DBRS Morningstar Finalizes Ratings on HGI CRE CLO 2022-FL3, LLC

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of notes to be issued by HGI CRE CLO 2022-FL3, LLC (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.

The initial collateral consists of 22 floating-rate mortgages secured by 35 mostly transitional properties with a cut-off balance of $546,821,293, including approximately $60 million of ramp-up mortgage assets and one delayed close, identified as Euclid Grand, having an expected trust principal balance of $56,220,000, which is expected to close prior to the Closing Date or within 90 days of the Closing Date. In addition, there is a two-year reinvestment period during which the Issuer may use principal proceeds to acquire additional eligible loans, subject to the eligibility criteria. During the reinvestment period, the Issuer may acquire future funding commitments, funded companion participations, and additional eligible loans subject to the eligibility criteria. The transaction stipulates a no-downgrade confirmation from DBRS Morningstar for all companion participations (greater than $1,000,000) if a participation of the underlying loan is already in the trust.

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, 20 loans, representing 84.7% of the initial pool, had a DBRS Morningstar As-Is debt service coverage ratio (DSCR) below 1.00 times (x), a threshold indicative of default risk. Additionally, the DBRS Morningstar Stabilized DSCRs for eight loans, representing 37.5% of the initial pool balance, are below 1.00x. 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 to stabilize above market levels.

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, affected more immediately. Accordingly, DBRS Morningstar may apply additional short-term stresses to its rating analysis by, for example, 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.

For more information regarding rating methodologies and the coronavirus pandemic, please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/384482.

All loans in the pool are secured by multifamily properties across 13 states with the largest pool concentrations in Florida (18.4%), Texas (16.4%), and Georgia (11.9%). Multifamily properties have historically seen lower probabilities of default (PODs) and typically see lower expected losses 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.

Acquisition financing represents 88.5% of the Closing Date cut-off balances. Acquisition loans are considered more favorable because the sponsor is usually required to contribute a significant amount of cash equity as part of the transaction. Acquisition financing is also generally based on actual transaction values rather than an appraiser’s estimate of market value.

The DBRS Morningstar Business Plan Score (BPS) for loans DBRS Morningstar analyzed was between 1.6 and 2.7, with an average of 2.04. 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.

None of the loans in the current pool are secured by properties in areas with a DBRS Morningstar Market Rank of 7 or 8, which are more densely populated and urban in nature. Loans secured by properties in such areas have historically benefited from increased liquidity and consistently strong investor demand, even during times of economic distress. Consequently, loans in these dense, urban locations often exhibit lower expected losses, and the lack of collateral in these areas can be a negative credit characteristic. Conversely, 16 loans, representing 62.8% of the current portfolio balance, are secured by properties in areas with a DBRS Morningstar Market Rank of 3 or 4, which are more suburban in nature. Loans secured by properties in such areas have historically exhibited elevated PODs and often have higher expected losses in the DBRS Morningstar approach. The DBRS Morningstar weighted-average (WA) Market Rank of 3.8 for this pool is generally indicative of a higher concentration of properties in less densely populated suburban areas.

All loans in the pool have floating interest rates and are interest only (IO) during the initial loan term, creating interest rate risk and a lack of principal amortization.

Based on the initial pool balances, the overall DBRS Morningstar WA As-Is DSCR of 0.76x and WA As-Is loan-to-value ratio (LTV) of 91.2% generally reflect high-leverage financing. Most of the assets are generally well positioned to stabilize, and any realized cash low growth would help offset a rise in interest rates and improve the loans’ overall debt yield. DBRS Morningstar associates its loss severity given default based on the assets’ As-Is LTV, which does not assume that the stabilization plan and cash flow growth will ever materialize. The DBRS Morningstar As-Is DSCR for each loan at issuance does not consider the sponsor’s business plan as the DBRS Morningstar As-Is NCF is generally based on the most recent annualized period. The sponsor’s business plan could have an immediate impact on the underlying asset performance that the DBRS Morningstar As-Is NCF is not accounting for.

Because of the ongoing coronavirus pandemic, DBRS Morningstar was able to perform site inspections on only two loans in the pool, The Cynwyd and Burlington Pointe. 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 eight loans, comprising 26.2% of the pool, having Average– or Below Average property quality.

ESG 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.

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

The DBRS Viewpoint platform provides additional information on this transaction and underlying loans including DBRS Morningstar metrics, commentary, servicer-reported cash flows, and other performance-related data.

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 (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.

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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