Morningstar DBRS Confirms Credit Ratings on All Classes of HGI CRE CLO 2021-FL2, Ltd.

DBRS Limited (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by HGI CRE CLO 2021-FL2, Ltd. as follows:

-- Class A 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 credit rating confirmations reflect the overall stable performance of the transaction, as the majority of borrowers are generally progressing toward completion of their stated business plans. The transaction consists of solely multifamily collateral across 26 loans, most of which are scheduled to mature within the next 12 months. Morningstar DBRS expects borrowers who have progressed in property stabilization efforts to successfully execute loan exit strategies in the near to medium term, given the underlying collateral has generally demonstrated stable to improving operating performance over the last several quarters.

A select number of loans, however, are exhibiting increased credit risk from issuance, including the largest loan in the pool, The Astor LIC (Prospectus ID#1; 12.1% of the pool balance), which transferred to the special servicer in December 2023 for monetary default, and the Lofts at Twenty 25 loan (Prospectus ID#28; 8.5% of the pool balance), which is currently being monitored on the servicer's watchlist for missed payments in April and May of this year. Both loans are outlined in additional detail below. The pool benefits from a considerable amount of collateral reduction to date as a result of successful loan repayments (totaling 25.4% since issuance), partially mitigating loan-level risk associated with underperforming assets.

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. To access this report, please click on the link under Related Documents below or contact us at [email protected].

The transaction closed in September 2021 with a cut-off pool balance totaling approximately $514.5 million, and a maximum funded balance of $579.5 million. At issuance, the pool consisted of 20 floating-rate mortgage loans secured by 22 properties. The transaction was a managed vehicle with a 24-month reinvestment period that expired with the September 2023 payment date. As of the May 2024 reporting, the pool comprises 26 loans secured by 31 properties with a cumulative trust balance of $432.1 million. Eleven loans with a former cumulative trust balance of $242.8 million have successfully repaid from the pool since issuance, including six loans with a former cumulative trust balance of $106.0 million since Morningstar DBRS' prior credit rating action in June 2023. An additional two loans with a current cumulative trust balance of $2.5 million have been added to the trust since June 2023.

The loans are concentrated by properties in suburban locations, which Morningstar DBRS defines as markets with a Morningstar DBRS Market Rank of 3, 4, or 5. As of May 2024, 20 loans, representing 67.0% of the current trust balance, were secured by properties in suburban markets. Three loans, representing 22.4% of the current trust balance, were secured by properties in urban markets, defined as markets with a Morningstar DBRS Market Rank of 6, 7, or 8. An additional three loans, representing 10.6% of the current trust balance, were secured by properties located in tertiary markets, defined as markets with a Morningstar DBRS Market Rank of 2.

Leverage across the pool has remained relatively static from closing, with a current weighted-average (WA) as-is appraised loan-to-value ratio (LTV) of 73.3% (compared with 74.2% at closing) and a WA stabilized LTV of 67.8% (compared with 67.0% at closing). Morningstar DBRS recognizes that select property values may be inflated as the majority of the individual property appraisals were completed in 2021 and 2022 and may not reflect the current interest rate and widening capitalization rate (cap rate) environment. In the analysis for this review, Morningstar DBRS applied upward LTV adjustments across 13 loans representing 56.1% of the current trust balance.

Through May 2024, the collateral manager had advanced cumulative loan future funding of $56.6 million allocated to 24 of the 26 remaining individual borrowers to aid in property stabilization efforts. The largest advance, $10.6 million, has been made to the borrower of the Marbella Apartments loan, which is secured by a multifamily property in Corpus Christi, Texas. Funds were advanced to the borrower to complete its capital improvement project across the property. The full $10.6 million future funding component has been advanced with the Class A note consisting of a $27.6 million piece in the subject transaction, a $19.8 million piece held in the HGI CRE CLO 2021-FL1, Ltd. transaction (also rated by Morningstar DBRS), and a non-securitized $4.3 million piece. An additional $12.7 million of loan future funding allocated to five of the remaining individual borrowers remains available. The largest portion of available funds ($5.9 million) is allocated to the borrower of The Lofts at Twenty25 loan, which is secured by a multifamily property in downtown Atlanta. The available funds are allocated for the borrower's capital improvement and lease-up plan.

As of the May 2024 remittance, one loan, representing 12.1% of the pool balance was in special servicing and 19 loans representing 73.3% of the pool balance were on the servicer's watchlist, the vast majority of which are being monitored for upcoming maturity dates. The specially serviced loan, The Astor LIC, is secured by the sponsor's leased-fee interest in a Class A, mid-rise 143-unit multifamily apartment building in Queens, New York. The collateral was constructed in 2021 and includes 12,000 square feet (sf) of retail space. The loan transferred to special servicing in December 2023 for payment default, and as of the May 2024 reporting, remains delinquent having last paid in September 2023. The special servicer has established contact with the borrower, noting a pre-negotiation agreement has been executed; however further resolution details and timing are pending.

The borrower is progressing with its stated business plan at issuance, which included leasing-up the property and stabilizing operations over a 12- to 18-month period. According to the Q1 2024 update from the collateral manager, property performance remains relatively unchanged compared with prior year's reporting. The borrower successfully leased the commercial space to Lexus of Queens, which was expected to take occupancy in May 2024. According to the February 2024 rent roll, the residential component was 94.4% occupied and 95.1% leased with an average rental rate of $3,384 per unit. The borrower has been successful in increasing rental rates at the property, with reported lease trade out premiums ranging from 10.0% to 33.0%, based on unit type. According to the financial reporting provided by the collateral manager for the trailing-12 month (T12) period ended February 29, 2024, the property generated NCF of $2.6 million (reflecting a debt service coverage ratio (DSCR) of 0.52 times (x)). Given the floating rate nature of the loan and the absence of an interest rate cap agreement, debt service obligations have increased considerably from issuance, placing downward pressure on the DSCR. The lender negotiated a cash management agreement with the sponsor, terms of which include lock box provisions. Although the collateral manager noted the sponsor continues to work towards refinancing and is also marketing the property for sale, Morningstar DBRS maintains a cautious outlook for the loan. In the analysis for this review, Morningstar DBRS increased the loan's expected loss by applying upward LTV adjustments to both the in-place and stabilized property value assumptions made by the appraiser at closing in addition to increasing the loan's probability of default penalty.

The Lofts at Twenty25 loan, is secured by a redeveloped 623-unit, high-rise multifamily property in Atlanta. The property, which was originally built it in 1951 as an office building, was completely gut renovated and redeveloped into its current use in 2021. The borrower's business plan at issuance was to increase occupancy and rental rates to market levels following the recent redevelopment. The three-year loan has an initial maturity date in July 2025 and includes two, 12-month extension options. The loan is currently being monitored on the servicer's watchlist due to two missed payments in April and May 2024.

According to the February 2024 rent roll, the property was approximately 29.0% occupied with an average rental rate of $1,256 per unit. The collateral manager noted the drop in occupancy and slowdown in leasing velocity is partially related to a number of tenant evictions. Property performance has also been weaker than expected as rental rates for the 215 affordable-rate units is approximately 25.0% below free market rental rates. According to the financial reporting for the trailing 12-month period ended February 29, 2024, the property generated NCF of under $100,000 (reflecting a DSCR of 0.01x). The collateral manager noted that the borrower has drawn the entirety of the initial $5.2 million interest reserve to cover shortfalls and has been making debt service payments out of pocket since November 2023. At issuance, the property was valued at $149.9 million, reflecting moderate leverage with an LTV of 65.1%, suggesting there may still be market equity remaining in the transaction; however, Morningstar DBRS believes the collateral's current market value has declined from closing. In the analysis for this review, Morningstar DBRS applied upward LTV adjustments to both the in-place and stabilized property value assumptions made by the appraiser at closing, in addition to increasing the loan's probability of default, resulting in an expected loss that was approximately 25.0% greater than the expected loss for the pool.

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 (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

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 related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

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.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

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 v 1.2.0.0, https://dbrs.morningstar.com/research/428797

Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024), https://dbrs.morningstar.com/research/428623

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

Legal Criteria for U.S. Structured Finance (April 15, 2024), https://dbrs.morningstar.com/research/431205

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/417279.

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