DBRS Morningstar Finalizes Provisional Ratings on Arbor Realty Commercial Real Estate Notes 2021-FL1, Ltd.

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of commercial mortgage-backed notes issued by Arbor Realty Commercial Real Estate Notes 2021-FL1, Ltd. (ARCREN 2021-FL1 or the Issuer):

-- Class A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

All trends are Stable.

The initial collateral consists of 37 floating-rate mortgage loans and senior participations secured by 64 mostly transitional properties, with an initial cut-off date balance totaling $635.2 million, which includes approximately $12.4 million of non-interest-accruing future funding that the Issuer will acquire at closing. Each collateral interest is secured by a mortgage on a multifamily property. The transaction is a managed vehicle, which includes an 180-day ramp-up acquisition period and 30-month reinvestment period. The ramp-up acquisition period will be used to increase the trust balance by $149.8 million to a total target collateral principal balance of $785.0 million. DBRS Morningstar assessed the $149.8 million ramp component using a conservative pool construct, and, as a result, the ramp loans have expected losses above the pool weighted-average (WA) loan expected loss. During the reinvestment period, so long as the note protection tests are satisfied and no event of default has occurred and is continuing, the collateral manager may direct the reinvestment of principal proceeds to acquire reinvestment collateral interest, including funded companion participations, meeting the eligibility criteria. The eligibility criteria, among other things, has minimum debt service coverage ratio (DSCR), loan-to-value (LTV) ratio, and loan size limitations. In addition, only mortgages secured by multifamily properties are allowed. Lastly, the eligibility criteria stipulates a rating agency confirmation (RAC) on ramp loans, reinvestment loans, and pari passu participation acquisitions above $1.0 million if a portion of the underlying loan is already included in the pool, thereby allowing DBRS Morningstar the ability to review the new collateral interest and any potential impacts to the overall ratings.

For the floating-rate loans, DBRS Morningstar used the one-month Libor index, which is based on the lower of a DBRS Morningstar stressed rate that corresponded to the remaining fully extended term of the loans or the strike price of the interest rate cap with the respective contractual loan spread added to determine a stressed interest rate over the loan term. When the cut-off balances were measured against the DBRS Morningstar As-Is Net Cash Flow, 16 loans, representing 47.1% of the initial pool balance, had a DBRS Morningstar As-Is DSCR of 1.00 times (x) or below, a threshold indicative of default risk. Additionally, the DBRS Morningstar Stabilized DSCR of four loans, representing 14.2% of the initial pool balance, are below 1.00x, which is indicative of elevated refinance risk. The properties are often transitioning with potential upside in cash flow; however, DBRS Morningstar does not give full credit to the stabilization if there are no holdbacks or if other loan structural features in place are insufficient to support such treatment. Furthermore, even with the structure provided, DBRS Morningstar generally does not assume the assets will stabilize to above-market levels.

The transaction will have a sequential-pay structure.

The sponsor for the transaction, Arbor Realty SR, Inc., is a majority-owned subsidiary of Arbor Realty Trust, Inc. (Arbor; NYSE: ABR) and an experienced commercial real estate (CRE) collateralized loan obligation (CLO) issuer and collateral manager. The ARCREN 2021-FL1 transaction will be Arbor’s 14th post-crisis CRE CLO securitization, and the firm has five outstanding transactions representing approximately $2 billion in investment-grade proceeds. Additionally, Arbor will purchase and retain 100.0% of the Class F Notes, the Class G Notes, and the Preferred Shares, which total $129,525,000, or 16.5% of the transaction total.

Throughout the term of the transaction, only multifamily loans are permitted. Multifamily properties benefit from staggered lease rollover and generally low expense ratios compared with other property types. While revenue is quick to decline in a downturn because of the short-term nature of the leases, it is also quick to respond when the market improves. The subject pool includes garden-style communities and mid-rise/high-rise buildings, and the eligibility criteria does not permit the collateral manager to purchase other types of commercial mortgage assets.

Twenty-six loans, representing 71.1% of the pool balance, represent acquisition financing. Acquisition financing generally requires the respective sponsor(s) to contribute material cash equity as a source of funding in conjunction with the mortgage loan, resulting in a higher sponsor cost basis in the underlying collateral and aligns the financial interests between the sponsor and lender.

The initial collateral pool is diversified across 11 states and has a loan Herfindahl score of approximately 24.5. The loan Herfindahl score is similar to recent ACREN CRE CLO transactions. Three of the loans, representing 14.2% of the initial pool balance, are portfolio loans that benefit from multiple property pooling. Mortgages backed by cross-collateralized cash flow streams from multiple properties typically exhibit lower cash flow volatility.

The business plan score for loans DBRS Morningstar analyzed was between 1.38 and 2.28, with an average of 1.86. Higher DBRS Morningstar business plan scores indicate more risk in the sponsor’s business plan. DBRS Morningstar considers the anticipated lift at the property from current performance, planned property improvements, sponsor experience, projected time horizon, and overall complexity of the business plan. Compared with similar transactions, the subject has a low average business plan score, which is indicative of lower risk.

The loan collateral was generally found to be in good physical condition as evidenced by the two loans (9.1% of the trust balance) secured by properties that DBRS Morningstar deemed to be Excellent in quality. An additional four loans, representing 22.8% of the trust balance, are secured by properties with Above Average quality. Furthermore, only two loans are backed by properties that DBRS Morningstar considered to be Average – quality, representing just 4.7% of the trust balance, and no collateral was classified as Below Average or Poor quality.

The ongoing Coronavirus Disease (COVID-19) pandemic continues to pose challenges and risks to the CRE sector, and while DBRS Morningstar expects multifamily to fare better than most other property types, the long-term effects on the general economy and consumer sentiment are still unclear. Arbor provided coronavirus and business plan updates for all loans in the pool, confirming that all debt service payments have been received in full through January 2021. Furthermore, no loans are in forbearance or other debt service relief, and only two modifications were requested, Falls of Braeburn (Prospectus ID#21; 1.6% of the pool balance) and The Fountains Apartments (Prospectus ID#31; 0.9% of the pool balance). However, these modifications were in response to the loans’ approaching maturity. Eighteen loans, totaling 66.0% of the trust balance, represent loans originated after March 2020, or the beginning of the pandemic. Loans originated after the pandemic include timely property performance reports and recently completed third-party reports, including appraisals. Given the uncertainty and elevated execution risk stemming from the coronavirus pandemic, 26 loans, totaling 64.6% of the trust balance, have substantial upfront interest reserves, some of which are expected to cover six months or more of interest shortfalls. For example, the Windham Chase Apartments loan (Prospectus ID#11; 3.5% of the trust balance) has a $1.2 million interest reserve that equals 12 months of debt service. Similarly, The Eddy at Riverview Landing loan (Prospectus ID#7; 5.4% of the trust balance) has an interest reserve of nearly $2 million, equivalent to nine months of debt service payments.

The transaction is managed and includes both a ramp-up and reinvestment period, which could result in negative credit migration and/or an increased concentration profile over the life of the transaction. The deal is 100.0% multifamily, and nonmultifamily loans are not allowed through the ramp-up or reinvestment period. Furthermore, future loans cannot be secured by student housing or healthcare type facilities such as assisted living and memory care. The risk of negative credit migration is also partially offset by eligibility criteria that outline DSCR, LTV, property type, and loan size limitations for ramp and reinvestment assets. DBRS Morningstar has RAC on new ramp loans, companion participations above $1.0 million, and reinvestment loans. DBRS Morningstar reviews these loans before they come into the pool to assess any potential ratings impact. DBRS Morningstar accounted for the uncertainty introduced by the 180-day ramp-up period by running a ramp scenario that simulates the potential negative credit migration in the transaction based on the eligibility criteria.

DBRS Morningstar has analyzed the loans to a stabilized cash flow that is, in some instances, above the in-place cash flow. It is possible that the sponsors will not successfully execute their business plans and that the higher stabilized cash flow will not materialize during the loan term, particularly with the ongoing coronavirus pandemic and its impact on the overall economy. A sponsor’s failure to execute the business plan could result in a term default or the inability to refinance the fully funded loan balance. DBRS Morningstar made relatively conservative stabilization assumptions and, in each instance, considered the business plan to be rational and the loan structure to be sufficient to execute such plans. In addition, DBRS Morningstar analyzes loss severity given default based on its As-Is LTV, assuming the loan is fully funded. Twenty-nine loans in the subject pool came through a prior transaction monitored by DBRS Morningstar. For those loans, DBRS Morningstar was able leverage its prior analysis of the loans.

Six loans, representing 26.2% of the trust balance, have DBRS Morningstar Stabilized LTVs equal to or greater than 80.0%, which significantly increases refinance risk at maturity. Four of these loans are in the top 10 largest loans in the pool, including Commuter Portfolio (Prospectus ID#3), The Kathryn at Grand Park (Prospectus ID#4), The Maxwell at Grand Park (Prospectus ID #5), and Peppertree Apartments (Prospectus ID#10). All six loans were originated in 2020 and 2021 and have sufficient time to reach stabilization. Additionally, half of the loans (72.1% of the allocated loan balance) are acquisition financing, with the sponsor contributing a considerable amount of cash equity at closing. These six loans have a WA expected loss of 8.3% (ranging from 5.8% to 10.4%), which is nearly 125 basis points higher than the WA expected loss of 7.1% for the deal. The largest of these six loans, Commuter Portfolio (6.3% of the trust balance), is secured by a granular portfolio of 24 multifamily properties in New Jersey. The loan benefits from favorable diversification, with a WA Market Rank of 5 and Metropolitan Statistical Area Group 3, resulting in a favorable expected loss below the deal average.

All loans in the pool have floating interest rates and are interest only during the initial loan term, as well as during all extension terms, creating interest rate risk. For the floating-rate loans, DBRS Morningstar used the one-month Libor index, which is based on the lower of a DBRS Morningstar stressed rate that corresponded to the remaining fully extended term of the loans or the strike price of the interest rate cap with the respective contractual loan spread added to determine a stressed interest rate over the loan term. Additionally, all loans have extension options, and to qualify for these options, the loans must meet minimum DSCR and LTV requirements. All loans are short term and, even with extension options, have a fully extended loan term of five years maximum. The borrowers for five loans, totaling 17.7% of the trust balance, have purchased Libor rate caps that range between 1.25% and 3.50% to protect against rising interest rates over the term of the loan.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

All ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

Notes:
All figures are in U.S. dollars unless otherwise noted.

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is North American CMBS Multi-Borrower Rating Methodology (August 7, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria. For a list of the structured-finance-related methodologies that may be used during the rating process, please see the DBRS Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.com in the Commentary tab under Regulatory Affairs. Please note that not every related methodology listed under a principal structured finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrsmorningstar.com.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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