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CRE Finance World, Winter 2014

A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 59 In the CMBS loans, we have often observed high volatilities in some states, such as Florida. These states were also the ones that experienced the biggest downturn during the recent recession. The nature of boom and bust in those states can have dramatic impact on CRE borrowers’ default behavior. We further investigate the ruthlessness of four of the states (Arizona, Florida, Georgia and Nevada) which suffered severely during the recession. Clearly, the evidence indicates that multifamily borrowers tend to default more ruthlessly when facing a more volatile market environment or a more stressed market. A number of issues may contribute to this. The properties may be even more distressed than is evident from the data available. Otherwise, option theory suggests that there is significant upside as the markets and properties return to periods of stability. Also, borrower liquidity could play a role here as borrowers recognized the potential upside but did not have the capacity to support the properties. Table 6 Geographic Comparison of Default Ruthlessness Source: Trepp and Freddie Mac Default Ruthlessness of Freddie Mac Multifamily Loans Freddie Mac’s current multifamily business model began in the late-1990s, similar to the CMBS data reviewed above. The extremely low delinquency rate (<1%) for Freddie Mac-financed properties contrasts sharply with the delinquency rate for multifamily loans in CMBS, which peaked near 15%. Brickman, Guggenmos and Li (2011)1 research provided some solid evidence and explanation for these results. In that research, Mysteries Revealed, it is clear that income and value underwriting were quite different for loans originated by CMBS conduits relative to those funded by Freddie Mac. On average, incomes and values were 5% to 15% more aggressive for conduits before the market crash. This CMBS underwriting practice often led to the approval of some loans unqualified for the Freddie Mac programs. Here we look at another factor, borrower decisions to default once a property goes underwater. We examine if the ruthless behavior is different among Freddie Mac borrowers from those of CMBS, and what are the factors that drive the differences. To analyze the default behavior in Freddie Mac loans, we look at the Freddie Mac multifamily fixed rate loan historic performance data from 2002 to 2012. We use a similar methodology to the one described above for the private label CMBS to obtain DCR and derived LTV for each year. Any loans that were foreclosed or liquidated with losses were counted as defaulted. Figure 1 Freddie Mac Multifamily Mortgage Default Ruthlessness Source: Freddie Mac Because the differences in asset management practices between Freddie Mac and CMBS, we further identify the distressed mortgages which were modified and became current. The most common types of modification include term modification, negotiated payoff and reinstatement. We believe that these loans, if securitized in the market, would otherwise default (comparable to a 60-day delinquent loan in CMBS). Hence, we add these loans to our default list in order to have a more precise comparison with the discussed CMBS loans. Figure 2 presents the revised Freddie Mac default ruthlessness in comparison with the CMBS default ruthlessness from 2002 to 2012. Figure 2 Comparison of Default Ruthless between Freddie Mac and CMBS Source: Trepp and Freddie Mac Default Ruthlessness: Examining Borrower Default Behavior


CRE Finance World, Winter 2014
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