DBRS Morningstar Finalizes Provisional Ratings on Arbor Realty Commercial Real Estate Notes 2019-FL2, Ltd.

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of secured floating-rate notes issued by Arbor Realty Commercial Real Estate Notes 2019-FL2, 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 (high) (sf)
-- Class E Secured Floating Rate Notes at BBB (low) (sf)
-- Class F Floating Rate Notes at BB (low) (sf)
-- Class G Floating Rate Notes at B (low) (sf)

All trends are Stable.

The transaction is a managed collateralized loan obligation pool that totals $635.0 million. The initial collateral consists of loans backed by multifamily properties. The vast majority of these properties have 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 November 2022. Reinvestment is subject to Eligibility Criteria that includes a rating agency condition (RAC) by DBRS Morningstar. The initial pool consists of 27 loans totaling $510.9 million secured by current cash-flowing assets in various stages of transition. DBRS Morningstar analyzed and modeled the existing loan pool in addition to loans that can be purchased subject to the Eligibility Criteria in the reinvestment period and assumes that the loans purchased within the reinvestment period will migrate toward the least-favorable criteria, as defined in the Eligibility Criteria, with consideration given to the initial pool composition as well. DBRS Morningstar 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 Morningstar 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.

As a result of the floating-rate nature of the loans, the index used (one-month LIBOR) was 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 In-Place Net Cash Flow (NCF) and their respective stressed constants, 15 loans, or 52.6% of the initial pool, have term debt service coverage ratios (DSCRs) below 1.0 times (x), a threshold indicative of a higher likelihood of term default. Additionally, the DBRS Morningstar Stabilized DSCR for only one loan, Preston Hollow, representing 4.1% of the initial pool balance, is below 1.00x, which is indicative of elevated refinance risk. The properties are often transitioning with potential upside in the 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 were insufficient to support such treatment. Furthermore, even with the structure provided, DBRS Morningstar 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 transactions issued in 2012 and 2013, DBRS Morningstar has rated ten 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 Realty Commercial Real Estate Notes 2017-FL2, Ltd.; Arbor Realty Commercial Real Estate Notes 2017-FL3, Ltd.; Arbor Realty Commercial Real Estate Notes 2018-FL1, Ltd.; Arbor Realty Commercial Real Estate Notes 2019-FL1, Ltd.; and Arbor Realty Collateralized Loan Obligation 2014-1, Ltd. DBRS Morningstar has reviewed Arbor Multifamily Lending, LLC’s servicing platform (and special servicing) and finds it to be an acceptable servicer. The Class F notes, the Class G notes and the preferred shares will be retained by ARMS Equity, an affiliate of the mortgage asset seller. The non-offered notes and preferred shares represent 15.9% of the transaction balance.

All loans in the initial pool are secured by multifamily properties. Although multifamily properties make up 100.0% of the initial collateral pool, exposure to industrial properties, retail properties, office properties, self-storage properties, hospitality properties or health-care properties in the trust is capped at 25.0% during the reinvestment period per the Eligibility Criteria. Twenty-five loans, totaling 85.7% of the initial pool balance, represent acquisition financing with borrowers contributing equity to the transaction. The properties are predominately located in suburban markets with the overall pool’s weighted-average (WA) DBRS Morningstar Market Rank at 3.4, which is not particularly high. One loan, totaling 4.1% of the pool, is located in a market with a DBRS Morningstar Market Rank of 1; eight loans, totaling 27.0% of the pool, are located in markets with a DBRS Morningstar Market Rank of 2; eight loans, totaling 24.6% of the pool, are in markets with a DBRS Morningstar Market Rank of 3; four loans, totaling 11.5% of the pool, are in markets with a DBRS Morningstar Market Rank of 4; and six loans, totaling 32.8% of the pool, are in markets with a DBRS Morningstar Market Rank of 5. The market ranks correspond to zip codes that are more suburban and tertiary in nature. None of the loans are located in urban markets, which are classified as DBRS Morningstar Market Ranks 6, 7 and 8.

All 27 loans have floating interest rates, and all loans are interest only during both the original term and the extension periods, which range from 24 months to 60 months, creating interest rate risk. All but three loans have extension options between six and 36 months.

The DBRS Morningstar As-Is DSCR is based on the DBRS Morningstar In-Place NCF and debt service calculated using a stressed interest rate. The WA stressed rate used is 5.418%, which is in line with the current WA interest rate of 5.362% (based on WA mortgage spread and an assumed 2.180% one-month LIBOR index). 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 Morningstar associates its loss given default (LGD) based on the assets’ DBRS Morningstar As-Is Loan-to-Value (LTV) ratio, which does not assume that the stabilization plan and cash flow growth will ever materialize. The DBRS Morningstar As-Is LTV is considered high at 85.2%, reflecting the transitional nature of the pool with substantial future funding as well as the generally high leverage. The high LTV results in a WA DBRS Morningstar Expected Loss of 6.8% for the pool, which translates to credit-enhancement levels at each rating category.

DBRS Morningstar has analyzed the loans to a stabilized cash flow that is, in some instances, above the current in-place cash flow. There is a possibility that the sponsors will not execute their business plans as expected and that the higher stabilized cash flow will not materialize during the loan term. 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 future funding amounts to be sufficient to execute such plans. In addition, DBRS Morningstar analyzes the LGD based on the DBRS Morningstar As-Is LTV, assuming the loan is fully funded.

Two loans, totaling only 14.3% of the initial pool balance, represent refinance financing. The refinance financings within this securitization generally do not require the respective sponsor(s) to contribute material cash equity as a source of funding in conjunction with the mortgage loan, resulting in a lower sponsor cost basis in the underlying collateral. Both of the refinance loans represent new-construction buildings with construction completed, and none of these are structured with future funding. This suggests that a large majority of the refinance loans have already executed business plans and are closer to stabilization, which would partially mitigate the higher risk associated with a sponsor’s lower cost basis.

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

For supporting data and more information on this transaction, please log into www.viewpoint.dbrs.com.

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 the North American CMBS Multi-borrower Rating Methodology, which can be found on www.dbrs.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 Global Structured Finance Related Methodologies document, which can be found on www.dbrs.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.

The rated entity or its related entities did 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. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS Morningstar long-term rating scale definition indicates that ratings of CCC or lower are assigned when the bond is highly likely to default or default is imminent, thereby prevailing over a sensitivity analysis.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at [email protected].

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