May 24, 2016

Keep It Moving

David Brickman
David Brickman, CEO

Ten years ago, Freddie Mac Multifamily envisioned a future multifamily housing finance system, and began the process of transforming our business – and we haven’t looked back. Where we once held on our books all of the risk on the loans we buy, today we transfer the vast majority of it – and literally are exploring every corner of our business to discover innovative ways to move more.

As a provider of market liquidity, stability, and affordability, our most effective and least volatile approach to moving housing forward is to take as much risk off of taxpayers as possible, transfer it to private investors, and in turn increase access to multifamily funding. To help ensure our consistent support, we seek to immunize ourselves and, ultimately, the market from credit cycles to the extent we can.

In terms of the public policy discussions around “too big to fail,” our model broadly diversifies and distributes – across the investment universe – the significant concentration of risk that we might otherwise assume as part of our core business. 

Our track record and, over the past several years, multifamily real estate have been strong, but as a monoline business – operating only in one area of finance – we cannot be complacent. Credit crunches and liquidity shocks are seldom predictable and frequently caused by events that have little direct relationship to our sector. You never can tell when that “100-year flood” will strike – and it may hit more often than once every 100 years.

So we continuously innovate to position our business to drive private capital up and more risk out on every loan we buy. Today, we securitize about 90 percent of the loans we buy from our approved lenders, which greatly reduces our reliance on our retained portfolio and government backstop guarantee.

Our flagship execution is our K-Deal program. Through it, we shift the vast majority of our credit risk to private investors. Since the program’s launch in 2009, we have funded $142 billion in multifamily loans through 116 K-Deals. The program has evolved to encompass a wide and growing range of our loan types. We are the leading issuer of commercial mortgage-backed securities, and they have negligible credit losses to date (and Freddie Mac has experienced none).

But the K-Deal is not our only execution, and not every loan is readily and effectively packaged into a K-Deal.

For example, our Multifamily Credit Income Fund, sponsored by Freddie Mac but funded with private capital, allows us to securitize supplemental mortgages related to certain pre-defined senior mortgages backing a previously issued K-Deal and sell the unguaranteed piece to a private investor. This is a new way to remove supplemental mortgages – illiquid assets – from our balance sheet.

In addition, we use our Tax-Exempt Bond Securitization (TEBS) and Tax-Exempt Loan structure to move away risk related to our credit enhancements on tax-exempt bonds issued by housing finance agencies for subsidized apartments. These mortgages fund some of the most affordable, Freddie Mac-mission-critical properties that we support – and for structural and legal reasons cannot be securitized via K-Deals.

Given our deep commitment to risk transfer, if one vehicle doesn’t work well for economic, legal, or structural reasons, then we look for or invent another. For example, while TEBS is our preferred structure going forward for tax-exempt bond credit enhancements, it can’t help us reduce the risk on our legacy portfolio of tax-exempt bond enhancements. That’s why we created Freddie Mac Multifamily Structured Credit Risk Notes (SCR Notes). The inaugural offering settled last week.

SCR Notes provide a synthetic risk-transfer structure with performance tied to the underlying bonds in a specified reference pool. These unsecured, unguaranteed corporate bonds build on the success of Freddie Mac Multifamily’s securities offerings and Single-Family’s Structured Agency Credit Risk® debt notes. Private capital market investors bear the first-loss credit risk.

And we are assessing ways to transfer risk before securitization – during aggregation. This is the single biggest exposure remaining in our business. We hope to introduce at least one innovative risk-transfer structure in the next year so that we can reduce risk for the entire life of a loan – from our purchase straight through to maturity.

Importantly, most of our risk-distribution strategies are considered "true sales", meaning that, after securitization, the underlying loans come off of our balance sheet. As a result, we are not and would not be required to hold significant capital against such exposures. This allows us, in effect, to recycle our capital – to reuse the funds from the sale to buy new mortgage loans – and would make it vastly easier to capitalize the business in the future. Markets, the investment community, and many regulators significantly distinguish between risks that are “sold” and those that are “shared.” Our pursuit of true sales is one of the most tangible displays of our commitment to risk transfer as a business model.

While we feel very good about our business, the multifamily market, and especially our credit culture, we are keenly aware of the need to expect the unexpected and to plan and manage for what could happen – when and if the cycle abruptly turns. Freddie Mac Multifamily is well positioned to stay on course, given the extent to which we already transfer risk. However, leadership is about more than numbers; we are determined to shore up even more, so that we could simply run our business as usual when and if that flood hits.