In March 2022, the United States Federal Reserve (the “Federal Reserve”) began a series of aggressive rate hikes in an effort to tame an 8.5% year-over-year inflation rate1 that peaked at 9.1%, the highest rate in roughly 40 years.2 In just over one year, the Federal Reserve raised the federal funds rate by 500 basis points (“bps”), a historic campaign for its speed and magnitude.3 As a result, commercial real estate collateralized loan obligation (“CRE CLO”) issuance, which experienced a blockbuster 2021 and strong start to 2022, has slowed considerably.4 With less favorable market conditions and slowing originations, some issuers have sought alternatives to CRE CLOs. Two Freddie Mac (“Freddie”) offerings, Multifamily Participation Certificates (“Multi PCs”) and Q-Deals, represent potential avenues for CRE CLO issuers seeking an exit strategy for mortgage loans secured by multifamily properties. Following the increased issuance of Multi PCs, Multifamily Structured Credit Risk (“MSCR”) Notes, which reference Multi PCs (among other reference obligations), have seen a sharp rise in recent activity that may continue as Freddie utilizes this credit risk transfer (“CRT”) program with respect to its Multi PC platform. Further, with significantly tighter spreads than CRE CLO issuances5 and a lower weighted average cost of capital for issuers,6 issuers can continue to take advantage of Freddie’s Q-Deal program to securitize eligible loans.
I. Multi PCs/MSCR Notes Background
Multi PCs are single-tranche securities often representing a single mortgage loan. They are fully serviced by Freddie, supported by the agency’s guarantee and issued either simultaneously with, or soon after, the loan’s purchase.7 These securities are backed by several different categories of multifamily properties, including “standard multifamily housing, student housing, seniors housing, manufactured housing communities, cooperative housing and Targeted Affordable Housing”, each of which satisfies Freddie’s requirements that the housing contains five or more units and is designed primarily for residential use.8 Typically, Freddie requires DSCR/LTV of 1.25–1.40x/80% for first mortgage-only loans and 1.15x/85% for first mortgage and subordinate mortgage loans.9 Particularly attractive for investors, Multi PCs have a “high level of call protection”.10
Freddie’s MSCR Notes program is a vehicle of the agency’s CRT program, providing “unique Multifamily exposure” to private investors.11 MSCR Notes are unguaranteed securities based on a reference pool of Multi PCs, other fully guaranteed Multifamily certificates and credit enhancement on affordable multifamily-backed bonds issued by state and local housing finance agencies and issued with the intent to transfer mortgage default risk from US taxpayers to capital markets investors.12
In creating a Multi PC reference pool for an MSCR issuance, loans underlying the relevant Multi PCs are evaluated under the pool’s eligibility criteria that may exclude loans that are 30 days or more delinquent from the date of acquisition, are in forbearance, have a DSCR less than 1.25x for conventional loans (1.15x for Targeted Affordable Housing Loans) or have an LTV greater than 80% for conventional loans (90% for Targeted Affordable Housing loans).13
After designation of the reference pool, a third-party trust issues unguaranteed notes to investors and invests the sale proceeds into eligible investments. The trust makes principal and interest payments to investors, typically based on an uncapped 30-day SOFR Average floating-rate coupon, and receives monthly credit premiums from Freddie.14 In return, Freddie receives protection on “defined credit or modification events on the reference pool”.15 In the event these defined credit or modification events occur on the underlying mortgage loans, Freddie receives payments that would have gone to the noteholders. In order to “further align [its] interest with investors through the life of the offering”, Freddie retains the senior risk and first-loss piece as well as a minimum 5% vertical slice of each tranche.16 As discussed below, Multi PCs have seen a dramatic rise in issuance, and this increase has provided support for the continued growth of the MSCR Notes program.
II. Q-Deals Background
Q-Deals bear similarities to Freddie’s K-Deals but differ in that the loans held by the third-party trust were not underwritten by Freddie at origination and may not have been sold to Freddie before they were securitized.17 In the Q-Deal securitization process, after Freddie re-underwrites the loan collateral and grants credit approval, the lender sells multifamily mortgage loans to a third-party depositor, and the depositor places the loans in a third-party trust. Once purchased by the third-party trust, the trust issues securities backed by the loans. Freddie then purchases and guarantees senior amortizing bonds as well as interest-only bonds and re-securitizes them by issuing Structured Pass-Through Certificates (here, “Q-Certificates”).18 While alternative structures may be issued, Freddie typically provides two different deal structures for fixed Q-Deal offerings: a Senior/Subordinate structure and a Guaranteed structure. In the Senior/Subordinate structure, Freddie does not guarantee certain subordinate bonds, typically representing the bottom 15–25% of the pool,19 which are issued by the third-party trust and either retained or sold to private investors.20 In the Guaranteed structure, Freddie guarantees all bonds and enters into an agreement with the sponsor that the sponsor will reimburse Freddie for losses up to a negotiated portion of the deal.21
Freddie’s Q-Deal securitization program is highly selective. The agency focuses on affordable housing, strict underwriting and geographic diversity, and as many as two-thirds of all loan pools examined are excluded from the Q-Deal program.22 Freddie typically seeks a minimum pool size of $150 million in aggregate unpaid principal balance (“UPB”) and employs a REMIC structure.23 Furthermore, loans eligible for the Q-Deal program include taxable small balance loans, loans supported by properties with 9% Low-Income Housing Tax Credits or Land Use Restrictive Agreements and rehab loans for affordable properties.24 While issuers must pay Freddie a guarantee fee ranging from 65 to 90 bps,25 recent Q-Deal spreads have been far tighter than recent CRE CLOs with the latest Q-Deals pricing at 77 bps,26 87 bps27 and 93 bps28 over one-month SOFR. This stands in contrast to the Class A bonds in a recent CRE CLO pricing at 230 bps over SOFR.29 Finally, Q-Deals have been reported to have significantly lower securitization costs for issuing firms as compared to CRE CLOs.30 Q-Deals represent a lower-cost alternative to CRE CLOs with better pricing for issuers holding affordable housing loans that align with Freddie’s goals and guidelines.
III. Issuance Trends in the Freddie Multifamily Capital Markets
As issuers have shied away from CRE CLOs under current market conditions, Multi PCs and MSCR Notes have seen a sharp increase in issuance volume. While data does not yet show a concurrent increase in issuance for Q-Deals, their relatively low securitization costs and tighter spreads may begin to draw typical CRE CLO issuers to securitize under the Q-Deal program.
With a history stretching back to the 1980s, Multi PCs have performed strongly with 99.9% of loans by outstanding UPB current as of April 2023 and no loans experiencing realized losses.31 Since the program’s reinvention in 2014, Freddie has issued 1,647 Multi PCs through March 2023 with a combined issuance of $35.6 billion.32 Issuance has increased sharply in recent years with at least $29 billion in volume issued since 2019.33 Industry professionals have speculated that Freddie has increased Multi PC issuance to enhance borrower flexibility and reduce interest rate risk, a considerable advantage in light of the Federal Reserve’s recent activity.34
Introduced in 2016, Freddie enhanced the MSCR Notes program in 2021 in order to align the program more closely with other CRT offerings.35 Like Multi PCs, MSCR Notes have seen a meteoric rise in total issuance volume. MSCR Notes issued in 2016 and 2017 were generally just under $1 billion in cut-off date loan balance for each deal, while MSCR Notes issued in 2021 and 2022 were between $4 and 6 billion in cut-off date loan balance for each deal. This increase in deal size has been driven, in part, by a sharp increase in the number of loans included in each reference pool. In 2016 and 2017, MSCR Notes included between 48 and 69 loans in each pool as compared to over 200 loans per pool in most 2021 and 2022 issuances.36 While money managers make up a significant proportion of investors, hedge funds represent nearly half of investors in MSCR Notes by total UPB since inception.37
A relatively new program, Freddie began issuing Q-Deals in 2014 and, through April 2023, Freddie has completed 21 transactions for a total issuance of $7.60 billion.38 Similar to Freddie’s Multi PCs, Q-Deals have an exceptional track record with 99.9% of loans current as of April 2023 with no realized losses and no REO properties.39 While the number of Q-Deals closed each year has varied, five deals closed in 2022 alone.40 Additionally, the number of unique senior bond investors participating in Q-Deals has risen.41 Money managers and banks make up the greatest proportion of investors, but pension plans and insurance companies have emerged in recent years with greater participation.42
Despite current market trends in the CRE industry, including interest rate hikes and a corresponding decrease in originations, Multi PCs and MSCR Notes have seen elevated execution levels. Furthermore, as borrowers continue to seek prepayment flexibility in the current interest rate environment, there may be increasing interest in the Multi PC program. As market uncertainty continues, institutional CRE CLO issuers may seek securitization alternatives, including Freddie’s Q-Deal program, to tap capital markets. Finally, Freddie’s strong underwriting standards and guarantee provide assurances to issuers and investors that each product’s strong performance history will continue.
1Gwynn Guilford, U.S. Inflation Accelerated to 8.5% in March, Hitting Four-Decade High, WALL ST. J. (Apr. 12, 2022), https://www.wsj.com/articles/us-inflation-consumer-price-index-march-2022-11649725215.
2 Gabriel T. Rubin, U.S. Inflation Hits New Four-Decade High of 9.1%, WALL ST. J. (July 13, 2022), https://www.wsj.com/articles/us-inflation-june-2022-consumer-price-index-11657664129?mod=article_inline.
3 Taylor Tepper, Federal Funds Rate History 1990 to 2023, FORBES ADVISOR, https://www.forbes.com/advisor/investing/fed-funds-rate-history/ (last updated May 3, 2023).
4 CRE CLO Issuance in the First Quarter, GREEN STREET COM. MORTG. ALERT, Apr. 7, 2023, at 16 (reporting a 92.7% year-over-year drop in first quarter CRE CLO issuance from $15,268.8 million in Q1 2022 to $1,120.2 million in Q1 2023); see CMBS Limps Along While CRE CLOs Dry Up, GREEN STREET COM. MORTG. ALERT, Feb. 24, 2023, at 1, 7.
5 Crickets in New-Issue CMBS Market, GREEN STREET COM. MORTG. ALERT, Dec. 9, 2022, at 4 (noting the $315.8 million Arbor Realty Trust Q-Deal, ARBOR 2022-Q021, priced “at 93 bp over one-month SOFR at par, far tighter than” the Rialto Capital and FS Investments CRE CLO, FSRIA 2022-FL7, which priced at 310 bp over one-month SOFR); see NewPoint JV Taps Freddie Q Program, GREEN STREET COM. MORTG. ALERT, May 26, 2023, at 5 (reporting that the senior notes of the $198.6 million NewPoint JV Q-Deal, NWPT 2023-Q022, priced at 77 bp over one-month SOFR).
6 ACRE Closes $424M Freddie Mac ‘Q-Series’ Transaction, CITYBIZ (Nov. 8, 2022), https://www.citybiz.co/article/345375/acre-closes-424m-freddie-mac-q-series-transaction/.
7 FREDDIE MAC MULTIFAMILY, MULTI PC PROGRAM HANDOUT (2022), https://mf.freddiemac.com/docs/multi_pc_overview.pdf.
8 Multi PCs, FREDDIE MAC MULTIFAMILY, https://mf.freddiemac.com/investors/pcs (last visited May 22, 2023).
11 FREDDIE MAC MULTIFAMILY, MULTIFAMILY STRUCTURED CREDIT RISK PROGRAM OVERVIEW (MSCR NOTES) (2023), https://mf.freddiemac.com/docs/mscr_notes_investor_presentation.pdf.
12 Id. See also MSCR Notes, FREDDIE MAC MULTIFAMILY, https://mf.freddiemac.com/investors/structured-credit-risk (last visited May 22, 2023).
13 See, e.g., FREDDIE MAC MULTIFAMILY, PRELIMINARY TERM SHEET, SERIES 2022-MN4 (2022), https://mf.freddiemac.com/docs/MSCR_2022-MN4_term_sheet.pdf.
17 Q-Deals, FREDDIE MAC MULTIFAMILY, https://mf.freddiemac.com/investors/q-deals (last visited May 22, 2023).
19 FREDDIE MAC MULTIFAMILY, Q-DEAL PROGRAM OVERVIEW (2023), https://mf.freddiemac.com/docs/qdeal_investor_presentation.pdf.
25 Freddie Q Deals Provide CLO Issuers an Exit, supra note 22; see also ACRE Closes $424M Freddie Mac ‘Q-Series’ Transaction, supra note 6 (reporting a guarantee fee of approximately 98 bps on the A-Bond of a $424 million, November 2022 Q-Deal transaction).
29 Debt Databases – CRE CLO, GREEN STREET, https://my.greenstreet.com/data-analytics/debt-db/cre-clo-database/deal/20235033 (last visited May 22, 2023). [Greenstreet login required]
31 FREDDIE MAC MULTIFAMILY, MULTI PC PERFORMANCE DATA (2023), https://mf.freddiemac.com/docs/multi_pc_performance.pdf.
32 FREDDIE MAC MULTIFAMILY, MULTI PC PROGRAM OVERVIEW (2023), https://mf.freddiemac.com/docs/pc_investor_presentation.pdf.
38 FREDDIE MAC MULTIFAMILY, Q-DEAL PERFORMANCE DATA (2023), https://mf.freddiemac.com/docs/q_deal_performance.pdf.