The Wonder Years: Freddie Mac’s K Series Turns 11

Andrew Foster is Associate Vice President in MBA’s Commercial/Multifamily Group. He is a former Analyst with S&P Global Ratings and Fitch Ratings as well as a regular contributor to MBA NewsLink and MBA Commercial/Multifamily NewsLink. Foster can be reached at afoster@mba.org or 202/557-2740.

Every once in a while, a new technology, an old problem, and a big idea turn into an innovation. – Dean Kamen.

Freddie Mac recently priced a new offering, FREMF 2020-K119 Multifamily Mortgage Pass-Through Certificates and Freddie Mac Structured Pass-Through Certificates, Series K-119. The K series is a securitization program developed to help with the mission of providing liquidity, stability and affordability to the U.S. housing market via multifamily housing. This new offering marks well over 100 10-year fixed product securitizations and $370 billion in bond issuance volume since the program launched in 2009. Mortgage loans are purchased from an approved seller/servicer network of just under 30 companies.

Here are the top 2019 Freddie Mac Lenders.   

There has been much written about the need for reform of the GSEs. In fact, the last few weeks have been dominated by coverage of the release of FHFA Multifamily Caps and FHFA Capital Rule. However, Freddie Mac’s K series quietly holds a place as an important, innovative multifamily market solution that has served borrowers, lenders, tenants and bondholders extremely well since its inception. Importantly for a government-sponsored entity, it also serves as a mechanism to transfer risk away from taxpayers.

Golden Age for Multifamily Landlords and Lenders

Freddie Mac’s multifamily total book of business of $358 billion comprises $281 billion of multifamily guarantees, $33 billion of non-securitized loans, $5 billion of multifamily mortgage-related securities, nearly $3 billion of other investments and over $36 billion of additional market support (primarily unguaranteed securities) according to the company’s website. As of June 30, 2020, there has been approximately $372 billion of K-Deal issuance since the start of the program.

The program’s creation and success has coincided with increased investor interest and growth in the multifamily asset class more broadly. As much as it has benefited from this market backdrop, it is hard to completely exclude the K series program as a contributing factor to the increased investor interest. It unquestionably created new vehicles and expanded entry points to buy, sell and trade multifamily credit risk. 

K Street: Securitization and the K Series

Freddie Mac’s K-Deal program securitizes mortgages for apartment/multifamily communities, many of which are associated with affordable rental properties. Freddie Mac utilizes the following process for the execution of K-Deal securitizations.

1. A multifamily mortgage loan is sold to a third-party investor, who then places that loan in a third-party trust.
2. The third-party trust issues private-label securities based on that loan. The securities are either Freddie Mac-guaranteed senior bonds or subordinate bonds with no guarantee.
3. The unguaranteed subordinate and mezzanine bonds are offered for sale to third-party investors.
4. Freddie Mac buys the guaranteed bonds and securitizes them through a Freddie Mac trust.
5. Freddie Mac publicly offers pass-through certificates backed by the guaranteed bonds – known as K-Certificates – to investors.

The innovation of K deals makes them an important development in the history of CMBS. The K series takes the securitization concept which had previously been applied in private-label CMBS context to Freddie Mac’s guarantee program. The creation of the K series involved the opportunity for creators to benefit from understanding how the private-label product had developed and performed over more than a decade. While the new product and process borrowed the securitization concept, the fee structures, the servicing processes and the centralized feature of having a loan guarantor in place are each very different than private-label CMBS.

The popularity of the initial 10 year fixed-rate program created the conditions for Freddie Mac to create numerous other offerings to meet various needs of borrowers and investors. These include five, seven and fifteen-year floating rate, single sponsor, senior housing, value add and green as examples. All in all, there have been approximately 350 securitizations including various products.

Given the growth and scale of lending via the K series program, it clearly fits into the CMBS asset class’s future as well. As the CMBS industry continues to evolve with new features and structures, future innovators will have the opportunity to benefit from understanding both private-label CMBS as well as K deals’ strengths and weaknesses over time. To date, the K series brought numerous features to securitization including an innovative servicing fee structure that compensates for surveillance duties, servicing standard that benefits from ability of one actor to establish rules of the game and strong underwriting track record.

As an example of the underwriting feature, DBRS released a 2017 commentary comparing the performance of multifamily loans in Freddie Mac and traditional multi-borrower conduit CMBS transactions supporting that K-Series multifamily loans should be treated differently from conduit multifamily loans, given the substantial differences in cash flow performance and issuance debt yield.

“The delinquency rate for K-Series loans has remained lower than 0.1% since 2011 while that of peer CMBS 2.0/3.0 multifamily loans has remained at around 1.0% during the same period,” the DBRS report said. “DBRS observes stronger cash flow growth and lower cash flow volatility in the K-Series multifamily loans between 2011 and 2016 and believes that it contributes to the lower delinquency rate. Moreover, empirical data also shows that K-Series multifamily loans were issued with lower debt yields in a consistent way, which indicates higher-quality properties, sponsors and markets present.”

Multifamily Resilience Continued

While the K series program is now 11 years old, private-label CMBS, which turned 25 last year, showed during the Great Financial Crisis that the durability and soundness of bond structures containing commercial mortgage collateral are truly understood and tested when loans perform poorly. As of September 2020, performance remains strong for over 19,000 loans outstanding with 99.95% of K deal loans current (not including REO). Freddie Mac reports 15 loans in special servicing, two REO loans and less than $20 million in total program losses.

Impacts from COVID began for borrowers and lenders in March. Freddie Mac reported the following in October: “We found that master servicers reported 1,215 forborne securitized loans, or 4.8% of our total securitized loan population. This equates to about $7.6 billion of outstanding unpaid principal balance (UPB) and represents 2.4% of our total securitized UPB.”

Even amidst incredibly impressive performance, the jury should remain out on how the conduit-like structure of the K series will perform in a downturn where multifamily performance suffers even with strong underwriting to mitigate downside risk.

“It is expected that Freddie Mac K-deal performance will continue to outperform multifamily in private label CMBS,” said Roy Chun, Managing Director of Kroll Bond Rating Agency and former Freddie Mac Senior Director of Asset Management and Surveillance. “However, performance of multifamily loans will face pressure from various eviction or foreclosure moratoriums enacted by state legislatures and national agencies owing to the pandemic, and expiration of additional unemployment benefits under the CARES Act. The extent of these factors still needs to play out.”

What can be said with certainty already is this:

While the private-label market currently faces challenges with loan performance and special servicing today, the innovation of the K series product applying conduit principals to government-backed product and its success to date demonstrates the continued relevance of the bond market to both multifamily and commercial finance. How the rules for K Series will be viewed and the special servicing process for distressed loans will be handled remains to be seen. When the multifamily market does face challenges, whenever and whatever that looks like for the K series program, the private-label market will have the opportunity to learn from what works and what does not. This benefit of seeing what works and what does not is something that the pioneers of the K series product and its servicing infrastructure took full advantage of with private-label challenges top of mind when the program began.  

Freddie Mac’s programs are only one execution option of many for borrowers. A trade association representing all sources of capital as well as intermediaries takes no sides as to which is better or worse. The fact is that a level playing field with many robust, stable sources of capital benefits the mortgage industry and its borrower customers the most. That said, it is important for CREF market participants to understand and appreciate the bond market and all its various solutions for distributing commercial and multifamily credit risk.

As private-label CMBS slowly works through the pandemic impacts and post-Global Financial Crisis specially serviced assets that have transferred since March, market participants are well served by considering some of the examples and lessons from Freddie Mac’s conduit program even while acknowledging it may still be growing up.

More details about the multifamily operation can be found in this Fitch servicer report: https://mf.freddiemac.com/docs/fitch_ratings_report_master_and_special_servicer.pdf

Spotlight on MBA CREF Education

Want to learn more about the GSE’s role in the multifamily market? Register here for complimentary December 17th offering, Small Balance Lending in Today’s Market moderated by MBA Associate Vice President for Commercial/Multifamily Sharon Walker.