the Wall Street Journal. Largely as projected, citywide prices for rent-stabilized buildings have fallen 18% on average from their peaks according to The Real Deal. Rent regulated properties above 96 Street in Manhattan have fared the worst, with average declines of 51%.
The timing and focus of the new wave of FRESB delinquencies appears similar to the distress recently experienced at New York Community Bank (NYCB). The falling knife of deteriorating multifamily prices crossed the electrical wire of distress in the New York City rent-regulated market. NYCB, a leading lender to rent-regulated properties with an $18.3 billion loan book in the sector, dramatically increased their loan loss reserves during the fourth quarter of 2023 and cut their dividend. According to management statements and press reports, about 14% of the rent-regulated loans were at risk of default and 0.51% were non-performing.
A backlog of FRESB loans in special servicing with similar profiles
There appears to be additional exposure to the rent-regulated market in the small balance program. In addition to the $557 million of loans (2.24% of UPB) currently delinquent, there is another $221 million (0.89%) that is in special servicing. Of that $221 million, $181 million is located in the state of New York. Spot checking against known rent-regulated buildings using the New York State Division of Housing and Community Renewal database confirms that there have been rent regulated units in some of those properties whose loans are in special servicing.
Longer workouts and higher loss severities
Whether the bulk of these loans in special servicing will remain current or migrate to non-performing is unknown. The potential impact of the rise in delinquencies is an eventual increase in involuntary prepayments, and for the B-piece buyers, credit losses. Based on analysis of the data in the most recent Freddie Mac SB-Deal Performance Report, the historical average loss severity for small balance loans is 41.4% and average the time to workout a loan is 1.9 years. The workout time is from the date of transfer to special servicing to the date the loan is resolved. This compares to an 11 month average workout time for Fannie Mae DUS loans and a 35% average loss severity.
Rent-regulated properties in New York have experienced such steep price declines that loss severities are at risk of being higher. Workout times may also be extended as foreclosed properties in the sector may struggle to find buyers.
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