Agency CMBS Market Primer

Transcription

1 Fixed Income Research FOR INSTITUTIONAL CLIENT USE ONLY Agency CMBS Market Primer Securitized Products Americas Research Analysts Serif Ustun Roger Lehman Sylvain Jousseaume Tee Chew The Agency CMBS market includes various mortgage-backed securities (MBS), where the underlying assets are commercial real estate, predominantly multifamily properties. Similar to their well-known larger cousins, the residential Agency MBS products, they have either an explicit US government guarantee or are guaranteed by one of the Government Sponsored Enterprises (GSEs); however, one important difference sets them apart from Agency RMBS the existence of strong call protection provisions for the underlying loans, which curb voluntary prepayments and provide a cushion to the undesirable negative convexity that is generally present in RMBS. These unique features make Agency CMBS an attractive asset class for fixed-income bond investors. The Agency CMBS market provides financing to borrowers on multifamily and healthcare properties as well as to small business owners with public policy goals (including affordable housing, community development, job creation, etc.). Issuance has increased significantly since the recession because of a void left by private commercial real estate lenders, most notably by CMBS issuers. Outstanding Agency CMBS, across all products, is $281 billion as of year-end With the increased depth and liquidity in this well-established segment of the Agency universe, we present a survey of various Agency CMBS products, including the following major securitization programs: Ginnie Mae Project Loan REMICs; Fannie Mae Multifamily DUS MBS, DUS Megas, and DUS REMICs; Freddie Mac Multifamily K-Deals, and Small Business Administration (SBA) Programs including SBA 7(a) Pools, SBA DCPCs (CDC/504), and SBIC Debentures. Some of the Agency CMBS products are traded as single-pool MBS (i.e., project loan certificates, DUS MBS); however, we focus mainly on multiple-pool structures (i.e., REMICs, Megas) in which investors get the diversification benefits and improved liquidity of larger issue sizes. We cover the basic features of each product, discussing issuance trends, collateral characteristics, loan origination processes, call provisions, deal structures, market pricing conventions, and prepayment and default analysis. We also provide a summary matrix highlighting the commonalities and differences for each sector. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

2 Table of Contents Agency CMBS Summary Matrix 3 Ginnie Mae Project Loans & GNR REMICs 6 Fannie Mae Multifamily DUS MBS 16 Freddie Mac Multifamily K-Deals 24 Small Business Administration (SBA) Programs 30 SBA 7(a) Program & SBA 7(a) Pools 31 SBA CDC/504 Program & SBA DCPCs 33 SBIC Program & SBIC Debentures 38 Appendix 1: Major FHA/HUD Project Loan Programs 42 Appendix 2: SBA 7(a) vs. SBA CDC/504 Program Summary 43 Appendix 3: SBIC Participating Securities (PSPC) 44 Agency CMBS Market Primer 2

3 Agency CMBS Market Primer 3 Agency CMBS Summary Matrix Program Ginnie Mae Project Loan REMICs FHA/GNMA Project Loans Fannie Mae DUS REMICs, DUS Megas DUS MBS (Delegated Underwriting Servicing) Bloomberg Ticker GNR DUS REMIC: FNA Market Size (outstanding balance as of year-end 2012) GNR: $57 billion Standalone GN: $16 billon DUS Mega: FN, MFMEG FNA: $26 billion Mega: $13 billion Example Deal GNR FNA 2012-M3 Deal Structure Multi-tranche, sequential pay classes Standalone DUS: $72 billion FN FN0030 FNA: Multi-tranche, sequential pay classes Mega: Single-tranche, pass through IO Class Yes FNA: Yes Average Deal Size in 2012 (range) $376 million ($208mn - $624mn) Mega: No Average # of Loans 71 FNA: 107 Loan Terms (most popular) Freddie Mac K-Deals Capital Markets Execution (CME ) FREMF (FHMS for guaranteed classes) Small Business Administration (SBA) SBA 7(a) Pools SBA 504 Debentures SBIC Debentures SBA 7(a) Loan Program SBA 504/CDC Loan Program SBA SBAP SBIC $43 billion $20 billion 20-year Debenture: $27 billion 10-year Debenture: $800 mil. FREMF 2012-K22 SBA SBAP F Multi-tranche, sequential pay classes with credit enhancement FNA: $744mn ($298mn-$1.43bn) $1.25 billion Mega: $69mn ($4mn -$263mn) Mega: 11 Fixed-rate, year maturity Fixed-rate, 10 year balloon with full amortization maturity with 30year SBAP D Single-tranche, pass through Single-tranche, pass through Yes (multiple) Optional No No ($448mn - $1.41 billion) amortization (10/9.5 DUS MBS) amortization $18 million ($1mn - $101mn) Small Business Investment Company (SBIC) Program Debentures: $4.9 billion PSPC: $1.3 billion SBIC A SBIC 2009-P10A 20yr: $406mn ($302mn-$507mn) $687 million 10yr: $39mn ($20mn - $58mn) year Debenture: 614 Fixed-rate, 10 year balloon maturity with 30 year Floating-rate, 5 to 25 year maturity loans. Indexed to Prime Rate, resetting monthly or quarterly 10-year Debenture: 74 Fixed-rate, 20-year maturity with full amortization (for 20- year Debenture) Single-tranche, pass through ($572mn - $802mn) 252 Fixed-rate, 10 year maturity, non-amortizing loans Payment Schedule Monthly Monthly Monthly Monthly Semi-annual Semi-annual Collateral / Property Types Mostly low- and moderateincome multifamily housing and healthcare loans (nursing homes and assisted-living facilities) Proceeds can be used for new construction or substantial manufactured housing, rehabilitation projects, as well as refinancing of existing mortgages Mostly standard conventional multifamily housing Other eligible property types: affordable multifamily housing and low-income housing tax credit, seniors housing, cooperative housing, student housing, military housing, rural rental housing Mostly standard conventional multifamily housing secured by occupied, stable and completed properties Limited amount of agerestricted multifamily, student housing, cooperative housing and Section 8 housing assistance payments (HAP) contracts Full-recourse loans to small Real estate for 20-year businesses Proceeds are used for expansion/renovation; new construction, purchase of land or buildings; purchase equipment, fixtures, leasehold improvements; working capital; refinance debt for compelling reasons; seasonal line of credit, inventory Debenture and machinery for 10-year Debenture Loan proceeds can only be used for fixed asset projects, such as purchasing and/or improving land, constructing new facilities, renovating existing facilities or purchasing machinery/equipment Non-recourse loans to small businesses Non-recourse equity investments in small businesses Proceeds are used for operating capital purposes and for acquisitions of existing businesses, as well as other activities including research & development and marketing

4 Agency CMBS Market Primer 4 Agency CMBS Summary Matrix Loan Origination Process Guarantee Nature of Guarantee Ginnie Mae Project Loan REMICs Loans are sourced/ originated by a network of Fannie Mae DUS REMICs, DUS Megas HUD-approved private lenders. network of private DUS lenders Loans are underwritten by HUD according to FHA statutory requirements Insured by HUD, and Ginnie Mae provides additional guarantee Full faith and credit guarantee of US government Full recovery and timely payment of principal and interest Loans are originated, underwritten and serviced by a Origination and servicing guidelines are set by Fannie Mae in DUS program (Delegated Underwriting Servicing) Losses are shared by a DUS lender and Fannie Mae according to a loss sharing arrangement Fannie Mae guarantee Full recovery and timely payment of principal and interest Prepayment penalties are not Yield maintenance (YM) guaranteed for IO bondholders payments associated with prepayments are not guaranteed Freddie Mac K-Deals Loans are sourced/ originated by Freddie Mac s Program Plus Seller/Servicer network of private lenders Loans are underwritten inhouse by Freddie Mac through its Capital Markets Execution (CME ) program Freddie Mac guarantee (on the senior classes) Timely payment of interest to senior classes (Classes A1, A2 and X1) Timely payment of principal to the classes A1 and A2 upon maturity of any loan, and ultimate payment of principal by final distribution date (no extension) Reimbursement of any realized losses and expenses allocated to senior classes upon resolution of defaulted loans (not on the date loan default occurs) Small Business Administration (SBA) SBA 7(a) Pools SBA 504 Debentures SBIC Debentures Originated and serviced by CDC/504 lending program Small Business Investment private sector lenders involves two loans: (1) a senior Companies (SBICs) are Lenders can sell the SBA lien loan from a private sector privately owned venture capital guaranteed portion of the lender (typically banks) covering funds licensed and regulated loans (75% to 85% of up to 50% of the project cost by the SBA balance) into secondary /collateral, (2) a junior lien loan SBICs raise funds from market, which are pooled and through the CDC (Certified private investors which are sold to institutional investors Development Company, matched by SBA at a 2:1 ratio as SBA Pools licensed by SBA) covering up to of public to private funding; i.e., 40% of the project cost for every $2 debt capital Only the junior liens from ( Leverage ) borrowed from the CDCs are backed by a 100% SBA, the SBICs must raise $1 SBA-guaranteed debenture, of capital from private investors which are pooled and securitized as SBA DCPCs Full faith and credit Full faith and credit guarantee Full faith and credit guarantee guarantee of US government of US government of US Government Full recovery and timely Full recovery and timely Full recovery and timely payment of principal and payment of principal and payment of principal and interest interest interest

5 Agency CMBS Market Primer 5 Agency CMBS Summary Matrix Call Protection Market Pricing Assumption Ginnie Mae Project Loan REMICs Combination of a hard lockout and penalties for a maximum of 10-year period Most popular call provisions in recent years are 2/8 (lockout for two years; followed six months by eight years of prepayment penalties) and 1/9 5/5 was the predominant call protection type for older cohort project loans (i.e., pre- 2005) 15% CPJ: the conventional Fannie Mae DUS REMICs, DUS Megas 10/9.5 DUS MBS: Yield Freddie Mac K-Deals Maintenance for 9.5 year, open the term of the loan except for six months (most popular) 7/6.5 DUS MBS: Yield Maintenance for 6.5 year, open Call protection features can Call protection features can also include defeasance, prepayment fees and lockout PLD curve for default, and 15% throughout life and no flat CPR for voluntary prepayments after lockout 0% CPY: zero default prepayment after the yield maintenance period ends Lockout and defeasance for the last 3 months (most popular) also include yield maintenance and prepayment penalties Source: Credit Suisse, HUD, Ginnie Mae, Fannie Mae, Freddie Mac, SBA, the BLOOMBERG PROFESSIONAL service Small Business Administration (SBA) SBA 7(a) Pools SBA 504 Debentures SBIC Debentures Prepayment penalty during the initial three years for loans with maturities 15- years or longer 20-year Debenture: 10 year of No call protection feature: prepay penalties (penalty equal the coupon in 1st year, reduced on any semi-annual payment by 10% annually until year 11) 10-year Debenture: 5 year of prepay penalties (penalty equal the coupon in 1st year, reduced by 20% annually until year 6) 0% CPR 12% to 14% CPR 5% CPR (secondary trading) 0% CPR (new issue pricing) borrowers can prepay in whole date. However partial prepayments are not allowed 7% CPR

6 February 2013 Ginnie Mae Project Loans & GNR REMICs Ginnie Mae Project Loan REMICs (GNRs) are multiple-pool deals collateralized by loans fully insured by FHA and wrapped by Ginnie Mae. The outstanding volume of GNR REMICs is $57 billion; $87 billion has been issued since Exhibit 1: GNR REMIC issuance Prior to 2010, annual GNR issuance ranged from $3 billion to $6 billion, $bn with an average of 18 deals each year b Issuance has surged since the beginning of the recession, reaching a record 50 deals 16 ($19 billion) in 2012 (Exhibit 1). A typical GNR deal included 70 project loans on average in 2012, with the loan count ranging from 23 to 147 project loans. The average deal size has been increasing over the last three years: $376 million in 2012, up from $316 million in 2010 versus $285 million for earlier vintages. Last year s deal sizes ranged from $208 million to $624 million. Collateral characteristics Project loans are mostly 35- to 40-year fully amortizing mortgages. The wide range of collateral includes the following: low- and moderate-income multifamily housing; nursing homes and assisted living facilities for the elderly; condominiums, cooperatives, multifamily rental units and rural developments; and hospitals and health care centers (ineligible for GNR REMICs). Loans are originated by a network of HUD-approved private lenders and underwritten by HUD according to FHA statutory requirements. 2 Outstanding FHA-insured project loans totaled $79 billion as of year-end 2012 of which $73 billion carried an additional Ginnie Mae guarantee; $57 billion of the $73 billion was securitized in GNR REMICs. The top loan originators for 2012 GNRs included Red Mortgage Capital, Greystone Servicing, Berkadia Commercial Mortgage, Wells Fargo Bank, Walker & Dunlop and Oppenheimer Multifamily Housing & Healthcare. Each project loan is underwritten according to the guidelines of the specific section of the National Housing Act, and as an industry convention, it is customary to refer to the program by the section number by which it is authorized (e.g., Section 221d4 for new construction multifamily or Section 232 for healthcare project loans). FHA provides mortgage insurance for the project loans, which then allows them to be wrapped by Ginnie Mae as single loan pass-through MBS. The FHA mortgage insurance fee (i.e., MIP) varies from 50 bp to 65 bp depending which section of the National Housing Act applies to the project. An additional Ginnie Mae guarantee is usually purchased for a small fee (usually 13 bp plus a nominal commitment authority fee) by the mortgage banker to ensure the timely payment of all principal and interest payments. The resulting Ginnie Mae pass-through certificate is also called a Ginnie Mae pool. Almost every pool is backed by a single FHA Source: Credit Suisse, Ginnie Mae * GNR Re-REMIC transactions are excluded. 1 Prior to the launch of Ginnie Mae REMIC (GNR) shelf in 2001, Ginnie Mae project loans were pooled and securitized under the Fannie Mae multifamily REMIC shelf (between 1995 and 2000). A total of $5.2 billion Ginnie Mae project loans were securitized under the Fannie Mae REMIC deals, which also included Fannie Mae multifamily certificates as collateral. 2 The National Housing Act of 1934 legislated the Federal Housing Administration (FHA) with the mandate to preserve the health of the single and multifamily housing markets. The FHA is now a part of the Department of Housing and Urban Development (HUD), which created Ginnie Mae to facilitate the secondary market of FHA-insured loans. Agency CMBS Market Primer 6

7 February 2013 project loan (99.4% by count); therefore, in this primer, we use the term project loan interchangeably with Ginnie Mae pool, for simplicity. Originators typically retain the servicing rights. The servicing fee is typically 12 bp. Underwriting criteria The underwriting criteria for project loans have been fairly consistent over the last decade. This compares favorably versus the underwriting on private label CMBS multifamily loans, which had become frothier (e.g., pro forma loans) prior to the recession. Despite benign FHA multifamily defaults, HUD tightened the underwriting requirements slightly in September This was partly done to shrink the government footprint in mortgage finance because with private capital sources (i.e., CMBS) scaling down in the aftermath of recession, FHA issuance volumes had doubled and the economy had started to recover. 3 The minimum DSCR required is generally 1.15x to 1.20x across different Sections (1.11x to 1.18x for pre-september 2010 project loans); maximum LTVs range from 83% to 90% (compared to 85% to 90% for pre-september 2010 loans). Appendix 1 includes a summary of various HUD lending programs and the underwriting criteria for some of the major sections. By property type, multifamily project loans make up approximately 71% of the collateral for GNR REMICs, and the rest are predominantly healthcare loans. Recent vintage deals may also include a small percentage, typically less than 1%, of rural development loans (we grouped them under the multifamily category). 4 These loans carry the US Department of Agriculture guarantee, pursuant to the Section 538 Guaranteed Rural Rental Housing Program, instead of the HUD/FHA guarantee. The project loan proceeds can be used for new construction (or substantial rehabilitation), acquisitions or refinancing existing debt. Refinanced project loans, the refis, are typically Section 223a7 or Section 223f loans, and they constitute more than half of GNR REMICs collateral. Recent vintage REMICs have higher percentages of refis: 77% for post-2009 deals versus 59% for earlier vintages, however, we expect this trend to reverse going forward. Multifamily vacancy rates are near historical lows (below 4.5%) and construction activity is picking up after dropping below the long-term averages in the past four years as shown in Exhibit 2. With the current administration s goal of increasing construction jobs and employment, and FHA being a constant and reliable source of capital for multifamily and healthcare, new construction pool concentration is likely to increase in future GNR transactions. Exhibit 2: Multifamily starts are rising near to pre-crisis levels Source: Credit Suisse, US Census Bureau The underlying new project loans (nonrefis) in GNR REMICs are either construction project loan certificates (CLC) or permanent project loan certificates (PLC). 5 A CLC will be converted into a PLC when construction is completed upon final FHA endorsement. CLCs represented 7% of original GNR REMIC collateral for pre-2009 vintage deals. However, recent vintages have double-digit CLC concentrations (16% on average). Exhibit 3 provides a detailed summary of various collateral sub-types for recent and older vintages. 600K 500K 400K 300K 200K 100K 0K 5+units building permits 5+units starts 3 Mortgage insurance premiums were also raised by 5 to 20 bp, depending on the Section, in April One notable exception is the GNR deal in which rural development loans made up 41% of the underlying collateral. 5 This applies both for the multifamily and healthcare project loans. Agency CMBS Market Primer 7

8 Exhibit 3: Dissection of GNR REMIC collateral Vintages 2009 to 2012 Vintages 2001 to % 80% Refi PLC Refi PLC 60% PLC 60% PLC CLC 35% CLC 40% 53% 40% 20% 5% 14% 0% Multifamily 24% 2% 2% Healthcare 20% 0% 28% 6% Multifamily 24% 6% Healthcare Source: Credit Suisse, Ginnie Mae Securitization process A single project loan can be traded as a stand-alone certificate (PLC or CLC); however, the majority are pooled and securitized in multiple-loan REMIC form. For example, 95% of project loans by count, issued between 2009 and 2011, ended up in GNR REMICs (87% by balance). 6 These REMICs are efficient investment vehicles, as pooling large numbers of project loans provides geographic, coupon and section (i.e., program type) diversity. In addition, the time-tranched nature of project loan REMIC securities makes it possible to tailor risk and return characteristics, which makes it easier to buy and sell project loans to a broad set of investors with different objectives. This, in turn, improves both the marketability and the liquidity of securitized deals. Explicit guarantee of the US Government Project loans have an explicit US government guarantee in the form of FHA insurance, which guarantees eventual payment of principal, less an assignment fee (1%) and one month of interest, and an additional Ginnie Mae guarantee, which ensures the full recovery and timely payment of principal and interest. 7 By virtue of this dual insurance on the underlying project loans, a GNR REMIC deal inherits the explicit government guarantee for the full recovery and timeliness of all cash flows when any of the project loans default. Another advantage project loans enjoy is that bank regulators attach a zero-percent risk weighting to mortgages guaranteed by Ginnie Mae, and therefore to GNR REMIC bonds. Ginnie Mae does not guarantee the payment of any prepayment penalties. However, upon voluntary prepayment, a lenders/servicer would only release the existing lien when it collects the full outstanding principal, interest and associated prepayment penalty. Therefore, only for defaulted loans (i.e., assignments, modifications/overrides), prepayment penalties are not collected. Call Protection Call protection on project loans is a combination of a hard lockout followed by a time period when penalties are imposed on voluntary prepayments for a maximum ten-year period. The most commonly used call provisions in recent years have been 2/8 and 1/9. The former type implies a two-year lockout followed by a declining eight-year penalty, which starts at 8% of the outstanding principal amount in year 3 and declines 1% each year after that. 6 Approximately half of the project loans not pooled in GNR REMICs are the Section 242 Acute Care Hospital project loans. Under the current guidelines, Section 242 loans may not include any equipment as a part of the security for such loans in order to be considered as eligible collateral for REMIC transactions. 7 Ginnie Mae s fee is 13 bp. Agency CMBS Market Primer 8

9 For 2012 issued GNR REMICs, 54% of project loans were 2/8 s and 32% were 1/9 s. The next most frequent call type was 0/10 with 11% of project loans having no or minimal lockout periods (i.e., less than six months). 8 Going forward, we expect more project loans to be 1/9 s and/or 0/10 s, giving more prepayment optionality to borrowers. We also note that prepayment penalties may be tax deductible for borrowers, therefore, the effective rate is lower. Pricing Convention: 15% CPJ The market pricing convention for GNR REMICs is 15% CPJ, which is a combination of a flat 15% constant prepayment rate (CPR) for voluntary prepayments and the Project Loan Default curve (PLD). For voluntary prepayments, 15% CPR is applied after the lockout period ends. The PLD curve is used to estimate the default behavior of project loans based on seasoning. Default rates are expressed as a per annum percentage of the thenoutstanding principal balance of a project loan in relation to its loan age. The humpshaped curve peaks in year 3 with a 2.51% annual default rate, then trends down in the subsequent years (Exhibit 4). The PLD curve was developed in late 1990s based on the historical project loan default experience. Deal Structure Exhibit 4: PLD: Project Loan Default Curve CDR 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Year Source: Credit Suisse, Ginnie Mae GNR REMICs are structured into time-tranched, sequential-pay classes. In recent years, deal structures have evolved to include more bespoke classes with targeted average lives. A typical deal in prior vintages would generally include a four-class structure (Classes A, B, C, and D) with average lives of 3-, 5-, 8- and 12-years, respectively, a 20-year Z class, which accrues interest that goes to pay down those four classes first while adding to the principal balance of the Z class, and an IO class, which gets the excess interest. In addition, the IO class receives all the prepayment penalties collected by the trustee. More recent vintage GNRs include additional front-pay classes, typically named Class AB, AC and so on, with varying payment windows and average lives. These classes would receive principal payments, along with Class A, based on a prescribed percentage formula until retired. 9 We illustrate both of these generic GNR REMIC deal structures in Exhibit 5. 8 We also note the existence of other call structures in GNR REMICs such as 5/5, 3/7, 2/3 but they are infrequent. The 5/5 structure was the predominant call type historically; 70% of loans in 2003 vintage GNR REMICs were 5/5 s. It is also possible to have different prepayment penalty patterns within a structure, for example a 2/8 with 8% penalty during the initial three-year after lockout, followed by 5%,4%,3%,2%,1%, but these are also infrequent. 9 Our second example deal in Exhibit 6 is based on GNR in which principal is distributed in the following order of priorty: 1. Concurrently, until AB has been retired: a. 32.2% to AC b. 51.4% to A, until retired, and then to B c. 16.4% to AB, until retired 2. Concurrently, as follows: a. 32.2% to AC, until retired b. 67.8% to B, until retired 3. To Z, until retired Agency CMBS Market Primer 9

10 Class IO Class IO 21 February 2013 Exhibit 5: Ginnie Mae project loan REMIC deal time tranching GNR structure (older vintages) Interest Sequential Pay Classes Only GNR structure (recent vintages) Interest Sequential Pay Classes Only Class A Avg Life 3yr Class B 5yr Class C 8yr Class D 12yr Class Z 20yr Class A Avg. Life 3yr Class B 10yr Class AB 3yr Class Z 20yr Class AC 5yr Source: Credit Suisse Prepayment Analysis Project loan prepayment rates, measured in CPR, have displayed a seesaw pattern in the last six years. Rates dropped from 30% CPR at the beginning of 2007, to 5% CPR by mid- 2009, and then increased back to 30% CPR by early Unlike the RMBS sector, in which prepayments are mostly rate-driven, several factors are at play for project loan prepayments. Borrowers often prepay in order to take out equity, either by refinancing at higher proceeds or by selling the underlying property. For example, CPRs slowed to midsingle digits as property values, measured by Moody s multifamily CPPI index, plunged by 39% from peak to trough (early 2008 to late 2009). In addition, financing became difficult, especially with conduit CMBS lending totally disappearing in the aftermath of the credit crisis, impeding refinancing. However, since early 2010, property values have been increasing; multifamily prices are up almost 51% from their low point in November 2009 (Exhibit 6). Concurrently CRE financing also rebounded, mostly due to robust issuance from Agency CMBS lenders (HUD/Ginnie Mae, Fannie Mae, Freddie Mac) and life insurance companies. In addition, the conduit CMBS issuance is also firming up in the past two years, giving project loan borrowers more financing alternatives, which leads to higher prepayment activity. Another incentive for prepayment arises from lower project loan rates, which enable borrowers to reduce their debt service payments by refinancing. With interest rates dropping to record levels in 2012 (also shown in Exhibit 6), borrowers are taking advantage of the low rates and refinancing into sub-4% coupon mortgages. On the flip side, we note that prepayment penalties are imposed to deter early prepayments in project loans. However, the burden of penalties is usually lessened since they are considered interest expense for tax purposes. In addition, if the borrower refinances into another HUD loan without any cash take-out, the prepayment penalty due from the prior loan can be rolled over into the new loan amount. Agency CMBS Market Primer 10

11 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan February 2013 Exhibit 6: CPR versus multifamily prices and project loan rates 35% 30% 25% 20% 15% 10% 5% 0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% CPR Multifamily Price Index GN PLC Rate Source: Credit Suisse, Ginnie Mae, HUD, Moody s During the full calendar year 2012, a total of 1,147 project loans, with $8.2 billion balance, paid off. This represented 22% of all prepayment eligible (i.e., not in lockout) loans out of the $37 billion GNR universe. As a comparison, only 4.6% of prepay eligible loans paid off during By property type and section, multifamily new construction pools (Section 221d4) had the highest prepayment rate with 49% of all prepayment eligible loans paying off in 2012 followed by healthcare loans (Section 232) at 29%. Refi pools (Section 223a7 and 223f) have much a lower prepayment rate at 14% for multifamily and 23% for healthcare. Across the 2001 to 2009 vintages, about 32% of prepay eligible pools paid off during the last year, followed by the 2010 and 2011 vintage pools at 14% and 5%, respectively. We note that the voluntary prepayment speed (i.e., CPR) calculation for project loans at the vintage/remic level is complicated, because each vintage/deal contains a myriad of call protection types such as 2/8s, 1/9s, 5/5s and so on. Exhibit 7 illustrates how the call protection types evolved over the years for GNR deals. Therefore, calculated CPRs for initial years would be solely based on the few project loans that are not in lockout, and these CPRs would be hard to interpret given the small sample set. Instead, we show the vintage level voluntary prepayment rates for each year after the underlying project loans exit their lockout periods. In earlier GNR vintages (2001 to 2004), we note that loans generally prepaid at levels higher than, or consistent with, a flat 15% CPR assumption. For recent vintages (i.e., post-2005), CPRs were in the single-digits after the lockout period expired and then they increased to double-digit levels at, or after, the third year (Exhibit 8). Agency CMBS Market Primer 11

12 Exhibit 7: Project loan call protection provisions changed materially over the last decade 3-4yr 8% 5yr 1% No lockout 3% 1yr Lockout 9% 3-4yr 4% 2yr Lockout 27% 5yr 6% Other 2% No lockout 7% Other 14% No lockout 3% 2yr 0% 1yr 0% 3-4yr 10% 2010 Vintage 2yr Lockout 79% 2007 Vintage 1yr Lockout 54% 2003 Vintage 5yr Lockout 73% Source: Credit Suisse, Ginnie Mae Exhibit 8: Project loan voluntary prepayments after lockout Year Since End of Lockout Period Vintage 2001 Vintage 2002 Vintage 2003 Vintage 2004 Vintage 2005 Vintage 2006 Vintage 2007 Vintage 2008 Vintage 2009 Vintage 2010 Vintages % 34.0% 16.1% 9.3% 8.3% 6.6% 0.9% 6.7% 7.1% 6.5% 12.8% % 20.5% 12.5% 15.3% 10.1% 6.5% 5.6% 6.8% 6.7% 11.0% % 13.3% 17.7% 18.6% 7.4% 7.8% 10.4% 15.2% 13.2% % 24.4% 29.0% 15.1% 12.1% 13.9% 15.4% 18.2% % 37.4% 29.9% 15.3% 10.9% 36.9% 26.4% % 19.8% 13.1% 12.8% 33.4% 25.4% % 10.1% 0.0% 12.6% 19.9% Source: Credit Suisse, HUD, Ginnie Mae Agency CMBS Market Primer 12

13 Default Analysis Project loan defaults are generally driven by soft property market fundamentals (i.e., rising vacancies, declining property values), similar to other multifamily loans. Although timely and full principal is guaranteed to GNR bondholders upon default, this is a form of involuntary prepayment in which IO bondholders do not receive any prepayment penalty and premium-priced bond holders are paid back at par. Therefore, it is important to understand how project loan defaults are defined/labeled before we present the statistics on actual default experience for GNR project loans. There are three workout strategies for defaulted project loans: assignment, modification and override. Project Loan Default Types Assignment is the traditional liquidation procedure in which a servicer assigns a defaulted project loan to HUD for execution of a claim, foreclosure and liquidation. At the assignment date, GNR REMIC investors receive full principal payment. Modifications and overrides are alternative workout remedies, also applicable to delinquent loans. In both cases, an assignment is bypassed; therefore, a claim is avoided against the HUD insurance fund mitigating losses, but the Ginnie Mae pool is paid off in full without any penalties collected. The underlying FHA loan is re-securitized with a different Ginnie Mae pool number. Historically for modifications, borrowers used to negotiate with the servicer for a lower rate and/or a less restrictive call protection provision. HUD would subsequently approve these modifications even though it was not involved with the negotiations. For overrides, borrowers negotiated directly with HUD to void the call protection provision. These resolution strategies came under the spotlight in mid-2000s amid allegations of contrived defaults. In these defaults, a borrower and a servicer conspire to circumvent the prepayment provision, mostly by arguing there has been deterioration in the property s financial viability, and then refinancing into a new project loan without any penalties collected on the former. The controversy dissipated in the latter half of the past decade as incidents of modifications and overrides declined. Modifications still occur for GNR pools, mostly in the form of Partial Payment of Claims (PPC), however, there is more confidence in the marketplace that defaults are not contrived. Unlike those mid-2000 modifications, HUD now actively participates in these negotiations and requires thorough underwriting as well as equity contributions from the borrowers. 10 On multifamily, borrowers must agree that in exchange for PPC, some portion of the units will be reserved for affordable housing even for market rate multifamily rental properties. We reiterate that from the investor s perspective, both modifications and overrides have the same impact as a traditional default (i.e., assignment) and no prepayment penalties are collected. As mentioned above, this distinction is especially critical for IO investors, who are usually entitled to receive prepayment penalties. Our default rate calculations include modifications and overrides. 10 A Partial Payment of Claims (PPC) effectively results in payoff of the Ginnie Mae pool without collection of any prepayment penalty. A new recast first mortgage note is issued as a new Ginnie Mae pool (typically around 50% of outstanding balance), and the second mortgage is held by HUD with the right to sell it. Agency CMBS Market Primer 13

14 February 2013 Historical GNR REMIC defaults and delinquencies Project loan defaults have been relatively subdued since the mid-2000s. This performance is quite remarkable considering that delinquencies for private label multifamily CMBS loans, multifamily and construction loans in bank portfolios increased significantly in Exhibit 9: Project loan CDRs the aftermath of the credit crisis. However, GNR annual default rates, measured by 4.0% the constant default rate (CDR), remained 3.5% below 1.5% for the past seven years CDR 3.0% (Exhibit 9 ). In 2012, only 34 project loans, with an outstanding balance of $481 million, defaulted (including both assignments and modifications/overrides), equivalent to only 1.0% of the outstanding universe at the beginning of the year. The current 60+day delinquency rate stands at 0.5%. As a comparison, 5.0% of the private label multifamily CMBS universe liquidated last year with 13.6% of the outstanding balance still being 60+days delinquent. PLD curve vs. realized CDRs 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Source: Credit Suisse, Ginnie Mae, HUD Actual defaults (including modifications and overrides) for GNR REMIC project loans have been also well below those estimated by the PLD curve, with the exception of the 2001 to 2003 vintages as shown in Exhibits 10 and 11. As discussed in the previous section, the early vintages defaults were mainly driven by modifications and overrides done in the mid- 2000s. For post-2004 vintages, realized default activity is only slightly above half of what the PLD curve implies. Even for the 2007 vintage, which is viewed as the worst-performing issue year in recent history, cumulative defaults total 5.7% of the original balance so far, implying a default rate about 65% of the PLD rate. This vintage is supposed to have the weakest performance, as the loans were originated when property values were, in general, at peak levels. Exhibit 10: Actual defaults: Vintages 2001 to 2003 Exhibit 11: Actual defaults: Vintages 2004 to % 6% Modifications/Overrides Assignments 7% 6% Modifications/Overrides Assignments 5% PLD 5% PLD 4% 4% 3% 3% 2% 2% 1% 1% 0% Year since securitization 0% Year since securitization Source: Credit Suisse, Ginnie Mae, HUD Source: Credit Suisse, Ginnie Mae, HUD Agency CMBS Market Primer 14

15 Project loan default rates also differ by the underlying program. In general, refinanced project loans (under Section 223a7 or Section 223f) have lower default rates compared to newly completed and/or construction project loans (under Section 221d4 or Section 232) as shown in Exhibit 12. By property type, multifamily project loans have generally higher default rates compared to healthcare loans (Exhibit 13). Exhibit 12: Project Loan Defaults by Section 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% New Construction Loans Sec 2214d (MF) and Sec 232 (HC) Modifications/Overrides Assignments PLD Refi Project Loans Sec 223a7 & 223f (MF) and Sec 232/223a7 & 232/223f (HC) 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% Modifications/Overrides Assignments PLD 0.0% Year since securitization 0.0% Year since securitization Based on project loans in vintage 2004 to 2009 GNRs Source: Credit Suisse, Ginnie Mae, HUD Based on project loans in vintage 2004 to 2009 GNRs Source: Credit Suisse, Ginnie Mae, HUD Exhibit 13: Project Loan Defaults by Property Type Multifamily Loans Sec 2214d and Sec 223a7 & 223f Healthcare Loans Sec 232 and Sec 232/223a7 & 232/223f 4.0% 3.5% 3.0% Modifications/Overrides Assignments PLD 4.0% 3.5% 3.0% Modifications/Overrides Assignments PLD 2.5% 2.5% 2.0% 2.0% 1.5% 1.5% 1.0% 1.0% 0.5% 0.5% 0.0% Year since securitization 0.0% Year since securitization Based on project loans in vintage 2004 to 2009 GNRs Source: Credit Suisse, Ginnie Mae, HUD Based on project loans in vintage 2004 to 2009 GNRs Source: Credit Suisse, Ginnie Mae, HUD Agency CMBS Market Primer 15

16 Fannie Mae Multifamily DUS MBS DUS MBS pools are Fannie Mae-guaranteed pass-through MBS backed by one or more multifamily loans. The loans are originated by the Fannie Mae licensed lenders under the DUS (Delegated Underwriting and Servicing) program according to the origination and servicing guidelines set by Fannie Mae. The DUS program started in Fannie Mae exclusively bought all DUS loans and held them, in its portfolio, during the initial years. In 1994, Fannie Mae began securitizing DUS loans by creating DUS MBS for investors. Over the years, annual DUS MBS issuance volumes varied depending on the level of Fannie Mae s preference to hold loans in its portfolio. After being placed in FHFA conservatorship in September 2008, Fannie Mae DUS MBS issuance rose significantly, as shown in Exhibit 14, with annual issuance over $30 billion in each of the last two years. Outstanding volume of DUS MBS is $110 billion. 11 Exhibit 14: DUS MBS Issuance Exhibit 15: $110 billion outstanding $bn DUS REMIC (FNA) $26bn $13bn DUS Mega $72bn Source: Credit Suisse, Fannie Mae Source: Credit Suisse, Fannie Mae DUS MBS (Single Pool) Investors can trade DUS MBS either as standalone pass-through MBS certificates or invest through diversified multiple-pool deal structures such as the DUS REMICs (FNAs) or Fannie Megas 12. We estimate that $39 billion of the $110 billion of outstanding DUS MBS have been pooled under DUS REMICs and Multifamily Megas (Exhibit 15). DUS REMIC issuance more than doubled in 2012 with 18 deals priced at over $13 billion versus only 9 deals, totaling about $5 billion, securitized in the prior year. Loss sharing with DUS lenders Fannie Mae s multifamily business model is different from that of HUD/Ginnie Mae and Freddie Mac as it entirely delegates the responsibility for underwriting and servicing loans to its lenders. Therefore, DUS lenders close and sell Fannie Maeguaranteed loans without a prior Fannie Mae review. However, the loss-sharing agreements with lenders help to align the interests of each side. Each lender has its own loss-sharing arrangement with Fannie Mae. A typical example would be the lender bearing one-third of the losses and Fannie Mae incurring the remaining two-thirds. In addition, the lender may be required to bear the entire loss, upon default, if Fannie Mae determines there was a breach of lender representations or warranties. 11 We note that DUS MBS can be created from new loan production as well as from seasoned loans Fannie Mae holds in its portfolio. For example, in 2011, $24 billion of the $31 billion DUS MBS issued came from new loan production and the remainder from seasoned loans in Fannie Mae s portfolio. However in 2012, nearly all DUS MBS securities were backed by new loan production including the refinanced loans. 12 Another Fannie Mae structure called Multifamily Assured Schedule Payment Trust (MASTs) has not been issued since Agency CMBS Market Primer 16

17 DUS lenders are required to follow the credit and underwriting criteria set by Fannie Mae. Lenders are also subject to quarterly and/or annual credit reviews. Exhibit 16 shows the list of 25 approved lenders carrying a DUS license. We note that more than half of the DUS originators (14 out of 25) are also part of Freddie Mac s Program Plus Seller Servicers network, which we discuss in the next section. Collateral characteristics Underlying collateral for a DUS MBS pool is often a single multifamily loan underwritten by DUS lenders. Only 2% of pools were collateralized by multiple loans in recent years. DUS loans provide financing for existing or newly constructed 5+ unit income-producing, multifamily properties. The wide range of eligible property types includes standard conventional multifamily apartments, affordable multifamily housing, seniors housing, student housing, military housing, rural rent housing, manufactured housing communities and cooperatives. DUS MBS pools are distinguished by their terms and call protection. The most prevalent loan structure, 10/9.5 DUS MBS, is a 10-year balloon loan with a 30-year amortization schedule, and prepayments are typically subject to a yield maintenance (YM) charge for a period of 9.5 years, followed by a six-month open prepayment period. Other popular loan types are 7/6.5 and 5/4.5 DUS MBS. Maturities for DUS MBS loans can be as long as 30 years. The majority of underlying loans have fixed-rate coupons. A three-tier credit structure, Tier 2 to Tier 4, is used for underwriting (there is no Tier 1). More favorable rates are granted to borrowers of Tier 4 loans. For Tier 2, the maximum allowed LTV is 80% and the minimum DSCR is 1.25x, compared to a maximum LTV of 55% and minimum DSCR of 1.55x for Tier 4. Exhibit 17 summarizes new issue loan statistics in 2012, by tier, for the 10/9.5 DUS MBS backed by multifamily properties. The underwriting standards are more stringent for other property types. Exhibit 17: Multifamily DUS MBS underwriting Underwriting Criteria 10/9.5 DUS MBS (new issue loans in 2012) Rating Minimum DSCR Maximum LTV Ratio Rating Wavg. DSCR Wavg. LTV Ratio Wavg. Note Rate Pct of 10/9.5 Issuance Tier x 80% Tier x 72% 3.92% 66% Tier x 65% Tier x 63% 3.85% 19% Tier x 55% Tier x 49% 3.48% 14% All Tiers 1.86x 67% 3.84% 100% Source: Credit Suisse, Fannie Mae Fannie Mae guarantee Exhibit 16: Fannie Mae DUS Lenders Alliant Capital AmeriSphere Multifamily Arbor Commercial Funding Beech Street Capital HomeStreet Capital Corp. There is no explicit US government guarantee for Fannie Mae DUS MBS pools. Fannie Mae bears the full responsibility for making payments under its guarantee, which is for the timely payment of principal and interest for DUS MBS, and the full payment of principal in the event of a default. 13 HSBC JP Morgan Chase KeyCorp Real Estate Capital Berkadia Commercial Mortgage M&T Realty Capital Corporation Berkeley Point Capital CBRE Capital Markets Centerline Mortgage Capital Citibank CWCapital Dougherty Mortgage Grandbridge Real Estate Greystone Servicing Corp. Oak Grove Capital Pillar Multifamily PNC Bank Prudential Mortgage Capital Red Mortgage Capital Walker & Dunlop Wells Fargo Note: DUS lenders, which are also part of Freddie Mac Program Plus Seller Servicers network, are highlighted in color. Source: Credit Suisse, Fannie Mae 13 However, Fannie Mae and Freddie Mac always had a "line of credit" with the U.S. Treasury which was viewed as an implicit guarantee in the marketplace. And since September 2008, the U.S. Treasury placed Fannie Mae and Freddie Mac into conservatorship run by the newly established Federal Housing Finance Agency (FHFA). Agency CMBS Market Primer 17

18 Class X 21 February 2013 Fannie Mae does not guarantee the yield maintenance payment associated with prepayments. This implies DUS MBS bondholders will only receive yield maintenance (YM) charges that are paid by the borrowers. Since the DUS lender produces the pay-off letter, it would include the YM payment as part of the pay-off, otherwise, the existing lender will not execute the release of the mortgage. We note that if the YM is not passed through, it is likely because a loan has defaulted. For DUS REMIC bonds, Fannie Mae guarantees the required payments of principal and interest on the certificates in a timely manner including the balloon payment. Unlike private label CMBS, there is no extension risk for DUS REMIC bondholders. Call protection Yield Maintenance (YM) is the most popular call feature for DUS MBS in which the borrower is permitted to prepay the loan if a yield maintenance fee (penalty) is paid. By construct, the YM fee increases when interest rates decline, deterring the borrowers from prepaying the loans, therefore mitigating negative convexity of DUS MBS. Investors may receive part of the YM fee, according to the formula specified in the prospectus, to the extent that collected premiums remain after Fannie Mae has deducted its full portion. As noted in the previous section, YM fees are not guaranteed by Fannie Mae. 14 DUS MBS loans may also have other types of call protections, though these are infrequent: Defeasance: Under this provision, the borrower is permitted to prepay the loan by exchanging Fannie Mae or US Treasury strips/securities, which would create a cash flow stream matching all the future unpaid mortgage payments for the loan. Prepayment Fee: This option is similar to Ginnie Mae project loan prepayment penalties, in which penalties are a percentage of the outstanding balance, and decline each year, such as 5%, 4%, 3%, 2%, 1%. Lockout: Prepayments are prohibited, except for the payments resulting from casualty or condemnation. Deal Structures: FNA DUS REMICs DUS REMICs, also called Fannie Mae ACES (Alternative Credit Enhancement Securities) with FNA pneumonic on Bloomberg, enable investors to invest in multiple-pool DUS MBS to gain the benefits of diversification and improved liquidity. In contrast to the homogenous pass-through deal structure of a DUS Mega discussed below, a DUS REMIC typically consists of sequential-pay classes (often with par coupon pricing) and an IO class. Exhibit 18: Sample DUS REMIC Sequential Pay Classes Class A1 Avg. Life 5yr Class A2 Class AB1 Interest Only We show a generic FNA deal in Exhibit 21. Classes AB1 and AB2 absorb any excess principal payments, on a predetermined formula, in order to provide stable cash Source: Credit Suisse flows and targeted weighted average lives for classes A1 and A2. Any unscheduled principal payments are allocated to Classes AB1, AB2, A1 and A2, in that order, until retired. 10yr 5yr Class AB2 10yr 14 When the loan exits the yield maintenance period, the borrower is still required to pay 1% of the prepaid balance to Fannie Mae (DUS investors do not receive this fee) unless the loan is maturing in the next three months. Agency CMBS Market Primer 18

19 Upon voluntary prepayment, the IO class usually receives 70% of the YM penalty, and the current pay bond receives the remaining 30%. As stated in the previous section, all DUS REMIC bonds are guaranteed to be paid off by the final maturity date as specified in the prospectus, implying no extension risk for investors. We also note that some of the recent deals include two collateral groups composed of seasoned and recently originated loans. In such deals, cash flows from each collateral group back separate sequential classes and related IO tranches. We show the list of FNA transactions since 2009 in Exhibit 19. FNA issuance began in the early 1990 s and the outstanding volume is $26 billion 15. Issuance peaked in 2012 with 18 deals totaling $13 billion. The average deal size was approximately $745 million last year, consisting of 107 DUS MBS pools per deal. The top ten pools made up 41% of the deal s balance, on average. The underlying pools in REMICs were predominantly standard multifamily (86%), followed by manufactured housing communities (5%) and cooperative loans (3%). Loan sizes varied from less than $500K to $175 million and the average loan size was about $7 million. Fannie Mae GeMS, or Fannie Mae Guaranteed Multifamily Structures, is Fannie Mae s main execution platform for securitizing the DUS MBS pools into DUS REMICs and Megas. 16 In a GeMS deal, underlying DUS MBS collateral is selected by Fannie Mae s Multifamily Capital Markets group, not by a dealer. After the debut of the program two years ago, 18 of the 27 FNAs (issued in 2011 and 2012) were GeMS deals as shown in Exhibit 19. We note that there is no structural difference between a GeMS FNA versus traditional FNA transaction, aside from the party aggregating the DUS MBS collateral. 15 As of December Syndicated DUS Megas are also offered under the GeMS program. Agency CMBS Market Primer 19