Morningstar DBRS Confirms Credit Ratings on All Classes of Arbor Realty Commercial Real Estate Notes 2021-FL3, Ltd.

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by Arbor Realty Commercial Real Estate Notes 2021-FL3, 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 G at B (low) (sf)

All trends are Stable.

The credit rating confirmations reflect the increased credit support to the notes as there has been a collateral reduction of 22.0% since the transaction became static in March 2024 following the post-closing 30-month Reinvestment Period. The transaction also benefits from being composed solely of loans backed by multifamily collateral, which has historically proven to better retain property value and cash flow compared with other property types. In its analysis for the review, Morningstar DBRS determined the majority of individual borrowers are progressing with their business plans to increase property cash flow and property value; however, some borrowers' business plans and loan exit strategies have lagged for a variety of factors, including increased construction costs, slowed rent growth, and increased debt service costs, which has increased the execution risk. The unrated, first-loss note of $127.5 million provides significant cushion against realized losses should the increased risks for those loans ultimately result in defaults and dispositions. 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 July 2024 remittance, the transaction had an outstanding balance of $1.17 billion with 39 loans secured by 52 properties remaining in the trust. Of the original 36 loans from the transaction closing in October 2021, 12 loans, representing 32.5% of the current pool balance, remain in the trust. Since the previous Morningstar DBRS credit rating action in September 2023, seven loans, representing 16.6% of the current pool balance, have been added to the trust. As referenced above, there has been significant collateral reduction since the previous credit rating action as 18 loans with a former cumulative trust balance of $464.1 million were successfully paid in full and another three loans with a former cumulative trust balance of $66.9 million were deemed credit-risk assets and were purchased out of the trust by the issuer.

The pool collateral is concentrated in properties located in suburban markets as 30 loans, representing 79.3% of the pool, are secured by properties in suburban markets, as defined by Morningstar DBRS, with a Morningstar DBRS Market Rank of 3, 4, or 5. An additional seven loans, representing 16.6% of the pool, are secured by properties with Morningstar DBRS Market Ranks of 1 and 2, denoting rural and tertiary markets, while the remaining two loans, representing 4.1% of the pool, are secured by properties with Morningstar DBRS Market Ranks of 6 or 7, denoting urban markets. This is in comparison with the pool at September 2023 when properties in suburban markets represented 75.3% of the collateral, properties in tertiary and rural markets represented 17.6% of the collateral, and properties in urban markets represented 7.0% of the collateral.

Leverage across the pool has declined since issuance as the current weighted-average (WA) as-is appraised value loan-to-value ratio (LTV) is 79.5% with a current WA stabilized LTV of 67.6%. In comparison, these figures were 84.1% and 71.6%, respectively, at issuance. Morningstar DBRS recognizes these appraised values may be inflated as the individual property appraisals were completed in 2021 or 2022 and do not reflect the current higher interest rate or widening capitalization rate environments. In the analysis for this review, Morningstar DBRS applied LTV adjustments to 18 loans, representing 62.8% of the current trust balance, generally reflective of higher cap rate assumptions compared with the implied cap rates based on the appraisals.

As of July 2024, two loans, representing 5.0% of the current pool balance, are reported as 30 to 59 days delinquent. The Landings at Brittany Acres loan (Prospectus ID#64; 2.8% of the current pool balance) is secured by a multifamily property in Bridgeton, Missouri. According to the collateral manager's Q1 2024 update, the borrower has continually made debt service payments late as the interest reserve is not sufficient to cover payments. The loan matured in April 2024 and was subsequently modified to allow the borrower to exercise the first 12-month extension without meeting the performance threshold as the debt service coverage ratio (DSCR) for the trailing 12 months (T-12) ended February 29, 2024, was 0.79 times (x). The collateral manager noted the borrower was also working to refinance the loan by the end of June 2024, but as of the July 2024 remittance the loans remains in the trust. The borrower is in the midst of its business plan to renovate all 280 units of the property. As of Q1 2024, 135 units had been upgraded and $0.5 million of the original $1.2 million of loan future funding remained in an interest-bearing account controlled by the collateral manager.

The collateral manager reported that two loans, representing 4.4% of the current pool balance, are specially serviced. The Estrella at Kiest loan (Prospectus ID#73; 2.2% of the current pool balance) is secured by a multifamily property in Dallas. The loan transferred to the special servicer in April 2024 for imminent default. The loan was modified to extend the loan maturity to September 2025 with the borrower purchasing a new interest rate cap agreement with a 5.0% strike rate and depositing $250,000 into a general reserve. The borrower will also be required to deposit $500,000 into the interest reserve if the balance in the reserve falls below $384,000. As of Q1 2024, the property was 78.9% occupied and the borrower had used $4.1 million of loan future funding to complete its renovation plan, including 120 of the 180 planned unit upgrades. There remains $1.1 million of available renovation dollars in an interest bearing account controlled by the collateral manager.

The other specially serviced loan, Casa Blanca & Casa Valencia (Prospectus ID#28; 2.2% of the current pool balance), is also secured by a multifamily property in Dallas. The loan transferred to special servicing in January 2024 for imminent default. The loan was modified in March 2024 whereby the borrower made a $1.0 million deposit to be used to pay past-due debt service, fund the renovation reserve, and fund the interest rate cap reserve. The borrower is also required to make an additional $1.0 million deposit to a newly created renovation and loan paydown reserve by December 2024 with another $0.5 million due by June 2025. Lastly, the borrower purchased a new 12-month interest rate cap agreement with a 5.25% strike rate. In return, the loan was extended to March 2026 and the lender will provide monthly advances of $100,000 for the borrower to complete its renovation program. As of Q1 2024, the borrower had completed 179 of the planned 227 unit upgrades, having used $3.8 million of loan future funding. The property was appraised at $24.6 million in June 2024, down from the original as-is appraised value of $27.6 million. The current LTV is elevated at 103.7%, suggesting the credit risk of the loan has increased materially from closing. The projected as-stabilized value of $30.2 million implies an elevated LTV of 84.4%, which may be aggressive as the implied cap rate based on the issuer's stabilized cash flow of $1.7 million is 5.6%. In its analysis for both specially serviced loans, Morningstar DBRS applied upward LTV adjustments to increase the loan level expected loss for each.

The servicer did not report any loans on the servicer's watchlist as of the July 2024 reporting; however, using the most recent available cash flow reports for a range of T-12s ended from December 31, 2023, to May 31, 2024, for all loans in trust, only nine loans, representing 22.0% of the current pool balance, reported DSCRs above 1.0x, suggesting the remaining loans should be on the servicer's watchlist for low DSCRs. In total, 20 loans, representing 61.9% of the current pool balance, have been modified. Terms for individual loan modifications vary; however, some common terms have allowed borrowers to extend maturity dates without meeting required property performance tests, extend renovation completion dates, and waive or defer the requirement to purchase new interest rate cap agreements with some borrowers securing subordinate preferred equity financing to purchase new rate cap agreements. In return, borrowers have made fresh equity deposits into renovation or operating reserves.

Throughout 2024, 10 loans, representing 19.9% of the current pool balance, have scheduled maturity dates. All 10 loans have extension options and, if property performance does not qualify to exercise the related options, Morningstar DBRS expects the borrowers and lenders to negotiate mutually beneficial loan modifications to extend loans, which would likely include fresh sponsor equity to fund principal curtailments, fund carry reserves, or purchase new interest rate cap agreements.

Through March 2024, the lender had advanced $113.0 million in cumulative loan future funding to 26 of the outstanding individual borrowers to aid in property stabilization efforts, including $64.4 million since the previous Morningstar DBRS rating action in September 2023. The largest advance to a single borrower ($25.1 million) was made to the Diplomat Tower loan, which is secured by a 2022-vintage multifamily property in Hallandale Beach, Florida. The borrower's business plan is to complete the initial lease-up phase of the property. Future funding of up to $30.1 million was available at loan closing to fund operating and debt service shortfalls as well as an earnouts tied to the borrower achieving multiple occupancy benchmarks. To date, $15.0 million of earnout dollars and $10.5 million of operating shortfall dollars have been released to the borrower. The remaining $5.0 million of future funding was reallocated for debt service shortfalls from an additional earnout and remains available to the borrower. According to the April 2024 rent roll, the property was 76.4% occupied with an average rental rate of $5,127 per unit. Property cash flow does not currently cover debt service as the DSCR for the T-12 ended April 30, 2024, was 0.28x.

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 private rating letters 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 DBRS Morningstar 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 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.

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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

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://www.dbrsmorningstar.com/research/419592

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

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/410863.

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