Morningstar DBRS Changes Trends on Six Classes of KREF 2021-FL2 Ltd. to Negative from Stable; Confirms All Credit Ratings

DBRS Limited (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by KREF 2021-FL2 Ltd. 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)
-- Class F at BB (low) (sf)
-- Class F-E at BB (low) (sf)
-- Class F-X at BB (low) (sf)
-- Class G at B (low) (sf)
-- Class G-E at B (low) (sf)
-- Class G-X at B (low) (sf)

Morningstar DBRS also changed the trends on Classes F, G, F-E, F-X, G-E, and G-X to Negative from Stable. The trends on the remaining classes remain Stable.

The trend changes reflect the increased credit risk to the transaction as a result of Morningstar DBRS' increased loan-level expected losses for the majority of the loans in the transaction, particularly for the six loans secured by office properties, which represent 44.7% of the current trust balance. In particular, the second and third largest loans in the transaction, Fifth Street Towers (Prospectus ID#31; 9.2% of the current pool) and 1635 & 1835 Market Street (Prospectus ID#29; 8.8% of the current pool), respectively, are both secured by office properties, which have both been modified in the last year to extend loan maturity and reduce the loans' floating interest rate spread. Regarding the Fifth Street Towers loan modification, the whole-loan bifurcated-with $120.0 million refinanced into the subject transaction priced at 30-day SOFR plus 2.25%, and the remaining $79.4 million of mezzanine debt priced at 30-day SOFR plus 4.5%. Business plan progression across both assets has been slow to date, with occupancy rates and/or cash flows below projected stabilized levels. Morningstar DBRS analyzed both loans with increased loan-to-value ratios (LTVs), resulting in expected loss levels approximately 30.0% and 50.0% greater than the pool's weighted-average (WA) expected loss, respectively. In aggregate, the WA expected loss for all office loans in the pool was approximately 30.0% greater than the pool's WA expected loss.

Over the next 12 months, 11 loans, representing 67.7% of the current trust balance, are scheduled to mature. Five of these loans, representing 38.0% of the current trust balance, are secured by office properties, including the Fifth Street Towers loan, which surpassed its July 2024 maturity date. According to the servicer's update, the borrower will exercise the loan's one, 12-month extension option. Given the ongoing headwinds in the office sector, lending activity on office properties slowed significantly in 2023 and continues to struggle through Q2 2024. As such, Morningstar DBRS expects borrowers to face difficulties in executing exit strategies over the near to medium term. While the majority of these loans include extension options, the borrowers will likely need loan modifications as the majority of these loans will be unable to achieve the performance-based extension requirements. The credit rating confirmations reflect the otherwise stable performance of majority of the loans in the pool, as the respective borrowers have generally been able to progress toward the completion of their stated business plans to date.

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 info-dbrs@morningstar.com.

At issuance, the transaction consisted of 20 floating-rate mortgages secured by 29 mostly transitional commercial real estate properties totaling approximately $1.0 billion, excluding approximately $260.5 million of future funding commitments. The Issuer then added additional proceeds into the proposed structure to bring the total transaction structure from $1.0 billion to $1.3 billion. The transaction had a Reinvestment Period that expired with the August 2023 payment date. The transaction now has a sequential-pay structure following the expiration of the Reinvestment Period.

As of the July 2024 remittance, the pool consists of 17 loans secured by 28 properties with a cumulative trust balance of $1.3 billion. Since the previous Morningstar DBRS credit rating action in August 2023, two loans with a former trust balance of $105.0 million were repaid in full. Over the same period, two loans, with a current trust balance of $116.1 million, representing 8.9% of the pool, were contributed to the trust.

Beyond the office concentration noted above, the transaction also comprises eight loans, representing 39.2% of the current trust balance, secured by traditional multifamily properties or mixed-use properties with a material multifamily component, two loans, representing 11.1% of the pool, secured by hotel properties, and one loan, representing 5.0% of the pool, secured by a portfolio of self-storage properties. In comparison with the August 2023 reporting, office properties represented 35.0% of the collateral while multifamily properties represented 14.8% of the collateral.

The loans are secured primarily by properties in suburban markets as 10 loans, representing 55.0% of the pool, are secured by properties in markets with Morningstar DBRS Market Ranks of 3, 4, and 5, which are suburban in nature and have historically had higher probability of default (POD) levels when compared with properties in urban markets. The remaining seven loans, representing 45.0% of the pool, are secured by properties in urban markets, with Morningstar DBRS Market Ranks of 6, 7, and 8. In comparison, as of August 2023, properties in urban markets represented 51.4% of the pool while suburban markets represented 48.6% of the pool.

Based on the original as-is appraised values from individual loan closing date, leverage across the pool has decreased from issuance, with a current WA LTV of 58.3%, down from 68.2% at issuance. Similarly, the projected WA as-stabilized LTV has also decreased to 58.9% from 65.4% at issuance. 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 rising interest rate or widening capitalization rate (cap rate) environments. In the analysis for this review, Morningstar DBRS applied upward LTV and/or POD adjustments across 11 loans, representing 68.3% of the current trust balance.

Through June 2024, the lender has advanced cumulative trust future funding of $268.5 million to 10 individual borrowers to aid in property stabilization efforts. The largest and third largest future funding advances have been released to the borrowers of the GCP Storage Advisors Portfolio loan (GCP; Prospectus ID#32; 5.0% of the pool; $131.8 million) and the Boston South End Life Science Campus loan (Prospectus ID#4; 10.3% of the pool; $41.5 million), respectively. The GCP loan was added to the trust in September 2023 and is secured by a portfolio of 13 self-storage assets located in various markets across the United States at loan closing in September 2023. The borrower's business plan is to acquire properties as collateral for the loan and to lease-up these assets and sell them at stabilization. According to Q1 2024 reporting, 10 properties remain in the portfolio. As of December 2023, the portfolio is approximately 32.1% occupied with an average gross rental rate of $1.50 per rentable square foot (rsf), in comparison to the issuance rates of 16.7% and $2.72 per rsf, respectively. The decline in rental rates is because of the sponsor prioritizing the lease-up of the collateral through signing leases at lower rates and offering move-in concessions for select assets. Per the financials provided by the collateral manager, the portfolio reported a negative NCF for the annualized Q1 2024 period. The Boston South End Life Science Campus loan is secured by two office and laboratory (lab) properties in Boston. The borrower has used loan future funding for leasing costs as well as ongoing capital improvement projects, including the conversion of one of the two properties from a traditional office building to a lab space. As of Q2 2024, the borrower was able to lease-up the converted property to 92.6%, while the other property's occupancy decline to 50.2%, with significant rollover risk through the next 12 months.

An additional $23.6 million of unadvanced loan future funding allocated to seven individual borrowers remains outstanding with the largest portion ($15.5 million) and second largest portion ($3.7 million) allocated to the borrowers of the GCP and Boston South End Life Science Campus loans mentioned above, respectively. In its analysis for this review, Morningstar DBRS applied upward POD adjustments for both loans, resulting in a loan-level expected loss that remains less than the pool's WA expected loss for the GCP loan, and a loan-level expected loss of approximately 44.2% greater than the pool's WA expected loss for the Boston South End Life Science Campus loan.

As of the July 2024 remittance, there are no delinquent loans or loans in special servicing. Only two loans, representing 15.4% of the pool, are on the servicer's watchlist, with one loan, The Woodlands Portfolio (Prospectus ID#21; 6.2% of the pool) being monitored for an informational reason. The loan is secured by a portfolio of three hotel properties in The Woodlands, Texas. The loan matures in October 2024, and according to the servicer, it plans to reach out to the borrower in the near term to determine the borrower's maturity strategy. The loans contains an extension option; however, as the servicer has yet to receive Q2 2024 financials, it is unable to determine at this time if the required performance based extension tests will be satisfied if the borrower desire to extend the loan maturity date. The other loan on the servicer's watchlist is the aforementioned Fifth Street Towers loan, which is flagged for the July 2024 maturity date, which Morningstar DBRS has confirmed has been extended. In total, 14 loans, representing 85.4 % of the pool, have been modified. In general, the modifications have allowed borrowers to bifurcate loans, reduce the floating interest rate spread, or exercise or modify loan extension options by amending loan terms. In return, borrowers have been required to make loan curtailment payments, deposit funds into reserves, or purchase of a new interest rate cap agreements.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective press releases at issuance.

Morningstar DBRS' long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued. The Morningstar DBRS short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

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 info-DBRS@morningstar.com.

The credit ratings were initiated at the request of the rated entity.

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

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

These are solicited credit ratings.

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

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
-- Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024), https://dbrs.morningstar.com/research/428623
-- Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (June 28, 2024), https://dbrs.morningstar.com/research/435293
-- 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 (July 17, 2023).

For more information on this credit or on this industry, visit https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.