DBRS Morningstar Finalizes Provisional Ratings on FREMF 2021-K741 Mortgage Trust, Series 2021-K741

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of Multifamily Mortgage Pass-Through Certificates, Series 2021-K741 issued by FREMF 2021-K741 Mortgage Trust, Series 2021-K741 (FREMF 2021-K741 or the Issuer):

-- Class A-1 at AAA (sf)
-- Class A-2 at AAA (sf)
-- Class X1 at AAA (sf)
-- Class X2-A at AAA (sf)

All trends are Stable.

The Class X1 and X2-A balances are notional.

The collateral consists of 33 fixed-rate loans secured by 22 garden-style, three mid-rise, three high-rise, and one townhome multifamily properties. The collateral also includes two student housing properties and two assisted-living facilities. Three loans (Arcadia Apartment Homes, Calloway At Las Colinas, and Verdant Apartment Homes), representing 13.8% of the trust balance, are associated with the same sponsorship group. However, these loans are neither cross-collateralized nor cross-defaulted and are in different metropolitan areas. All 33 loans in the trust have seven-year loan terms. The transaction is a sequential-pay pass-through structure. DBRS Morningstar analyzed the pool to determine the provisional ratings, reflecting the long-term risk that the Issuer will default and fail to satisfy its financial obligations in accordance with the terms of the transaction. When the cut-off loan balances were measured against DBRS Morningstar’s net cash flow (NCF) and their respective actual constants, 19 loans, representing 76.9% of the pool balance, had a DBRS Morningstar Term debt service coverage ratio (DSCR) at or above 1.75 times (x), a threshold indicative of a lower likelihood of midterm default.

Classes A-1, A-2, A-M, X1, XAM, and X3 of the FREMF 2021-K741 transaction have been conveyed into a trust by Freddie Mac to issue corresponding classes of Structured Pass-Through Certificates (SPCs) guaranteed by Freddie Mac (see the Transaction Structural Features section for more information). All DBRS Morningstar-rated classes will be subject to ongoing surveillance, confirmations, upgrades, or downgrades by DBRS Morningstar after the date of issuance. DBRS Morningstar assigned its initial ratings of the FREMF 2021-K741 Certificates and the Freddie Mac Structured Pass-Through Certificates, Series K-741 (Freddie Mac SPCs K-741) without giving effect to the Freddie Mac guarantee. Please see the FREMF 2021-K741 Structural and Collateral Term Sheet for more information about the structure of the Freddie Mac SPCs K-741.

The loans benefit from strong origination practices and strong loan performance history. Loans on Freddie Mac's balance sheet, which it originated according to the same policies as those for securitization, have an extremely low delinquency rate of 0.01% as of December 2020. This compares favorably with the delinquency rate for commercial mortgage-backed securities (CMBS) multifamily loans of approximately 3.89%. Since the inception of the K-Program through July 2020, Freddie Mac has securitized 20,359 loans, totaling approximately $414.17 billion in guaranteed issuance balance. To date, Freddie Mac has not realized any credit losses on its guaranteed issuances, although B-piece investors have realized a combined $18.8 million in total losses, representing fewer than 1.0 basis points of total issuance. The loans in the transaction benefit from experienced and financially strong borrowers compared with typical CMBS multifamily loans, with 30 of the 33 loans, representing 82.0% of the cut-off pool balance, receiving Strong DBRS Morningstar sponsor strength scores. Additionally, many of the borrowers are repeat clients of Freddie Mac that have performed as agreed.

Two of the top three loans, The Alexander at Rego Center and One East River Place, which combined represent 16.5% of the trust balance, are in areas identified as DBRS Morningstar Market Ranks 7 or 8, which are generally characterized as highly dense urbanized areas that benefit from increased liquidity driven by consistently strong investor demand, even during times of economic stress. Markets ranked 7 and 8 benefit from lower default frequencies than less dense suburban, tertiary, and rural markets. Both loans are in New York City. When compared with Freddie Mac’s K-700 series transaction recently rated by DBRS Morningstar, the 16.5% of the pool in DBRS Morningstar Market Ranks 7 or 8 is lower than the 28.8% in the FREMF 2020-K739 transaction. However, it is higher than the 0.0% in the FREMF 2020-K738 transaction. When compared with Freddie Mac’s K-100 series transactions recently rated by DBRS Morningstar, FREMF 2021-K741 is more favorable than FREMF 2021-K123, FREMF 2020-K122, and FREMF 2020-K118, which exhibited 11.6%, 0.7%, and 3.8%, respectively, in terms of DBRS Morningstar Market Ranks 7 or 8 concentrations.

The transaction exhibits favorable credit metrics as evidenced by a weighted-average (WA) DBRS Morningstar Issuance and Balloon loan-to-value (LTV) of 66.4% and 64.6%, respectively. These metrics are more favorable than the ones in series FREMF 2020-K739 and FREMF 2020-K738 rated by DBRS Morningstar: FREMF 2020-K739 has a WA DBRS Morningstar Issuance and Balloon LTV of 68.5% and 65.0%, respectively, and FREMF 2020-K738 has a WA DBRS Morningstar Issuance and Balloon LTV of 67.1% and 64.7%, respectively. These metrics are also comparable or better when compared with the three K-100 series recently rated by DBRS Morningstar, the FREMF 2021-K123, FREMF 2020-K122, and FREMF 2020-K118, which demonstrated a WA DBRS Morningstar Issuance and Balloon LTV of 70.3% and 63.8%, respectively. Further, the WA DBRS Morningstar Term DSCR of 2.16x is substantially higher than that of FREMF 2020-K739 at 1.89x and FREMF 2020-K738 at 1.86x.

While the WA expected loss of 2.20% is higher than the 1.81% expected loss in FREMF 2020-K739, it is lower than the 2.38% in FREMF 2020-K738. This expected loss is also lower than the Freddie Mac K-100 series recently rated by DBRS Morningstar, including FREMF 2021-K123, FREMF 2020-K122, and FREMF 2020-K118, which demonstrated an average expected loss of 2.35%.

Twenty-seven loans, representing 88.2% of the pool by balance, have an upfront debt service reserve (DSR) designed to mitigate any potential impact of the ongoing Coronavirus Disease (COVID-19) pandemic. Freddie Mac is generally requiring coronavirus-related reserves, based on the property subtype and loan metrics at origination, which can be released back to the borrower if certain conditions are met.

In response to the ongoing pandemic, Freddie Mac made changes to its standard servicing practices to permit a temporary deferral of loan payments and forbearance of various remedies, which could, among other things, adversely affect cash flow. While DBRS Morningstar views the inclusion of coronavirus-related upfront DSRs for a portion of the loans as a positive mitigant of some of the potential coronavirus-related disruptions, the economic fallout from the ongoing pandemic continues to evolve. While DBRS Morningstar generally expects multifamily properties to fare better than hospitality and retail properties, short- and medium-term challenges still exist in this sector. In addition to imposing various containment-related restrictions, certain jurisdictions have also placed temporary moratoriums on evicting tenants that may be continued, extended, or expanded. Furthermore, government programs, such as the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), that provide, among other things, supplemental unemployment benefits to displaced employees, will eventually expire, and terms will continue to be in flux. This could result in additional stress on properties whose residents have been disproportionately affected by furloughs and layoffs. In addition, the resurgence of coronavirus cases has created additional uncertainty and increased stress on the planned reopening of businesses. Also, in its “Global Macroeconomic Scenarios: January 2021 Update,” DBRS Morningstar projected generalized commercial real estate asset value declines of approximately 15% under its moderate scenario and 30% under its adverse scenario for the U.S.

Six loans, representing 11.8% of the pool, did not have a coronavirus DSR. None of these loans were originated before the start of the pandemic. The six loans are: Linq Midtown, Carmel Center Apartments, Four Seasons At Southtowne, City Views Apartments, The Portland, and White Laurel. The Linq Midtown and Carmel Center Apartments loans are among the 15 largest in the pool. The WA DBRS Morningstar Term DSCR for these six loans was healthy at 2.15x. In addition, all six loans show strong occupancy levels, ranging from 89.2% to 97.6%, with a WA occupancy of 94.5% as of December 2020 and January 2021. Eighteen loans, representing 76.4% of the pool balance and including 13 of the top 15 loans, have full-term interest-only (IO) periods, which is high relative to FREMF 2020-K739 at 52.8% and FREMF 2020-K738 at 59.8%. An additional 13 loans, representing 21.5% of the pool balance, are structured with partial-IO periods ranging from 12 months to 60 months. For partial-IO loans, DBRS Morningstar calculates the probability of default (POD) using a DSCR that includes amortizing debt service. Furthermore, the DBRS Morningstar POD factors in loan balloon LTVs and, in cases where the loan lacks amortization, the balloon LTV will be penalized with a higher POD.

The pool is concentrated by property type as conventional multifamily properties represent 87.3% of the collateral; the remaining assets in the pool are nontraditional multifamily property types, including two student housing properties (7.7% of the pool) and two assisted-living facilities (5.0% of the pool). Compared with other property types, multifamily assets generally benefit from staggered lease rollover and lower expense ratios. While revenue is quick to decline in a downturn because of the short-term nature of the leases, it is also quick to respond when the market improves. The DBRS Morningstar model treats student housing and assisted-living properties with higher PODs and/or loss severity given default than traditional multifamily properties.

According to the Exceptions to the Representation and Warranties - 6 (Condition of Mortgage Property), the mortgage loan seller did not perform, or cause to perform, certain customary due diligence for 12 loans regarding the condition of the mortgaged property when originating the loans. DBRS Morningstar did not obtain a complete property condition report or physical risk report, as applicable, and/or an in-person inspection of the mortgaged property was not conducted at origination of the loans. Of these 12 loans, seven loans, accounting for a combined 8.9% of the pool, were either not included in the DBRS Morningstar sample, not inspected by DBRS Morningstar, or generally appeared to be of lower property quality per third-party reports. To mitigate against any issues resulting from the absence of the customary due diligence, DBRS Morningstar applied a POD penalty to these seven loans: Four Seasons At Southtowne, Saint Andrews At Palm Aire, Greystone Place Apartments, Juniper Canyon, Ten50 Apartments, The Portland, and White Laurel.

New York City’s multifamily market has seen a decline in occupancy rates since the inception of the coronavirus pandemic as residents opt to leave the city for the suburbs because of extended remote working capability and shutdowns that have reduced the quality of life. Concessions have also picked up noticeably in general, with properties offering two to three months of free rent over the past few months. Two of the top three loans, The Alexander at Rego Center and One East River Place, which combined represent 16.5% of the trust balance, are in Queens and Manhattan, respectively. The occupancy rate at The Alexander at Rego Center has dropped substantially to 82.1% in December 2020 from 91.4% in July 2020. Similarly, the occupancy rate at One East River Place has declined to 87.0% in December 2020 from 94.5% in April 2020. For more information and detailed analysis, please refer to the individual loan summaries in the presale report. DBRS Morningstar reviewed occupancy statistics over time for the two properties and found that there has been a general decline, rather than simply reflecting a point in time. Consequently, DBRS Morningstar in its analysis applied the in-place vacancy loss to both properties, which reflects the lowest occupancy points throughout the operating history for The Alexander at Rego Center since July 2019 and One East River Place since January 2018. The vacancy rates applied were also substantially higher than the 4.6% and 3.9% Reis submarket vacancy rates for Queens and Manhattan, respectively.

Reis is forecasting a recovery in occupancy over the next several years, with vacancy rates falling back to below 5.0% for the New York metropolitan area. Both properties are in areas identified as DBRS Morningstar Market Ranks 7 or 8, which are generally characterized as highly dense urbanized areas that benefit from increased liquidity driven by consistently strong investor demand, even during times of economic stress.

Individual loan information provided generally included monthly collection reports through October 31, 2020, which may not fully reflect any reductions to income as a result of coronavirus-related economic conditions. The DBRS Morningstar NCF analysis generally applied a vacancy loss that reflected projected submarket vacancy rates through 2026. These rates were either in line with or higher than current submarket vacancy rates, adding a marginal amount of conservatism to the NCFs. For loans that DBRS Morningstar did not sample, DBRS Morningstar applied a 10.0% reduction to the Issuer’s cash flow as applied. This reduction was consistent with the sample average NCF variance of -9.9%. Twenty-seven loans, representing 88.2% of the pool by balance, have an upfront coronavirus DSR designed to mitigate any potential impact of the ongoing coronavirus pandemic.

Under Freddie Mac’s coronavirus forbearance program, borrowers whose properties are financed with a Freddie Mac Multifamily loan that is performing as agreed can defer their loan payments for up to 90 days by showing hardship as a consequence of the pandemic and by gaining lender approval. Freddie Mac subsequently announced an expansion of its relief offerings to borrowers on June 28, 2020, including the option to delay the start of the repayment period following forbearance, an extension of the repayment period, and/or an extension of the forbearance period with an optional extended repayment period. In return for such relief, borrowers must agree not to evict any tenants solely for nonpayment of rent during the forbearance period, may not charge their tenants late fees or penalties solely because of the nonpayment of rent during the forbearance period (or the borrowers’ repayment period), and are required to provide tenants with repayment flexibility by allowing the payment of back rent over time and not in a lump sum.

Twenty-seven loans, representing 88.2% of the pool by balance, established DSRs at origination to ensure that adequate funds are available to pay any deficit on the monthly debt service. Pursuant to the related loan agreement, if the borrower fails to collect a predetermined amount of rent in a given month, the borrower may request a disbursement from the coronavirus DSR, and the disbursement will be applied to the deficit in the monthly debt service payment due on the related underlying mortgage loan.

Importantly, as set forth in the applicable loan agreement, for so long as there are enough funds in the DSR to pay the next monthly debt service payment in full, the borrower may not assert or establish a hardship in an attempt to qualify for any forbearance option offered by Freddie Mac or otherwise available under federal law. In addition, upon an event of default, the lender may make additional disbursements from the DSR at the lender’s discretion, including applying amounts to prepay the outstanding principal balance of the related underlying mortgage loan. The loan agreements generally preclude disbursements from the DSR during any forbearance period, and following the forbearance period, disbursements from the DSR may only be used for the payment of the then-current monthly payment. The DSR can be terminated and the funds can be released back to the borrower upon the written request of the borrower and the satisfaction of certain conditions. These conditions include, among others, that it has been at least 90 days following the lifting of all federal, state, or local state of emergency declarations, shelter-in-place orders, or similar governmental actions related to the coronavirus pandemic affecting the jurisdiction in which the related mortgaged real property is located or a period of at least 12 months after the origination date of the underlying mortgage loan has passed. Generally, the lender must also receive, in accordance with the related loan agreement, rent schedules, operating statements, and/or other evidence satisfactory to the lender that demonstrates that the property has achieved an average collection of rent equal to or greater than a predetermined threshold, and no event of default has occurred or is continuing.

No loans in the pool have requested, or are currently subject to, a forbearance agreement, and the pool’s WA occupancy rate is 91.8%. For more asset-level information, please refer to the individual loan summaries in the presale report. With regard to the coronavirus, the magnitude and extent of performance stress posed to global structured finance transactions remain highly uncertain. This considers the fiscal and monetary policy measures and statutory law changes that have already been implemented or will be implemented to soften the impact of the crisis on global economies. Some regions, jurisdictions, and asset classes are, however, affected more immediately. Accordingly, DBRS Morningstar may apply additional short-term stresses to its rating analysis, for example by front-loading default expectations and/or assessing the liquidity position of a structured finance transaction with more stressful operational risk and/or cash flow timing considerations.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Classes X1 and X2-A are IO certificates that reference a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall.

All ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

For supporting data and more information on this transaction, please log into www.viewpoint.dbrsmorningstar.com. DBRS Morningstar provides analysis and in-depth commentary in the DBRS Viewpoint platform.

DBRS Morningstar provides updated analysis and in-depth commentary in the DBRS Viewpoint platform for the following loans in the transaction:

-- Prospectus ID#1 – Bell Summit At Flatirons (9.1% of the pool)
-- Prospectus ID#2 – The Alexander At Rego Center (8.3% of the pool)
-- Prospectus ID#3 – One East River Place (A-2) (8.2% of the pool)
-- Prospectus ID#4 – Moontower (5.8% of the pool)
-- Prospectus ID#5 – Arcadia Apartment Homes (5.0% of the pool)
-- Prospectus ID#6 – IMT Ballantyne (4.9% of the pool)
-- Prospectus ID#7 – Ashford 75 (4.9% of the pool)
-- Prospectus ID#8 – Calloway At Las Colinas (4.6% of the pool)
-- Prospectus ID#9 – Linq Midtown (4.4% of the pool)
-- Prospectus ID#10 – Verdant Apartment Homes (4.2% of the pool)
-- Prospectus ID#11 – Palo Alto Commons (4.0% of the pool)
-- Prospectus ID#12 – Coles Crossing Apartment Homes (3.7% of the pool)
-- Prospectus ID#13 – Carmel Center Apartments (3.2% of the pool)
-- Prospectus ID#14 – Lakeside Retreat At Peachtree Corners (3.2% of the pool)
-- Prospectus ID#15 – Markana Modern Living Apartments (3.1% of the pool)
-- Prospectus ID#16 – Luxe Belle (1.9% of the pool)
-- Prospectus ID#17 – The Rutherford Assisted Living And Memory Care (1.1% of the pool)
-- Prospectus ID#18 – Arcadia Lofts (0.6% of the pool)

For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com. The platform includes issuer and servicer data for most outstanding CMBS transactions (including non-DBRS Morningstar rated), as well as loan-level and transaction-level commentary for most DBRS Morningstar-rated and -monitored transactions.

Notes:
All figures are in U.S. dollars unless otherwise noted.

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is the North American CMBS Multi-Borrower Rating Methodology (August 7, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria. For a list of the structured-finance-related methodologies that may be used during the rating process, please see the DBRS Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.com in the Commentary tab under Regulatory Affairs. Please note that not every related methodology listed under a principal structured finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrsmorningstar.com.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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