FREDDIE MAC MADE SOME BIG changes to its underwriting standards in the first quarter, a trend many see continuing throughout the year.

While Freddie Mac only made slight underwriting tweaks to standard 10-year deals, it took a tough stance on shorterterm loans due to uncertainty over the challenging economy.

“As the term got shorter, the Freddie Mac base box credit got tighter,” says Steve Wendel, managing director of New York City-based Deutsche Bank Berkshire Mortgage. “They're saying that over a 10-year cycle, exits should work well, but the shorter you go, the less confident they are that we'll be in a better place.”

Leverage levels fell 5 basis points, and debt service coverage ratios (DSCR) were raised 5 basis points on seven-year deals. And the pain was double for five-year deals: Loan-to-value (LTV) ratios fell by 10 basis points, and DSCR grew by 10 basis points.

The more controversial move announced by Freddie Mac concerned cash-out refinancing—when a property is refinanced for more than it owes on an existing mortgage, and the owner pockets the difference. This is a critical strategy for many multifamily owners who will take the equity from a refis of a strong property and balance their portfolio by investing the cash in a weaker one. But 10-year cash-out refis from Freddie Mac now offers LTV ratios around 65 percent and 1.30x DSCR— and the terms are even tougher for fiveand seven-year deals.

Since the government-sponsored enterprises (GSEs) are the last men standing in the multifamily debt world, they can afford to be choosy on the types of deals they want to back. However, while tighter underwriting standards is the prudent move in a tough economic climate, these changes could have unintended consequences.

“You wonder if this will crimp some potential opportunities for developers to tap into places that can help them ride through this downturn,” says Phil Melton, a senior vice president at Charlotte, N.C.- based Grandbridge Real Estate Capital. “Now, you're trapping the equity within a specific transaction.”

Freddie Mac lenders also express concern that the move will equally punish good borrowers with well-maintained properties. But Steve Griffin, a regional managing director with Freddie Mac, said that shouldn't be the case. “We're actually in the process of developing some strategies around those situations now,” Griffin says. “If we've got a borrower who's made their payments and taken care of the property, then we should respond favorably.”

The GSEs are expected to soon tighten up on supplemental loans, raising the DSCR to 1.30x as well as taking a hard line approach to requests for a third supplemental loan.

In general, the concern with these tighter underwriting standards is that they will proceed to make a bad market worse. And that's a delicate balancing act for the GSEs. “If we're cutting back the amount of money we can lend to an acquisition, we are increasing the pressure on real estate values, which makes the problem worse,” says Don King, head of GSE production at Needham, Mass.-based CWCapital. “You risk falling into the death spiral.”

Jockeying for Position

Although Fannie Mae smoked Freddie Mac on pricing in the first quarter—at times by as much as 50 basis points —Freddie has aggressively responded, adjusting its pricing in April to reclaim the lead.

Freddie Mac's portfolio loans were pricing at about the same levels as Fannie Mae's in late April, but the difference is in the securitized offerings. Freddie Mac's Capital Markets Execution (CME) program was offering rates on standard 10-year deals of around 5.25 percent, while Fannie Mae's mortgage-backed securities pricing was closer to 5.5 percent.

Early indications are that the GSEs will begin charging a slight premium for portfolio loans, providing a further incentive for borrowers to go the securitized route.

CWCapital closed its first CME deal in late December, offering a rate below 5 percent on a 10-year deal for a low-leverage stabilized asset in a primary market. The rate was a perfect storm—the deal was extremely conservative, and it was rate-locked during a rally in the Treasuries in early December when rates were at their lowest of the quarter.

The move to securitization programs is perhaps the biggest change to the way the GSEs approach multifamily lending since being taken over by the federal government. The GSEs are under a regulatory mandate to shrink the size of their portfolios. Securitization programs, which sell groups of loans to investors, are a way to keep liquidity flowing without impacting the size of the agencies' books.

The shift is more dramatic for Freddie, since Fannie is an old hand at securitizing loans. Freddie has always behaved more akin to a life insurance company, holding about 86 percent of its loans in portfolio. Fannie, on the other hand, only holds about 53 percent of its multifamily business on its books. The CME program, however, is just the first step in the company's push toward reducing its portfolio.

Freddie Mac is planning to securitize the bulk of all conventional multifamily mortgages by the end of next year and is working on a securitized product road map that includes several niche product lines.

“We aspire to see upwards of half of our conventional mortgage volume go through a securitization path by the end of 2010,” says David Brickman, Freddie Mac's vice president of multifamily CMBS/capital markets. “And we are looking to follow CME with other mortgage products that lend themselves to securitization.”

The company is busy modifying existing mortgage products, including senior housing mortgages, to make them more friendly to the investment market, such as by adding defeasance provisions as opposed to yield maintenance.

“We're looking to see how we can expand to fit some of the more niche products into securitization,” Brickman says. “A seniors-only type of securitization, for instance, is something we are looking at.”

The first CME issuance (of about $1 billion) will hit the market by the beginning of June, and the company hopes to have a second issuance, for which it is now collecting loans, by the end of the year. The goal is to produce a quarterly issuance schedule by the beginning of 2010.

The Here and Now

While concerns loom regarding the long-term fates of the GSEs, borrowers, at least for now, don't seem to mind the uncertainty. “A thirsty man doesn't question the glass of water handed to him,” notes John Cannon, head of agency lending at Horsham, Penn.-based Capmark Finance, a top GSE lender which now processes about 90 percent of its overall multifamily business through the agencies, up from just 35 percent a couple of years ago.

Lenders report a greater degree of interaction between themselves and the GSEs since the conservatorship took hold. “It feels much more collaborative than it did before,” says Grandbridge's Melton. “We're more closely in touch with them and find ways to work in the current framework.”

Despite the conservatorship, business is proceeding relatively normally. The conservator doesn't get involved in the day-to-day business of the GSEs, Griffin of Freddie says. “They're really not looking over our shoulder,” he adds. “In fact, we received a letter from James Lockhart recently expressing concern that we not get too conservative.”

In a sense, the Treasury Department's support of the GSEs is acting as a federal stimulus. Government support is keeping the GSEs' cost of capital low and helping to prop up apartment values by providing a flow of liquidity that is the envy of the office and retail sectors. A world without the GSEs would undoubtedly see apartment values drop significantly. “The players who truly have a choice about being in the market have pulled back,” says Heidi McKibben, Fannie Mae's head of multifamily production. “That's why Treasury support is so critical, and why this part of the commercial real estate sector is as valuable as it is today—the loans are available.”