Morningstar DBRS Changes Trends on Nine Classes of STWD 2022-FL3, Ltd. to Negative from Stable, Confirms Credit Ratings on All Classes

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by STWD 2022-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)
-- Class E-E at BBB (low) (sf)
-- Class E-X at BBB (low) (sf)
-- Class F-E at BB (low) (sf)
-- Class F-X at BB (low) (sf)
-- Class G-E at B (low) (sf)
-- Class G-X at B (low) (sf)

Morningstar DBRS changed the trend on Classes E, F, G, E-E, E-X, F-E, F-X, G-E, and G-X to Negative from Stable. The trend on all other classes is Stable.

The trend changes reflect the increased credit risk to the transaction as a result of increased loan-level loss expectations for several of the loans in the transaction, including the one specially serviced loan in the transaction, 700 Louisiana and 600 Prairie Street (Prospectus ID#11), which represents 3.7% of the current trust balance and is discussed in greater detail below. In total, there are eight loans secured by office collateral, representing 26.9% of the current trust balance. The majority of the borrowers of these loans have been unable to meaningfully increase property occupancy rates and cash flows since their respective loan closings and, as such, the likelihood of the borrowers being able to refinance loans or sell properties at loan maturity remains low. In its analysis for this review, Morningstar DBRS stressed the as-is and/or the as-stabilized loan-to-value ratios (LTVs) of these loans, resulting in increased loan-level expected losses (EL). Individual loan EL figures ranged from approximately 3.0% to 25.0%.

Morningstar DBRS also notes that select borrowers of loans secured by collateral other than office properties are facing increased execution risk in their respective business plans because of a combination of factors, including decreased property values, increased construction costs, slower rent growth, and increases in debt service costs stemming from the current elevated interest rate environment, as all loans have floating interest rates. The transaction faces heightened maturity risk as 22 loans, representing 49.1% of the current trust balance, are scheduled to mature in the next six months. While all of the loans have built-in extension options, Morningstar DBRS notes some loans exhibiting slow performance growth will not qualify to exercise the related options based on current collateral performance and will therefore likely need to be modified.

The credit rating confirmations reflect the concentration of loan collateral secured by multifamily properties (28 loans, totaling 58.7% of the current trust balance), which has historically proven to be better able to retain property value and cash flow compared with other property types. In its analysis for this review, Morningstar DBRS determined that a majority of individual borrowers are progressing with their business plans to increase property and property value. The unrated, first-loss note of $75.0 million provides a 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 published a Surveillance Performance Update report with an in-depth analysis and credit metrics for the transaction, along with business plan updates on select loans. To access this report, please click on the link under Related Documents below or contact us at info-DBRS@morningstar.com.

As of the September 2024 remittance, the pool comprises 41 loans secured by 96 properties with a cumulative trust balance of $993.9 million, representing a minimal collateral reduction of 0.6%. The transaction had an initial 24-month reinvestment period that ended with the February 2024 remittance. Since Morningstar DBRS' last credit rating action in September 2023, nine loans from the pool with a previous cumulative trust balance of $139.0 million have been successfully repaid in full, including five loans with a former cumulative trust balance of $33.5 million that the Issuer purchased from the trust as credit risk assets.

The 700 Louisiana and 600 Prairie Street loan is secured by a 1.3 million-square foot office tower and parking garage in downtown Houston. As of the September 2024 reporting, the senior loan balance is $249.0 million with a $37.0 million pari passu piece in the trust. Morningstar DBRS also rates an additional piece securitized in the TWD 2019-FL1 transaction. The loan transferred to special servicing in December 2023 for maturity default after it matured in September 2023. In February 2024, the loan was modified, extending the loan maturity to January 2026. The modification also added a preferred equity partner to contribute up to $30.0 million of capital for leasing costs, capital expenditures, and projected carry costs. As of the June 2024 rent roll, the property was 66.9% occupied, up from 65.2% as of YE2023. According to the servicer, the property generated YE2023 net operating income (NOI) of $18.1 million, which resulted in a debt service coverage ratio (DSCR) of 1.10 times (x) and a debt yield of 7.2%. Despite the recent modification, Morningstar DBRS notes that the asset is likely overleveraged. An updated appraisal dated January 2024 valued the property at $284.0 million on an as-is basis, an 11.5% reduction from the issuance appraisal of $321.0 million. The updated valuation is indicative of a 6.4% cap rate based on the YE2023 NOI, which Morningstar DBRS determined to be aggressive. In its current analysis, Morningstar DBRS applied upward cap rate adjustments to both the as-is and as-stabilized LTVs. The resulting as-is LTV was above 100.0%, while the as-stabilized LTV was above 80.0%. Morningstar DBRS also applied a probability of default (POD) penalty to reflect the increased business plan execution risk and the status of the loan. The resulting loan EL was more than twice the weighted-average (WA) EL for the pool.

While only one loan is in special servicing, there are four additional loans, representing 8.0% of the current trust balance, that were reportedly delinquent as of September 2024. In its analysis of these loans, Morningstar DBRS adjusted the respective loan PDs, increasing the loan EL levels to reflect the increased credit risk. Additionally, 19 loans are on the servicer's watchlist, representing 36.3% of the current trust balance. Seven of these loans were flagged for performance issues with low occupancy rates and/or DSCRs; however, this was anticipated at individual loan closing as borrowers continue to progress through business plans to stabilize the assets. Additionally, debt service payments have increased given the floating-rate nature of all the loans in the pool in the current interest rate environment.

Beyond these multifamily and office collateral concentrations, there are three loans, representing 8.1% of the current trust balance, secured by hotel properties and two loans, representing 6.3% of the current pool balance, secured by mixed-use properties

In terms of leverage, the pool has reported consistent figures with 2023 and issuance periods, reporting a current WA appraised LTV of 68.5% and a WA stabilized LTV ratio of 62.6%. By comparison, these figures were 68.6% and 63.4%, respectively, at issuance in February 2022. Morningstar DBRS recognizes that the current market values of the collateralized properties may be inflated as the individual property appraisals were completed in 2021 and 2022 and do not reflect increased interest rate and widening capitalization (cap) rate environments. Morningstar DBRS applied LTV adjustments to 18 loans, representing 69.8% of the current trust balance, which generally reflects higher cap rate assumptions compared with the implied cap rates based on the appraisals.

Through September 2024, the lender had advanced cumulative loan future funding of $245.1 million to 36 of the 41 outstanding individual borrowers to aid in property stabilization efforts. The largest advance of $73.6 million was made to the borrower of the Anthem Row loan (Prospectus ID#29; 4.0% of the current pool balance), which is secured by two connected 12-story office buildings in Washington, D.C. The borrower's business plan centers on achieving stabilized occupancy levels and bridging the property through existing free rent periods. An additional $121.5 million of future funding allocated to 28 individual borrowers remains available. Of this outstanding amount, the largest portion is allocated to the borrower of The Global Hotel Group G6 Southeast Portfolio (Prospectus ID#43; 7.3% of the current pool balance) for its stabilization efforts. The loan is secured by a 40-property lodging portfolio spread throughout the Eastern and Southeastern United States; the borrower's business plan is to use future funding to finance renovations throughout the portfolio. According to the Q2 2024 collateral manager update, the renovations are ongoing and were approximately 53% completed.

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 Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

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 Multi-Borrower Rating Methodology (March 1, 2024), https://dbrs.morningstar.com/research/428797.

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.

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, Inc.
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Chicago, IL 60602 USA
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.

-- Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (September 19, 2024), https://dbrs.morningstar.com/research/439702
-- Legal Criteria for U.S. Structured Finance (April 15, 2024), https://dbrs.morningstar.com/research/431205
-- North American CMBS Insight Model v 1.2.0.0, https://dbrs.morningstar.com/research/428797
-- North American Commercial Mortgage Servicer Rankings (August 23, 2024), https://dbrs.morningstar.com/research/438283

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