DBRS Morningstar Finalizes Provisional Ratings to Arbor Realty Commercial Real Estate Notes 2021-FL2, Ltd.

DBRS, Inc. (DBRS Morningstar) finalized provisional ratings to the following classes of commercial mortgage-backed notes to be issued by Arbor Realty Commercial Real Estate Notes 2021-FL1, Ltd. (ARCREN 2021-FL1 or the Issuer):

-- 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 collateral consists of 25 floating-rate mortgage loans and senior participations secured by 50 mostly transitional properties, with an initial cut-off date balance totaling $653.0 million, which includes approximately $9.0 million of non-interest-accruing future funding that the Issuer will acquire at closing. Each collateral interest is secured by a mortgage on a multifamily property or a portfolio of multifamily properties. The transaction is a managed vehicle, which includes a 180-day ramp-up acquisition period and a 30-month reinvestment period. The ramp-up acquisition period will be used to increase the trust balance by $162.0 million to a total target collateral principal balance of $815.0 million. DBRS Morningstar assessed the $162.0 million ramp component using a conservative pool construct, and, as a result, the ramp loans have expected losses above the pool WA loan expected loss. During the reinvestment period, so long as the note protection tests are satisfied and no event of default has occurred and is continuing, the collateral manager may direct the reinvestment of principal proceeds to acquire reinvestment collateral interest, including funded companion participations, meeting the eligibility criteria. The eligibility criteria, among other things, has minimum debt service coverage ratio (DSCR), loan-to-value ratio (LTV), and loan size limitations. In addition, only mortgages secured by multifamily properties are allowed as ramp-up collateral interests, while other commercial property types, except healthcare, retail, and hospitality properties, are allowed as reinvestment collateral interests, subject to pool concentration limitations. Lastly, the eligibility criteria stipulates a rating agency confirmation (RAC) on ramp loans, reinvestment loans, and pari passu participation acquisitions above $500,000 if a portion of the underlying loan is already included in the pool, thereby allowing DBRS Morningstar the ability to review the new collateral interest and any potential impacts to the overall ratings.

For the floating-rate loans, DBRS Morningstar used the one-month Libor index, which is based on the lower of a DBRS Morningstar stressed rate that corresponded to the remaining fully extended term of the loans or the strike price of the interest rate cap with the respective contractual loan spread added to determine a stressed interest rate over the loan term. When the cut-off balances were measured against the DBRS Morningstar As-Is NCF, 16 loans, representing 51.9% of the initial pool balance, had a DBRS Morningstar As-Is DSCR of 1.00x or below, a threshold indicative of default risk. Additionally, the DBRS Morningstar Stabilized DSCR of three loans, representing 9.5% of the initial pool balance, are below 1.00x, which is indicative of elevated refinance risk. The properties are often transitioning with potential upside in cash flow; however, DBRS Morningstar does not give full credit to the stabilization if there are no holdbacks or if other loan structural features in place are insufficient to support such treatment. Furthermore, even with the structure provided, DBRS Morningstar generally does not assume the assets will stabilize to above-market levels. The transaction will have a sequential-pay structure.

The sponsor for the transaction, Arbor Realty SR, Inc., is a majority-owned subsidiary of Arbor Realty Trust, Inc. (Arbor; NYSE: ABR) and an experienced commercial real estate (CRE) collateralized loan obligation (CLO) issuer and collateral manager. The ARCREN 2021-FL2 transaction will be Arbor’s 15th post-crisis CRE CLO securitization, and the firm has five outstanding transactions representing approximately $2 billion in investment-grade proceeds. Additionally, Arbor will purchase and retain 100.0% of the Class F Notes, the Class G Notes, and the Preferred Shares, which total $140,588,000, or 17.25% of the transaction total.

Twenty-one loans, representing 82.8% of the pool balance, represent acquisition financing. Acquisition financing generally requires the respective sponsor(s) to contribute material cash equity as a source of funding in conjunction with the mortgage loan, resulting in a higher sponsor cost basis in the underlying collateral and aligns the financial interests between the sponsor and lender.

The initial collateral pool is diversified across 11 states and has a loan Herfindahl score of approximately 28.3. The loan Herfindahl score is similar to those of recent Arbor CRE CLO transactions. Three of the loans, representing 15.1% of the initial pool balance, are portfolio loans that benefit from multiple property pooling. Mortgages backed by cross-collateralized cash flow streams from multiple properties typically exhibit lower cash flow volatility.

The DBRS Morningstar Business Plan Scores (BPS) for loans analyzed by DBRS Morningstar ranged between 1.38 and 3.08, with an average of 2.08. Higher DBRS Morningstar BPS indicate more risk in the sponsor’s business plan. DBRS Morningstar considers the anticipated lift at the property from current performance, planned property improvements, sponsor experience, projected time horizon, and overall complexity of the business plan. Compared with similar transactions, the subject has a low average DBRS Morningstar BPS, which is indicative of lower risk.

The loan collateral was generally found to be in good physical condition as evidenced by one loan (4.6% of the trust balance) secured by properties that DBRS Morningstar deemed to be Excellent in quality. An additional three loans, representing 12.9% of the trust balance, are secured by properties with Above Average quality.

The ongoing Coronavirus Disease (COVID-19) pandemic continues to pose challenges and risks to the CRE sector, and, while DBRS Morningstar expects multifamily to fare better than most other property types, the long-term effects on the macroeconomy and consumer sentiment remain unsettled. Arbor provided coronavirus and business plan updates for all loans in the pool, confirming that all debt service payments have been received in full through January 2021. Furthermore, no loans are in forbearance or other debt service relief. Twenty-five loans, totaling 100.0% of the trust balance, were originated after March 2020, or the beginning of the pandemic. Loans originated after the pandemic include timely property performance reports and recently completed third-party reports, including appraisals. Given the uncertainty and elevated execution risk stemming from the coronavirus pandemic, 12 loans, totaling 43.4% of the trust balance, have substantial upfront interest reserves, some of which are expected to cover six months or more of interest shortfalls.

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.

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

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 North American CMBS Multi-Borrower Rating Methodology (March 26, 2021), 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.

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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