Morningstar DBRS Downgrades Credit Ratings on Two Classes of Ready Capital Mortgage Financing 2023-FL12, LLC, Changes Trends on Two Additional Classes to Negative

DBRS Limited (Morningstar DBRS) downgraded its credit ratings on two classes of commercial mortgage-backed notes issued by Ready Capital Mortgage Financing 2023-FL12, LLC as follows:

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

In addition, Morningstar DBRS confirmed its credit ratings on the remaining classes 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 (sf)
-- Class E at BBB (low) (sf)

Morningstar DBRS changed the trends on Classes D and E to Negative from Stable. All other trends are Stable with the exception of Classes F and G, which are assigned credit ratings that do not typically carry a trend in commercial mortgage-backed securities (CMBS) transactions. 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 and with 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].

The credit rating downgrades on Classes F and G are the result of ongoing accumulated interest shortfalls, which have persisted since October 2023 and have surpassed the Morningstar DBRS tolerance for the BB or B credit rating category of six months. The shortfalls originally stem from the difference in the floating interest rate benchmark between the bonds and some of the individual loans in the transaction. As of May 2024 reporting, cumulative interest shortfalls on the Class F Notes totalled $1.8 million, and cumulative interest shortfalls on Class G total $1.7 million.

The Negative trends on Classes D and E reflect the increased credit risk to the transaction related to the five loans in special servicing, which include the second- and fifth-largest loans in the pool and collectively represent 25.1% of the current trust balance. The borrowers of all five loans have been unable to achieve meaningful progress in the respective business plans to date with three loans, representing 9.5% of the current trust balance, at least two months delinquent on debt service payments as of May 2024 reporting. While all loans have been modified or are in the process of being modified with select borrowers expected to receive a forbearance agreement, Morningstar DBRS notes the credit risk on each asset has materially increased from closing. Additionally, rated bonds above Class F are now more susceptible to additional interest shortfalls, a consideration for the Negative trends with this credit rating action.

The credit rating confirmations on the remaining classes reflect the overall stable performance on the remaining loan collateral as borrowers are generally progressing in the stated business plans to increase property cash flow and value. Additionally, as of the May 2024 remittance, there has been a total collateral reduction of 10.6% since issuance as four loans with a former cumulative trust loan balance of $74.3 million have successfully repaid from the pool.

The initial collateral pool consisted of 35 floating-rate mortgage loans secured by 59 mostly transitional properties with a cut-off date balance of $648.6 million. The loans were mostly secured by cash flowing assets, many of which were in a period of transition, with plans to stabilize and improve the asset value. All loans had origination dates ranging from December 2019 to May 2023. As of the May 2024 remittance, the pool comprises 31 loans secured by 54 properties with a cumulative loan balance of $582.1 million.

The pool is concentrated by property type with loans secured by both multifamily and industrial/flex properties representing 84.1% and 15.9% of the current pool balance, respectively. The collateral pool for the transaction is static; however, the issuer can acquire funded loan participation interests into the trust through the June 2025 Payment Date subject to stated criteria and provided the monthly Par Value Ratio and Interest Coverage Ratio tests are passed. As of May 2024, the Interest Coverage Ratio test was failed as the ratio was 111.0%, below the minimum 120.0% requirement. As such, the Issuer cannot utilize the outstanding $2.7 million balance in the Acquisition Account to purchase funded loan participation interests into the trust at this time.

The loans are primarily secured by properties in suburban markets with 25 loans, representing 79.1% of the current trust balance secured by properties in suburban markets, as defined by Morningstar DBRS, with a Morningstar DBRS Market Rank of 3, 4, or 5. An additional four loans, representing 17.0% of the current cumulative trust balance, are secured by properties with a Morningstar DBRS Market Rank of 6, 7, and 8, denoting an urban market.

The largest loan in special servicing, the Appletree Portfolio (Prospectus ID#2, 9.8% of the current pool balance), is secured by a portfolio of six multifamily properties (four located in Columbia, South Carolina, and two located in Memphis, Tennessee) totalling 933 units. The borrower’s business plan at closing was to invest $11.4 million to renovate all 933 units ($6.5 million), improve the quality of amenities at the properties ($4.3 million), and address deferred maintenance items ($0.6 million). The loan transferred to special servicing in February 2024 for imminent monetary default. According to the servicer, the borrower has requested a loan forbearance and modification with terms reportedly being negotiated. Potential terms are expected to require an equity injection from the borrower and the nonaccrual of defaulted interest in exchange for relief.

According to the YE2023 rent roll, the collateral was 72.6% occupied, with an average rental rate of $963 per unit, a 32.1% increase from the average in-place figure of $729 per unit at issuance, but below the Issuer’s stabilized figure of $1,045 per unit. According to an update from the collateral manager, 413 units have been renovated as of May 2024. According to the YE2023 rent roll, 72 of the 933 units (approximately 7.7%) are down, likely as a result of the ongoing renovations. The loan’s origination date in March 2022 and maturity in April 2026 indicate that the borrower’s original business plan is behind schedule. As of the YE2023 reporting, the property generated negative net cash flow (NCF), and as such, Morningstar DBRS believes the market value of the portfolio has declined from the original As-Is portfolio value of $72.2 million derived by the appraiser at loan closing. In its current analysis, Morningstar DBRS applied an upward loan-to-value ratio (LTV) and probability of default (POD) adjustments to reflect the increased credit risk of the loan. The resulting loan expected loss (EL) was greater than 150.0% times the expected loss for the pool EL.

The second-largest loan in special servicing, Mission Matthews Place & Waterford Hills (Prospectus ID#6, 5.8% of the pool), is secured by a 662-unit two-property portfolio of Class B multifamily properties in Charlotte, North Carolina. The loan transferred to special servicing in October 2023 for imminent monetary default. A loan modification and forbearance was executed in April 2024 with terms including a pause on interest payments, a $3.0 million equity injection from the borrower, and a 12-month maturity extension. All deferred interest amounts are due at the initial August 2025 maturity date.

The borrower’s business plan at closing was to spend $5.9 million to upgrade the interiors of 137 classic units and complete exterior renovations. According to YE2023 reporting, the portfolio was 85.0% occupied, below the Issuer’s underwritten and projected stabilized figures of 96.5% and 95.4%, respectively. Average rental rates increased by 17.2% over issuance to $1,359 per unit as of February 2024, but remain below the Issuer’s stabilized figure of $1,502 per unit. An update on the status of future funding disbursements was not provided; however, the NCF figure increased to $4.4 million as of YE2023, from $ 3.7 million at issuance. The figure remains below the Issuer’s stabilized figure of $8.4 million. Given the slow cash flow growth and the loan’s status, Morningstar DBRS applied an upward adjustment to both the As-is and As-stabilized LTVs as well as the POD to reflect the increased credit risk of the loan. The resulting loan expected loss exceeded the overall pool expected loss by greater than 50.0%.

As of the May 2024 remittance, there were 18 loans on the servicer’s watchlist, representing 53.1% of the current trust balance. The loans have generally been flagged for low occupancy rates, low debt service coverage ratios, and upcoming maturities. The largest loan on the servicer’s watchlist is the SAMO Apartments Portfolio loan (Prospectus ID#1, 10.3% of the pool), which was flagged for deferred maintenance and the loan’s upcoming maturity in October 2024. Although the loan has exhibited strong cash flow growth, which now exceeds the projected stabilized figure, occupancy has fallen below issuance and stabilized levels. The business plan at closing included a $4.0 million budget to create 22 accessory dwelling units (ADUs) with project financing available for an $8.0 million loan future funding component as $4.0 million was available via a performance-based earnout. As of the YE2023 rent roll, a total of 403 units were online, compared with the 399 units available at issuance, but well below the projected unit count of 421 upon completion of the business plan. It appears the borrower has funded the cost of the new units out of pocket as only approximately $40,000 of loan future funding has been advanced to the borrower since loan closing and none since May 2023. According to the collateral manager, the right to request any additional future funding has ceased. The loan was analyzed with upward POD and LTV adjustments to account for the lack of progress on the business plan and decreased occupancy levels.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, or 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), 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. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The Morningstar DBRS Long-Term Obligation Rating Scale definition indicates that credit ratings of CCC or lower are assigned when the bond is highly likely to default or default is imminent, thereby prevailing over a sensitivity analysis.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS’ outlooks and credit ratings are monitored.

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
-- DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023), https://dbrs.morningstar.com/research/420982
-- Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024), https://dbrs.morningstar.com/research/428623
-- 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].