Underwriting Underscores Strong Credit Culture
By SVP of Multifamily Underwriting & Credit Debby Jenkins
Sound underwriting is central to Freddie Mac Multifamily’s ability to support the nation’s rental housing market, while reducing risk to U.S. taxpayers and attracting private capital to the market. The Multifamily business underwrites every mortgage we fund. Each transaction is unique – we shape each mortgage loan to fit borrower, property, and market conditions, while managing credit risk appropriately. Through prudent underwriting, Freddie Mac Multifamily helps keep the rental housing market strong.
Freddie Mac Multifamily is unique in the GSE world in that we follow a prior-approval model. This means that we underwrite each multifamily mortgage loan in-house before accepting it for purchase; we do not delegate our due diligence or credit analysis. Our credit philosophy guides our decisions and, because we decide what we will or will not accept, we are directly involved in the process of making each loan. For loans that we purchase, we are integral to the mortgage-production process.
Multifamily loans have shorter terms than single-family loans – typically, seven or 10 years. Upon maturity, the loan must be paid off. Usually, it’s refinanced. So we apply a proprietary refinance test during the underwriting process to assess each loan’s ability to refinance at maturity. The test is reviewed at least quarterly and revised as needed to reflect current market conditions. In part, we look at amortization over the loan’s term. In today’s environment, loans amortize more quickly than in a more historically typical interest-rate environment; at a 3.5 to 4 percent interest rate, close to 23 percent of the loan will be paid down by Year 10, whereas at 6.5 percent (still low by historical standards), the pay-down is about 15 percent. We also project the property’s net operating income (NOI), interest and capitalization rates at loan maturity, and the property’s overall value proposition. If we think the loan might not qualify for refinancing, we resize it during initial underwriting.
Loans with an interest-only (IO) payment element have long been common in the multifamily and commercial real estate industry. With interest rates around historic lows, IO and partial interest-only (PIO) loans are even more in demand. These types of loans involve certain payment characteristics that must be addressed carefully as part of the overall credit decision.
With IO and PIO loans, the main characteristics that raise concerns are payment shock at conversion to amortizing payment and maturity risk. To help avoid payment shock, we underwrite loans as if both principal and interest would be paid from Day 1 (that is, on an amortizing debt coverage ratio – typically, 1.25 or higher). Moreover, on full IO loans, we have lower loan-to-value (LTV) and higher debt coverage ratio (DCR) requirements. In effect, we require borrowers to pay more principal upfront, reducing the overall loan amount and related risk. It’s important to note that we do not allow borrowers to choose an IO or a PIO loan to qualify for more loan dollars. In this way, the decision regarding IO is about payment structure and not a mechanism for qualifying for a bigger loan, as it was in the residential market before the financial crises. As a result, many borrowers choose to take a more conservative loan amount in return for an IO period. To manage maturity risk, IO and PIO loans must pass our refinance test, which frequently requires a borrower to decide whether to borrow fewer dollars and qualify for a few years of IO or borrow more dollars and receive no IO period.
The effect of these credit standards is reflected in the stability of our credit metrics – most notably, our LTV ratios at origination and, importantly, at maturity. While the percentage of type of IO and PIO loans that we purchase may vary, our average credit ratios have remained remarkably consistent.
Experienced In-house Team
Our underwriters have the knowledge and creativity needed to address the complexities of designing mortgage solutions for multifamily rental properties. In addition to business and industry expertise, local-market understanding is a critical factor. That’s why we take a regional approach to production and underwriting, with team members based in key cities nationwide.
The Underwriting team collaborates with the Production & Sales team, our network of seller/servicers, and well-qualified borrowers to identify and craft transactions that make business sense for all parties involved. Because most new business is intended for securitization through our K-Deal program, we have a Capital Markets Execution Underwriting team who specialize in capital markets and work hand-in-hand with the Loan Pricing & Securitization team.
Results Reflect Our Success
The market grades our performance every few weeks – every time we issue a K-Deal, which is structured to transfer most credit risk to privately capitalized investors. Our securities are consistently well-received in the marketplace and our underwriting is viewed favorably.
More specifically, our business results reflect the quality of and market confidence in our underwriting approach. In 2012, we reported:
- Credit losses of 0.03 percent
- Delinquency rate among the industry’s lowest at 0.19 percent
- Record securitization volume of $21.2 billion through 17 K-Deals
- Profitability extended to 12 straight quarters, delivering more than $4.4 billion in segment earnings from 2010 through 2012
Access to affordable rental housing is essential to society, and Freddie Mac Multifamily is committed to making it possible. Our Underwriting team supports the market through prudent credit decision making. It’s what our customers and taxpayers expect of us. It’s what we demand of ourselves.