Fitch Downgrades ARMSS 2004-1; Assigns Outlooks and LS Ratings

ARMSS 2004-1 is primarily collateralized by subordinate commercial real estate (CRE) debt (66.4% of total collateral is either B-notes, mezzanine debt, or preferred equity positions). Fitch expects significant losses upon default for these assets since they are generally highly leveraged debt classes. Further, one loan (1.5%) is currently defaulted. Fitch expects a full loss on this B-note.

ARMSS 2004-1 is a $434 million CRE collateralized debt obligation (CDO) managed by Arbor Realty Trust, Inc. The transaction had a four-year reinvestment period that ended April 2009. As of the October 2009 trustee report and per Fitch categorizations, the CDO was substantially invested in 36 assets as follows: B-notes (32.8%), CRE mezzanine loans (23.3%), preferred equity positions (10.3%), whole loans/A-notes (29.5%), CMBS (3.3%), a defeased CRE loan asset (0.7%), and uninvested proceeds (0.1%). All overcollateralization (OC) and interest coverage ratios are currently in compliance.

Under Fitch's updated methodology, approximately 63.2% of the portfolio is modeled to default in the base case stress scenario, defined as the 'B' stress. In this scenario, the modeled average cash flow decline is 10.9% from either trailing 12 month (T12) third or fourth quarter 2008 or T12 first quarter 2009 cash flows. Fitch estimates that average recoveries will be low at 26.8%, due to the highly leveraged and subordinate nature of the assets.

The largest component of Fitch's base case loss expectation is a pari passu A-note and a B-note secured by a 1,028 unit multifamily property located in Ypsilanti, Michigan. Performance has suffered due to poor market conditions; and cash flow from the property is not supporting debt service. A significant loss is expected on this loan.

The next largest component of Fitch's base case loss expectation is a senior and junior B-note secured by a high end 390-unit multifamily property located in Clearwater, Florida. While occupancy was 90.3% in March 2009, cash flow from the property was not sufficient to support the loan; the loan was modified to maintain a 4% interest rate for an additional 12 months to allow further time to lease up the vacant units. The interest rate will revert to 7.25% in May 2010. Based on the highly leveraged position of these B-notes, Fitch expects a full loss.

The third largest component of Fitch's base case loss expectation is a junior mezzanine position in a 1.2 million square foot office tower located in midtown Manhattan. While performance at the property has been relatively stable, debt service is currently unable to support the loan. Further, the debt service requirement is expected to increase beginning in late 2010 as the interest only period expires. Fitch expects a full loss on this overleveraged position.

This transaction was analyzed according to the 'U.S. CREL CDO Surveillance Criteria', which applies stresses to property cash flows and DSCR tests to project future default levels for the underlying portfolio. Recoveries are based on stressed cash flows and Fitch's long-term capitalization rates. The default levels were then compared to the breakeven levels generated by Fitch's cash flow model of the CDO under the various default timing and interest rate stress scenarios, as described in the report 'Global Criteria for Cash Flow Analysis in CDOs'. Based on this analysis, the class A and B notes' breakeven rates are generally consistent with the 'BB' rating category; and the class C and D notes' breakeven rates are generally consistent with the 'B' rating category.

The class A through D notes were each assigned a Negative Rating Outlook reflecting Fitch's expectation of further negative credit migration of the underlying collateral. These classes were also assigned Loss Severity (LS) ratings ranging from 'LS4' to 'LS5'. The LS ratings indicate each tranche's potential loss severity given default, as evidenced by the ratio of tranche size to the expected loss for the collateral under the 'B' stress. LS ratings should always be considered in conjunction with probability of default indicated by a class' long-term credit rating.

Fitch has downgraded and assigned Loss Severity (LS) ratings and Rating Outlooks to the classes as follows:

--$179,793,874 class A to 'BB/LS4' from 'AAA'; Outlook Negative;

--$51,590,000 class B to 'BB/LS5' from 'AA'; Outlook Negative;

--$27,635,768 class C to 'B/LS5' from 'A-'; Outlook Negative;

--$11,183,232 class D to 'B/LS5' from 'BBB+'; Outlook Negative.

Additionally, all classes are removed from Rating Watch Negative.

These rating actions reflect the application of Fitch's current criteria which are available at 'www.fitchratings.com' and specifically include the following reports:

--'Global Structured Finance Rating Criteria' (Sept. 30, 2009);

--'U.S. CREL CDO Surveillance Criteria' (Nov. 9, 2009);

--'Criteria for Structured Finance Loss Severity Ratings' (Feb. 17, 2009);

--'Global Criteria for Cash Flow Analysis in CDOs' (Nov. 9, 2009).

Additional information is available at 'www.fitchratings.com'.

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