Morningstar DBRS Confirms Credit Ratings on All Classes of KREF 2022-FL3 Ltd.
CMBSDBRS Limited (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by KREF 2022-FL3 Ltd. (the Issuer) 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-X at BB (low) (sf)
-- Class F-E at BB (low) (sf)
-- Class G at B (low) (sf)
-- Class G-X at B (low) (sf)
-- Class G-E at B (low) (sf)
All trends are Stable.
The credit rating confirmations and Stable trends reflect the overall stable performance of the underlying loans, supported by the 100% concentration of collateral in multifamily property types. Morningstar DBRS notes multifamily properties have historically exhibited lower default rates as compared with other property types. The majority of individual borrowers are progressing in their stated business plans to increase property cash flows. Additionally, the transaction benefits from a sizeable nonrated first loss PREF Class which has a balance of $67.5 million, with no losses incurred to date. There are some loans in the transaction for which the borrower's respective business plans have stalled or there have been other signs of increased credit risks since issuance. Where applicable, Morningstar DBRS considered stressed scenarios for those loans to increase the loan-level expected losses (ELs) and, while this approach resulted in an increased pool EL, the overall analysis supported the credit rating confirmations.
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. 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 comprised 16 loans secured by 18 properties with a cumulative trust balance of $1 billion. The transaction is a managed vehicle and was structured with a 24-month reinvestment period that expired with the February 2024 payment date, whereby the Issuer could acquire Companion Participations in either the form of a mortgage loan, a combination of a mortgage loan and a related mezzanine loan, or a fully funded pari passu participation. In addition, the transaction is structured with a Replenishment Period, which began on the first day after the Reinvestment Period and ended with the August 2024 payment date, the sixth payment date after the Reinvestment Period. Since issuance, three loans with a cumulative trust balance of $140.0 million have been paid in full, one of which ($40.0 million) repaid since Morningstar DBRS' previous credit rating action in October 2023. Additionally, one loan, totaling $8.0 million, has been added to the trust since October 2023.
As of September 2024, no loans were in special servicing, and two loans, representing 11.2% of the current trust balance, were being monitored on the servicer's watchlist for upcoming maturities. While borrowers continue to make progress on their business plans to stabilize the assets, the majority of loans report debt service coverage ratios (DSCRs) below 1.0x based on the most recent financials, largely as a result of the floating-rate nature of all the loans in the pool, which has increased debt service payments. To date, 14 loans have been modified; 12 of these loans were modified to allow the transition of the floating-interest rate benchmark from Libor to Term Secured Overnight Financing Rate. Three loans, specifically Aven (11.4% of the current pool balance), The Kendrick (Prospectus ID#12, 7.2% of the current pool balance), and Orchards Portfolio (Prospectus ID#15, 4.3% of the current pool balance), received an extension to the initial maturity dates.
Thirteen loans, representing 79.6% of the current trust balance, are secured by properties in suburban markets, as defined by the Morningstar DBRS Market Ranks of 3, 4, and 5. Two loans, representing 15.4% of the pool, are secured by properties in Morningstar DBRS Market Ranks of 6 and 7, denoting urban markets, while one loan, representing 5.0% of the pool, is secured by a property in a tertiary market, as defined by its Morningstar DBRS Market Rank of 2. Leverage across the pool has remained relatively unchanged since issuance as the current weighted-average (WA) as-is appraised loan-to-value (LTV) ratio is 69.7% and the WA stabilized LTV is 66.1%. In comparison, these figures were 70.5% and 66.4%, respectively, at issuance. The majority of the individual property appraisals were completed in 2022 and as such, the appraisers' cap rates may not reflect the rise in interest rates (and corresponding widening of cap rates) that began later that year. Morningstar DBRS evaluated the appraised values and the implied cap rates on the issuer's cash flows and, where applicable, made upward adjustments to reflect the current valuation and lending environments. This analysis impacted five loans, representing 34.4% of the current trust balance.
Through August 2024, the lender had advanced a cumulative $57.4 million in loan future funding to 10 individual borrowers to aid in property stabilization efforts. The largest advance of $19.9 million was made to the borrower of Crystal Towers and Flats, which is secured by a portfolio of two multifamily properties in Arlington, Virginia. The borrower's business plan is focused on increasing rents to market levels by completing a comprehensive renovation for both assets, with total costs estimated at approximately $28.1 million. An additional $27.1 million of loan future funding allocated to seven individual borrowers remains available. The largest unadvanced portion of $8.1 million was allocated to the borrower of the aforementioned Crystal Towers and Flats. As discussed further in the accompanying Surveillance Performance Update for this transaction, the business plan for that loan has stalled and as such, Morningstar DBRS' analysis considered a stressed scenario to increase the loan-level EL.
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
Environmental (E) Factors
At issuance, it was noted that The Kendrick had an open environmental issue, first identified after the loan's origination, involving levels of trichloroethylene, a potentially carcinogenic substance, in indoor air and soil gas exceeding regulatory limits. The matter is subject to a mandated in-process (early-stage) regulatory order by the Massachusetts Department of Environmental Protection to investigate and remediate the identified contamination until fully resolved, potentially over an estimated five-year timeline. Eighteen of the units identified as affected are considered down units and were concluded as vacant by Morningstar DBRS at issuance.
According to the collateral manager as of Q2 2024, the sponsor of The Kendrick loan was granted a 12-month maturity extension through April 2025 to complete the remediation work associated with an environmental issue at the property. The sponsor anticipates the remediation work to take six to 12 months, with an expected completion date by February 2025 and then plans to market the property for sale thereafter.
There were no 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 Factors in Credit Ratings at https://dbrs.morningstar.com/research/437781 (August 13, 2024).
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 01, 2024; https://dbrs.morningstar.com/research/428797/north-american-cmbs-multi-borrower-rating-methodology).
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 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.
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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 / North American CMBS Insight Model v 1.2.0.0 (March 01, 2024; https://dbrs.morningstar.com/research/428797/north-american-cmbs-multi-borrower-rating-methodology).
-- Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (September 19, 2024; https://dbrs.morningstar.com/research/439702/morningstar-dbrs-north-american-commercial-real-estate-property-analysis-criteria)
-- North American Commercial Mortgage Servicer Rankings (August 23, 2024; https://dbrs.morningstar.com/research/438283/north-american-commercial-mortgage-servicer-rankings)
-- Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024; https://dbrs.morningstar.com/research/428623/interest-rate-stresses-for-us-structured-finance-transactions)
-- Legal Criteria for U.S. Structured Finance (April 15, 2024; https://dbrs.morningstar.com/research/431205/legal-criteria-for-us-structured-finance)
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.
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