Morningstar DBRS Downgrades Credit Ratings on Two Classes of ACRE Commercial Mortgage 2017-FL3 Ltd.; Confirms All Other Classes

DBRS, Inc. (Morningstar DBRS) downgraded its credit ratings on two classes of Floating Rate Notes issued by ACRE Commercial Mortgage 2017-FL3 Ltd. as follows:

-- Class E to B (low) (sf) from BB (low) (sf)
-- Class F to CCC (sf) from B (low) (sf)

Morningstar DBRS also confirmed its credit ratings on the remaining classes of notes as follows:

-- 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 (low) (sf)

The trends on all classes are Stable with the exception of Class F, which has a rating that does not carry a trend.

The credit rating downgrades reflect the increased credit risk to the transaction as a result of an increase in projected losses to the trust in connection with the resolution of the Old Orchard Towers loan. The loan represents 9.2% of the transaction and is in special servicing for delinquency and a maturity default. The loan is secured by an office property in Skokie, Illinois, and according to a Q4 2023 update from the collateral manager, the property is expected to be sold, with closing planned for the end of Q1 2024. A previous attempt to sell the property at a price of approximately $11.0 million was unsuccessful and Morningstar DBRS expects the property will ultimately sell even lower than that figure, with a projected loss severity of approximately 90.0% upon resolution of the $56.9 million loan. While the expected loss is expected to be contained to the $52.9 million unrated equity bond held by the issuer, the resulting deterioration in credit support to the rated bonds supports the credit rating downgrades to Classes E and F. The remaining collateral in the pool is generally performing in line with Morningstar DBRS’ expectations, with individual borrowers progressing in the stated business plans. As such, the remaining credit ratings have been confirmed with Stable trends.

In conjunction with this press release, Morningstar DBRS has published a Surveillance Performance Update report with in-depth analysis and credit metrics for the transaction as well as business plan updates on select loans. For access to this report, please click on the link under Related Documents below or contact us at [email protected].

As of the March 2024 remittance, the pool comprises 16 loans secured by 17 properties with a cumulative trust balance of $525.8 million. Most loans are in a period of transition with plans to stabilize and improve asset value. Since the previous Morningstar DBRS rating action in March 2023, three loans with a former cumulative trust balance of $23.1 million have been repaid in full. The transaction is structured with a Reinvestment Period, which ended with the March 2024 Payment Date. Since March 2023, the issuer has contributed three additional loans to the trust with a cumulative balance of $114.5 million. With the March 2024 remittance, the issuer applied $31.1 million of cash collateral previously held in the Reinvestment Account to the outstanding Class A balance, thereby increasing the credit enhancement to the bonds. Total collateral reduction to date is 5.6%

In general, borrowers are progressing toward completion of the stated business plans. Twelve of the 16 outstanding loans were structured with future funding components and, according to an update from the collateral manager, $87.9 million in loan future funding had been advanced to 11 borrowers through February 2024. The largest advances were made to the borrowers of the Caterpillar Aurora ($36.0 million) and Northridge Commons ($19.3 million) loans. The Caterpillar Aurora loan is secured by a 4.0 million-square-foot industrial property in Montgomery, Illinois. The loan’s potential fully funded balance was upsized in 2023 to $137.7 million after the borrower’s business plan to complete a capital expenditure project and release individual buildings throughout the property proved to be successful. The collateral manager reported the property was expected to become 100.0% leased; however, a pending tenant for approximately 50.0% of the net rentable area had yet to be finalized. There is no future funding remaining and the loan matures in May 2024. Morningstar DBRS expects the borrower to exercise a one-year extension option to provide time to for property operations to continue to stabilize.

The Northridge Commons loan is secured by an office and flex industrial property in Sandy Springs, Georgia. The borrower used loan future funding for accretive leasing costs and capital improvements. The property is approaching stabilized occupancy as the December 2023 occupancy rate was reported at 87.0%; however, the reported year-end (YE) 2023 net operating income of $4.0 million remains below the issuer’s stabilized net cash flow (NCF) figure of $4.9 million. The loan has no more future funding dollars available and has a final maturity date in December 2024 after the borrower exercised its final extension option in December 2023. An additional $2.9 million of unadvanced loan future funding remains across the pool, allocated to four individual borrowers. The largest portion ($1.6 million) is allocated to the borrower of the 251 Monroe loan, secured by an industrial property in Kenilworth, New Jersey, with loan future funding available to fund leasing costs and as a performance-based earn-out.

The transaction is concentrated by loan size, as the largest 10 loans represent 84.2% of the current trust balance and 79.5% of the maximum funded pool balance. The transaction consists of four loans (totaling 32.4% of the current trust balance) secured by industrial properties, three loans (totaling 23.9% of the current trust balance) secured by office properties, three loans (totaling 18.8% of the current trust balance) secured by multifamily properties (including one student-housing property), and five loans (totaling 12.1% of the current trust balance) secured by self-storage properties.

There are currently five loans, representing 33.6% of the current trust balance, on the servicer’s watchlist. These loans have generally been flagged for upcoming maturity dates or below breakeven debt service coverage ratios (DSCRs). The largest loan on the servicer’s watchlist, Accent Overlook & 525 East Bay (Prospectus ID#48, 12.7% of the current trust balance), is primarily secured by a 283-unit multifamily property in Charleston, South Carolina; however, the collateral also includes a separate 27,000-sf office property. The loan is on the servicer’s watchlist for a low DSCR, which the collateral manager reported as 0.53x at YE2023. The multifamily component of the property was only 67.0% occupied as of December 2023 with the consolidated property NCF reported at $2.8 million, below the issuer’s stabilized projection of $4.6 million. The borrower is reportedly achieving its targeted rental rate, having chosen to sacrifice the occupancy rate to date in order to maintain rental rates similar with competitive Class A properties in the submarket. The loan matures in November 2024 with a fully extended maturity date of November 2026, allowing the borrower additional time to stabilize operations. In its analysis, Morningstar DBRS recognized the desirability and overall stability of the Charleston multifamily market. The credit risk on the loan remains similar with issuance levels with an expected loss slightly above the overall expected loss for the pool.

The collateral manager reported four loans, representing 28.7% of the current trust balance, have been modified. The modifications have allowed borrowers to extend loans while waiving performance-based extension tests or to amend interest rate cap agreement requirements. In the context of loan maturity extensions, borrowers were required to either make a principal curtailment on the loan or to consent to the placement of cash traps through the remaining loan term in addition to purchasing new interest rate cap agreements.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

All credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by Morningstar DBRS.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is North American CMBS Surveillance Methodology (March 1, 2024; https://dbrs.morningstar.com/research/428798).

Other methodologies referenced in this transaction are listed at the end of this press release.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

DBRS, Inc.
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Tel. +1 312 332-3429

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

North American CMBS Multi-Borrower Rating Methodology (March 1, 2024)/North American CMBS Insight Model Version 1.2.0.0, https://dbrs.morningstar.com/research/428797

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023), https://dbrs.morningstar.com/research/420982

North American Commercial Mortgage Servicer Rankings (August 23, 2023), https://dbrs.morningstar.com/research/419592

Interest Rate Stresses for U.S. Structured Finance Transactions (June 9, 2023), https://dbrs.morningstar.com/research/415687

Legal Criteria for U.S. Structured Finance (December 7, 2023), https://dbrs.morningstar.com/research/425081

A description of how Morningstar DBRS analyzes structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/410863.

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