Morningstar DBRS Confirms Credit Ratings on All Classes of HGI CRE CLO 2022-FL3, LLC; Changes Trend to Negative from Stable on One Class

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all the classes of notes issued by HGI CRE CLO 2022-FL3, LLC (the Issuer) as follows:

-- 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)

Morningstar DBRS also changed the trend on the Class G notes to Negative from Stable. The trends on the remaining classes remain Stable.

The trend change on the Class G notes reflects the increased credit risk to the transaction as a result of the higher loan-level loss expectation for the one specially serviced loan in the transaction, Lofts at Twenty 25 (Prospectus ID#27; 7.0% of the current trust balance), which Morningstar DBRS liquidated in its current analysis. The loan, described in more detail below, is secured by a high-rise multifamily property in Atlanta. The loan transferred to special servicing in April 2024 for imminent payment default and is currently six months delinquent. According to the servicer, the foreclosure sale occurred in August 2024 and the lender is ultimately expected to take title. Morningstar DBRS also notes select borrowers are facing execution risk with their respective business plans because of a combination of factors, including decreased property values, increased construction costs, slower rent growth, and increases in debt service costs stemming from the current elevated interest rate environment, as all loans have floating interest rates.

The credit rating confirmations reflect the overall stability of the pool as the trust is solely secured by multifamily collateral, which has historically proven to be better able to retain property value and cash flow compared with other property types. In its analysis for the review, Morningstar DBRS determined a majority of the individual borrowers are progressing with their business plans to increase property cash flow and property value. The unrated, first-loss note of $50.6 million provides significant cushion against realized losses should the increased risks for any loans ultimately result in defaults and dispositions.

In conjunction with this press release, Morningstar DBRS has published a Surveillance Performance Update report with an in-depth analysis and credit metrics for the transaction and with business plan updates on select loans. To access this report, please click on the link under Related Documents below or contact us at info-DBRS@morningstar.com.

The initial collateral consisted of 22 loans secured by 35 transitional multifamily properties, totaling a trust balance of $546.8 million. The transaction was formerly a managed vehicle as the 24-month reinvestment period expired with the March 2024 Payment Date. As of the September 2024 remittance, the pool comprises 21 loans secured by 25 properties with a cumulative trust balance of $526.5 million, reflecting a collateral reduction of 4.4% since issuance. Of the original 22 loans, 17 loans, representing 74.4% of the current trust balance, remain in the pool. Since the previous Morningstar DBRS credit rating action in October 2023, no loans have been added to the trust, while four loans, totaling $55.6 million, have paid in full, including one loan (former trust balance of $11.5 million), which was purchased out of the trust by the Issuer as a credit risk asset.

The pool is primarily secured by properties in suburban markets, with 16 loans, representing 70.7% of the pool, assigned a Morningstar DBRS Market Rank of 3, 4, or 5. An additional three loans, representing 23.6% of the pool, are secured by properties in urban markets with a Morningstar DBRS Market Rank of 6. The remaining two loans are backed by properties with a Morningstar DBRS Market Rank of 2, denoting tertiary markets. These market-type concentrations remain generally in line with the pool composition as of the October 2023 Morningstar DBRS credit rating action.

Leverage across the pool has remained consistent as of the September 2024 reporting when compared with issuance metrics, as the current weighted-average (WA) as-is appraised loan-to-value ratio (LTV) is 69.5%, with a current WA stabilized LTV of 64.2%. In comparison, these figures were 72.3% and 65.0%, respectively, at issuance. Morningstar DBRS recognizes that select property values may be inflated as the majority of the individual property appraisals were completed in 2022 and may not fully reflect the effects of increased interest rates and/or widening capitalization rates in the current environment. In the analysis for this review, Morningstar DBRS applied upward LTV adjustments across 11 loans, representing 71.6% of the current trust balance, generally reflective of higher cap rate assumptions as compared with the implied cap rates based on the appraisals.

The Lofts at Twenty 25 loan has a current senior note balance of $98.9 million with a $36.8 million piece in the subject trust as of the September 2024 reporting. The property was originally built as an office property and was converted to multifamily use in 2021. The borrower's business plan was to utilize $6.9 million of loan future funding to finance its ongoing capital expenditure plan budgeted at $5.1 million. The plan has stalled with only $1.2 million having been advanced to the borrower. According to the servicer, the lender initiated foreclosure proceedings in August 2024 and Morningstar DBRS expects the lender to ultimately assume the title of the property. The property was 27.6% occupied as of July 2024 and generated a negative cash flow. A total of 214 units are subject to a Land Use Restriction Agreement (LURA), which are offered as affordable units in return for reduced real estate tax payments. The agreement expires in 2034. The property was valued on an As-Is basis at loan closing in May 2022 at $149.0 million ($236,000 per unit); however, given the status of the loan and the needed capital improvements, which are expected to result in an extended resolution timeline, Morningstar DBRS believes the current market value has declined significantly, by up to 50.0%. In its analysis, Morningstar DBRS liquidated the loan from the trust, assuming a stressed property valuation with a resulting loan loss severity of approximately of 40.0%.

There are 17 loans on the servicer's watchlist, representing 74.2% of the current trust balance, which have primarily been flagged for below-breakeven debt service coverage ratios (DSCRs) and upcoming maturity dates. The largest loan on the servicer's watchlist, Euclid Grand (Prospectus ID #1; 11.0% of current trust balance), is secured by a 240-unit, mid-rise multifamily property in downtown Cleveland, Ohio. The loan is on the servicer's watchlist for low net cash flow (NCF), which was most recently reported to be $2.3 million for the trailing 12-month period ended February 29, 2024, according to the Q1 2024 collateral manager update, resulting in a 0.57x DSCR and a 4.0% debt yield. The borrower's business plan was to complete the initial lease up phase of the property and to burn off residential rental concessions to stabilize operations. In January 2024, the loan was modified, which extended the loan maturity date to April 2026 from April 2025 initially, reduced the interest rate spread, replaced the property manager, and allowed 24 units were approved to be leased as short-term rentals for a period of 27 months (expiring April 2026). The remaining $0.8 million of available loan future funding was reallocated for the purchase of a new interest rate cap agreement. The lender also allowed the waiver of a $1.0 million letter of credit in return for the borrower depositing $1.25 million into the interest reserve.

As a result of lagging business plans and loan exit strategies, the borrowers of eight loans, representing 48.9% of the current trust balance, have received loan modifications. Terms for the modifications vary from loan to loan; however, common terms include waiving property performance tests to exercise maturity extensions, loan interest deferrals, and the waiver or modification of replacement interest rate cap agreement terms. The transaction faces moderate near-term maturity risk as eight loans, representing 26.7% of the current trust balance, will mature by YE2024. The collateral manager expects four loans to pay in full while the borrowers of the other loans are expected to request available extension options. Morningstar DBRS expects the borrowers and lenders to agree to loan modifications if property performance tests are not met. Potential modifications are expected to require fresh equity from borrowers in the form of loan curtailments, deposits into an interest reserve, and/or the purchase of a new interest rate cap agreement.

Through August 2024, the lender had advanced cumulative loan future funding of $47.9 million to 19 of the 21 outstanding individual borrowers, including $29.8 million since June 2023 as most borrowers continued to make progress in their respective business plans. The largest advance to a single borrower, $9.9 million, was made to the borrower of the Tzadik Portfolio Pool 4 loan (Prospectus ID#26; 11.2% of the current trust balance), which is secured by a portfolio of four multifamily properties totaling 728 units located throughout the Tampa, Florida, metropolitan area. The advances have been used by the borrower to fund capital improvements across the portfolio including unit-interior and property-wide upgrades. According to the Q1 2024 update from the collateral manager, the borrower has completed the majority of the planned upgrades and the portfolio was 88.6% occupied with an average rental rate of $1,133 per unit, representing a rental premium of 17.9% over the average in-place rental rate at loan closing. There is no future funding remaining and the loan matures in June 2025. The loan was modified to allow the borrower to purchase a replacement interest rate cap agreement with a strike rate of 2.50% and expiration at loan maturity. The original agreement at loan closing had a strike rate of 1.25%.

An additional $4.5 million of loan future funding allocated to two outstanding individual borrowers remains available. The largest portion of the available funding ($4.3 million) is allocated to the borrower of the Park at Glenwood loan (Prospectus ID#24; 3.0% of the current trust balance), which is secured by a 212-unit multifamily property in Decatur, Georgia. The available funds will be used to fund the borrower's capital improvement program, which is focused on bringing 70 down units back on-line and upgrading an additional 60 units. The borrower appears to be behind in its business plan as only $0.4 million has been advanced to it since loan closing and according to the Q1 2024 update from the collateral manager, the property was only 33.1% occupied and was generating a negative cash flow. The loan matures in February 2025 and, while there are extension options available to the borrower, a loan modification likely needs to be executed for the loan term to be extended.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective private rating letters at issuance.

Morningstar DBRS' long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued. The Morningstar DBRS short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

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

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

The principal methodology is the North American CMBS Surveillance Methodology (March 1, 2024) https://dbrs.morningstar.com/research/428798.

Other methodologies referenced in this transaction are listed at the end of this press release.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

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The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

-- North American CMBS Multi-Borrower Rating Methodology (March 1, 2024)/North American CMBS Insight Model Version 1.2.0.0 https://dbrs.morningstar.com/research/428797
-- Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (September 19, 2024) https://dbrs.morningstar.com/research/439702/morningstar-dbrs-north-american-commercial-real-estate-property-analysis-criteria
-- North American Commercial Mortgage Servicer Rankings (August 23, 2024) https://dbrs.morningstar.com/research/438283/
-- Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024) https://dbrs.morningstar.com/research/428623
-- Legal Criteria for U.S. Structured Finance (April 15, 2024) https://dbrs.morningstar.com/research/431205
-- Rating North American CMBS Interest-Only Certificates (June 28, 2023) https://dbrs.morningstar.com/research/435294

A description of how Morningstar DBRS analyzes structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/410863.

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.