DBRS Morningstar Finalizes Provisional Ratings on HGI CRE CLO 2021, Ltd.

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of notes issued by HGI CRE CLO 2021-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 (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

The initial collateral includes 23 mortgage loans or senior notes, consisting of 10 whole loans and 13 fully funded senior, senior pari passu, or pari passu participations secured by multifamily real estate properties with an initial cut-off date balance totaling $498.2 million. All 23 of the mortgages have floating interest rates tied to the Libor index. The transaction is a managed vehicle, which includes a ramp-up acquisition period and subsequent 18-month reinvestment period. The ramp-up acquisition period will be used to increase the trust balance by $60.0 million to an aggregate deal balance of $558.2 million. DBRS Morningstar assessed the $60.0 million ramp component using a conservative pool construct, and, as a result, the ramp loans have expected losses (E/Ls) above the weighted-average pool E/L. 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 that meet the eligibility criteria. The eligibility criteria, among other things, has minimum debt service coverage ratio (DSCR), loan-to-value ratio (LTV), and loan size limitations. Lastly, the eligibility criteria stipulates Rating Agency Confirmations on ramp loans, reinvestment loans, and a $1.0 million threshold on pari passu participation acquisitions if a portion of the underlying loan is already included in the pool, thereby allowing DBRS Morningstar 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 (NCF), 21 loans, representing 92.6% 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, 15 loans, representing 66.1% of the initial pool balance, had a DBRS Morningstar Stabilized DSCR of 1.00x or below, which is indicative of elevated refinance risk. Most properties are 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 the other loan structural features are insufficient to support such treatment. Furthermore, even with the structure provided, DBRS Morningstar generally does not assume the assets to stabilize above current market levels.

The transaction will have a sequential-pay structure.

All loans in the total pool are secured by multifamily properties across 11 states including California, Texas, Florida, and New Jersey. Multifamily properties have historically seen lower probability of default (POD) and typically see lower E/Ls within the DBRS Morningstar model. 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. Additionally, most loans in the pool are secured by traditional multifamily properties, such as garden-style communities or midrise/high-rise buildings, with no independent living/assisted-living/memory care facilities included in this pool.

Eighteen loans, composing of 73.4% of the initial trust balance, represent acquisition financing wherein sponsors contributed significant cash equity as a source of initial funding in conjunction with the mortgage loan, resulting in a moderately high sponsor cost basis in the underlying collateral.

Lower Business Plan Execution Risk: The business plan score (BPS) for loans DBRS Morningstar analyzed was between 1.38 and 3.00, with an average of 2.26. On a scale of 1 to 5, a higher DBRS Morningstar BPS indicates 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. Compared with similar transactions, this pool has a lower average BPS, which is indicative of lower risk.

The ongoing Coronavirus Disease (COVID-19) pandemic continues to pose challenges and risks to the commercial real estate (CRE) sector, and while DBRS Morningstar expects multifamily (100.0% of the pool) to fare better than most other property types, the long-term effects on the general economy and consumer sentiment are still unclear. DBRS Morningstar received coronavirus and business plan updates for all loans in the pool, confirming that the sponsors have made all debt service payments in full through March 2021. Furthermore, no loans are in forbearance or other debt service relief, and no borrowers requested loan modifications. All loans in the pool have been originated after March 2020, or the beginning of the pandemic in the U.S. Loans originated after the pandemic include timely property performance reports and recently completed third-party reports, including appraisals.

The sponsor for the transaction, HGI CFI REIT, is a first-time CRE collateralized loan obligation issuer and collateral manager. HGI CFI REIT will purchase and retain 100.0% of the eligible horizontal residual interest in accordance with the U.S. Credit Risk Retention Rules. DBRS Morningstar met with the sponsor to better understand its investment strategy, organization structure, and origination practices. Based on this meeting, DBRS Morningstar found that HGI CFI REIT met its issuer standards.

The transaction is managed and includes three delayed-close loans, a ramp-up component, a reinvestment period, and a replenishment period, which could result in negative credit migration and/or an increased concentration profile over the life of the transaction. Eligibility criteria for ramp and reinvestment assets partially offsets the risk of negative credit migration. The criteria outlines DSCR, LTV, Herfindahl, and property type limitations. DBRS Morningstar can provide a no-downgrade confirmation for new ramp loans, companion participations above $1.0 million, and new reinvestment loans. Before the loans come into the pool, DBRS Morningstar will analyze them for any potential ratings impact. DBRS Morningstar accounted for the uncertainty introduced by the ramp-up period by running a ramp scenario that simulates the potential negative credit migration in the transaction based on the eligibility criteria.

Transitional Properties: DBRS Morningstar has analyzed the loans to a stabilized cash flow that is, in some instances, above the as-is 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 analyzed loss severity given default based on the as-is credit metrics, assuming the loan was fully funded with no NCF or value upside.

Because of the ongoing coronavirus pandemic, DBRS Morningstar was only able to perform site inspections on two loan in the pool, Transit Village and Park Terrace. As a result, DBRS Morningstar relied more heavily on third-party reports, online data sources, and information from the Issuer to determine the overall DBRS Morningstar property quality score for each loan. DBRS Morningstar made relatively conservative property quality adjustments with only three loans, Cobalt Apartments (2.9% of the pool), Avery Pompano Beach (5.9% of pool), and Harper Place ( 5.6% of pool), having Average + property quality. Furthermore, no loans received an Excellent or Above Average property quality distinction, and three loans, representing 14.1% of the pool, had Average - property quality.

All 23 loans in the pool, have floating interest rates and are interest only during the initial loan term, creating interest rate risk should interest rates increase. 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, which based on historical data DBRS Morningstar model treats more punitively. The borrowers for eight loans, totaling 24.5% of the trust balance, have purchased Libor rate caps that range between 0.50% and 2.00% to protect against rising interest rates over the term of the loan.

Three loans, representing 22.1% of the initial cut-off pool balance, have a sponsor with negative credit history and/or limited financial wherewithal, including Transit Village (Prospectus ID#2), Riverdale Portfolio 2 (Prospectus ID#3), and Harper Place (Prospectus ID#7). For more information about these loans, see the individual write-ups on pages 20, 25, and 31, respectively. DBRS Morningstar deemed these loans to have Weak sponsorship strength, effectively increasing the POD for each loan.

ESG CONSIDERATIONS
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.

For supporting data and more information on this transaction, please log into www.viewpoint.dbrsmorningstar.com DBRS Morningstar provides analysis and in-depth commentary in the DBRS Viewpoint platform.

DBRS Morningstar provides updated analysis and in-depth commentary in the DBRS Viewpoint platform for the following loans in the transaction:

-- Prospectus ID#1 – Cobalt Apartments (11.0% of the pool)
-- Prospectus ID#2 – Transit Village (9.0% of the pool)
-- Prospectus ID#3 – Riverdale Portfolio 2 (7.6% of the pool)
-- Prospectus ID#4 – Laurelwoode Apartments (7.4% of the pool)
-- Prospectus ID#5 – Park Terrace (6.5% of the pool)
-- Prospectus ID#6 – Avery Popano Beach (5.9% of the pool)
-- Prospectus ID#7 – Harper Place (5.6% of the pool)
-- Prospectus ID#8 – Tigertail Ave (5.0% of the pool)
-- Prospectus ID#9 – Drumcastle Apartments (4.6% of the pool)

For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com The platform includes issuer and servicer data for most outstanding CMBS transactions (including non-DBRS Morningstar rated), as well as loan-level and transaction-level commentary for most DBRS Morningstar-rated and -monitored transactions.

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 rating 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 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.

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

DBRS, Inc.
22 West Washington Street
Chicago, IL 60602 USA
Tel. +1 1 312 332-3492