DBRS Morningstar Assigns Provisional Ratings to Arbor Realty Commercial Real Estate Notes 2020-FL1

DBRS, Inc. (DBRS Morningstar) assigned provisional ratings to the following classes of commercial mortgage-backed notes to be issued by Arbor Realty Commercial Real Estate Notes 2020-FL1, Ltd. (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 (high) (sf)
-- Class E BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

All trends are Stable.

The initial collateral consists of 31 floating-rate mortgages secured by 97 mostly transitional properties, with an initial cut-off balance totaling $640.52 million, including approximately $27.4 million of non-interest-accruing future funding. The transaction is a managed vehicle with a 180-day ramp-up period, a target collateral principal balance of $800.0 million, and a 36-month principal reinvestment period. The subject transaction, unlike prior deals, also includes an optional note repricing provision. For more information, please refer to the Transaction Structural Features section of the presale report.

Most loans are in a period of transition with plans in place to stabilize and improve the asset value. The Issuer may direct principal proceeds to acquire a portion of one or more companion participations without rating agency confirmation (RAC), subject to the reinvestment and eligibility criteria. The reinvestment and eligibility requires, among other things, for the underlying mortgage loan not to be a defaulted mortgage loan or specially serviced loan, for no event of default to have occurred and/or be continuing, and for certain note protection tests to be satisfied. Commercial real estate collateralized loan obligation transactions often allow for principal proceeds to be held in an account and used to purchase pari passu companion participations of existing trust assets, instead of being used to pay down bonds. Typically, if RAC is not required to acquire these participations, DBRS Morningstar performs a paydown analysis whereby the loans in the pool with the lowest expected loss (EL) that have no future funding are assumed to pay off and then all future funding is brought in, with the pool balance remaining constant. The effect of this paydown analysis is that the EL migrates to a higher level as DBRS Morningstar assumes a worst-case scenario where only good loans pay off, and as a result, the pool loss levels are higher than they would be on the pool as it stands at closing. The transaction stipulates a $1.0 million threshold on pari passu participation acquisitions before RAC is required if a portion of the underlying loan is already included in the pool. Please see the presale report for participations that the Issuer will be allowed to acquire.

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, 15 loans, comprising 43.2% of the initial pool, had a DBRS Morningstar As-Is Debt Service Coverage Ratio (DSCR) below 1.00 times (x), a threshold indicative of default risk. Additionally, none of the DBRS Morningstar Stabilized DSCRs 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 above market levels. The transaction will have a sequential-pay structure.

The loans are all secured by multifamily properties. Additionally, none of the multifamily loans in the pool are currently secured by a student housing property, which often exhibits higher cash flow volatility than traditional multifamily properties.

The initial collateral pool is diversified across 13 states and has a loan Herfindahl score of approximately 23.2. Three of the loans, representing 14.6% 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.

Twelve loans in the pool, totaling 83.2% of the DBRS Morningstar sample by cut-off-date pool balance, are backed by a property with a quality deemed to be Average, Average (+), or Above Average by DBRS Morningstar. The borrowers of 12 of the floating-rate loans have purchased LIBOR rate caps that range between 1.8% and 4.4% to protect against rising interest rates over the term of the loan.

Twenty-four loans, representing 68.9% of the initial 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.

The pool consists of mostly transitional assets. Given the nature of the assets, DBRS Morningstar determined a sample size representing 72.4% of the pool cut-off-date balance. Physical site inspections were also performed, and each sampled asset received a business plan score. DBRS Morningstar also notes that when it visits the markets, it may actually visit properties more than once to follow the progress (or lack thereof) toward stabilization. The servicer is also in constant contact with the borrowers to track progress.

All of the loans in the pool have floating interest rates, and all loans are interest-only during the original term with original term ranges between 12 months and 36 months, 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 in order to qualify for these options, the loans must meet minimum DSCR and loan-to-value (LTV) requirements.

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 analyzed loss given default based on the as-is LTV, assuming the loan is fully funded.

The pool loss multiples for this transaction are outside the ranges identified for CMBS conduit transactions, which are representative of a universe comprising approximately 90% of CMBS 2.0, or later, conduit transactions. In general, CRE CLO transactions are structured with lower leverage and comprise pools of higher average expected loss than typical conduit transactions, resulting in pool loss multiples that are typically lower than those for conduits. For that reason, DBRS Morningstar typically utilizes the multiples indicated by the pool-level distribution of losses when rating CRE CLO transactions, and relies less on the multiple ranges implied by the CMBS 2.0 conduit universe. Correspondingly, DBRS Morningstar utilized the multiples indicated by the pool-level distribution of losses as the basis for calculating deviations for this transaction.

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 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 Morningstar 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.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at [email protected].

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

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