DBRS Morningstar Finalizes Provisional Ratings on Arbor Realty Commercial Real Estate Notes 2021-FL3 Ltd.

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings to the following classes of notes issued by Arbor Realty Commercial Real Estate Notes 2021-FL3 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)

All trends are Stable.

The initial collateral consists of 36 floating-rate mortgage loans and senior participations secured by 50 mostly transitional properties, with an initial cut-off date balance totaling approximately $1.19 billion. Each collateral interest is secured by a mortgage on a multifamily property or a portfolio of multifamily properties. The transaction is a managed vehicle, which includes an 180-day ramp-up acquisition period and 30-month reinvestment period. The ramp-up acquisition period will be used to increase the trust balance by $352.2 million to a total target collateral principal balance of $1.5 billion. DBRS Morningstar assessed the $352.2 million ramp component using a conservative pool construct, and, as a result, the ramp loans have expected losses above the pool WA loan expected loss. During the reinvestment period, so long as the note protection tests are satisfied and no EOD has occurred and is continuing, the collateral manager may direct the reinvestment of principal proceeds to acquire reinvestment collateral interest, including funded companion participations, meeting the eligibility criteria. The eligibility criteria, among other things, has minimum DSCR, LTV, and loan size limitations. In addition, mortgages exclusively secured by multifamily properties are allowed as ramp-up collateral interests, with a small portion of student housing properties (7.5% of total pool balance) allowed during the reinvestment period. Lastly, the eligibility criteria stipulates a rating agency confirmation (RAC) on ramp loans, reinvestment loans, and pari passu participation acquisitions above $500,000 if a portion of the underlying loan is already included in the pool, thereby allowing DBRS Morningstar the ability 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 NCF, 21 loans, representing 51.9% of the initial pool balance, had a DBRS Morningstar As-Is DSCR of 1.00x or below, a threshold indicative of default 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 to above-market levels. The transaction will have a sequential-pay structure.

The sponsor for the transaction, Arbor Realty SR, Inc., is a majority-owned subsidiary of Arbor Realty Trust, Inc. (Arbor; NYSE: ABR) and an experienced commercial real estate (CRE) collateralized loan obligation (CLO) issuer and collateral manager. The ARCREN 2021-FL3 transaction will be Arbor’s 16th post-crisis CRE CLO securitization, and the firm has six outstanding transactions representing approximately $4 billion in investment-grade proceeds. In total, Arbor has been an issuer and manager of 15 CRE CLO securitizations totaling roughly $7.2 billion. Additionally, Arbor will purchase and retain 100.0% of the Class F Notes, the Class G Notes, and the Preferred Shares, which total $262,500,000, or 17.5% of the transaction total.

The transaction's initial collateral composition consists entirely of multifamily properties, which 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. The subject pool includes garden-style communities and midrise/high-rise buildings. After closing, as part of the ramp-up and reinvestment period, the collateral manager may only acquire loans secured by multifamily properties. The prior ARCREN 2021-FL2 transaction allowed the collateral manager to also acquire industrial and office properties. Compared to the ARCREN 2021-FL2 transaction, the subject pool has more favorable property type requirements during the reinvestment period.

Thirty-three loans, representing 88.0% of the 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, which results in a higher sponsor cost basis in the underlying collateral and aligns the financial interests between the sponsor and lender.

The WA DBRS Morningstar Stabilized LTV is lower than recently rated Arbor transactions. Eleven loans, representing 25.8% of the total trust balance, have a DBRS Morningstar Stabilized LTV less than 70.0%, which decreases refinance risk at maturity. Two of these loans are in the top 10 largest loans in the pool, including Bevel LIC (#2) and Commons at White Marsh (#8). Additionally, there are no loans in the pool with a DBRS Morningstar Stabilized LTV of 80.0% or greater.

The initial collateral pool is diversified across 15 states and has a loan Herfindahl score of approximately 30.1. The loan Herfindahl score is similar to recent Arbor CRE CLO transactions. Three of the loans, representing 15.1% 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.

The eligibility criteria has degraded from prior transactions, and now allows for higher LTV and lower DSCR's when compared to the two prior ARCREN 2021 transactions. The collateral manager has the option to acquire multifamily loans with an As-Stabilized LTV of 80.0% and a minimum DSCR of 1.15x. This compares to 75.0% LTV and 1.25x DSCR in ARCREN 2021-FL1 and ACREN 2021-FL2. DBRS Morningstar modeled the hypothetical ramp-up loans with the maximum LTV of 80.0% and DSCR minimum of 1.15x, which results in higher POD and LGD adjustments compared to the prior 2021 ARCREN transactions. Before the collateral manager can acquire new loans, the loans will be subject to a No Downgrade Confirmation by DBRS Morningstar. The business plan score is an input into the DBRS Morningstar model and drives the blended POD used for the loan's expected loss. A riskier business plan drives a higher POD.

The transaction is managed and includes both a ramp-up and reinvestment period, which could result in negative credit migration and/or an increased concentration profile over the life of the transaction. The deal's initial collateral composition is 100.0% multifamily. During the ramp-up period, only loan secured by multifamily properties can be added. However, during the reinvestment period, student housing loans can be added as well, as long as they do not exceed 7.5% of the total pool balance. Future loans cannot be secured by office, hospitality, industrial, retail, or healthcare-type facilities, such as assisted living and memory care. The risk of negative credit migration is also partially offset by eligibility criteria that outline DSCR, LTV, property type, and loan size limitations for ramp and reinvestment assets. Before ramp loans, reinvestment loans and companion participations above $500,000 can be acquired by the Collateral manager, a No Downgrade Confirmation is required from DBRS Morningstar. DBRS Morningstar accounted for the uncertainty introduced by the 180-day ramp-up period by running a ramp scenario that simulates the potential negative credit migration in the transaction based on the eligibility criteria.

DBRS Morningstar has analyzed the loans to a stabilized cash flow that is, in some instances, above the in-place 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 analyzes LGD based on its As-Is LTV, assuming the loan is fully funded.

All loans in the pool have floating interest rates and are IO during the initial loan term, as well as during all extension terms, creating interest rate risk and lack of principal amortization. DBRS Morningstar stresses interest rates based on the loan terms and applicable floors or caps. The DBRS Morningstar adjusted DSCR is a model input and drives loan level POD's and LGD's. 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.

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.

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, 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.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

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.

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

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