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Reducing Taxpayer Risk Through Multifamily Securitizations

VP of Pricing, Costing and Capital Deployment Mitchell Resnick

Since joining Freddie Mac a year ago, I've spoken to many people about our flagship Multifamily securitization program. Most people understand and accept the need for such a program in today's commercial real estate market. However, I still get a few questions about the benefits of securitization for borrowers, investors, and the American taxpayer whose investment in Freddie Mac has helped stabilize the single-family and multifamily mortgage markets.

My response: securitization is the best vehicle we have for pairing our borrowers' financing needs with the risk appetite and return requirements of a diverse group of capital markets investors. This allows us to offer our borrowers lower interest rates than traditional portfolio executions. In short, our securitization program is the best way to preserve taxpayer investment in Freddie Mac because it transfers risk away from the company while generating consistent profits.

How Does Freddie Mac Multifamily Transfer Risk?

This is a very basic question about how securitization works and why we do it. Today, most of our Multifamily new business comes through the Capital Markets Execution (CME) product. Through this product, we purchase mortgages secured by apartment housing from our approved Seller/Servicer lender network, and then pool them and sell them as commercial mortgage-backed securities, known as Freddie K-Deals.

In addition to the structured credit enhancement provided by the same subordination structure one would find in a typical CMBS deal, Freddie Mac wraps, or in other words guarantees, the senior portion of the securities. In addition, we sell the unguaranteed subordinate bonds to private capital investors. Each K-Deal is comprised of about $1.2 billion in senior, guaranteed bonds and about $200 million in unguaranteed subordinate bonds.

It is important to note that while the $200 million of unguaranteed subordinate bonds represents a small percentage of the total deal, it accounts for the vast majority of the loans' risk. Freddie's risk of losses is then transferred up the capital stack to the bonds we guarantee. In turn, our guarantee typically covers bonds that are already receiving a AAA-equivalent rating, based solely on the underlying collateral strength, so even if a loan were to experience losses, they would be absorbed by the subordinate bonds we have already sold to third-party investors.

How Does Freddie Mac Manage Risk?

This transfer of risk can only be successful if we also carefully manage the risk associated with any individual loan we bring into the CME program. We accomplish this through the Freddie Mac Multifamily prior approval underwriting process, which is governed by a strong credit culture with a proven track record.

Unlike a delegated underwriting approach, our in-house underwriters make credit decisions on each loan based on a number of factors before accepting the loan for purchase. These factors include strength of sponsors, historical property operations, cash equity, the underwriter's knowledge of markets, and other pertinent information. The work of our dedicated team of underwriters, along with conservative credit policies and strong asset management on the portfolio side have resulted in some of the industry's lowest delinquency rates of around 27 basis points. Even though our CME program is only four years old, we have seen similar performance across our nearly $40 billion of settled K-Deals.

In short, our Multifamily business line has built a solid reputation for being a leader in underwriting standards, credit risk management, and securitization transactions. The success of this business has improved Freddie Mac Multifamily's profile in the market and continues to reward taxpayer investment in us.

Freddie Mac Multifamily
FY 2011
FY 2010
Segment earnings
$1.652 billion
$1.319 billion
$965 million
Mortgage purchases
$19.2 billion
$20.3 billion
$15.4 billion
K-Deals settled UPB
$13.9 billion
$13.7 billion
$6.4 billion
Number of units financed
60-day + delinquencies
27 bps
22 bps
26 bps



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