DBRS Morningstar Finalizes Provisional Ratings on Shelter Growth CRE 2022-FL4 Issuer Ltd

DBRS, Inc. (DBRS Morningstar) finalized provisional ratings on the following classes of notes issued by Shelter Growth CRE 2022-FL4 Issuer Ltd (SGCP 2022-FL4):

-- 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 collateral pool consists of 23 short-term, floating-rate mortgage assets with an aggregate cut-off date balance of $400.7 million secured by 24 properties. The aggregate unfunded future funding commitment of the future funding participations as of the cut-off date is approximately $49.8 million. The holder of the future funding companion participations, Shelter Growth Master Commercial Real Estate Credit Fund B IV LP (Credit Fund B Seller), Shelter Growth Master Term Fund B III LP (Term Fund B Seller or the Sponsor), Shelter Growth Capital Partners LLC (SGCP), or another affiliate or entity managed by or under common management with SGCP has full responsibility to fund the future funding companion participations. The collateral pool for the transaction is static with no ramp-up period or reinvestment period. However, the Issuer has the right to use principal proceeds to acquire funded pari passu companion participations subject to stated Acquisition Criteria during the Permitted Funded Companion Participation Acquisition period, which ends on the payment date in December 2023. Acquisition of future funding participations (when funded) of $500,000 or greater will require rating agency confirmation (RAC).

Of the 24 properties, 23 are predominantly multifamily assets (92.8% of the mortgage asset cut-off date balance). The remaining loan (Phoenix Huron Campus) is secured by a mixed-use asset (7.2% of the mortgage asset cut-off date balance).

The loans are mostly secured by cash-flowing assets, most of which are in a period of transition with plans to stabilize and improve the asset’s value. Two loans, Phoenix Huron Campus and The Palmer (1.4% of the cut-off balance) have negative DBRS Morningstar As-Is Net Cash Flows (NCFs). Five are whole loans (18.5% of the mortgage asset cut-off date balance), while the other 18 loans (81.5% of the mortgage asset cut-off date balance) are participations with companion participations that have remaining future funding commitments totaling approximately $49.8 million. The future funding for each loan is generally to be used for capex to renovate the property or build out space for new tenants.

All of the loans in the pool have floating interest rates initially indexed to either Libor (16 loans; 77.3% of the aggregate mortgage asset cut-off date balance) or Secured Overnight Financing Rate (SOFR) (seven loans; 22.7% of the aggregate mortgage asset cut-off date balance). All 23 loans are interest only (IO) through their initial terms; 22 loans are IO through all extension options (96.8% of the mortgage asset cut-off date balance), while the remaining loan (3.2% of the mortgage asset cut-off date balance) provides for amortization using a fixed amortization schedule during the related extension period(s). As such, to determine a stressed interest rate over the loan term, DBRS Morningstar used the one-month Libor index, which was the lower of DBRS Morningstar’s stressed rates that corresponded to the remaining fully extended term of the loans and the strike price of the interest rate cap with the respective contractual loan spread added. 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 the other loan structural features are insufficient to support such treatment. Furthermore, even if the structure is acceptable, DBRS Morningstar generally does not assume the assets will stabilize above market levels.

The transaction is sponsored by Term Fund B Seller, an affiliate of SGCP and SG Capital Partners LLC (SG Capital). As of April 1, 2022, SG Capital has funded $3.6 billion of loans and invested in more than 500 individual credit commercial mortgage-backed securities (CMBS) bonds since 2015, totaling $6.5 billion of market value in purchases as of April 1, 2022. SGCP was founded in 2014 and has approximately $1.1 billion in assets under management as of April 1, 2022, including uncalled capital commitments. SGCP 2022-FL4 will be SG Capital’s fourth commercial real estate collateralized loan obligation (CRE CLO) transaction; of the three prior securitized transactions, SGCP 2018-FL1 was called in January 2021; a notice to call SGCP 2019-FL2 has been put in and the transaction is expected to be collapsed in June 2022; and SGCP 2021-FL3 is performing.

Shelter Growth Term Fund III CRE 2022-FL4 Sub-Notes Holder LLC (SGCP Holder 1), a Delaware limited liability company, which is a wholly-owned subsidiary of Term Fund B Seller, will purchase on the Closing Date 100% of the Class F Notes and the Class G Notes. It is also anticipated that SGCP Holder 1 and its affiliates will purchase on the Closing Date $26,553,000 of the Class C Notes and 100% of the Class D Notes and the Class E Notes (the Retained Offered Notes). However, SGCP Holder 1 will not be required to continue to hold any such Classes of Notes.

The pool is mostly composed of multifamily assets (92.8% of the mortgage asset cut-off date balance). Historically, multifamily properties have defaulted at much lower rates than other property types in the overall CMBS universe.

All of the loans in the pool were originated after the onset of the Coronavirus Disease (COVID-19) pandemic, resulting in the pool’s WA remaining fully extended term of 52 months, which gives the sponsors enough time to execute their respective business plans without risk of imminent maturity. In addition, the appraisal and financial data provided are reflective of conditions after the onset of the pandemic.

There are five properties, comprising 32.6% of the mortgage asset cut-off date balance, that were built after 2017. Because many of the loans are backed by recently built collateral, approximately 31.2% of the pool received a property quality score of either Above Average or Average +.

There are 21 loans, or 74.2% of the pool balance, that 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 the lender.

The DBRS Morningstar Weighted-Average (WA) Stabilized Loan-to-Value Ratio (LTV) is lower than those of many CRE CLO transactions recently rated by DBRS Morningstar. Thirteen loans (out of a DBRS Morningstar modified loan count of 20), representing 58.2% of the total trust balance, have a DBRS Morningstar Stabilized LTV of less than 70.0%, which decreases refinance risk at maturity.

DBRS Morningstar has analyzed the loans to a stabilized cash flow that is, in some instances, above the in-place cash flow. It is possible that a related loan sponsor will not successfully execute its business plan 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. The loan sponsor’s failure to execute the business plan could result in a term default or the inability to refinance the fully funded loan balance. However, DBRS Morningstar sampled a large portion of the loans, representing 83.0% of the mortgage asset cut-off date balance. In addition, DBRS Morningstar made relatively conservative stabilization assumptions and, in each instance, considered the business plans to be rational and the loan structure to be sufficient to substantially implement such plans. In addition, DBRS Morningstar analyzes loss given default (LGD) based on the as-is credit metrics, assuming the loan is fully funded with no NCF or value upside.

The 10 largest loans in the pool make up a significant portion of the entire pool at approximately 66.0% of the mortgage asset cut-off date balance. Additionally, the pool (based on the DBRS Morningstar modified loan count of 20 loans) has a relatively low Herfindahl score of 13.1, which is below that of recent CRE CLO transactions. Furthermore, five loans, representing 18.4% of the cut-off date balance, are in Tulsa and Oklahoma City, Oklahoma, and have related sponsors. However, the largest loan in the pool, City Club Crossroads KC, makes up approximately 16.3% of the cut-off date balance and exhibits the lowest expected loss level in the pool. In addition, DBRS Morningstar combined the Oklahoma loans with the related sponsor into two loan groups representing 9.6% and 8.8% of the cut-off balance.

Ubiquity Solar Inc. (Ubiquity), which occupies 21.0% of the net rentable area (NRA) at Phoenix Huron Campus under three leases expiring between June 30, 2026, and September 30, 2026, has termination options through July 31, 2022, covering 21.0% of the NRA at the mortgaged property, if it fails to receive $25,000,000 in irrevocable funding commitments, an approved incentive offer from the New York State Empire State Development agency, and obtaining operational permits from the local municipality for tenant operations. As of a May 2022 update, only one of three contingencies has been met. If the contingencies are not met and Ubiquity exercises its termination option, there could be a negative impact of more than $3.7 million, or 19.5% of annual gross potential rent, on the DBRS Morningstar As-Stabilized NCF. However, according to the Issuer, the tenant is on track to file an initial public offering by the end of the second quarter of 2022, which should help it achieve its funding commitment target. In addition, DBRS Morningstar modeled the loan with a DBRS Morningstar Business Plan Score (BPS) adjustment to increase the DBRS Morningstar BPS to 3.5 from the model-derived 2.68. A higher DBRS Morningstar BPS indicates more execution risk for a sponsor’s business plan and impacts the probability of default (POD), and ultimately the expected loss, of a loan in the model. Further, the loan is structured with a $3.7 million upfront debt service reserve to offset the potential negative impact on the property’s NCF.

Eleven loans (Oklahoma #10, #12, and #15 Roll Up and Oklahoma #7 and #9 Roll Up), representing 52.6% of the pool balance, are secured by properties with DBRS Morningstar Market Ranks of 3 or 4, which represent areas that are generally suburban in nature and have historically had higher default and loss rates. Additionally, 11 loans, representing 34.8% of the pool balance, are secured by properties with DBRS Morningstar Market Ranks of 1 or 2, which are indicative of more rural or tertiary settings. No loans are within DBRS Morningstar Market Ranks 7 or 8, and the pool’s DBRS Morningstar WA Market Rank of 3.5 indicates a high concentration of properties in less densely populated areas. However, DBRS Morningstar analyzed properties in less densely populated markets with higher PODs and LGDs than those in more urban markets.

All loans have floating interest rates, and all loans are IO during the original term with remaining initial terms ranging from 19 months to 32 months. However, all loans are short-term loans and, even with extension options, have a fully extended maximum loan term of five years. In addition, 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. Further, the borrowers of all floating-rate loans have purchased Libor rate caps that result in mortgage rate caps ranging from 3.50% to 6.75% to protect against rising interest rates through the duration of the loan term. In addition to the fulfillment of certain minimum performance requirements, exercise of any extension options would also require the purchase of interest rate cap protection through the duration of the respectively exercised option.

The current transaction Note benchmark is Term SOFR, which provides an indication of the one-month forward-looking measurement of SOFR based on market expectations implied from derivatives markets. Because Term SOFR is a relatively new rate, the Notes will likely have no established trading market when issued, and an established trading market may never develop or may not be very liquid. Market terms for debt securities linked to Term SOFR, such as the spread over the rate reflected in interest rate provisions, may evolve over time, and trading prices of the Notes may be lower than those of later-issued Term SOFR-based debt securities as a result. Similarly, if Term SOFR does not prove to be widely used in securities like the Notes, the trading price of the Notes may be lower than those Notes linked to rates that are more widely used. In the event that Term SOFR is discontinued as specified in the definition of Benchmark Transition Event or is not available, a Benchmark Replacement will occur. If a Benchmark Transition Event occurs with respect to any Benchmark, such Benchmark will be replaced with the applicable Benchmark Replacement, as determined by the Designated Transaction Representative in accordance with the procedures and notice provisions set forth in the Indenture. Noteholders will not have any right to approve or disapprove of any changes as a result of a Benchmark Transition Event, the selection of a Benchmark Replacement or Benchmark Replacement Adjustment, or the implementation of any Benchmark Replacement Conforming Changes (as those terms are defined in the offering documents), and Noteholders will be deemed to have agreed to each of the foregoing determinations and to have waived and will be deemed to have released any and all claims relating to any such determinations.

In the event of a Benchmark Replacement, the new benchmark under the Asset Documents may not be based on the same base rate or match the applicable Benchmark Replacement at which interest on the Notes will accrue. Currently, some of the Mortgage Loans are based on Libor and some are based on SOFR. The triggers for a conversion from the benchmark under the Asset Documents may also differ from each other and that under the Indenture. Mismatches between SOFR-based rates, and between SOFR-based rates and other rates, may cause economic inefficiencies, particularly if market participants seek to hedge one kind of SOFR-based rate by entering into hedge transactions based on another SOFR-based rate or another rate.

Consistent with the ongoing evolution of Administrative Modifications and Criteria-Based Modifications, the transaction permits the Directing Holder to cause the Special Servicer to effectuate a wider range of Administrative Modifications and Criteria-Based Modifications subject to certain conditions; the Servicing Standard does not apply to such Administrative Modifications and Criteria-Based Modifications. A Criteria-Based Modification is defined as one that would result in a change in interest rate, a delay in the required timing of any payment of principal, an increase in the principal balance of the related loan, the related sponsors incurring additional indebtedness in the form of a mezzanine loan or preferred equity, or a change of maturity date or extended maturity date of the related loan. The transaction limits the number of Criteria-Based Modifications to five subject to, among other conditions, satisfaction of the Par Value Test, no event of default having occurred or occurring, and an RAC from DBRS Morningstar. However, the five Criteria-Based Modifications allowed in this transaction are generally less than the number allowed in recent CRE CLO transactions.

ENVIRONMENTAL (E) FACTORS
Two loans in the pool, City Club Crossroads KC and Phoenix Huron Campus, had Environmental factors that had a relevant effect on the credit analysis, as a result of having a recognized environmental condition (REC) and a controlled recognized environmental condition (CREC), respectively. In the case of City Club Crossroads KC, the REC is due to the presence of volatile organic compounds in the soil and groundwater at levels slightly higher than the Missouri Department of Natural Resources (MDNR) thresholds, which represent concentrations below which exposure would not create a risk to human health. In the case of Phoenix Huron Campus, the CREC is a result of certain chemicals (used by IBM (a former owner/operator) to clean metal parts used in the manufacture of mainframe computers) leaching into the groundwater. In addition, three inactive storage tanks were identified on the property that were not properly removed. However, for the City Club Crossroads KC property, the affected soil has been removed, albeit without MDNR oversight, and there is environmental insurance in place. In addition, DBRS Morningstar modeled the loan with a cap rate adjustment and a value lower than that concluded by the appraiser. In the case of Phoenix Huron Campus, IBM continues to be responsible for the remediation of the environmental impacts on the groundwater. The previous owner assigned IBM’s indemnity to the related loan sponsor (but not directly to the lender) and the sponsor indemnified the lender, and, separately, $625,000 was reserved upfront to finance the costs of decommissioning the three 250,000-gallon inactive storage tanks on the property and installing secondary containment in the two 10,000-gallon tanks that do not have secondary containment. Furthermore, DBRS Morningstar modeled the Phoenix Huron Campus property with a Below Average property quality score.

There were no Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

The DBRS Morningstar sample included 17 loans, and site inspections were performed at all of the sampled properties, representing 83.0% of the pool by mortgage asset cut-off date balance. The photos and content in the site inspection summaries in the related Presale Report refer to the property and market conditions at the time of the inspection.

DBRS Morningstar completed a cash flow review and cash flow stability and structural review on 17 of the 23 loans, representing 83.0% of the pool by mortgage asset cut-off date balance. Overall, the Issuer’s cash flows were generally recent, from early or mid-2021, and reflective of recent conditions. For the loans not subject to the NCF review, DBRS Morningstar applied NCF variances of -37.7% and -5.0% to the Issuer’s As-Is and Stabilized NCFs, respectively.

DBRS Morningstar applied upward cap rate adjustments to eight loans—City Club Crossroads KC, The Pier Conway, Residence at Lake Highlands Apartments, Amalie Point & Greenbriar Apartments, The Mason, Cityscape Arts, Park 7, and The Centennial—comprising 48.2% of the cut-off date pool balance. DBRS Morningstar adjusted values to reflect its view of the respective markets and the inherent risk associated with the sponsors’ business plans.

One loan, City Club Crossroads KC, has additional debt in the form of a B note. All subordinate debt is held by the Issuer. No loans in the pool are permitted to obtain additional future debt.

Eighteen loans, representing 81.5% of the initial pool balance, have a future funding component. The aggregate amount of future funding remaining is approximately $49.8 million, with future funding amounts per loan ranging from $420,000 to $12.1 million. The proceeds necessary to fulfill the future funding obligations will primarily be drawn from a committed warehouse line and will be initially held outside the trust but will be pari passu with the trust participations. The future funding is generally to be used for property renovations and leasing costs. It is DBRS Morningstar’s opinion that the business plans are generally achievable, given market conditions, recent property performance, and adequate available future funding (or upfront reserves) for planned renovations and leasing costs.

There are no leasehold loans in the pool.

Two loans—Phoenix Huron Campus and Amalie Point & Greenbriar Apartments—allow for the release of a specific portion of the mortgaged collateral, subject to the payment of a release price that varies across the loans. For Phoenix Huron Campus, the borrower shall have the ability to release an individual property from the collateral, subject but not limited to a release price of 125% of allocated loan amount (ALA) in connection with the sale or 100% of the net sale proceeds if greater. For Amalie Point & Greenbriar Apartments, the borrower shall have the ability to release the Greenbriar individual property from the collateral, subject but not limited to a release price of 115% of ALA in connection with the sale or 100% of the net sale proceeds if greater.

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.

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.

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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