DBRS Morningstar Confirms Credit Ratings on FS Rialto 2022-FL5 Issuer, LLC; Changes Trend on Two Classes to Negative from Stable

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by FS Rialto 2022-FL5 Issuer, LLC (the Issuer) as follows:

-- Class A Notes at AAA (sf)
-- Class A-S Notes at AAA (sf)
-- Class B Notes at AA (low) (sf)
-- Class C Notes at A (low) (sf)
-- Class D Notes at BBB (sf)
-- Class E Notes at BBB (low) (sf)
-- Class F Notes at BB (low) (sf)
-- Class G Notes at B (low) (sf)

The trends on the Class F and Class G Notes have been changed to Negative from Stable. The trends on the remaining classes remain Stable.

The trend changes are a result of the increased credit risk to the transaction as five loans, representing 19.2% of the current pool balance, are in special servicing. In its current analysis of these five loans, Morningstar DBRS applied a stressed probability of default (POD) penalty and/or stressed loan-to-value ratio (LTV) to three loans: 3500 The Vine (Prospectus ID#7; 7.6% of the pool), 360 Huguenot (Prospectus ID#8; 6.5% of the pool), and Nob Hill (Prospectus ID#15; 3.9% of the pool), which resulted in increased loan-level expected losses. An additional loan, Washington Pointe and The Landings at 56th (Prospectus ID#24; 1.7% of the pool), was liquidated with a loss severity of approximately 30.0%. The final loan, 1125 E. Campbell (Prospectus ID#27; 0.5% of the pool), is expected to be resolved without a loss to the trust.

The credit rating confirmations reflect the overall credit support to the transaction with an unrated, first-loss piece of $56.9 million as well as two below investment-grade bonds, Class F and Class G, totaling $63.0 million. There has also been collateral reduction of 8.0% since issuance. The transaction benefits from a favorable collateral composition as the majority of loan collateral consists of multifamily properties (13 loans, representing 57.3% of the pool); however, it should be noted, four of these loans (18.7% of the pool) are in special servicing. Historically, loans secured by multifamily properties have exhibited lower default rates and the ability to retain and increase asset value. 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].

The initial collateral consisted of 23 floating-rate mortgage loans secured by 52 mostly transitional properties with a cut-off balance totaling $600 million. Most loans were in a period of transition with plans to stabilize performance and improve values of the underlying assets. The transaction had a maximum funded balance of $690.0 million and a two-year Reinvestment Period that expired with the June 2024 Payment Date. As of the September 2024 remittance, the pool comprised 23 loans secured by 52 properties with a cumulative trust balance of $637.9 million. Eighteen of the original 23 loans, representing 88.5% of the current pool balance, remain in the trust.

Since the previous Morningstar DBRS rating action in October 2023, one loan, representing 8.5% of the current pool balance, has been added to the trust. Over the same period, one loan with a former trust balance of $52.1 million was paid in full while two additional loans with a former cumulative trust balance of $57.0 million were purchased from the trust by the issuer as credit-risk assets. Beyond the multifamily concentration noted above, four loans (representing 18.1% of the current pool balance) are secured by hotel properties, another four loans (representing 16.1% of the current pool balance) are secured by office properties, and two loans (representing 8.5% of the current pool balance) are secured by industrial properties.

Leverage across the pool has remained similar since issuance as the current weighted-average (WA) as-is appraised LTV is 66.7% with a current WA stabilized appraised LTV of 61.3%. In comparison, these figures were 68.4% and 61.7%, respectively, at issuance. Morningstar DBRS recognizes these appraised values may be inflated as the majority of the individual property appraisals were completed in 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 13 loans, representing 69.2% of the current pool balance, generally reflective of higher cap rate assumptions compared with the implied cap rates based on the appraisals.

The 3500 The Vine loan is secured by a 508-unit multifamily property in Atlanta. The loan transferred to special servicing in June 2024 for payment default, with debt service last paid in May 2024. The loan has a current balance of $74.3 million with a $48.3 million piece in the trust. An additional loan piece is securitized in the FS Rialto 2022-FL6 transaction, which is also rated by Morningstar DBRS. As of the December 2023 rent roll, the property was 83.9% occupied and generated net cash flow (NCF) of $3.6 million, which equated to a debt service coverage ratio (DSCR) of 0.51 times (x) and debt yield of 4.1%. Prior to the transfer, the borrower had used $3.0 million of loan future funding to complete 100 unit renovations, exterior renovations, and the correction of deferred maintenance. Renovated units reportedly achieve an average monthly rental rate premium of $160 per unit. About $0.7 million of available future funding renovation remain. According to the Q2 2024 collateral manager's report, the sponsor has paused its business plan of completing unit renovations and is now focused on evicting delinquent tenants. According to the servicer, the borrower has signed a pre-negotiation letter with resolution discussions ongoing between the lender and borrower; however, no expected resolution timing was provided. In its current analysis, Morningstar DBRS applied a POD adjustment to the loan, which resulted in a loan expected loss in excess of the WA expected loss for the overall pool.

The 360 Huguenot loan is secured by a 280-unit, high-rise apartment property in New Rochelle, New York. The loan transferred to special servicing in April 2024 for payment default, with debt service last paid in February 2024. The loan has a current balance of $105.0 million with a $35.1 million piece in the trust. An additional loan piece is securitized in the FS Rialto 2022-FL6 transaction. As of Q2 2024, the property had an occupancy rate of 87.6%, down from 91.0% at Q1 2024. The property has continued to face leasing challenges and difficulties reducing collection loss. The borrower has completed 57 tenant evictions, including 13 evictions in 2024; however, 18 tenants that are at least one month delinquent on rental payments remain in occupancy, which has contributed to declining NCF quarter over quarter. As of the trailing 12 months (T-12) ended June 30, 2024, NCF was $3.0 million, equating to a 3.0% debt yield. According to the servicer, the borrower has signed a pre-negotiation letter with resolution discussions ongoing between the lender and borrower; however, the lender also plans to dual track foreclosure as a receiver order was entered in August 2024. In its current analysis, Morningstar DBRS applied upward LTV adjustments and an increased POD to the loan, which resulted in a loan expected loss in excess of the WA expected loss for the overall pool.

The Nob Hill loan is secured by a 150-building, 1,326-unit multifamily property in Houston. The loan transferred to special servicing in June 2024 for payment default, with debt service last paid in March 2024. The loan has a current balance of $88.1 million with a $25.0 million piece in the trust. Additional loan pieces are securitized in the FS Rialto 2022-FL4 and FS Rialto 2022-FL6 transactions, which are both rated by Morningstar DBRS. As of Q2 2024, the property was 74.8% occupied, down from 84.0% at YE2023, but up slightly from the previous quarter. Prior to the transfer, the borrower had used $18.4 million of loan future funding to complete 300 unit renovations, exterior renovations, and the correction of deferred maintenance. Renovated units reportedly achieved monthly rental rate premiums between $100 per unit and $125 per unit. Future funding of $5.5 million for renovations remains available; however, the sponsor has halted renovations and shifted its focus to curing tenant delinquencies by removing non-paying tenants. In addition, marketed rental rates have been lowered in an effort to increase occupancy. According to the servicer, the borrower has signed a pre-negotiation letter with resolution discussions ongoing between the lender and borrower. In its current analysis, Morningstar DBRS applied a POD adjustment to the loan, which resulted in a loan expected loss in excess of the WA expected loss for the overall pool.

Six loans, representing 34.2% of the current trust balance, are on the servicer's watchlist as of the September 2024 reporting. The loans have been flagged for debt service coverage ratios (DSCRs) below breakeven and upcoming loan maturities. The largest loan on the servicer's watchlist, Sage Canyon Apartments Homes (Prospectus ID#1; 9.3% of the current pool balance), is secured by a 344-unit multifamily property in Temecula, California. The loan is being monitored for the upcoming February 2025 maturity date and the lack of borrower-provided financials. According to the Q2 2024 collateral manager's report, the borrower has progressed with its business plan to finish the renovation of 120 classic units leaving only 39 units to be upgraded. NCF for the T-12 ended June 30, 2024, was $5.8 million, equating to a DSCR of 0.93x and debt yield of 6.6%. Cash flow is approaching the Morningstar DBRS stabilized conclusion of $5.9 million but trails the issuer's figure of $7.1 million. Based on the performance trajectory, the borrower will likely be able to successfully execute its exit strategy on the loan.

As a result of lagging business plans and loan exit strategies, the borrowers of 13 loans, representing 49.8% of the current pool balance, have received loan modifications. Terms of the modifications vary from loan to loan; however, common terms include waiving property performance tests to exercise maturity extensions, loan interest deferrals, and the waiver or modification of replacement interest rate cap agreement terms. The transaction faces near-term maturity risk as 12 loans, representing 45.4% of the current trust balance, will mature through Q1 2025. All loans except the Sage Canyon Apartments Homes loan have extension options available to the individual borrowers. Morningstar DBRS expects the borrowers and lenders to agree to loan modifications if property performance tests are not met. Potential modifications are expected to require fresh equity from borrowers in the form of loan curtailments, deposits into an interest reserve, and/or the purchase of a new interest rate cap agreement.

Through September 2024, the collateral manager had advanced cumulative loan future funding of $121.4 million to 17 of the outstanding individual borrowers, including $105.5 million since the previous Morningstar DBRS credit rating action as borrowers continued to make progress in their respective business plans. The largest cumulative advance ($23.4 million) has been made to the borrower of the Spectrum Center loan, which is secured by a Class A office property in Addison, Texas. The borrower has used the funds to complete its significant capital expenditure (capex) and leasing plan. Future funding of $15.1 million remains available to the borrower.

An additional $57.5 million of future loan funding allocated to 12 of the outstanding individual borrowers remains available. The largest portion of available funds ($15.2 million) is allocated to the borrower of the Buckhead Centre loan, which is secured by a Class B office building in Atlanta. The sponsor's business plan is to complete a $16.0 million capex plan to improve the property's quality and convert the building into a boutique Class A office product. The property's performance has been declining in recent years as the occupancy rate decreased to 51.6% as of the August 2024 rent roll from 64.8% as of June 2023 and 66.9% as of January 2023. Based on the YE2023 financials, the loan reported a DSCR of 0.21x and debt yield of 1.3%. To date, the lender has only advanced $0.6 million of loan future funding to the borrower as the business plan is behind schedule. In its current analysis, Morningstar DBRS increased the LTV, resulting in a loan expected loss in excess of the WA expected loss for the overall pool.

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 Factors in Credit Ratings (August 13, 2024); 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.

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.

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.

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.

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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 (September 19, 2024), https://dbrs.morningstar.com/research/439702

North American Commercial Mortgage Servicer Rankings (August 23, 2024), https://dbrs.morningstar.com/research/438283

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].