DBRS Assigns Provisional Ratings to Arbor Realty Commercial Real Estate Notes 2017-FL1, Ltd.

DBRS, Inc. (DBRS) has today assigned provisional ratings to the following classes of Secured Floating-Rate Notes (the Notes) to be issued by Arbor Realty Commercial Real Estate Notes 2017-FL1, Ltd. (the Issuer):

-- Class A Senior Secured Floating-Rate Notes at AAA (sf)
-- Class B Secured Floating-Rate Notes at AA (sf)
-- Class C Secured Floating-Rate Notes at BBB (low) (sf)

All trends are Stable.

The transaction is a managed collateralized loan obligation pool that totals $360.0 million. The initial collateral primarily consists of multifamily properties that have some level of transition or stabilization, which is the premise for seeking floating-rate short-term debt. The transaction has a replacement period expected to expire in April 2020. Reinvestment is subject to Eligibility Criteria, which includes a rating agency condition (RAC) by DBRS. The initial pool consists of 22 loans with a total of $296.2 million of participation. Most of the loans are secured by current cash flowing assets in a period of transition, with viable plans and a viable loan structure to stabilize and improve the assets’ value. DBRS analyzed and modeled the existing loan pool in addition to loans that can be purchased subject to the Eligibility Criteria in the replacement period; DBRS assumes that the loans purchased within the replacement period will migrate to the least-favorable characteristics permitted by the Eligibility Criteria. DBRS also anticipates that the pool could become more concentrated in the future in terms of sponsor concentrations or additional concentrations (property type, loan size and geography); as a result, DBRS will have the ability to provide an RAC on loans that are being added to the pool during the replacement period in order to evaluate any credit drift caused by loan concentrations. Following the replacement period, the transaction will have a sequential-pay structure.

DBRS performed site inspections and met with the on-site property manager, leasing agent or representative of the borrowing entity for 19 properties, totaling 86.4% of the initial pool balance. The floating-rate mortgages were analyzed to determine the probability of loan default over the term of the loan and its refinance risk at maturity based on a fully extended loan term. As a result of the floating-rate nature of the loans, the index DBRS used (one-month LIBOR) was the lower of a DBRS 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 In-Place Net Cash Flow (NCF) and their respective stressed constants, there were 21 loans, representing 97.8% of the initial pool balance, with term debt service coverage ratios (DSCRs) below 1.15 times (x), a threshold indicative of a higher likelihood of term default. Additionally, to assess refinance risk, DBRS applied its refinance constants to the balloon amounts, resulting in 13 loans, or 67.5% of the initial pool balance, having refinance DSCRs below 1.00x, relative to the DBRS Stabilized NCF. The properties are often transitioning with potential upside in the cash flow; however, DBRS does not give full credit to the stabilization if there are no holdbacks or if other loan structural features in place were insufficient to support such treatment. Furthermore, even with the structure provided, DBRS generally does not assume that the assets will stabilize above market levels.

The Issuer, servicer, mortgage loan seller and advancing agent are related parties and non-rated entities. Arbor Realty SR, Inc. has a proven track record with several collateralized loan obligation platforms that performed well in 2004, 2005 and 2006. In addition to recently issued transactions in 2012 and 2013, DBRS rated four transactions: Arbor Realty Collateralized Loan Obligation 2014-1, Ltd.; Arbor Realty Commercial Real Estate Notes 2015-FL1, Ltd.; Arbor Realty Commercial Real Estate Notes 2015-FL2, Ltd.; and Arbor Realty Commercial Real Estate Notes 2016-FL1, Ltd. DBRS has reviewed Arbor Multifamily Lending, LLC’s servicing platform (and special servicing) and finds it to be an acceptable servicer. The preferred shares will be retained by ARMS Equity, an affiliate of the trust asset seller. The preferred shares represent 22.5% of the transaction balance.

The loans are predominately secured by multifamily properties, and only two loans, representing 8.3% of the initial pool balance, are secured by self-storage and self-storage/retail properties. Additionally, industrial, retail, office and self-storage properties’ exposure for the trust is capped at 25.0% during the reinvestment period per the Eligibility Criteria. Nineteen loans, totaling 80.0% of the initial pool balance, represent acquisition financing, with borrowers contributing equity to the transaction. The overall weighted-average (WA) DBRS Term and Refinance (Refi) DSCRs of 0.74x and 0.87x, respectively, and corresponding DBRS Debt and Exit Debt Yields of 5.6% and 7.3%, respectively, are considered high-leverage financing. The DBRS Term and Refi DSCRs are based on the DBRS In-Place NCF and debt service calculated using a stressed interest rate. The WA stressed rate used of 7.48% is 1.47% greater than the current WA interest rate of 6.03% (based on WA mortgage spread and an assumed 0.75% one-month LIBOR index). Regarding the significant refinance risk indicated by the DBRS Refi DSCR of 0.87x, the credit enhancement levels are reflective of the increased leverage that is substantially higher than in recent fixed-rate transactions. The assets are generally well positioned to stabilize, and any realized cash flow growth would help to offset a rise in interest rates and improve the overall debt yield of the loans. DBRS associates its probability of default based on the assets’ in-place cash flow, which does not assume that the stabilization plan and cash flow growth will ever materialize. Only two loans, representing 4.2% of the pool, are secured by properties located in tertiary or rural markets. Properties located in tertiary and rural markets were analyzed with significantly higher probabilities of default than those located in urban and suburban markets.

The ratings assigned to the Notes by DBRS are based exclusively on the credit provided by the transaction structure and underlying trust assets. All classes will be subject to ongoing surveillance that could result in upgrades or downgrades by DBRS after the date of issuance.

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

The principal methodologies are North American CMBS Multi-borrower Rating Methodology and Unified Interest Rate Model for Rating U.S. Structured Finance Transactions, which can be found on dbrs.com under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

With regard to due diligence services, DBRS was provided with the Form ABS Due Diligence-15E (Form 15-E), which contains the description of the information that the third party reviewed when conducting the due diligence services and a summary of the findings and conclusions. While DBRS did not rely on the due diligence services outlined in Form 15-E, DBRS did use the Data File outlined in the Independent Accountant’s Report in its analysis to determine the ratings.

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