DBRS Morningstar Finalizes Provisional Ratings on HGI CRE CLO 2021-FL2, Ltd.

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings to the following classes of notes issued by HGI CRE CLO 2021-FL2, Ltd. (the Issuer):

-- Class A 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.

With regard to the Coronavirus Disease (COVID-19) pandemic, 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, feeling more immediate effects. Accordingly, DBRS Morningstar may apply additional short-term stresses to its rating analysis. For example, DBRS Morningstar may front-load default expectations and/or assess the liquidity position of a structured finance transaction with more stressful operational risk and/or cash flow timing considerations.

The initial collateral includes 20 mortgage loans or senior notes, consisting of seven whole loans and 13 fully funded senior, senior pari passu, or pari passu participations secured by multifamily real estate properties with an initial cut-off date balance totaling $514.5 million. All 20 mortgages have floating interest rates tied to the Libor index. The transaction is a managed vehicle, which includes a ramp-up acquisition period and subsequent 24-month reinvestment period. The ramp-up acquisition period will be used to increase the trust balance by $65.0 million to an aggregate deal balance of $549.4 million. DBRS Morningstar assessed the $65.0 million ramp component using a conservative pool construct, and, as a result, the ramp loans have expected losses (E/Ls) above the weighted-average pool E/L. 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 that meet the eligibility criteria. The eligibility criteria has, among other things, minimum debt service coverage ratio (DSCR), loan-to-value (LTV) ratio, and loan size limitations. Lastly, the eligibility criteria stipulates that a No Downgrade Confirmation (Rating Agency Confirmation (RAC)) must be received from DBRS Morningstar before acquiring new ramp loans, reinvestment loans, and participations on loans already owned by the Issuer in excess of $1.0 million. The No Downgrade Confirmation requirement allows DBRS Morningstar to review the new collateral interest and assess potential impacts on 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 Net Cash Flow (NCF), 18 loans, representing 80.9% of the initial pool balance, had a DBRS Morningstar As-Is DSCR of 1.00 times (x) or below, a threshold indicative of default risk. On the other hand, only three loans, representing 15.8% of the initial pool balance, had a DBRS Morningstar Stabilized DSCR of 1.00x or below, which is indicative of elevated refinance risk. Most properties are 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 the other loan structural features are insufficient to support such treatment. Furthermore, even with the structure provided, DBRS Morningstar generally does not assume the assets to stabilize above current market levels.

The transaction will have a sequential-pay structure.

All loans in the pool are secured by multifamily properties across 13 states including Illinois, Texas, Florida, and New York. Multifamily properties have historically seen lower probabilities of default (PODs) and typically see lower E/Ls within the DBRS Morningstar model. Multifamily properties benefit from staggered lease rollover and generally low expense ratios compared with other property types. 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. Additionally, most loans in the pool are secured by traditional multifamily properties, such as garden-style communities or mid-rise/high-rise buildings, with no independent living/assisted living/memory care facilities or student housing properties included in this pool. Furthermore, during the transaction’s reinvestment period, only multifamily properties (excluding senior housing and student housing properties) are eligible to be brought into the trust.

Eleven loans, composing 66.0% of the initial trust balance, represent acquisition financing wherein sponsors contributed significant cash equity as a source of initial funding in conjunction with the mortgage loan, resulting in a moderately high sponsor cost basis in the underlying collateral.

All loans were originated in 2021, with the earliest loan having a note date of April 2021. The loan files are recent, including third-party reports that consider impacts from the coronavirus pandemic.

The DBRS Morningstar Business Plan Score (BPS) for loans DBRS Morningstar analyzed was between 1.5 and 2.8, with an average of 2.16. On a scale of 1 to 5, a higher DBRS Morningstar BPS indicates 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. Compared with similar transactions, this pool has a lower average DBRS Morningstar BPS, which is indicative of lower risk.

The ongoing coronavirus pandemic continues to pose challenges and risks to the commercial real estate (CRE) sector, and while DBRS Morningstar expects multifamily (100.0% of the pool) to fare better than most other property types, the long-term effects on the general economy and consumer sentiment are still unclear. All loans in the pool have been originated after March 2020, or the beginning of the pandemic in the U.S. Loans originated after the pandemic include timely property performance reports and recently completed third-party reports, including appraisals.

The sponsor for the transaction, HGI CFI REIT, is a newer CRE collateralized loan obligation (CLO) issuer and collateral manager, and the subject transaction is its second securitization. HGI CFI REIT will purchase and retain the most subordinate portion of the capital structure totaling 20.125%, including Notes F and G, in addition to the Preferred Shares. This provides protection to the Offered Notes, as the Issuer will incur first losses up to 20.125%. DBRS Morningstar met with the sponsor to better understand its investment strategy, organization structure, and origination practices. Based on this meeting, DBRS Morningstar found that HGI CFI REIT met its issuer standards. Furthermore, as of June 30, 2021, Harbor Group International, LLC had $14.5 billion of assets under management, including direct equity, debt investments, and real estate securities.

The transaction is managed and includes one delayed-close loans, a ramp-up component, a reinvestment period, and a replenishment period, which could result in negative credit migration and/or an increased concentration profile over the life of the transaction. Eligibility criteria for ramp and reinvestment assets partially offsets the risk of negative credit migration. The criteria outlines DSCR, LTV, Herfindahl, and property type limitations. A No Downgrade Confirmation (RAC) is required from DBRS Morningstar for ramp loans, reinvestment loans, and companion participations above $1.0 million. Before loans are acquired and brought into the pool, DBRS Morningstar will analyze them for any potential ratings impact. DBRS Morningstar accounted for the uncertainty introduced by the ramp-up period by running a ramp scenario that simulates the potential negative credit migration in the transaction based on the eligibility criteria.

DBRS Morningstar has analyzed the loans to a stabilized cash flow that is, in some instances, above the as-is cash flow. It is possible that the sponsors will not successfully execute their business plans and that the higher stabilized cash flow will not materialize during the loan term, particularly with the ongoing coronavirus pandemic and its impact on the overall economy. A sponsor’s failure to execute the business plan could result in a term default or the inability to refinance the fully funded loan balance. DBRS Morningstar made relatively conservative stabilization assumptions and, in each instance, considered the business plan to be rational and the loan structure to be sufficient to execute such plans. In addition, DBRS Morningstar analyzed loss severity given default (LGD) based on the as-is credit metrics, assuming the loan was fully funded with no NCF or value upside.

Because of the ongoing coronavirus pandemic, DBRS Morningstar was able to perform site inspections on only two loans in the pool, The Astor LIC and One Arlington. As a result, DBRS Morningstar relied more heavily on third-party reports, online data sources, and information from the Issuer to determine the overall DBRS Morningstar property quality score for each loan. DBRS Morningstar made relatively conservative property quality adjustments with five loans, comprising 25.2% of the pool, having Average – or Below Average property quality.

All 20 loans in the pool have floating interest rates and are interest only during the initial loan term, creating interest rate risk and a lack of principal amortization. DBRS Morningstar stresses interest rates based on the loan terms and applicable floors or caps. The DBRS Morningstar Adjusted DSCR is a model input and drives loan level PODs and LGDs. All loans have extension options, and, to qualify for these options, the loans must meet minimum DSCR and LTV requirements. All loans are short term and, even with extension options, have a fully extended loan term of five years maximum, which, based on historical data, the DBRS Morningstar model treats more punitively. The borrowers for nine loans, totaling 42.5% of the trust balance, have purchased Libor rate caps that range between 1.00% and 2.50% to protect against rising interest rates over the term of the loan.

Three loans, representing 17.4% of the initial cut-off pool balance, have a sponsor with negative credit history and/or limited financial wherewithal, including Congressional Village, Marbella Apartments, and Prosper Fairways. DBRS Morningstar deemed two loans to have Weak sponsorship strength, effectively increasing the POD for each loan.

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.

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#01 – The Astor LIC (9.7% of the pool)
-- Prospectus ID#02 – Monterosso (8.4% of the pool)
-- Prospectus ID#03 – Ravella at Sienna (8.2% of the pool)
-- Prospectus ID#04 – One Arlington (7.5% of the pool)
-- Prospectus ID#05 – Congressional Village (7.1% of the pool)
-- Prospectus ID#06 – Riverdale Portfolio 1 (6.8% of the pool)
-- Prospectus ID#07 – A17 (6.0% of the pool)
-- Prospectus ID#08 – Upland Townhomes (5.9% of the pool)
-- Prospectus ID#09 – Avon Mills (5.7% of the pool)
-- Prospectus ID#10 – Westcreek Apartments (5.6% of the pool)
-- Prospectus ID#11 – Chapel View (5.5% of the pool)
-- Prospectus ID#12 – Marbella Apartments (5.4% of the pool)
-- Prospectus ID#13 – Prosper Fairways (4.9% of the pool)
-- Prospectus ID#18 – Meridian Tower (1.6% 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 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.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

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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