Apartment Finance Today

MORTGAGE LENDING

FREDDIE MAC

Lower Spreads, Higher Barriers

APARTMENT FINANCE TODAY • July/August 2008

Freddie Mac's acq-rehab products boom while it preps capital markets program.

BY JERRY ASCIERTO

Freddie Mac is lowering its pricing on long-term deals even as its credit standards grow more conservative.

Freddie Mac lender spreads, which reached a high of 250 basis points over the 10-year Treasury in March, began to creep down about five basis points a week beginning in early April and through early June.

For a typical 10-year deal, Freddie Mac was quoting about 210 basis points over the yield on the 10-year Treasury in early June. The 10-year Treasury rate was 3.97 percent June 2, making the all-in rate around 6 percent.

As its pricing on long-term deals goes down, its credit standards are going up. In the spring, rival Fannie Mae moved to a standard 1.25x debtservice coverage ratio (DSCR) and 1.20x in strong markets. Last year, Fannie Mae had lowered that threshold to a standard 1.20x and down to 1.15x in strong markets. Freddie Mac’s underwriting has followed this trend with the same upward movement in DSCRs in the early summer.

That movement is partly a reflection of reduced competition, as conduit lenders continue to wait on the sidelines. It’s also a reflection of concern about the economy.

“Property values may be moderating or potentially falling, so we’ve upped our credit standards slightly,” said Mike May, Freddie Mac’s senior vice president of multifamily sourcing. “For the right deal, the right sponsorship, and the right property, we’ll get a little bit more aggressive.”

Freddie Mac can afford to be choosy these days. The company has been processing so many loan requests since the meltdown of the commercial mortgage-backed securities (CMBS) market that it has the luxury of choosing only the best deals, industry watchers report. “Our volumes are more than double than what they were a year ago,” said May.

While it processes deals at a record pace, Freddie Mac is also working hard on developing its Capital Markets Execution (CME) program, which would bundle loans made by Program Plus lenders and sell them as CMBS.

The program is in the pilot stage, with a subset of five Freddie Mac lenders, including Capmark Finance and Holliday Fenoglio Fowler, originating loans for securitization later in the year. An underwriting guide was finished in March, and the pilot program began April 1. By June 1, about $100 million in multifamily loans had been originated through the pilot program. (For more on this program, see page 30.)

Rocking rehabs

As Freddie Mac gets more aggressive on 10-year deal pricing, the pricing of five-year loans has begun to creep up. That reflects the company’s desire to rebalance its portfolio toward longer-term deals.

Freddie Mac has been inundated with requests for shorter-term deals in the first half of 2008, mainly because the benchmark rate for five-year deals, the five-year Treasury note, has been very low, May said. Additionally, demand for Freddie Mac’s acquisitionrehabilitation and acquisition-upgrade products has added to the deluge of short-term loan requests.

The programs, rolled out in October 2007, have been very well received by the industry: Freddie Mac processed about $800 million in such deals in 2007, in the span of less than three months. According to Program Plus lenders, that pace has been sustained through the first half of 2008.

Part of that success is due to timing: The high cost of land is scuttling many new construction ventures, so more developers are concentrating on repositioning deals. Also, there’s a great deal of multifamily housing 10 years or older in need of some level of rehabilitation in many markets. And the leverage and terms that the products offer are too good for many developers to pass up.

The acquisition-rehabilitation product is aimed at substantial rehabs of up to $30,000 per unit and features a loan-to-value (LTV) ratio of 86 percent and a DSCR of 1.15x (down to 1.10x for the interest-only portion of the loan). The acquisition-upgrade product, aimed at more cosmetic rehabs of up to $10,000 per unit, features an LTV of up to 86 percent, and a DSCR of 1.20x (down to 1.15x for the interest-only period).

Beyond the favorable underwriting and terms, acquisition-rehab and acquisition-upgrade loans can be processed quickly and creatively.

Grandbridge Real Estate Capital recently funded a $96.7 million fourproperty portfolio acquisition through the acquisition-upgrade program. The buyer, New Dawn Cos., needed to close one of the four loans very quickly, and Grandbridge was able to process that $45 million loan in just two days.

“From the time they decided they wanted to lock the rate, we went from that standpoint to close in 48 hours, which is faster than we’ve ever done it,” said Al Rex, a senior vice president with Grandbridge.

That loan, for the Lexington Apartments in Nashville, Tenn., sold by Harbor Group International, featured a fixed-rate seven-year term with three years of interest-only, and a 30-year amortization.

The other three loans, for apartment communities in Raleigh, N.C., being sold by Equity Residential, weren’t facing such a tight timeframe. But New Dawn Cos. wanted some adjustable-rate mortgage (ARM) features on those three remaining loans. The only problem was that Freddie Mac’s acquisition-upgrade program was not specifically tailored for an adjustable-rate execution. So Grandbridge worked with Freddie Mac to merge elements of its ARM program with the acquisition-upgrade product.

“We were able to structure in some good prepayment flexibility and mix fixed- and floating-rate deals in the same pool,” said Rex.

Looking ahead

The outlook for the apartment sector over the second half of the year remains mixed. Sales transaction velocity has slowed this year. It’s down 46 percent through the end of April compared to the same period in 2007, according to Real Capital Analytics.

“There’s a real disconnect between buyers and sellers in terms of where they see value, so the market has slowed down,” said May. “We see the market contracting slightly.”

Even so, Freddie Mac and Fannie Mae are the last ones standing in a market where many other capital providers, such as life insurance companies and banks, have either decreased their lending activity or exited altogether, like CMBS lenders. The dollar volume of loans made by Fannie Mae and Freddie Mac lenders increased 62 percent in the first quarter over the same period in 2007, according to a recent Mortgage Bankers Association report.

Although some conduit lenders have begun ramping up their debt programs again, many expect the agencies to continue their recent dominance through the rest of 2008.

“When the conduits come back, they’re going to get inundated with office and retail and industrial properties, and their spreads are still going to be challenging to try and get competitive with the agency lenders,” said Phil Melton, a senior vice president with Grandbridge. “The agencies are still going to rule the multifamily side in the second half.”