Amid current market dislocation, Origin Credit Advisers’ expertise in multifamily credit investment shines. While we maintain our long-term perspective on macroeconomic fundamentals, it is during these times of higher interest rates, inflation and the threat of a recession that our ability to identify opportunities in debt financing becomes most critical. It allows us to seize opportunities that others might overlook or not be prepared to capitalize on. These market conditions are validating our strategic approach to credit investment, where we are able to promptly identify potential, react swiftly and utilize our expertise to secure beneficial assets for our Strategic Credit Fund.
We don’t stop investing during economic volatility. Instead, we’ll do it in a defensive manner. As part of our exclusive focus on multifamily real estate, with its strong historical returns, lower volatility compared with other sectors, and favorable long-term outlook, we operate within the most protected portion of the capital stack and partner with Freddie Mac as an underwriter.
Capitalizing on the Potential of Multifamily Credit Investment
MSCR (pronounced “m-score”) notes, or multifamily structured credit risk notes, are issued by Freddie Mac and leverage its underwriting and credit risk management standards to give capital markets investors exposure to the multifamily housing market. These unguaranteed securities, grouped into pools and issued by Freddie Mac, transfer to investors credit risk associated with eligible multifamily mortgages.
Essentially, the noteholder buys risk from Freddie Mac, and in return, Freddie Mac pays the noteholder an interest payment through the distributions of the properties within the pool. Freddie Mac holds the senior risk, the first-loss piece and a minimum 5% interest in each tranche. If loans in a pool start defaulting, Freddie Mac must make payments toward those defaulted loans. The MSCR note represents a partnership between the noteholder—investors such as Origin Credit Advisers—and Freddie Mac to take on the payments of those losses. The noteholder takes on some of that risk for a premium. In this case, the return is a fixed spread over SOFR, or Secured Overnight Financing Rate. As SOFR moves, the noteholder’s return moves as well.
In exchange for this partnership, Freddie Mac pays a monthly credit premium to a third-party trust, such as a bank, which acts as middleman in issuing the notes and investing sale proceeds. In turn, the trust makes monthly payments of interest and principal to noteholders.
Positioned as a Freddie Mac Purchaser
The journey to this recent multifamily credit investment started two years ago, when Freddie Mac approved Origin as a B-Piece investor (learn more on this video) after more than a year and a half of scrutiny. Since then, Origin Credit Advisers and its affiliate partner, Origin Investments, have purchased more than $275 million in Freddie Mac products—including, in early June, $25 million in MSCR notes.
The story of that latest purchase reflects our key competitive advantages:
- an innovative approach that gives us speed to act;
- scrupulous due diligence that underlines our credibility;
- and an emphasis on relationships that gives us priority access to opportunities.
In early May, Freddie Mac representatives let us know that in a few days, the agency would be introducing an MSCR investment opportunity totaling $102.5 million. Here’s how the process works: Freddie Mac releases information on a portfolio of notes, and companies like us analyze the portfolio. At the end of this due diligence period, interested parties raise their hand to be included in the deal, and the third-party trust chooses the noteholders.
Due Diligence at the Speed of Artificial Intelligence
The advance notice from Freddie Mac was, for us, a powerful sign of trust and credibility. A few days later, when the agency released the portfolio, the clock started ticking: We had four days to review a total of 357 loans and decide if we wanted to bid. While our credit team undertook their own performance analysis, we leveraged a critical and powerful tool: Origin MultilyticsSM, our proprietary suite of machine-learning models, which was able to process the enormous amount of data quickly and return a “red flag” report that would highlight any potentially problematic loans. Multilytics has repeatedly given us an edge in our due diligence process, not just in terms of granularity and accuracy but in speed. And in this case, speed was critical. Between the two approaches, we quickly assessed the quality of the overall portfolio and identified five loans that appeared higher risk than the others. We flagged the anomalous loans to Freddie Mac and the portfolio’s third-party trust.
We had decided that we wanted to invest $25 million in this portfolio, and when the due diligence period ended, we were allocated every dollar of that amount—another coup, given that not every bidder receives the full amount that they request. These MSCR notes became the final major investment in our Multifamily Credit Fund, with a blended floating rate of 13.75% at the time of purchase.
This is a huge win for Origin and speaks to the reputation we’ve built with Freddie Mac. We believe we got our full allocation because we did the hard work and asked good questions during the underwriting process, leveraging Multilytics and our own expertise in the process. Rather than treating Freddie Mac like a monolith that is merely transactional, we engaged with the agency to point out where we saw risk in the pool.
Freddie Mac and Origin Credit Advisers: What the Future Holds
While an MSCR note is a different type of debt financing and risk than the portfolio of Freddie Mac loans that we have invested in previously, such as K-Deals and B-Pieces; these types of deals partly comprise our Strategic Credit Fund. There is a comparatively higher reward for MSCR notes if the spread over SOFR is greater than the spread over SOFR in a traditional B-Piece at origination. Investors in B-Piece loan pools must meet stricter criteria for approval—one of which allows the investor to pull a loan out of the pool and operate it themselves. By contrast, with an MSCR note, investors are buying risk, not a portion of a loan.
This doesn’t necessarily mean that we will exclusively seek MSCR deals in the future; we favor diversity among the debt financing vehicles in our Funds. The Strategic Credit Fund is gaining momentum, and its pipeline is filling with the opportunity to acquire multifamily credit investment bonds very similar to the MSCR notes acquired for our Multifamily Credit Fund. In addition to the MSCR notes, we are in continual conversations with sellers of the paper in the secondary market.
Origin is poised to continue to leverage our deep-rooted market expertise, as we have done previously, by optimizing our exposure to floating rate bonds in the Multifamily Credit Fund as a hedge against climbing interest rates. And we continue to utilize our growing reputation as a preferred buyer from leading financial institutions such as Freddie Mac and leading financial institutions to benefit investors in our Strategic Credit Fund.