DBRS Assigns New Ratings to Arbor Realty Commercial Real Estate Notes 2018-FL1, Ltd.

DBRS, Inc. (DBRS) assigned new ratings to the following classes of Secured Floating-Rate Notes to be issued by Arbor Realty Commercial Real Estate Notes 2018-FL1, Ltd. (the Issuer):

-- Class A Senior Secured Floating Rate Notes at AAA (sf)
-- Class A-S Senior Secured Floating Rate Notes at AAA (sf)
-- Class B Secured Floating Rate Notes at AA (low) (sf)
-- Class C Secured Floating Rate Notes at A (low) (sf)
-- Class D Secured Floating Rate Notes at BBB (low) (sf)
-- Class E Floating Rate Notes at BB (low) (sf)
-- Class F Floating Rate Notes at B (low) (sf)

All trends are Stable.

The transaction is a managed collateralized loan obligation pool that totals $560.0 million. The initial collateral consists primarily of multifamily properties, though there is also one self-storage property, one office property and one health-care property, with the vast majority having some level of transition or stabilization, which is the premise for seeking floating-rate short-term debt. The transaction has a reinvestment period expected to expire in June 2022. Reinvestment is subject to Eligibility Criteria that includes a rating agency condition (RAC) by DBRS. The initial pool consists of 28 loans totaling $494.4 million. Most of the loans are secured by current cash-flowing assets in a period of transition, though there are two loans with no current in-place cash flow; however, all loans have viable plans and a viable loan structure to stabilize and improve the asset value. DBRS analyzed and modeled the existing loan pool in addition to loans that can be purchased subject to the Eligibility Criteria in the reinvestment period; DBRS assumes that the loans purchased within the reinvestment period will migrate to the least-favorable criteria, as defined in the Eligibility Criteria, with consideration given to the initial pool as well. 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 reinvestment period in order to evaluate any credit drift caused by loan concentrations. Following the reinvestment period, the transaction will have a sequential-pay structure.

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, 96.6% of loans in the initial pool have 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 22 loans, or 85.0% 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 the assets to 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 seven 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.; Arbor Realty Commercial Real Estate Notes 2016-FL1, Ltd.; Arbor Realty Commercial Real Estate Notes 2017-FL1, Ltd.; Arbor Commercial Real Estate Notes 2017-FL2, Ltd; and Arbor Commercial Real Estate Notes 2017-FL3, Ltd. DBRS has reviewed Arbor Multifamily Lending, LLC’s servicing platform (and special servicing) and finds it to be an acceptable servicer. The Class E and F Notes and the preferred shares will be retained by ARMS Equity, an affiliate of the trust asset seller. The non-offered notes and preferred shares represent 21.3% of the transaction balance.

All but three loans in the initial pool are secured by multifamily properties. Exposure to industrial properties, retail properties, office properties, self-storage properties, hospitality properties or health-care properties in the trust is capped at 30.0% during the reinvestment period per the Eligibility Criteria. Eighteen loans, totaling 52.2% of the initial pool balance, represent acquisition financing with borrowers contributing equity to the transaction. The overall weighted-average (WA) DBRS Term DSCR and DBRS Refinance (Refi) DSCR of 0.72x and 0.88x, respectively, and corresponding DBRS Debt Yield and Exit Debt Yield of 5.2% and 7.6%, respectively, are considered very high leverage financing. The DBRS Term DSCR and DBRS Refi DSCR are based on the DBRS In-Place NCF and debt service calculated using a stressed interest rate, respectively. The WA stressed rate used of 7.35% is 0.96% greater than the current WA interest rate of 6.28% (based on WA mortgage spread and an assumed 1.93% one-month LIBOR index). Regarding the significant refinance risk indicated by the DBRS Refi DSCR of 0.88x, 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 also 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.

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

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

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

The principal methodology is North American Multi-borrower CMBS Methodology, which can be found on dbrs.com under Methodologies. For a list of the Structured Finance related methodologies that may be used during the rating process, please see the DBRS Global Structured Finance Related Methodologies document on www.dbrs.com. 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.

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

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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