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A landscape of rising prepayments in agency multifamily
admin | October 30, 2020
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.
The sharp drop in interest rates this year has accelerated prepayments in most agency multifamily loans despite often significant penalties required to prepay. Penalties in Ginnie Mae project loans, Freddie Mac small balance loans and floating-rate K-series typically decline over time, and these loans are seeing some of the fastest prepayments. Loan size and product type matter, with fixed-rate small balance loans repaying a bit faster than hybrid ARMs. IO investors need to pay attention since the downside from principal prepayments can offset the upside from collecting penalties.
Opportunity and decision
The decision to refinance a multifamily loan is fundamentally driven by the same factors as a single-family loan–the value of the rate incentive and the ability or desire to tap equity in the property. The prepayment penalties make the hurdle to refinancing higher, and the additional scrutiny of borrower financials and re-evaluation of the property can make the process more cumbersome.
Over the last decade the yield on the 10-year Treasury has ranged from a high of 4.00% to a recent low of 0.50% (Exhibit 1). Purely based on rate incentive, the vintages with the strongest incentive to refinance include 2010, 2011 and 2018, when rates were close to or above 3.00% for most of the year. However, the recent pandemic-induced rally has meant even loans that refinanced during the previous troughs in 2012 and 2016 now have up to a 100 bp incentive before accounting for prepayment penalties.
Exhibit 1: The 10-year Treasury rate has varied significantly over the last decade
Note: on-the-run rate.
Source: Bloomberg
Ginnie Mae Project Loans
Prepayment penalties in Ginnie Mae project loans typically start at 9% to 10% of the outstanding balance after any lockout expires and decline by 1% per year over 10 years. Speeds in Ginnie Mae project loans picked up again in October for most penalty cohorts, though the 1- to 3-point and 7- to 8-point penalty cohorts show signs of stabilization (Exhibit 2).
Exhibit 2: Ginnie Mae project loan prepayment speeds by penalty amount
Source: Intex, Amherst Pierpont Securities
Loans with the largest prepayment penalties are actually reaching speeds close to 25 CRR. Over the past year speeds have been above the long-term historical average based on refinance incentive for all but the highest levels of incentive where these very old, high rate loans are clearly showing significant burnout (Exhibit 3).
Exhibit 3: Ginnie Mae project loan S-curves by rate incentive
Source: Intex, Amherst Pierpont Securities
The impact of refinance incentive tends to be persistent over time, with vintages that have higher average rates having faster lifetime CPRs than those with lower rates (Exhibit 4). The relatively higher rate vintages in 2010, 2011, 2014 and 2019 have the highest lifetime CPRs of the vintages of the past decade. The 2017 vintage, which has a lot of loans originated in the rate trough of the second half of 2016, has the slowest lifetime CPR at 3.6, excluding the 2020 vintage where rates are even lower. Those 2016-2017 vintage loans are also those with 7- to 8-point penalties remaining under the most common scheme, which explains why that cohort is prepaying somewhat slower than expected all else being equal.
Exhibit 4: Ginnie Mae project loan prepayment speeds by year since issuance
Note: CPR speeds include voluntary and involuntary prepayments.
Source: Intex, Amherst Pierpont Securities
Prepayments in small balance loans are slower and influenced by loan type
Freddie Mac’s small balance loans have a variety of different loan structures and their prepayment penalties overall tend to be considerably lower than those in Ginnie Mae project loans, Freddie K-series and Fannie Mae DUS. For example, when FRESB loans have a point system they often start at 5% or 3% of the outstanding balance as a prepayment penalty, which declines over three to five years, then remains at 1% for most of the remaining term. Despite the lower overall penalty structure, FRESB loans tend to prepay more slowly regardless of the rate incentive, then accelerate as the loan approaches the balloon payment or the end of the IO period (Exhibit 5). The prepayment speeds for the A5F (fixed-rate) and A5H (hybrid ARM) tranches, either have a balloon payment or begin to amortize down at the 5-year mark. These tranches, as seen in the 2015 vintages, have speeds that tend to rise gradually over time then jump higher at the balloon or amortization threshold.
Exhibit 5: FRESB prepayment speeds by loan vintage and tranche
Note: CPR speeds include voluntary and involuntary prepayments. Average speeds include 2014 vintages which are not shown in the tables above.
Source: Intex, Amherst Pierpont Securities
Notably the lifetime speeds by vintage, and the average historical speed by tranche type, both tend to be a bit higher for the fixed-rate loans than those of the hybrid ARMs. This could be because the teaser rates for the hybrid ARMs tend to be lower than those for comparable vintage fixed-rate loans so the rate incentive is somewhat lower, or it could reflect a stronger borrower preference to avoid a balloon payment in fixed-rate loans as opposed to an amortization period that’s more common when the ARM transitions from fixed to floating. Either way it’s a persistent enough difference that IO investors who want slower speeds should favor the hybrid ARM tranches across all terms.
Freddie Mac K-series floaters prepay faster than supplementals
Prepayments are tracked in Freddie Mac K-series floaters (K-Fs) and supplemental loans (K-Js). Across almost all vintages floaters prepay somewhat to considerably faster than supplemental loans (Exhibit 6), with the most recent 2019 vintage being the lone exception.
Exhibit 6: Prepayment speeds ramps by vintage
Note: CPR speeds include voluntary and involuntary prepayments.
Source: Intex, Amherst Pierpont Securities
The supplemental loans have much higher coupons than the floaters, so it’s not purely a rate incentive story. Prepayment speeds in supplementals are likely following prepayments on the first lien loans. Those loans could have additional credit concerns or the additional debt may make refinancing more difficult. The additional loan isn’t a significant deterrent, as the lifetime speeds on the supplemental and floating rate loans by vintage are much faster than the speeds on Ginnie Mae project loans. K-series loans generally tend to be much larger in size than Ginnie Mae project loans – roughly $13 million at origination versus $5.5 million. The borrowers may be more sophisticated and tend towards professional developers with larger portfolios of projects, who aggressively refinance or sell properties when the opportunity arises.
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