Alternative (or non-traditional) assets are important for portfolio diversification because they allow investors to distribute risk across several investments, rather than build their portfolio (and potential risk) around a single asset. Real estate is a suitable alternative asset for many, and the multifamily sector has demonstrated strong rent and occupancy trends in recent years. This blog will take a closer look at the K-Deal and K-Certificate program from Freddie Mac, a multifamily securitization and debt investment program with some notable benefits for bondholders.
What is a K-Deal?
As noted in a Washington Post article penned by David Brickman, Freddie Mac’s current president and the former head of Freddie Mac Multifamily, mortgage credit risk is a major concern for federal policymakers. The ideal system involves private capital bearing the lion’s share of residential mortgage risk and safeguards in place to ensure the federal government will step in only if the situation becomes dire.
Freddie Mac’s K-Deal program securitizes mortgages for apartment/multifamily residence loans, most of which are associated with affordable rental properties. Freddie Mac utilizes the following process for K-Deal securitization.
- The multifamily loan is sold to a third-party investor, who then places the loan in a third-party trust.
- The third-party trust issues private label securities based on the loan. These securities take two forms: guaranteed senior bonds and unguaranteed subordinate and mezzanine bonds.
- The unguaranteed subordinate and mezzanine bonds are offered to third-party bond investors.
- Freddie Mac buys the guaranteed senior bonds and securitizes them through a Freddie Mac trust.
- Freddie Mac publicly offers pass-through certificates backed by the guaranteed bonds – known as K-Certificates – to senior bond investors.
There are several different K-Certificate loan options with varying terms. These include:
- K-000 Series: Backed by multifamily mortgages, usually with 10-year terms.
- K-500 Series: Loans with five-year terms.
- K-700: Series: Loans with seven-year terms.
- K-1500 Series: Fixed loans with terms exceeding 10 years.
- K-F00 Series: Loans with floating rates.
- K-J00 Series: Supplemental loans.
- K-L00 Series: Large loans.
- K-P00 Series: Seasoned portfolio-based loans.
- K-S00 Series: Backed by multifamily mortgages for senior housing properties.
- K-W00 Series: Workforce housing loans.
- K-X00 Series: Seasoned loans.
- K-ABC Series: Single loan or single borrower securitizations.
Risks and benefits for investors
Under the K-Deal structure, private investors who have purchased subordinate bonds bear the initial risk if credit losses occur. This position is known as the ‘first-loss position’ or ‘B-piece,’ and usually represents about 7% to 8% of the K-Deal’s mortgage pool. If losses persist, they will negatively impact mezzanine bond investors, who cover up to 10% of the remaining mortgage pool.
These non-guaranteed bonds constitute 15% to 18% of the average K-Deal mortgage pool. Because losses are impact the total pool, and not on a loan-by-loan basis, the subordinate and mezzanine bonds will likely absorb all of the losses, allowing the rest of the pool to remain unaffected. Given Freddie Mac’s historically low delinquency and loss rates, a 15% to 18% cushion is very favorable.
A K-Deal can be beneficial to those attempting to diversify their portfolio and spread risk across multiple assets. Freddie Mac guarantees strong credit and provides call protection for bondholders that limits costs related to yield maintenance or prepayment premiums.
How to obtain a K-Certificate
New K-Certificates are issued most weeks during a given quarter, either on Mondays or the first business day of the week if a federal holiday occurs. The average K-Deal includes roughly 80 individual loans; Freddie Mac staff underwrite, design, and price each loan. After K-Deals and K-Certificates are announced, investors begin coming into play. Each K-Deal involves about a dozen senior bond investors, along with subordinate and mezzanine bond investors who will bear most of the risk.
Third-party investors receive private offers on unguaranteed subordinate and mezzanine bonds after the third-party trust begins issuing certificates. Freddie Mac buys all senior bonds issued by the same third-party trust and securitizes them in a Freddie Mac trust. Once this process is complete, the company’s placement agents will publicly offer the guaranteed K-Certificates.
Freddie Mac publishes a quarterly recap of issued K-Certificates, including the K-Deal name and projected issuance amount. You can find an up-to-date issuance calendar on the Freddie Mac website. Issuance sizes of most K-Deals vary, ranging from $650 million to $1.5 billion.
For more information about K-Deals and K-Certificates, please visit the following pages on Freddie Mac’s website: