In its continuing effort to shield taxpayers from potential defaults, Freddie Mac is now offering investors exposure to the credit risk of multifamily mortgages that are awaiting securitization.

The government-sponsored enterprise already offloads the majority of risk on multifamily loans that it insures via K-deals, which issue two classes of bonds, senior guaranteed and unguaranteed mezzanine and subordinate bonds. Capital markets investors who purchase the unguaranteed bonds are on the hook for early losses.

The new program, called KT Certificates, transfers the risk that multifamily loans go bad while Freddie is still aggregating them.

“Our existing K-deal products transfer credit risk on a long-term basis,” said Bill Buskirk, chief financial officer of Freddie’s multifamily business. “So where do we still have risk? It’s during the aggregation period.”

It typically takes the company just five to seven months to assemble a pool of loans that is sufficiently large and diverse to securitize. While few loans go bad so early, the risk is higher if the securitization market were to freeze. “In that scenario, with the market in a downturn, there’s more potential for losses,” Buskirk said. “We wouldn’t be able to execute a securitization as quickly as we might have in the past.” The loans could sit up to three years.

Like K-deals, KT Certificates issue senior bonds that are guaranteed and mezzanine and subordinte bonds that are unguaranteed. The first $1 billion offering priced on Feb. 2, with the senior A notes, which were broadly distributed, paying 32 basis points over one-month Libor. Pricing for the B and C notes, which were privately place, was not disclosed. Freddie retained the most subordinate D notes and a portion of the senior A notes.

Buskirk said the investors in the warehouse facility are the same types of investors, if not the same names, that purchase K deals.

Here’s how it works: If loans go into default during the aggregating period, Freddie auctions them and the proceeds go into the trust. For example, if there are $10 million in loans in default that sell for $6 million, the trust takes the $4 million loss.

“The facility has a three-year life, and it will turn over maybe twice a year,” Buskirk said. “So it will handle $4 billion to $6 billion over that [three-year] period.”

He said Freddie hopes to do more. “We’ll always be limited by the size of the portfolio of loans awaiting securitization. Historically that has been $10-15 billion in aggregate – smaller for our bread and butter five- and seven-year loans.” Future facilities might offload the risk of different kind of loans or different types of collateral.

Bonds that transfer credit risk are one of the only ways Freddie and sister company Fannie Mae can raise capital while they are in conservatorship.

The company, which reported its fourth-quarter financial results on Feb. 17, currently has a net worth of $5.1 billion and is slated to pay $4.4 billion to the Treasury Department in March. Under an agreement with Treasury and Federal Housing Finance Agency, the GSE must turn over all profits to the government. It is not allowed to raise additional capital.

That will leave the company with a net worth of $600 million as a capital buffer.

Freddie has completed $180 billion of risk transfer transactions involving multifamily mortgages since 2013, including $51 billion in 2016.

“The FHFA is encouraging of risk transfer products,” Buskirk said. We’re always exploring ways that we can that we can transfer risk to third parties.”

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