DBRS Morningstar Assigns Provisional Ratings to FS Rialto 2021-FL3 Issuer, Ltd.

DBRS, Inc. (DBRS Morningstar) assigned provisional ratings to the following classes of notes to be issued by FS Rialto 2021-FL3 Issuer, 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.

Coronavirus Overview
With regard to the Coronavirus Disease (COVID-19) pandemic, the magnitude and extent of performance stress posed to global structured finance transactions remain highly uncertain. This considers the fiscal and monetary policy measures and statutory law changes that have already been implemented or will be implemented to soften the impact of the crisis on global economies. Some regions, jurisdictions, and asset classes are, however, feeling more immediate effects. Accordingly, DBRS Morningstar may apply additional short-term stresses to its rating analysis. For example, DBRS Morningstar may front-load default expectations and/or assess the liquidity position of a structured finance transaction with more stressful operational risk and/or cash flow timing considerations.

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/baselinemacroeconomic-scenarios-application-to-credit-ratings.

The initial collateral consists of 26 short-term, floating-rate mortgage assets with an aggregate cutoff date balance of $1.1 billion secured by 68 properties. The aggregate unfunded future funding commitment of the future funding participations as of the cutoff date is approximately $95.1 million. The holder of the future funding companion participations will be FS CREIT Finance Holdings LLC (the Seller), a wholly owned subsidiary of FS Credit REIT, or an affiliate of the Seller. The holder of each future funding participation has full responsibility to fund the future funding companion participations. The collateral pool for the transaction is managed with a 30-month reinvestment period, which includes the Delayed Close Extension Period. During this period, the Collateral Manager will be permitted to acquire Reinvestment Collateral Interests, which may include Funded Companion Participations, subject to the satisfaction of the Eligibility Criteria and the Acquisition Criteria. The Acquisition Criteria requires that, among other things, the Note Protection Tests are satisfied; no event of default is continuing; and Rialto Capital Management, LLC (Rialto) or one of its affiliates acts as the sub-advisor to the Collateral Manager. The Eligibility Criteria has a minimum debt service coverage ratio (DSCR), loan-to-value ratio (LTV), 19.5 Herfindahl score, and property-type limitations, among other items. Of the 26 loans, one (Paradise Plaza, Prospectus ID#2; representing a total initial pool balance of 6.6%) is a delayed-close loan, unclosed as of October 14, 2021. The Issuer has 90 days after closing to acquire the delayed-close interest. If the Delayed Close Collateral Interest is not acquired within 90 days of the closing date, the Issuer can use the allocated balance of the delayed-close loan to acquire Reinvestment Collateral Interests during the Delayed Close Extension Period. The transaction stipulates that any acquisition of any Funded Companion Participation over $1 million and any Reinvestment Collateral Interest will need a rating agency confirmation regardless of balance size. The loans are mostly secured by cash flowing assets, many of which are in a period of transition with plans to stabilize and improve the asset value. The transaction will have a sequential-pay structure.

Of the 68 properties, 58 are multifamily assets (83.6% of the mortgage asset cutoff date balance). No other property type exceeds 6.6% of the mortgage asset cutoff date balance. The loans are mostly secured by cash flowing assets, most of which are in a period of transition with plans to stabilize and improve the asset value. Nine loans are whole loans and the other 17 are participations with companion participations that have remaining future funding commitments totaling $95.1 million. The future funding for each loan is generally to be used for capital expenditures to renovate the property or build out space for new tenants. All of the loans in the pool have floating interest rates initially indexed to Libor and are interest only (IO) through their fully extended loan term. To determine a stressed interest rate over the loan term, DBRS Morningstar used the one-month Libor index, which was the lower of DBRS Morningstar’s stressed rates that corresponded to the remaining fully extended term of the loans and the strike price of the interest rate cap with the respective contractual loan spread added. When the debt service payments were measured against the DBRS Morningstar As-Is Net Cash Flow (NCF), 11 loans, comprising 47.9% 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. However, the DBRS Morningstar Stabilized DSCR of only two loans, comprising 6.8% of the initial pool balance, was 1.00x or below, 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 the other loan structural features are insufficient to support such treatment. Furthermore, even if the structure is acceptable, DBRS Morningstar generally does not assume the assets will stabilize above market levels.

The securitization sponsor, FS Credit REIT, is an experienced commercial real estate collateralized loan obligation issuer and collateral manager. FS Credit REIT is externally managed by FS Real Estate Advisor, LLC, an affiliate of Franklin Square Holdings, L.P. (FS Investments) and FS Credit REIT Sub-Advisor (Rialto). Founded in 2007, FS Investments had $25 billion in total assets under management as of June 30, 2021. Rialto houses a vertically integrated operating platform and has $7.8 billion in total current assets under management.

FS Rialto 2021-FL3 Holder, LLC, a subsidiary of the Seller, will acquire the Class F Notes, the Class G Notes, and the Preferred Shares, representing the most subordinate 18.1% of the transaction by principal balance.

Four loans, comprising 20.3% of the total pool balance, are secured by properties DBRS Morningstar deemed to be Above Average in quality, with three loans, totaling 12.8% of the total pool balance, secured by properties identified as Average + in quality. Equally importantly, no loans were secured by a property DBRS Morningstar deemed to be Below Average, and only four loans, comprising 9.6% of the total pool balance, are secured by properties DBRS Morningstar deemed to be Average –.

As no loans in the pool were originated prior to the onset of the coronavirus pandemic, the weighted-average remaining fully extended term is 58 months, which gives the Sponsor enough time to execute its business plans without risk of imminent maturity. In addition, the appraisal and financial data provided are reflective of conditions after the onset of the pandemic.

Eighteen loans, representing 62.5% 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, resulting in a higher sponsor cost basis in the underlying collateral, and aligns the financial interests between the Sponsor and lender.

The DBRS Morningstar Business Plan Scores (BPS) for loans DBRS Morningstar analyzed range between 1.30 and 2.38, with an average of 1.96. Higher DBRS Morningstar BPS indicate more risk in the Sponsor’s business plan. DBRS Morningstar considered the anticipated lift at the properties from current performance, planned property improvements, sponsor experience, projected time horizon, and the business plan’s overall complexity. Compared with similar mixed-property-type transactions, the subject has a low average BPS, which is indicative of lower risk.

DBRS Morningstar analyzed the loans to a stabilized cash flow that is, in some instances, above the in-place cash flow. It is possible that the Sponsor will not successfully execute its 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. The Sponsor’s failure to execute the business plans could result in a term default or the inability to refinance the fully funded loan balance. DBRS Morningstar sampled a large portion of the loans, representing 76.5% of the pool cutoff date balance. DBRS Morningstar made relatively conservative stabilization assumptions and, in each instance, considered the business plans to be rational and the loan structure to be sufficient to execute such plans. In addition, DBRS Morningstar analyzes loss given defaults based on the as-is credit metrics, assuming the loan is fully funded with no NCF or value upside.

The deal is concentrated by property type with 23 loans, representing 83.6% of the mortgage loan cutoff date balance, secured by multifamily properties. Multifamily properties benefit from staggered lease rollover and generally have 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. Furthermore, the average expected loss of the loans secured by multifamily properties is roughly 30% lower than the average expected loss of the overall pool. DBRS Morningstar sampled 76.5% of the pool, representing 71.9% of the total multifamily loan cutoff balance, thereby providing comfort for the DBRS Morningstar NCF.

All loans have floating interest rates and are IO during the fully extended loan term. Initial loan terms range from 24 months to 60 months, creating interest rate risk. The borrowers of all 26 loans have purchased Libor rate caps that have a range of 0.5% to 3.00% to protect against a rise in interest rates over the term of the loan. All loans are short term and, even with extension options, have a fully extended maximum loan term of six years. Additionally, all loans have extension options, and, in order to qualify for these options, the loans must meet minimum DSCR and LTV requirements.

DBRS Morningstar conducted property tours on only 12 properties, representing 14.9% of the initial pool, because of health and safety constraints associated with the ongoing coronavirus pandemic. As a result, DBRS Morningstar relied more heavily on third-party reports, online data sources, and information provided by the Issuer to determine the overall DBRS Morningstar property quality assigned to each loan. Recent third-party reports were provided for all loans and contained property quality commentary and photos.

The underlying mortgages for the transaction will pay the floating rate, which presents potential benchmark transition risks as the deadline approaches for the elimination of Libor. The transaction documents provide an alternative benchmark rate for the transition, which is primarily contemplated to be either Term Secured Overnight Financing Rate (SOFR) plus the applicable Alternative Rate Spread Adjustment or Compounded SOFR plus the Alternative Rate Spread Adjustment.

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.

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 (March 26, 2021), 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.

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.dbrsmorningstar.com or contact us at [email protected].

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