Now that it has the green light to expand its role in multifamily housing, Freddie Mac is looking at more ways to shift the credit risk on apartment building mortgages that it insures.

The rental market is red hot, and rents are rising, stoking demand for the kind of affordable housing that Freddie and rival Fannie Mae support. Until 2009, the two government-sponsored enterprises kept most of these multifamily loans on their books. When they were put into conservatorship, this put taxpayers on the hook for any losses.

Freddie now transfers about 90% of the credit risk in multifamily mortgages to investors through K-Deals, which look a lot like private-label commercial mortgage bonds. It assembles diversified pools of loans backing apartment buildings and uses them as collateral for deals with two classes of bonds: guaranteed senior bonds and unguaranteed bonds known as subordinate and mezzanine bonds. Together, these two subordinate tranches offload the risk of the first 15% of losses on the mortgage pool.

Over $140 billion of K-Deals have been issued to date.

The new program, called Structured Credit Risk, targets loans issued by state and local housing authorities, which aren't eligible to be used as collateral for K-deals. These loans already serve as collateral for bonds issued by housing authorities and guaranteed by Freddie.

Instead, Freddie modelled SCR on one of one of its programs for transferring credit risk on single-family mortgages, known as Structured Agency Credit Risk, or STACR, notes. Both STACR and SCR are general obligations of Freddie Mac, but their performance is linked to interest and principal payments on a reference pool of mortgages.

In this initial offering, dubbed SCR Notes Series 2016-MDN1, Freddie Mac sold $52 million of class B notes transferring the risk of the first 5% of losses on a reference pool of more than 50 multifamily mortgage loans originated between 2007 and 2015 with an approximate unpaid principal balance of $1.04 billion.

The notes have a legal, final maturity of 15 years, but can be called after 10 years. "We expect that, similar to all of our multifamily programs, it will perform very well, from a credit perspective," said Victor Pa, Freddie's vice president of multifamily investments. "In 10 years, we hope that we won’t need credit protection."

The entire tranche was sold to a single investor, Systima Capital Management. That’s typical for K-Deals, according to Pa. In the future, Freddie may sell a larger mezzanine tranche that might be syndicated among several investors, he said.

The notes are unrated and pay a coupon of 13%. Freddie did not disclose pricing, however. Depending on whether Systima Capital paid more or less than the face value of the notes, their effective yield could be below or above 13%.

Freddie retains the senior loss credit risk on the Series 2016-MDN1.

Wells Fargo is the sole structuring agent, lead manager and sole bookrunner.

Freddie expects to have one or two SCR note offerings a year, and to expand the program over time. Future offerings could involve the sale of a mezzanine tranche, allowing it to offload the risk of even more losses on the mortgages.

The GSE provides guarantees for $1 billion to $2 billion of state and local housing tax exempt bonds each year.

The new program comes as the Federal Housing Finance Agency, which regulates Fannie and Freddie, just lifted a lending cap on multifamily loans they can insure from $31 billion to $35 billion. Demand for rental housing is growing, and the FHFA is concerned that there won’t be enough financing available for new construction. There is also a need to refinance the large number of existing multifamily mortgages coming due this year.

The Mortgage Bankers Association estimates that borrowers will need to take out or refinance $260 billion of multifamily loans this year.

Fannie and Freddie's combined share of total multifamily originations has fallen consistently since 2009, when they financed approximately 70% of all loans, according to the Urban Institute. The decline comes as rents are rising quickly across the nation due to historically low vacancy rates. Higher rental demand among millennials and former homeowners is expected to further increase the cost of renting in coming years.

Fannie has a very different approach for offloading credit risk on multifamily mortgages; it generally acquires these loans from designated lenders who retain one third of the underlying credit risk and must post collateral to secure their obligations. Typically, the lenders deliver a loan to Fannie in exchange for notes backed exclusively by that loan and guaranteed by Fannie.

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