Capital Markets Desk

CARMEL, Ind. – Leading financial services provider Merchants Capital (MCC), along with Merchants Bank of Indiana (MBI), announces today that it has completed a $214 million Commercial Mortgage Backed Securities (CMBS) securitization of 14 multifamily mortgage loans secured by 24 mortgaged properties through a Freddie Mac-sponsored Q-Series transaction. This is MCC’s second such transaction – last year, MCC secured a $262 million Q-Series transaction, which consisted of 15 workforce housing properties owned and operated by some of MCC’s biggest clients. Unlike the previous transaction, 100% of the securities were guaranteed by Freddie Mac and sold to the market. MCC will continue to sub-service the loans in the pool. The $214 million in loans consisted of 14 multifamily properties in Georgia, Indiana, Michigan, New York and Ohio. The developments range in size from 60 to 352 units. On a weighted average basis, the portfolio had 93.7% of units under 80% area median income (AMI), 52.1% of units under 60% AMI and 26.8% of units under 50% AMI. Several properties were made possible by low-income housing tax credits (LIHTC) and the U.S. Department of Housing and Urban Development (HUD). The collateral pool is all seven-year capped adjustable-rate mortgages (ARMs), a new product for the platform. Due to the characteristics of the underlying mortgage loans, the certificates are designated as “Social Bonds” within the Social Bonds Framework, published on Freddie Mac’s website. Proceeds from Social Bonds are used to provide liquidity to social impact financial institutions (community development financial institutions, housing finance agencies and other financial institutions), such as MBI. These social impact financial institutions finance affordable housing to low-income communities and underserved populations consistent with the Social Bonds Framework. Freddie Mac engaged Sustainalytics, Inc., an affiliate of Morningstar, Inc., to independently evaluate the Social Bonds Framework. MCC has also created its own ESG Social Bonds Framework for use in their future deals, aligning with the four core components of the Social Bond Principles from Freddie Mac, and similarly evaluated by Sustainalytics. The ongoing assessment is based on the use of proceeds, project evaluation and selection, management of proceeds and reporting.

While rising home prices are troubling new home buyers, affordability is also a big concern for renters across the nation who have limited housing options — despite earning decent incomes. The National Multifamily Housing Council and National Apartment Association’s Vision 2030 report suggests the nation needs 4.6 million new rental units by 2030 or will face a serious shortage, as the demand for apartments is at an all-time high with the number of renters reaching an unprecedented level. In fact, almost one in eight people in the United States call an apartment home. The pricing of multifamily housing falls into three segments: Affordable housing, which is reserved for individuals or families earning 30–60 percent of area median income (AMI). This segment also includes federally subsidized Section 8 units. Workforce housing, which is priced for individuals or families earning 60–120 percent AMI. Market-rate housing and class “A” luxury apartments. The middle segment, workforce housing, is a huge opportunity for today’s developers. The majority of such developments are simple and have few amenities, but they provide a lower-cost and higher-quality home than any alternative on the market. In this blog, we’ll explore the current housing crisis and explain the role of developers in workforce housing projects as a possible solution to the nationwide shortage. What’s the difference between affordable and workforce housing? As stated above, households that would fall into the workforce housing bucket are understood to have earned income that is insufficient to secure quality housing in reasonable proximity to the workplace. Therefore, these individuals would not necessarily qualify for affordable housing but would have a hard time paying market-rate rent. Workforce housing allows people who work in a neighborhood to live nearby when they’d typically be either priced out by luxury apartment units or wouldn’t qualify for traditional Section 8 units. Workforce housing developments reduce barriers to being successful at work and increase employee retention. On the flip side, affordable housing is reserved for individuals or families earning 30–60% of AMI. The median income for all cities across the country is defined each year by U.S. Department of Housing and Urban Development. The 2019 AMI for the New York City region is $96,100 for a three-person family (100% AMI). A family of three in New York City earning $57,660 or less (60% AMI) a year would be considered low-income and qualify for affordable housing options. And currently, a single minimum-wage worker can’t afford a two-bedroom apartment anywhere in the U.S., according to a 2018 report from the National Low Income Housing Coalition (NLIHC). The cost of rent is a major contributing factor towards individuals living within their means and therefore being successful at work, building relationships with friends and family, being active in their community and more. Housing costs have steadily increased along with growing demand for rental housing in the decade since the Great Recession. At the same time, new rental construction has tilted toward the luxury market because of increasingly high development costs, according to a Chicago Tribune article about the report. The number of apartments and homes renting for $2,000 or more per month nearly doubled in a decade, between 2005 and 2015. Is there a housing crisis? The United States is in the middle of an affordable and workforce housing crisis. Due to increased demand and stunted millennial home ownership, rental markets in major cities don’t question whether rent is rising — but by how much. Reporting by Curbed explains that the crisis is the logical result of economic forces and a failure to build enough low-cost housing: “If you’ve spent any time in the last few years searching for an apartment in the United States, you’ve likely come to the conclusion that current prices are, in a word, unprecedented.” Even some two-income households with people working full time and earning competitive wages, such as teachers and social workers, are struggling to afford a simple apartment. As part of their 2019 “Out Of Reach” study, the NLIHC developed an interactive map that shows how much an individual would need to earn to afford a modest apartment in their state. Hawaii ranks the highest for required housing wage, requiring a $36.82 an hour wage to afford a two-bedroom rental home. That equates to 146 hours of work a week needed at the federal minimum wage to afford a two-bedroom rental home. According to the report, some of the most costly areas are: California: $34.69/hour, 116 hours/week Washington, D.C.: $32.02/hour, 91 hours/week Massachusetts: $33.81/hour, 113 hours/week New York: $30.76/hour, 111 hours/week On the other end of the spectrum, Puerto Rico ranks 52nd in terms of affordability, requiring a $9.59 an hour wage to afford a two-bedroom rental. That equals 53 hours of work a week needed at minimum wage to affordable a two-bedroom rental home — much lower than a place like Hawaii, but still out of reach. More affordable areas include: Arkansas: $14.26/hour, 62 hours/week West Virginia: $14.27/hour, 65 hours/week Mississippi: $14.43/hour, 80 hours/week Kentucky: $14.84/hour, 94 hours/week This is why the role of developers in terms of building and preserving workforce housing options for working low- and middle-class income individuals is important, particularly in costly states and metropolitan cities with sky-high rents. How are workforce housing projects the solution? One example of the workforce housing model working is in Rochester, Minnesota, where we secured financing for a nearly $20 million mixed-income workforce housing community known as Technology Park Apartments. Merchants Capital secured the loan through the first-ever Freddie Mac Non-LIHTC Forward Commitment on behalf of Real Estate Equities. The apartments were financed through a 10-year Freddie Mac Non-LIHTC Forward Commitment loan where the interest rate was locked at the closing of the Merchants Bank of Indiana construction loan. The key to this financing is that it is a great way to take interest rate risk off the table in return for offering more affordable rents, and the loan can be used by for-profit and non-profit organizations. Historically, borrowers were only issued forward commitments for projects with new LIHTC equity, so this product is attractive to borrowers that are not looking to cash out at conversion and want to lock their permanent loan rate up-front at construction loan closing. “We are very excited to be on the forefront of developing a modern workforce housing product that is not heavily reliant on government funding sources,” said Alexander Bisanz, director of acquisitions at Real Estate Equities, said in a Post Bulletin story about the financing partnership with Merchants Capital. The crisis is clear and in front of us. Merchants Capital is proud to have the opportunity to address this problem head on with our partners, therefore assisting in the development of workforce housing communities to close the gap. We recognize more workforce housing developments, and innovation within those developments in terms of financing and other offerings, is the solution to the nation’s multifamily housing crisis. Are you ready to finance a workforce housing project? Contact a Merchants Capital originator at originations@merchantscapital.com today.

As we approach the midpoint of 2019, one of the most surprising market developments has been the resurgence of the bond bull market. Yields on US 10 Year securities which is viewed as the benchmark rate for GNMA project loan securities, are currently hovering at 2.14%. For perspective, those levels were last seen September of 2017 and since that point there have been FIVE fed funds rate hikes by the FOMC. Furthermore, over the last six months, we’ve experienced over a 100 basis-point drop in 10 Year yields. To say this would be a surprise to market participants at the beginning of the year would be an understatement. In a Bloomberg survey taken 11/9/2018, the average 2019-year end forecast for the 10 Year Treasury was 3.45%, with most of the market believing there would be two hikes in 2019. As with most market predictions, this may serve as good reminder to take it with a grain of salt. A few factors are behind this resurgent bond market. Geopolitical tensions continue to produce headlines daily. The inability of the U.S and China to reach common ground over the yearlong “Trade War” has lead to lower expectations for global economic growth. According to a study prepared by Trade Partnership Worldwide, if all tariffs proposed by the U.S were implemented, combined with Chinese retaliation, it is estimated to curb U.S GDP by (~1%) annually. Meanwhile, this period of uncertainty has led to a flight to quality in safe-haven assets, which has acted as a catalyst for the bond market rally (yields fall as bond prices rise). Other risks abroad include, a dimming outlook for Euro area growth, potential fallout from Brexit proceedings, and mounting tensions between the U.S and Iran in the Middle East. Another more recent development that could cause some concern would be the commingling of political issues with economic policy as seen with the U.S threatening to place tariffs on Mexico if they are unable to take more action on U.S immigration. With regards to monetary policy, the Fed continues to preach patience going forward. Despite not hitting its 2% inflation target, the U.S economy seems to be on solid ground as we near the later stage of its expansion cycle. However, policy makers are now in the market’s crosshairs, as virtually the entire yield curve is below the fed funds rate and the likelihood of an interest cut in July 2019 is 78% while December 2019 is above 90%. While inflationary data may not support a cut, going forward it will be interesting to see if the FOMC deviates away from its data driven decision making and bows to market forces. After a tumultuous start to the year due to the government shutdown, GNMA project loan securities have come back to life, as investors have tightened spreads ~15 basis points since January. Strong demand looks likely to stay as prepayment speed assumptions tick up. Broker dealers; who provide capital to this space, largely have clear balance sheets and appetite to do deals, feeding the natural supply and demand fundamentals needed to keep spreads in check. We continue to see strong demand for Agency products regardless of spikes in market volatility and lower yields. Spreads on shorter term DUS paper have held firm year to date, while we’ve seen some tightening farther out the curve as more investors are trying to get their hands on yield. Merchants Capital Corp. (MCC) has originated and closed more than $13 billion in loans since its inception in 1990 and now services more than $10 billion. Merchants Capital Markets group serves as a conduit between MCC customers and the real estate capital markets by marketing GNMA and FNMA securities directly to Wall Street in order to obtain the best execution.

Is this the calm before the storm? According to the Wall Street Journal, the last month of trading has seen volatility, as measured by positive and negative price movements in the S&P 500, at its lowest levels in over two decades. What is causing this sustained tranquility? On June 23rd, Britain voted to leave the EU (have you already forgotten about “Brexit?”), setting up a classic risk-off trade: stocks down, safe-haven bonds up. After a couple weeks, the market effect of Brexit was muted. Some market observers have blamed a “summer lull,” which does happen most years, when traders break for the beach. More likely, this is our new reality- where the market expects the Fed and international central banks to continue accommodative policy and prop up markets indefinitely. 10 year treasury, the benchmark rate for GNMA project loan securities, has settled into a tight range of 1.50-1.60, with only momentary exceptions. One big driver of this rate will be the Fed’s decision on whether to raise the federal funds rate in September (and/or December). Be on the lookout for clues of any uptick in inflation that gets us closer to the Fed’s 2% target. That seems to be the last remaining hurdle for the Fed to raise rates, after a few solid months of job gains. In our corner of the world, GNMA rates have done well the last few weeks- some 223fs are locking around 3.00% note rate! Immediately post-Brexit, traders gapped their spreads over the 10 year treasury. Now that treasury rates have settled in this context, we have seen gradual erosion of spreads, as a result of strong demand from REMIC investors. We don’t see signs of an abrupt turnaround, but at these historically low levels, why gamble with such significant downside risk? Merchants Capital, a subsidiary of PR Mortgage & Investments, serves as the conduit between PR Mortgage customers and the real estate capital markets, by marketing GNMA securities directly to Wall Street. In 2015, Merchants Capital issued over $1.2 billion in GNMA securities, which represented 6% of the market nationally. This production and direct access to capital markets allows PR to offer industry leading rates.

Merchants Capital, a subsidiary of PR Mortgage & Investments, serves as the conduit between PR Mortgage customers and the real estate capital markets, by marketing GNMA securities directly to Wall Street. In 2015, Merchants Capital issued over $1.2 billion in GNMA securities, which represented 6% of the market nationally. This production and direct access to capital markets allows PR to offer industry leading rates. The story of the year in financial markets has been global tumult and the resiliency of the domestic US economy. As the prolonged slump in commodities has taken its toll on developing economies, the Chinese economy has fared particularly poorly. China has continued accommodative monetary policy, in an attempt to prop up slow growth and stabilize markets. In Europe (and now Japan), the Central Bank has kept negative interest rates to stimulate long-running stagnant economies. With fewer monetary tools remaining to jumpstart international economic activity, the US Federal Reserve has been hesitant to continue to raise rates domestically. The job market has been steady and improving in the US, although wages have lagged. There are positive signs that inflation is starting to tick up. How immune is the US economy to sickness abroad? The stock market has been volatile in Q1, demonstrating a high correlation to rock bottom oil prices. In fixed income world, spreads have widened across asset classes- bond prices fall as yields rise. The riskiest bonds have done the worst. We have seen a “flight to quality” assets, which has resulted in increased demand and lower yields for US Treasuries. The 10 year treasury, an important benchmark for pricing real estate bonds has settled below 2.00% for much of the year. GNMA offers “risk-lite” bonds, with the explicit backing of the US Government. So, GNMA rates have been relatively better than other capital sources. In the chart below, you can see the widening spreads for GNMA permanent and construction loans. We have seen spreads tighten in the first few weeks of March, and we are optimistic for even lower rates for our borrowers as the summer approaches.