Fannie Mae ACES IO Investment Strategy Overview

FNMA ACES deals are comprised of pooled FNMA Delegated Underwriting and Servicing
(DUS) loans. The loans have short-stated final maturities associated with mandatory balloon
payments (usually 10 years or less), and have call protection which typically runs until the
final 3 months of the loan.

Most DUS loans require borrower prepayments be accompanied by yield maintenance

penalties (YMP) (as opposed to defeasance, lockout or fixed-penalty points). When paid, a
portion of the penalty is passed through to ACES IO bondholders (usually 70%), thus
providing additional income which may surpass the cash flows of the IO component, thereby
increasing returns.

Deals in the targeted universe are currently carrying mortgage rates roughly 50 -200 bps
higher than current rates, which act as incentive for borrowers to prepay to refinance sooner,
as perceptions are that rates are expected to rise in the near future.

Any YMP paid by borrowers are generally capitalized into a new mortgage, so the
combination of a new lower mortgage rate, along with the interest deduction taken for
payment of the penalty, can make the short-period breakeven time a more practical business
decision compared with risking higher mortgage rates while waiting for penalties to burn off.

Replacement of durable goods necessary in multifamily buildings usually occurs around the
7-year timeframe, combined with mandated balloon payoffs in 7-10 years, borrowers are more
willing to refi slightly earlier to capture lower rates.

Many of the loans underlying the targeted securities currently enjoy embedded equity
ranging from 50%-150% of appraised value, making earlier refinancing desirable to tap equity
embedded in the properties as soon as possible.

Majority of underlying loans in this program were originated in the post-subprime-calamity

time period, and were subject to higher underwriting scrutiny and therefore tend to be more
stable. Both Fannie and Freddie were under tremendous political and regulatory pressure to
be disbanded during this period, so any loans made during this period tended to be
underwritten exceptionally well.

All indications are that the FED is poised to continue to raise rates, so borrowers may try to
get ahead of the FED and lock in lower rates as soon as it becomes economically
reasonable to do so.

ACES IO Strategy Overview Fannie Mae ACES IOs can offer a unique
investment opportunity due to the distinctive

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attributes of the underlying pooled Fannie Mae DUS
loans, upon which the ACES securities owe their
cash flows. Historical prepayment performance of
190 Fannie Mae ACES loan pools, totaling $57.64
billion, along with the universe of applicable Fannie
Mae DUS loans (totaling almost $200 billion) clearly
illustrate the correlation between observed faster
prepayment speeds and the shortening of time until
maturity balloon.
Driving this strategy is the receipt of YMP payments
to bondholders, associated with faster prepayment
speeds on the underlying DUS loans, which can
complement the traditional interest-only class
investment yields.
Obviously, prepayments may not benefit all ACES
IO securities, but for those where the underlying
DUS loans exhibit the desired metrics, and the
associated IO securities are priced appropriately,
the combination may result in increased returns.
Historical prepayment performance analysis of
Fannie Mae ACES pools originated since 2009,
clearly illustrates a prepayment speed ramp-up over
time, which increases as the underlying loans trend
towards their balloon maturities. A similar ramp is
seen when the larger universe of DUS loans is
analyzed. The results of these analysis are
discussed below in the Fannie Mae DUS
Prepayment Performance section.
Although loan prepayment activity is fundamentally
related to traditional economic triggers such as
interest rates and asset valuations, multifamily-
borrower behavior plays a significant role in the
decision of when loan payoffs occur. Unique to
multifamily properties, is the need to replace the
durable goods (i.e. refrigerators, stoves, etc.)
provided in each housing unit. Reaching the end of
their operative lives, the necessary replacement of
these amenities can result in earlier loan
prepayments as borrowers look to recapture
replacement costs and take advantage of higher
appraisal values associated with new equipment.
This often-overlooked component of borrower
behavior is a meaningful contributor in the decision-
making process multifamily owners must consider
when deciding when to pay off their existing loans.
Extensive use of yield maintenance penalty call
protection, along with limited knowledge of
multifamily borrower behavior, creates a product line
in which many investors are unfamiliar. This blind
spot presents an opportunity where knowledgeable
investors can financially benefit by taking advantage
of potentially higher returns associated with
educating themselves on an off-the-run investment
opportunity.
The strategy outlined herein is predicated upon the
performance of the Fannie Mae DUS loans
underlying these securities, along with an
understanding of how borrower behavior affects the
timing of the associated cash flows. Given the
importance of these aspects to the performance of
the strategy, a brief overview of the Fannie Mae DUS
program, along with the associated multifamily-
borrower behavior, has been included to help
familiarize the reader with the concepts underlying
the investment strategy.
Page | 2
Fannie Mae DUS Program Overview
Fannie Maes Delegated Underwriting and Servicing
(DUS) program was created in 1988 to drive,
enhance and maintain product standardization in the
multifamily marketplace. Fannie Maes multifamily
book of business totals more than $300 billion
financed since 2000, with over $40 billion originated
in 2015 alone. This is a unique business model in
the commercial mortgage industry (with the
exception of a less frequently used FHA risk-sharing
product). Standard industry practice is for a loan
purchaser or guarantor to underwrite or re-
underwrite each loan before making a decision to
purchase or guaranty it. Under the DUS model,
designated lenders are authorized to commit Fannie
Mae to acquire multifamily loans. The loans must be
underwritten, originated and serviced according to
standards established by Fannie Mae. In exchange
for this authority, DUS lenders must share the risk of
Table 1: Types of Multifamily Mortgaged Properties Eligible for DUS MBS
Property Type Description
loss over the life of the loan, generally retaining one-
third of the underlying credit risk on each loan sold
to Fannie Mae. DUS lenders must post collateral to
secure their risk sharing obligations1.
Under the DUS program, approved lenders can
originate fixed-rate, adjustable-rate, balloon, fully
amortizing, partial and full-term interest-only
multifamily mortgage loans. These DUS loans can
be financed through MBS, DMBS, or Bond Credit
Enhancement executions. The most common final
balloon maturities for fixed rate multifamily loans are
5, 7, 10, 12, and 15 years, while adjustable-rate
mortgage loans usually have final balloon maturities
of 5, 7 or 10 years. The most common DUS MBS is
a 10/9.5 fixed rate (a 10-year balloon with 9.5 years
of yield maintenance), followed by the 7/6.5 fixed
rate (a 7-year balloon with 6.5 years of yield
maintenance)2.

Standard Conventional Multifamily A multifamily loan secured by a residential property composed of five or more dwelling units and in which
generally no more than 20 percent of the net rentable area is rented to, or to be rented to non-residential
tenants.

Multifamily Affordable Housing and Low- A multifamily loan on a mortgaged property encumbered by a regulatory agreement or recorded restriction that
Income Housing Tax Credit limits rents, imposes income restrictions on tenants or places other restrictions on the use of the property.

Seniors Housing A multifamily loan secured by a mortgaged property that is intended to be used for elderly residents for whom
the owner or operator provides special services that are typically associated with either independent living or
assisted living. Some Alzheimers and skilled nursing capabilities are permitted.

Manufactured Housing Community A multifamily loan secured by a residential development that consists of sites for manufactured homes and
includes utilities, roads and other infrastructure. In some cases, landscaping and various other amenities such
as a clubhouse, swimming pool, and tennis and/or sports courts are also included.

Cooperative Blanket A multifamily loan made to a cooperative housing corporation and secured by a first or subordinate lien on a
cooperative multifamily housing project that contains five or more units.

Dedicated Student Housing Multifamily loans secured by multifamily properties in which college or graduate students make up at least
80% of the tenants.

1
An Overview of Fannie Maes Multifamily Mortgage Business, May 2012
2
Over Twenty Years of Multifamily Mortgage Financing Through Fannie Maes Delegated Underwriting and Servicing (DUS) Program, March 2015

Credit Quality of DUS Mortgage Loans cooperatives with a minimum of five individual units.
These multifamily properties must be existing,
Eligible multifamily properties must be income-
recently completed, or in need of moderate
producing multifamily rental properties or

Page | 3
rehabilitation. A majority of the properties qualify for
30-year amortization schedules. A DUS mortgage
loan tends to range in size from $1 million to $50
million and is generally non-recourse3 to the
borrower. Additionally, DUS loans generally are
assumable after a review of the proposed
transferee, although a one-percent transfer fee
payable to Fannie Mae is commonly charged, which
is not passed on to the MBS investor.
Each mortgage is underwritten to a three-tier credit
structure based on debt service coverage ratio
(DSCR) and loan-to-value ratio (LTV). Table 2
summarizes the LTV and DSCR values for each tier
for standard conventional multifamily loans. DSCR
and LTV requirements are subject to change based
on market conditions. Stricter underwriting
standards apply to other asset classes such as
Seniors Housing, Student Housing, and
Manufactured Housing. Various asset classes are
described in the associated Multifamily MBS
Prospectus.
Table 2: Tier Level Credit Characteristics
Rating Minimum DSCR
Tier 2 Generally no lower than 1.25
Tier 3
Usually falling within a range of Usually falling within a range of
1.35 1.55
Tier 4 Usually in excess of 1.55
In addition to tier assignments, each property
underlying the multifamily MBS is subject to three
assessments.
* These figures are not an indication of the DSCR or LTV characteristics that will apply to any
given MBS, regardless of Tier. The DSCR, LTV and Tier for each MBS are disclosed in the
offering documents for that MBS.
1. An appraisal of the property is performed by a
licensed appraiser selected by the DUS lender.
Appraisals must conform to Uniform Standards of
Professional Appraisal Practice (USPAP)
standards. Fannie Mae does not approve specific
appraisers. The DUS lender is responsible for
selecting the appraiser and is solely accountable
for their performance.
2. Either an environmental assessment or an
American Society for Testing and Materials
(ASTM) screen is required and an ongoing
operations and maintenance plan may also be
required to ensure the property is operated in an
environmentally sound manner.
3. A physical needs assessment must be completed
by a qualified evaluator designated by the DUS
lender. If tenant safety, marketability, or property
conditions are compromised by unacceptable
circumstances, repairs may be ordered.
Generally, if the repairs are not completed by the
time of closing, a reserve fund for payment of the
repairs may be established.
DSCR and Net Operating Income (NOI), is collected
Maximum LTV Ratio by Fannie Mae and disclosed on an annual basis.
Generally no higher than 80%
It is important to note that the underwriting guidelines
in the DUS Guide are guidelines and not rigid
65% 55%
requirements. A waiver or exception may be granted
Usually below 55% if it is deemed by Fannie Mae to be prudent given
the applicable circumstances4.

3
Non-recourse: In the event of default, the lender agrees to take the pledged property as satisfaction for the debt and to have no claim on any other assets of the borrower.
4
Over Twenty Years of Multifamily Mortgage Financing Through Fannie Maes Delegated Underwriting and Servicing (DUS) Program, March 2015

DUS Prepayment Protection (YMP) or a declining percentage of the unpaid

principal balance. Other methods for calculating
As part of the DUS program, each DUS loan prepayment premiums are also possible. The
generally has voluntary prepayment protection prospectus supplement will specify whether the
provisions. For fixed-rate loans, the prepayment loans in an MBS pool have prepayment premiums
premium is usually a yield maintenance premium

Page | 4
and, if so, will specify the method for calculating the Mae will not pay any portion of the prepayment
prepayment premiums. The prospectus supplement premium to the investor.
will also state whether certificateholders share in any
prepayment premiums collected on prepaid loans in The Treasury reference note used to compute the
the pool and, if so, will describe the method of yield maintenance prepayment premium effectively
allocation. increases this premium by the present value of the
spread differential between a DUS MBS and
Yield maintenance, the most common form of Treasuries. If the borrower prepays during the three
prepayment protection, allows for full prepayments months after the end of the yield maintenance
along with a yield maintenance prepayment period, the borrower may be charged a one percent
premium payable by the borrower. The yield prepayment premium based on the amount of
maintenance prepayment premium for each prepaid principal. Prepayment premiums paid in
mortgage loan is payable during a period of time, the connection with prepayments occurring after the
yield maintenance period. If a borrower voluntarily yield maintenance end date are not passed through
prepays a mortgage loan during the yield to MBS investors.
maintenance period, the yield maintenance
prepayment premium is based on a standard Fannie Mae publishes a Monthly Yield Maintenance
calculation, but is, at a minimum, 1% of the Factor report which investors can use to calculate
outstanding unpaid principal balance of the loan at their share of yield maintenance for those MBS
the time of payoff, during the YMP period. paying yield maintenance in the current month.

It is important to note that Fannie Mae calculates the The various prepayment protection methods on
share of the prepayment premium to be retained by DUS loans provide considerable compensation to
the company and the share of prepayment premium investors and reduce the incentive for a DUS loan to
to be passed on to the investor. Fannie Mae will be repaid before the prepayment end date
pass the yield maintenance prepayment premium to (curtailment). Voluntary partial prepayments
the investor only to the extent that collected generally are prohibited on DUS loans. Involuntary
premiums remain after the company has deducted prepayments such as condemnation awards or
its full portion. Fannie Mae does not guarantee insurance proceeds may occur. Investors can
payment of any prepayment premiums and Fannie determine the prepayment premium or yield
Mae will only pass through the MBS investors maintenance formula that applies to the loan
portion of a yield maintenance payment to the extent underlying a particular MBS by reading the
it is collected. If a borrower prepays a mortgage loan Prospectus Supplement for that MBS type5.
on or after the yield maintenance end date, Fannie

5
Over Twenty Years of Multifamily Mortgage Financing Through Fannie Maes Delegated Underwriting and Servicing (DUS) Program, March 2015

Fannie Mae DUS REMIC Programs pricing) and an IO class (Figure 1). Current
outstanding DUS REMIC volume is in excess of $80
Fannie Mae DUS REMICs, also called ACES or billion. The average deal size is around $550 million,
GeMS, represent an alternative way to gain consisting of more than 100 DUS MBS pools per
exposure to multiple DUS MBS pools. In contrast to deal, on average, at issuance. The underlying pools
the homogenous pass-through deal structure of a in REMICs are predominantly standard multifamily
DUS Mega, a DUS REMIC typically consists of (84%), followed by cooperative loans (6.5%) and
sequential-pay classes (often with par coupon manufactured housing communities (4.8%). Unlike

Page | 5
the clustered DUS MBS pools in a Mega, the range
of coupons within a DUS REMIC can be much wider,
such as in FNA 2010-M7, in which coupons ranged
from 4.64% to 7.14% (or 250 bps). DUS Megas can
also be part of the collateral in DUS REMICs. Upon
voluntary prepayment, the IO class usually receives
70% of the YM penalty, and the current pay bond
receives the remaining 30%6.
Fannie Mae Guaranteed Multifamily Structures
(Fannie Mae GeMS) are structured multifamily
securities created from multifamily MBS collateral
selected by Fannie Maes Multifamily Capital
Markets Desk. The Fannie Mae GeMS program is
an umbrella for all Fannie Mae portfolio structured
multifamily products. The program was launched in
2011 and includes Multifamily Megas and REMICs.
The program attracts additional capital to multifamily
finance from larger institutional investors who might
not find the characteristics of smaller, single-loan
DUS MBS attractive. GeMS provide par-priced,
block size, structured securities with collateral
MBS/DUS securities which are structured into
sequential, bullet, IO, floater and inverse floater
classes. The ACES program predates the GeMS
program, but is similar in that both allow inclusion of
multiple prefix pools, have no coupon range
requirements and are created through Fannie Maes
FNM Structured Transactions conduit. Both also
allow for collateral diversity, improved liquidity by
block-size securities offerings and allow for
customized cash flows to meet investor demand8.
Figure 1: Sample Fannie Mae DUS REMIC deal
Underlying Collateral Deal Structure: Interest
for DUS REMIC (FNA) Sequential Pay Classes Only Class
Class A1
$50mm (10%)
5yr Wtd Avg Life
140 DUS MBS Pools

Class X
$500 million
diversity and customized cash flows to meet investor Class A2
(100%)
demand7. In 2015, Fannie Mae issued $11.7 billion $450mm (90%)
10yr Wtd Avg Life
in GeMS.

Fannie Mae Alternative Credit Enhanced Securities

(Fannie Mae ACES) are structured multifamily
securities created from multifamily MBS collateral
and are similar in structure to GeMS securities.
Fannie Mae ACES are REMICS backed by

6,7
Credit Suisse, Agency CMBS Market Primer, September 21, 2011
8
FNMA, ASF 2011: Fannie Mae Securitization Overview, February 2011

THE 10-YEAR BALLOON A LESSON IN HISTORY

Ever stop to consider why the vast majority of non-
agency CMBS loans have balloon maturities (in the
form of Anticipated Redemption Dates ARD), and
most Agency CMBS loans (excepting GNMA) carry
explicit 10-year balloon language? Is it just a
coincidence that Commercial Mortgage Backed
Securities (CMBS) loans carry call protection no
longer than 10 years? What is so special about that
10th year? Current use of 10-year terms for CMBS call
protection and balloon periods owe their roots to
multifamily properties once being the sole
securitized CRE collateral type.
It would be expedient to say that the choice of 10
years term for balloon date and maximum call
protection was simply a matter of convenience, but

Page | 6
looking back to the earliest days of commercial real approached the end of the 12 -year period, property
estate securitization confirms that the 10-year term owners actively sought to sell their properties for new
was not an arbitrary choice. The two main reasons ones, effectively exchanging them and thus, re-
why trace their roots back to the early days of CRE setting the depreciation clock. Given the time
financing. necessary to find new target properties, along with
the process of selling their current property, the
Although current commercial real estate
majority of transactions occurred somewhere
securitizations include loans made on many different
between the 10th and 12th years of the original
property types, this was not always the case. Prior to
mortgage term. Accelerated-depreciation exchange
the creation of CMBS in the early 1990s, the only
activity was not limited to multifamily properties, but
public securitized CRE program was one confined to
as described below, multifamily buildings have a
multifamily lending through the securitization of
separate and unique quality which exacerbated the
Federal Housing Authority (FHA)-originated loans.
effect.
The FHA multifamily program was established to
focus exclusively on those properties associated with Considering the nature of multifamily properties
Section 8 voucher and Housing Assistance Program unique characteristics relative to other CRE property
(HAP) programs, as the idea was to increase types, an interesting and sometimes-overlooked
financing opportunities on lower-quality aspect of borrower behavior becomes significant.
affordable-housing buildings. Initially, these loans Consider for a moment that a multifamily property is,
were guaranteed solely by the FHA (at a slight simply stated, an aggregation of a number of small
discount, issuing debentures in the event of default),
but in the early 1970s, individual FHA-originated
loans were further wrapped and guaranteed by homes contained in a single structure. In each of
Ginnie Mae, creating a program that was more these homes is found a number of standard
appliances (i.e. refrigerators, ovens, dishwashers,
widely accepted by investors looking for the security
etc.), referred to in aggregate as durable goods, for
of a U.S. government guarantee, combined with
which the building owner is responsible to provide.
timely payment and ultimate payment pledges. Due
These durable goods typically have a life expectancy
to the nature of the underlying collateral (typically,
of somewhere between 7 and 10 years. It can be
housing projects), the name Project Loan stuck,
further argued that the builder-quality amenities
and has been used since to describe multifamily
often found in apartments tend to be of slightly lower
housing loans associated with low-to-moderate-
quality and thus may need to be replaced earlier than
income properties (customarily, the name is reserved
comparable amenities found in private homes.
for GNMA Project Loan Certificates (GNMA PLC), but
has been used in other contexts as well). Given that the majority of these durable goods will
likely begin to reach the end of their usefulness
Prior to the sweeping tax reform changes enacted in
around the same time, multifamily property owners
1986 (Tax Reform Act of 1986), investors in
recognize that once some of the items need to be
commercial real estate properties were able to enjoy
replaced, there is a very high likelihood that the
what was known as accelerated depreciation. This
remainder will need to shortly thereafter. To lower
tax loophole allowed property owners to
costs, property owners tend to buy the replacement
depreciate their CRE properties over a 12 -year
items in bulk, and attempt to complete the
periodroughly 1/3 of the typical 35- to 40-year
replacement of these items at one time. Because the
amortization termresulting in significant savings.
cost of replacement, although meaningful,
As the advantages of accelerated depreciation
represents a relatively small percentage of the value

Page | 7
 of the asset, property owners tend to pay
replacement costs out-of-pocket as opposed to
taking out a supplemental loan. With the funds
coming out of operating income, property owners are
incentivized to want to quickly refinance or sell to get
that money back. Historically, this activity usually
occurs somewhere between the 7th and 10th years.
Prior to 1986, if a multifamily property owner was
incentivized to sell his property prior to the 12th
anniversary of his outstanding loan to restart the
accelerated-depreciation clock, and also had to
replace the durable goods in his building, he would
elect to sell or refinance right after the replacement
of the durable goods. This helped ensure he would
receive the highest appraisal/valuation on the
property. The timeframe where necessary
replacement of durable goods coincided with the
runoff of the depreciation credit was referred to as
the cross-over period. Although each property had
its own specific circumstances, the tendency was for
these events to occur around the 10th year.
Recognizing that their loans would remain
outstanding for around 10 years, these borrowers
adopted the practice of buying down their loan
rates by including prepayment penalty covenants for
Fannie Mae DUS Prepay Performance
Historical performance data of more than 190 loan
groups (totaling $57.64 billion) within the targeted
universe of Fannie Mae ACES deals confirms that
as the underlying DUS loans approach their
mandatory balloon dates, prepayment speeds
increase rapidly (Figure 2). Many of these loans pay
off with yield maintenance penalties, a significant
portion of which (usually 70%) are passed through
to IO class bondholders, boosting returns.
the first 10 years of their loans. Since the likelihood
was low that they would have to exit their loans
early, including call-protection provisions on their
loans impacted their operations little, yet was a
benefit in lowering mortgage costs.
Since being implemented, the Tax Reform Act of 1986
replaced the accelerated-depreciation loophole with
the now-current straight-line depreciation
deduction, which permits depreciation of CRE
holdings over a longer, 29 -year schedule. Although
the change in the tax code removed the depreciation-
savings incentive to sell properties prior to the 12th
year, multifamily borrowers still needed to recoup
the cost of the replacement of durable goods.
Because of this necessity, multifamily property
owners found themselves more amenable to
refinancing rather than selling, but the 10-year
timeframe remained consistent.
With the arrival of CMBS securitization in the early
1990s, although non-multifamily property types
were introduced into the marketplace, the
convention of 10-year loan payoffs and call
protection provisions, established over many years of
multifamily property activity, became the norm, and
remains today.
Pooled REMIC securitizations (such as ACES deals)
offer monthly performance updates which allows for
more granular surveillance of loan pay-down activity.
This increased transparency clearly illustrates the
prepayment ramp speed pickup phenomena as
loans move towards their balloon maturities.
Observed speeds vary by loan composition, but the
trend is clear: as loans move inside the final 48
months until maturity, prepayment speeds ramp up
asymptotically towards maturity, with a significant
number of loans prepaying with penalty payments.
Figure 2: Fannie Mae ACES Speeds vs WAM
Page | 8

ACES Average Prepay Speeds
(April 2016) 60%
50%
6 Month Speeds 40%
CPR
30%
12 Month Speeds
20%
10%
0%
5 4 3 2 1 patterns noted in ACES deals are consistent in the
REMAINING WAM (YRS)
Additional analysis of the entire applicable
universe of Fannie Mae DUS loans (~$200 billion),
encompassing the most commonly-issued
structures found in ACES deals (10/9 and 5/4),
covering the past 15 years performance, resulted in
the clear emergence of prepayment patterns which
further corroborates the direct relationship between
shorter loan WAM periods and higher payoff speeds.
It is important to note that not all DUS loans are
securitized into ACES deals, but all ACES deals are
backed by pools of DUS loans. Therefore, although
the data from the larger universe of DUS loans is not
Using trailing 6-month prepayment speeds on ACES
deals, the correlation between remaining WAM to
balloon and prepayment speed is graphically
illustrated below (Figure 4). Note the high
correlation of faster speeds on those loan groups
with shorter balloon WAMs. Shorter cohorts can
illustrate the correlation in more granularity, but due
to the relatively small amount of loans in each deal
(typically 100-150 loans at origination), shorter
timeframes produce more volatile speeds between
periods, since a single loan payoff of a larger loan
may skew the data in a shorter observed period.
Trailing 6-month averages were chosen to capture
payoff trends, yet maintain a true representation of
speeds by smoothing the curves over a reasonable
near-term timeframe.
directly applicable to any specific ACES security, the
prepayment ramps which emerged are an important
confirmation of the performance of the collateral
group as a whole.
DUS payoff data, available on Fannie Maes website
is updated quarterly, but is segmented into annual
cohorts. Despite being less granular than the
monthly-reported ACES data, the Fannie Mae data
offers further corroboration that the prepayment
broader DUS universe, as would be expected
(Figure 3).
Figure 3: Annual DUS Prepay Speeds by Vintage
Historical DUS Prepay Speeds
(2000-2015)
(annual cohorts)
100%
80%
60%
CPR
40%
20%
0%
Year Year Year Year Year Year Year Year Year Year
1 2 3 4 5 6 7 8 9 10
It should be noted that this analysis, although
confirming the presence of faster prepayment
speeds as loans trend towards their balloon
maturities, is not intended to create a universal
prepay speed curve to be applied to all ACES loans
groups, but rather, to identify the speed pick-up trend
specifically associated with this collateral type.
Each loan group underlying ACES deals has unique
qualities specific to that group, and therefore needs
to be evaluated individually to forecast future
prepayment expectations. Factors used to gauge
future speeds include: loan origination dates, gross
WACs, remaining time until balloon, penalty
costs/pass-through amounts and property equity.
Page | 9
 Figure 4: ACES Loan Group Prepay Speeds (6-month rolling averages) vs Remaining WAM

FN ACES Prepay Speeds

(6mo Rolling Averages - April 2016)
11 100
10 90
9 80
8
70
Loan WAM (yrs)

7
60

CPR %
6
50
5
40
4
30
3
2 20

1 10

0 0
Outstanding FNA ACES Pools
<--Later Originations Earlier Originations-->

Fannie Mae DUS Prepay Motivation

Economics of Time Value
Traditional expectations apply when considering
prepayment probabilities on loans where the
borrowers in-place mortgage rates are higher than
the current rate environment. Obviously, this will be
tempered by the amount of penalty charged for an
early payoff, but historical performance has shown
that even with larger penalties, some borrowers will
elect to pay penalties if they believe rates are
headed higher, for fear of missing out on the
opportunity to lock in lower rates.
It is somewhat counter-intuitive to believe a borrower
will pay a high penalty to refinance, but other factors
weigh in to the borrowers motivation:
Borrowers utilizing the Fannie Mae DUS program
are aware that they must pay off their loans by the
stated balloon maturity date. Unlike traditional
CMBS where balloon payoffs are considered
anticipated, and can be extended by the Special
Servicer, Fannie Mae will immediately remove any
delinquent or matured loans (up to 60 days grace)
and pay off the remaining balance to bondholders
via the Fannie Mae guarantee. This hard final makes
borrowers acutely aware they need to insure they
have a takeout strategy in place before the loan
reaches maturity, or risk losing their property.
Knowing that they need to have an exit strategy,
borrowers are more inclined to act earlier to avoid
triggering a default event if something delays their

Page | 10
take-out strategy. If they can refinance into a new
mortgage that is significantly lower than their current
rate, they tend to do so more readily particularly if
they believe rates are headed higher in the near
future.
This phenomena has its basis in the fact that if a
borrower knows he has to pay off his current loan in
the next 2 or 3 years, and there is a likelihood of
higher rates on the horizon, even with paying
prepayment penalties, the cost of that penalty can
be made up with a lower loan rate. If by waiting for
the penalty to decrease, rates move higher, it can
result in an economically worse financial situation.
Example:
If a loan requires a 10-point penalty to prepay
today, and a new loan is 200 bps lower in rate
than the current mortgage rate, the penalty
would be made up by the 5th year of the new
loan (200bps savings/year x 5 years =
1000bps).
Alternatively, if a year later, the penalty
dropped to 8%, but rates rose 100 bps, a
borrower would then have to recoup the 8-
point penalty cost with a new loan that is only
100 bps lower than the old rate, thereby
requiring 8 years to break even thus making
the decision to refi earlier and pay the 10-point
penalty, a more prudent business decision.
Additionally, any penalties paid to exit a loan can be
capitalized into the new loan, as well as taken as a
tax deduction, somewhat softening the blow of
paying the penalty.
Remember that these borrowers are in the business
of leveraging their properties. Unlike a residential
borrower whose goal is to completely pay off his loan
and own the property outright, multifamily borrowers
are not trying to completely pay down their loans,
rather, they want to leverage their properties to
achieve the best performance against their business
activities. As such, even paying a high penalty may
make more financial sense than waiting for lower
penalties if they can lock in a lower mortgage rate to
defray the net cost.
Borrower Behavior
Multifamily, as a property type, is unique in the
commercial real estate space in that it is the only
property type where property owners are faced with
the task of periodically replacing consumer durable
goods contained in each apartment unit. Durable
goods, in this context, refer to the typical residential
appliances found in most apartment units. Although
the strategy outlined herein applies to multifamily
borrowers within the Fannie Mae DUS program, the
multifamily-borrower behavior related to the
replacement of durable goods described below, is
not limited to any specific loan platform. It is
however, important to recognize that this behavior,
when combined with hard balloon maturities such as
those found in the DUS program, can result in loan
prepayments earlier than may be normally expected.
Borrowers in Fannie Maes DUS program know that
they must sell or refinance their properties prior to
loan maturity. Although empirical data is scarce,
based on anecdotal knowledge, the majority of these
borrowers tend to be in the business of owning and
operating multifamily properties, and therefore many
elect to refinance their properties rather than sell. In
either case, whether they choose to sell or refinance
their loans, borrowers attempt to garner the highest
appraisal (if refinancing), or sale value for their
properties to receive either the most leverage or sale
proceeds possible.
To obtain the highest valuations, the building and
units need to be in the best-possible condition. This
requires the borrower to perform routine
maintenance as well as the periodic replacement of
old appliances in the individual units. It is in the
borrowers best interest to complete any necessary
work prior to a sale or securing a new loan since
upgrades usually translate into higher property
valuations.
A multifamily property is, simply stated, a cluster of
small homes contained within a single building. Each
of these homes typically has included in each unit
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standard appliances such as refrigerators, ovens,
air-conditioners, etc. The average useful life of these
durable goods tends to be around 7-10 years. Most
property owners, in an effort to save money, choose
builder-grade appliances, which tend to be of
lesser quality and therefore need replacing towards
the shorter end of the obsolescence curve. It is a
reasonable assumption to expect that once the first
few appliances need replacing, the remainder will
follow shortly thereafter. To this end, property
owners typically buy replacements in bulk, and
switch out all of the appliances in the building at one
time, to save money.
Considering the time necessary to order the goods
and complete the work, borrowers have historically
undertaken beginning the process with around 2-3
years to go before the outstanding loan maturity to
insure that any unforeseen delays do not run up
against the loan maturity dates. Since these financial
outlays are reasonably large and are a cash drag on
the borrower, once completed, borrowers tend to
want to recover the expenses as soon as possible.
Because this work occurs at a point that is not too
far from the time the loan is due to mature, taking out
a short supplemental loan isnt practical. The costs
associated with these upgrades usually comes out
of the propertys operating capital. Borrowers will
need recoup the outlay by refinancing or selling the
property. These factors usually translate into earlier
payoffs of the existing loans.
The borrower behavior described above tends to be
a universal practice, but given the current interest
rate environment and expectations of higher rates in
the not-too-distant future, the combination makes for
a very compelling incentive for borrowers to want to
refinance their loans sooner in the cycle than if
prevailing mortgage rates were equal to or higher
than in-place rates.
As described, although paying penalties will figure
into borrower math as to the timing of existing loan
payoffs, the facts are that these loans will have to be
paid off relatively soon, and the combination of
currently low mortgage rates with the strong desire
to recapture upgrade/maintenance expenses is a
very compelling incentive to act sooner rather than
wait and try to time the market. The data compiled
and highlighted in the charts above illustrate that
borrowers within the targeted universe are indeed
prepaying despite the penalty payments. Any rise in
interest rates should only intensify this activity as
borrowers feel they miss the opportunity to lock in
lower rates if they dont act quickly.
Remarkably enough, when data from each of the
2000-2003 and 2009-2012 timeframes are analyzed
(periods of consistantly falling interest rates), the
early payoff phenomena is still present. Despite
lowering rates along with prepayment penalties that
were also trending down, a significant number of
DUS borrowers still elected to prepay their loans
early and pay the penalties. Although the actual
motives for this borrower behavior cannot be known
with certainty, the reasoning described above offers
a plausible explanation.
Fannie Mae Multifamily Underwriting
With respect to loan performance and default
expectations, note that Fannie Mae has been
engaged in the multifamily sector since 1988, and
currently has almost $200 billion of multifamily loans
outstanding. According to Fannie Maes data, loans
owned or guaranteed by Fannie Mae have enjoyed
extremely low default histories. Recently, serious
delinquency rates were quoted by Fannie Mae at
0.05%9.
Also noteworthy is the understanding that along with
the characteristically conservative underwriting
criteria that Fannie Mae utilizes, loans comprising
the targeted universe of our strategy were originated
during the post-subprime-crisis era, in which both
Fannie Mae and Freddie Mac were under
tremendous political pressure. Remember that
during this period, congress was seriously
considering disbanding both GSEs. The intense
scrutiny resulted in loans originated during this
timeframe to be especially clean since neither
agency wanted to have to explain any negative
events and give any additional reason to shut them
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down. Even today, both Freddie Mac and Fannie
Mae remain in conservatorship.
Source: Fannie Mae Business Information, February 2016
9
Fannie Mae, Fannie Mae Multifamily Mortgage Business Information, February 2016
ACES IO Market Imbalance
Fannie Mae ACES IO securities represent a small
subset within the Fannie Mae multifamily program,
which itself, is a subgroup of the broader Agency
CMBS universe. Because of its limited size, ACES
IOs attract less investor attention. Combined with
the steeper learning curve associated with the
ACES/DUS programs, including the unique impact
of multifamily borrower behavior, ACES IOs are
often overlooked by investors. The confluence of
these factors creates a supply/demand imbalance.
Approximately $60 billion (original face) of ACES IO
bonds have been issued to date. When factored-
down balances (current face) and discount pricing
are taken into consideration, the investable market
of these securities shrinks to around $2.5 billion.
With a significant portion of these bonds likely to
remain in account hands, it is estimated that the
actual amount of market-available ACES IO
securities is between $50 and $200 million annually.
When considering the amount of investable dollars
Source: Fannie Mae Business Information, February 2016
available in IO classes structured off of ACES deals,
it quickly becomes apparent that this smaller corner
of the CRE market can be easily overlooked.
Risk/Reward Tradeoff
Traditionally, higher-yielding investment
opportunities are associated with a higher risk
profile, balancing against the potential of greater
returns. ACES IOs, although not immune to
downside risk, can offer investors a different
risk/reward tradeoff due to the relative short duration
of the securities, combined with the tendency of the
underlying collateral to perform as expected.
All DUS pools have hard balloon maturities, which in
the universe of ACES IO class securities targeted for
the strategy, tend to have relatively short timeframes
(typically 1-5 years). Assurance that the loans will
pay off by maturity (Fannie Mae guarantee), allow
investors to know the absolute longest period of time
the associated IO securities will last. Combined with
the presence of the established historical
prepayment curves, a reasonable expectation of
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worst case early amortization events may also be
achieved. Note that any prepayments during the
YPM period will be accompanied by penalties
passed through to investors, potentially offsetting IO
coupon loss, and in many cases, can increase yields
as compared to the traditional IO cash flows. These
boundaries allow investors the opportunity to apply
conservative downside scenarios to potential
investment securities to optimize the risk/reward
profiles.
The FNA ACES IO strategy exploits the high
probability of early loan payoffs (with accompanying
penalty payments to bondholders) on the underlying
collateral, and leverages the structure of these
securities to produce returns which may exceed
standard IO cash flow returns. By targeting those IO
classes backed by loan pools exhibiting the
characteristics which best capture the performance
desired, investors can better manage risk/reward
metrics.
100%CPY and the Asteroid
Typically, a 100%CPY assumption is used to
analyze a worst case scenario on securities with
prepayment penalties on the underlying loans. This
assumption implies the earliest payoff scenario
without receipt of any penalties being paid to
bondholders. Although mathematically correct, the
application of 100%CPY on Fannie Mae ACES
securities as a worst case scenario is inaccurate, ill-
advised, and can significantly misrepresent risk.
Working in concert, there are a number of factors
which contribute to the very high likelihood that a
significant amount of borrowers will not pay off their
loans right when the YMP period ends.
These factors are as follows:
1) Although the borrowers YMP period typically
expires 6 months from maturity, the
additional 1% penalty imposed by Fannie
Mae (which is not passed through to
bondholders) extends the borrowers actually
penalty period up until the final 3 months of
the loan. Even though 100%CPY is
mathematically correct in the assumption
that penalties expire when the YMP ends,
the 100%CPY assumption does not take this
additional penalty into consideration. It is
therefore reasonable to expect that if a
borrower gets to within the final 6 months of
the loan, he may consider holding off just
another 3 months to avoid paying any
penalties at all.
2) When calculating YMP, the formula takes
into consideration a number of salient factors
to arrive at the amount of penalty due. This
formula also has a provision that, in no case
will the minimum YMP be lower than 1% of
the UBP. Mathematically, the 1% minimum
threshold typically is reached about 3 months
prior to the actual end of the YMP period.
Given that a penalty will go no lower than the
minimum, borrowers must decide if they will
wait until the penalties expire, or pay the 1%
minimum. As stated above, if they wait, they
will likely be paying off after the YMP end
date, which is longer than the 100%CPY
assumption, if they choose to pay the 1%
minimum, it is likely that they will do so as
early as possible to be able to recapture
expenses, tap any latent equity, and secure
new financing. In either case, the 100%CPY
payoff point will likely be missed.
3) Discussed in the sections above, borrower
behavior is a significant contributing factor in
the timing of when loans tend to prepay. As
has been illustrated, historical trends clearly
show a high predisposition for borrowers to
prepay early and pay penalties. These
events will also make a 100%CPY
assumption inaccurate.
4) Historical analysis of Fannie Mae ACES
pools indicate that a significant number of
loans (roughly 15% of the original balance,
which represents a higher current balance
percentage) remain outstanding until the
final months of the loan. This may be due to
similar burnout activity as seen in
residential loans, or to some borrowers not
being as sophisticated as others when it
comes to financial matters. Whatever the
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 reasoning, the activity is present and it
contributes to the position that using
100%CPY is an inaccurate measure of
payoff probability.
Conventional wisdom in the investment community
is to analyze any opportunity to a perceived worst
case scenario, then work backwards to determine if
an acceptable risk/reward profile emerges. This
approach is a valid one so long as the downside
boundary selected is reasonable with respect to
the likelihood of occurrence.
Consider the absurd notion that a worst-case
scenario involved an asteroid destroying the Earth
tomorrow. Yes, it is a worst case, but the likelihood
is relatively remote. If investors were to consider this
event when buying securities, virtually nothing would
be a viable investment choice. Recognizing the
absurdity of the argument above, but using it as an
illustration of a point, it is easily seen that risk and
probability are not the same. If a risk exists, but its
probability is low, should it be called into
consideration as a reasonable downside boundary?
The use of 100%CPY to determine a worst-case
prepayment scenario on ACES loans is certainly a
risk, but the factors listed above, along with the
supporting data behind them, make the probability
of the event very low. As such, although current
street convention is to utilize the 100%CPY hurdle
as a potential worst-case prepayment event on
securities with prepayment-protected loans, in the
case of ACES securities, the likelihood of this event
is sufficiently remote, such that its implementation
usually results in an overstatement of risk.
Additionally though not as common, depending upon
the composition of the underlying loans and the
configuration of any given ACES pool, using
100%CPY may produce results which, in some
cases may overstate returnsan equally
problematic issue as that of being too conservative.
Analytics Accuracy
When evaluating any security, the accuracy of the
analytics systems used to generate cash flows need
to be precise. This is never truer than when
evaluating Fannie Mae ACES securities since in
addition to the standard principal and interest cash
flows, the system used needs to be able to consider
the cash flows contributed from any penalties that
are passed through to bondholders. This has been
more challenging than would be expected.
Since, as discussed above, the DUS/ACES
programs represent a smaller subset of the Agency
CMBS world, and therefore offer fewer securities
than other programs, analytics capabilities have
been slower to catch up in applying accurate cash
flows with respect to the allocation of prepayment
penalties.
As such, it is imperative to insure that any analytics
systems used to generate return and cash flow
profiles accurately account for the additional
prepayment penalties. Many providers of analytics
have been addressing this issue, but at the time of
this writing some have been less successful than
others.
Investors analyzing these instruments need to
insure that the analytics providers used to generate
cash flows on these securities are reflecting
accurate results.
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Sources:
FNMA, November 1, 2011 article titled Basics of Multifamily MBS
FNMA, May 1, 2012 article titled An Overview of Fannie Maes Multifamily Mortgage Business
FNMA, March 2015 MBSenger article titled Over Twenty Years of Multifamily Mortgage Financing
Through Fannie Maes Delegated Underwriting and Servicing (DUS) Program
Credit Suisse, February 21, 2013 article titled Agency CMBS Market Primer
FNMA, February 2011 article titled ASF 2011: Fannie Mae Securitization Overview

Page | 16
 FNMA, February 2016 article titled Fannie Mae Multifamily Business Information
JRER, No.2 2003 Frank E. Nothaft and James L. Freund, article titled The Evolution of Securitization in
Multifamily Mortgage Markets and Its Effect on Lending Rates
Freddie Mac, February 2016 article titled Freddie Mac Update

Agency CMBS Summary Matrix

Ginnie Mae Fannie Mae Freddie Mac

Project Loan REMICs DUS Megas, K-Deals
DUS REMICs

Program FHA / GNMA Project Loans DUS MBS (Delegated Underwriting Capital Markets Execution
Servicing)

Market Size (Outstanding $93 billion $200 billion $128 billion

Balance)

Bloomberg Ticker GNR Mega: FN FREMF,

REMIC: FNA (FHMS for guaranteed classes)

Example Deal GNR 2015-183 FNA 2015-M17 FREMF 2015-K51

Deal Structure Multi-tranche, Mega: Single-tranche, pass Multi-tranche, sequential pay

sequential pay classes through, classes with credit enhancement
REMIC: Multi-tranche, sequential
pay classes

IO Class Yes Mega: No Yes (multiple)

REMIC: Yes

Average Deal Size Range $180mm - $780mm Mega: $80mm $530mm - $1.25 Bil
REMIC: $550mm

Average # of Loans per Deal 65 Mega: 25 70

REMIC: 135

Loan Terms (most popular) Fixed rate, 35 - 40 year maturities Fixed-rate, 10 year balloon Fixed-rate, 10 year balloon
with full extension maturities with 30 year maturities with 30 year
amortization (10/9.5s) amortization

Payment Schedule Monthly Monthly Monthly

Page | 17
Collateral / Property Types Mostly low, and moderate
income multifamily housing and
healthcare loans (nursing homes
and assisted living facilities)
Proceeds can be used for new
construction or substantial
rehabilitation projects, as well as
refinancing of existing mortgages
Mostly standard conventional
multifamily housing
Other eligible property types:
affordable multifamily housing and
low-income housing tax credit,
seniors housing, manufactured
housing, coops, student housing,
military housing, rural rental
housing
Mostly standard conventional
multifamily housing secured by
occupied, stable and completed
properties
Limited amount of age-restricted
multifamily, student housing,
cooperative housing and Section 8
housing assistance payments (HAP)
contracts
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 Ginnie Mae Fannie Mae Freddie Mac
Project Loan REMICs DUS Megas, K-Deals
DUS REMICs

Loan Origination Process Originated and underwritten by a
network of HUD-approved private
lenders according to FHA statuary
requirements
Loans are insured by HUD, and
Ginnie Mae provides additional
guarantee
Origination and servicing
guidelines are set by Fannie Mae in
DUS program (Delegated
Underwriting Servicing)
Loans are originated,
underwritten and serviced by a
network of private DUS lenders
Loans are shared by a DUS lender
and Fannie Mae according to a loss
sharing arrangement
Originated are
sourced/originated by Freddie
Mac's Program Plus Seller/Servicer
network of private lenders
Loans are underwritten in-house
by Freddie Mac through its Capital
Markets Execution (CME) program

Guarantees Full faith and credit guarantee of Fannie Mae guarantee Freddie Mac guarantee
US government (on the senior classes)

Nature of Guarantee Full recovery and timely payment
of principal and interest
Prepayment penalties are not
guaranteed for IO bondholders
Full recovery and timely payment Timely payment of interest to
of principal and interest senior classes (Classes A1, A2, and
Yield maintenance payments X1)
(YMP) associated with prepayments Timely payment of principal to
are not guaranteed the classes A1 and A2 upon
maturity of any loan, and ultimate
payment of principal by final
distribution date (no extension)
Reimbursement of any realized
losses and expenses allocated to
senior classes upon resolution of
defaulted loans (not on the date
loan default occurs)

Call Protection "2/8". Lockout for 2yrs, followed
by 8yrs prepayment penalty which
declines 1% annually from 8% to
1%. Once the most popular call
provision (i.e. 2005-2013).
"5/8". Lockout for 5yrs, followed
by 5yrs prepayment penalty which
declines 1% annually from 5% to
1%. Once the most popular call
provision (i.e. pre-2005).
"Decreasing 10". No lockout
period. Prepayment penalties begin
immediately, starting at 10%, which
decrease 1% annually until gone.
Currently the most popular penalty
type.
"10/9.5" DUS MBS. Yield Lockout and Defeasance for the
Maintenance for 9.5yrs, open last 6 term of the loan except for the last
months (most popular) 3 months
"7/6.5" DUS MBS. Yield
Maintenance for 6.5yrs, open last 6
months
Call protection features can also
include defeasance, prepayment
fees and lockout
Fannie Mae also places a fixed,
1% penalty on prepayments which
occur after YMP expire, until final 3
months prior to balloon.

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 Ginnie Mae Fannie Mae Freddie Mac
Project Loan REMICs DUS Megas, K-Deals
DUS REMICs

Market Pricing Assumption 15% CPJ, the conventional Project 0% CPY: zero defaults and no
Loan Default (PLD) curve for
default, and 15% flat CPR for
voluntary prepayments after
lockout
0% CPR
prepayments after lockout
Vectored analysis; due to
passthrough of YM penalties on
prepayments, vectored speeds
need to be applied to capture
"true" value. Historically, 0% CPR
was (and to some degree, still is)
the conventional market pricing
assumption, but historical
performance of these securities
illustrates the need for further
prepay analysis

Sources: Ginnie Mae, Fannie Mae, Freddie Mac, CREFC, Credit Suisse, Morgan Stanley, Bloomberg

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