An Update on Multifamily Mortgage Risk

My Arbor CRE CLO Morningstar surveillance review reveals...: "All trends are Stable" and no ratings action was indicated.

The above is what Morningstar reported for every Arbor CRE CLO (deals from 2021 and 2022) in surveillance reports in June and November 2023.

How could this possibly be the case since Arbor itself reported a pronounced increase in non-performing loans and the multifamily sector has faced ongoing pressure from cost increases and rising rates.

Further, as I previously reported the collateral is 100% transitional multifamily mortgages. Hardly an asset class one can bestow with the benign "All Trends are Stable" moniker in this climate.

A review from Morningstar's own surveillance report for a sample deal reveals all is not stable. The chart below shows that even after stabilization assumptions (e.g. after the property transition), only 4 out of 10 largest loans have a Debt Service Coverage Ratio (DSCR) greater than 1.0.

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The surveillance report further notes that though there were no delinquencies, 16% of the loans had been modified - certainly a yellow flag if not a red flag, even if the modifications were technical in nature.

Finally, though Morningstar reported modest LTVs, a huge caveat is noted in the following excerpt:

"DBRS Morningstar recognizes that select property values may be inflated as the majority of the individual property appraisals were completed in 2021 and 2022 and may not reflect the current rising interest rate or widening capitalization rate environments."

That Morningstar puts out a surveillance report missing such a critical piece of information is somewhat disappointing to put it mildly.

I suspect Morningstar (and Moody's who also has rated a number of these deals) may be out with a not so stable update this quarter.