DBRS Morningstar Finalizes Provisional Ratings on Arbor Realty Commercial Real Estate Notes 2022-FL1, Ltd.

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of notes issued by Arbor Realty Commercial Real Estate Notes 2022-FL1, Ltd. (ARCREN 2022-FL1):

-- 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 44 floating-rate mortgage loans and senior participations secured by 59 mostly transitional properties, with an initial cut-off date balance totaling approximately $1.61 billion. In addition, there are $96.5 million of non-interest accruing reserves associated with 28 collateral interests contributed to the trust, bringing the total reference date portfolio balance to $1.70 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 a 180-day ramp-up acquisition period and 30-month reinvestment period. The ramp-up acquisition period will be used to increase the trust balance to a total target collateral principal balance of $2.05 billion. DBRS Morningstar assessed the ramp component using a conservative pool construct although the ramp loans have expected losses that are generally in line with the pool’s weighted-average (WA) expected loss. 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, meeting 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. In addition, mortgages exclusively secured by multifamily properties and student housing properties (up to 5.0% of the total pool balance) are allowed as ramp-up collateral interests. Lastly, the eligibility criteria stipulates a rating agency confirmation 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. The transaction has a sequential-pay structure.

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, 33 loans, representing 71.0% of the initial pool balance, had a DBRS Morningstar As-Is DSCR of 1.00 times or below, a threshold indicative of elevated default risk. The properties are often transitional with potential upside in cash flow; however, DBRS Morningstar does not typically give full credit to the stabilization if there are no holdbacks, reserves or future funding, 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 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 2022-FL1 transaction will be Arbor’s 18th post-crisis CRE CLO securitization, and the firm has seven outstanding transactions representing approximately $5 billion in investment-grade proceeds. In total, Arbor has been an issuer and manager of 17 CRE CLO securitizations totaling roughly $10.6 billion. Additionally, Arbor will purchase and retain 100.0% of the Class F Notes, the Class G Notes, and the Preferred Shares, which total $397,188,000, or 19.4% 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 mid-/high-rise buildings. After closing, as part of the ramp-up and reinvestment period, the collateral manager may acquire loans secured by multifamily properties and student housing properties as long as student housing properties represent less than 5.0% of the total pool. The prior ARCREN 2021-FL4 transaction allowed the collateral manager to also acquire only multifamily properties, but the eligibility criteria for this transaction is similar to that of the ARCREN 2021-FL3 transaction.

Forty loans, representing 89.2% 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 initial collateral pool is diversified across 20 states and has a loan Herfindahl score of approximately 29.9. While the loan Herfindahl score is lower than the ARCREN 2021-FL4 transaction, it is higher than the average Herfindahl score of the average Arbor CRE CLO transactions issued in 2021. Seven of the loans, representing 18.6% 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.

The DBRS Morningstar Business Plan Score (BPS) for loans DBRS Morningstar analyzed was between 1.40 and 3.13, with an average of 2.08. A higher DBRS Morningstar BPS indicates more execution 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 of the business plan. Compared with past Arbor transactions, the subject has a low average DBRS Morningstar BPS, which is indicative of lower risk.

The loan collateral was generally found to be in good physical condition as evidenced by the one loan, 30 Morningside Drive (Prospectus ID#22; 2.2% of the trust balance), secured by a property that DBRS Morningstar deemed to be Excellent in quality. An additional two loans, representing 7.5% of the trust balance, are secured by properties with Above Average quality and four loans, representing 9.4% of the trust balance, are secured by properties with Average + quality. Furthermore, only one loan is backed by a property that DBRS Morningstar considered to be Average – quality, representing just 4.4% of the trust balance, and no collateral was classified as Below Average or Poor quality.

Only one loan, representing 2.2% of the current portfolio balance, is secured by a property in an area characterized as having a DBRS Morningstar Market Rank of 7 or 8, which are considered to be more densely populated and urban in nature. Loans secured by properties located in such areas have historically benefited from increased liquidity and consistently strong investor demand, even during times of economic distress. Consequently, loans in these dense, urban locations often exhibit lower expected losses and the lack of collateral in these areas can be a negative credit characteristic. Conversely, 35 loans, representing 83.0% of the current portfolio balance, are secured by properties in markets characterized as having a DBRS Morningstar Market Rank of 3 or 4, which are considered to be more suburban in nature. Loans secured by properties located in such areas have historically exhibited elevated probabilities of default (PODs) and often have higher expected losses in the DBRS Morningstar approach. The DBRS Morningstar WA Market Rank of 3.5 for this pool is generally indicative of a higher concentration of properties being located in less densely populated suburban areas. This WA market rank is lower than all three ARCREN deals rated in 2021. DBRS Morningstar concluded higher PODs and loss severity given default (LGDs) in this transaction than in similar pools with more exposure to urban markets.

DBRS Morningstar analyzed five loans, representing 15.3% of the current portfolio balance, with Weak sponsorship strengths. These loans include The Caden at East Mil (Prospectus ID#1; 5.9% of initial pool), Shore House (Prospectus ID#7; 4.3% of the initial pool), Boat House (Prospectus ID#11; 3.4% of the initial pool), Autumn Chase (Prospectus ID#31; 0.9% of the initial pool), and The Pines (Prospectus ID#32; 0.8% of the initial pool). DBRS Morningstar applied a POD penalty to loans analyzed with Weak sponsorship strength.

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 loans secured by multifamily or student housing properties (up to 5.0% of the pool) can be added. Future loans cannot be secured by office, hospitality, industrial, retail, or healthcare 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 Disease (COVID-19) 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 interest only 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 PODs and LGDs. All loans have extension options, and to qualify for these options, the loans must meet minimum DSCR and LTV requirements.

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 (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.

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

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