DBRS Morningstar Assigns Provisional Ratings to Bunker Hill Loan Depositary Trust 2020-1

DBRS, Inc. (DBRS Morningstar) assigned provisional ratings to the following Mortgage-Backed Notes, Series 2020-1 (the Notes) to be issued by Bunker Hill Loan Depositary Trust 2020-1 (BHLD 2020-1):

-- $135.2 million Class A-1 at AAA (sf)
-- $9.3 million Class A-2 at AA (sf)
-- $12.5 million Class A-3 at A (low) (sf)
-- $10.5 million Class M-1 at BBB (sf)
-- $7.2 million Class B-1 at BB (sf)
-- $6.0 million Class B-2 at B (sf)

Other than the specified classes above, DBRS Morningstar does not rate any other classes in this transaction.

The AAA (sf) rating on the Class A-1 Notes reflects 28.25% of credit enhancement provided by subordinated notes. The AA (sf), A (low) (sf), BBB (sf), BB (sf), and B (sf) ratings reflect 23.30%, 16.65%, 11.10%, 7.30%, and 4.10% of credit enhancement, respectively.

This transaction is a securitization of a portfolio of fixed- and adjustable-rate prime and nonprime first-lien residential mortgages funded by the issuance of the Notes. The Notes are backed by 560 loans with a total principal balance of $188,494,662 as of the Cut-Off Date (June 1, 2020).

Compared with BHLD 2019-3, the overall collateral characteristics of the pool backing BHLD 2020-1 is stronger and the transaction structure has been modified into a simple sequential structure, in contrast to the pro rata senior structure in the prior transaction. The Representations and Warranties (R&W) framework and enforcement mechanism of BHLD 2020-1 are similar to that of BHLD 2019-3.

In accordance with U.S. credit risk retention requirements, Grand Avenue Acquisition Company, LLC (the Sponsor), either directly or through a Majority-Owned Affiliate, will retain an eligible horizontal residual interest consisting of the Class B-3 and Class XS Notes representing not less than 5% economic interest in the transaction, to satisfy the requirements under Section 15G of the Securities and Exchange Act of 1934 and the regulations promulgated thereunder. Such retention aligns sponsor and investor interest in the capital structure.

The Sellers, shown in the Transaction Parties section below, are investment funds advised by Oaktree Capital Management, L.P. (Oaktree or the Aggregator) under an indemnification agreement between the funds and the Sponsor. Oaktree has invested over $4.0 billion of capital since 2008 as an aggregator of performing and nonperforming mortgage loans as well as an equity investor in Selene Finance LP, as residential mortgage servicer, and in Genesis Capital LLC, an originator of fix and flip loans. Since launching the non-Qualified Mortgage (QM) platform in 2018, Oaktree has acquired over $1.0 billion of residential mortgage loans and issued three non-QM residential mortgage-backed security (RMBS) deals in 2019. The Aggregator’s platform includes several investment funds and separate accounts that make investments in the residential assets, including non-QM loans. The funds include real estate debt (inception in 2010; $3.2 billion in assets under management (AUM)), real estate income (inception in 2016; $1.2 billion in AUM), and real estate opportunities (inception in 1994; $5.2 billion in AUM). The Aggregator does not use its own underwriting guidelines and generally acquires loans from various approved mortgage originators based on an investment criterion that, among other factors, includes lower borrower loan-to-value (LTV) ratios and higher credit scores.

Through bulk purchases, Oaktree acquired the mortgage loans from Metro City Bank (Metro City; 47.6%), A&D (33.8%), Citadel Servicing Corporation (Citadel or CSC; 18.1%), and other originators (0.5%). For more details, please refer to the Transaction Counterparties section.

Citadel will service approximately 18.1% of the mortgage loans by balance directly or through subservicers. A&D will be the Servicer of record for approximately 33.8% of the loans and will use Specialized Loan Servicing LLC (SLS), a Delaware limited-liability company, as subservicer to service the loans. SLS will also service approximately 0.5% of the loans and Metro City will service the remaining 47.6%.

DBRS Morningstar conducted an aggregator review of Oaktree, an originator and servicer review of CSC and Metro City, a servicer review of SLS, and an originator review of A&D, and deems them to be acceptable.

Wells Fargo Bank, N.A. (rated AA with a Negative trend by DBRS Morningstar) will act as Master Servicer, Paying Agent, Certificate Registrar, Note Registrar, REMIC Administrator, and Custodian. The Bank of New York Mellon (rated AA (high) with a Stable trend by DBRS Morningstar) will serve as an Indenture Trustee.

Grand Avenue Acquisition Company, LLC will serve as the R&W Provider for approximately 52.4% of the loans by balance. Metro City will serve as the R&W Provider for the remaining 47.6% of the loan balance. The repurchases made by the Sponsor are subject to the $25 million cap; however, the cap does not apply to the repurchases by Metro City.

Although 55.0% of the mortgage loans by balance were originated to satisfy the Consumer Financial Protection Bureau (CFPB) Ability-to-Repay (ATR) rules, they were made to borrowers who generally do not qualify for agency, government, or private-label non-agency prime jumbo products for various reasons, including but not limited to income documentation requirements, limited credit history, loan size and debt-to-income (DTI), a prior housing or credit event, or prior mortgage delinquency. Approximately 45.0% of the loans were originated under programs that are exempt from the ATR rules.

The Servicers will fund advances of delinquent principal and interest (P&I) on any respective mortgage until such loan becomes 180 days delinquent, and they are obligated to make advances in respect of taxes, insurance premiums, and reasonable costs incurred in the course of servicing and disposing of properties. The loans originated by Citadel will not be subject to any P&I Advances, and the Master Servicer will have no obligation to make any P&I Advances for any such loans. However, all Servicers will be required to pay customary, reasonable, and/or necessary expenses (servicing advances) incurred in the performance of the servicing obligations, including the mortgagor’s escrow payments (escrow advances).

On or after the earlier of (1) the three-year anniversary of the Closing Date or (2) the date when the aggregate stated principal balance of the mortgage loans is reduced to 30% of the Cut-Off Date balance, the Depositor may, at the direction of the Class XS Noteholders, purchase all outstanding Notes (call the deal) at a price equal to the greater of the sum of (1) the outstanding class balance plus accrued and unpaid interest, including any cap carryover amounts; unreimbursed advances; any fees, expenses, and indemnification amounts of the transaction parties; and (2) the sum of balance of the mortgage loans plus accrued and unpaid interest thereon and the fair market value of each real estate owned property, less estimated liquidation expenses; unreimbursed advances and fees; expenses; and indemnification amounts of the transaction parties. The Depositor may also purchase all of the Notes from the Noteholders (call the deal) at a price equal to the aggregate outstanding Notes balance of all classes, accrued and unpaid interest thereon (including any cap carryover amounts and step-up interest payment amounts).

Unlike the prior BHLD securitizations, which incorporate a pro rata feature among the senior tranches, this transaction employs a sequential-pay cash flow structure across the entire capital stack. Also, principal proceeds can be used to cover interest shortfalls on the A-1 and A-2 Notes before paying principal to the outstanding senior Notes sequentially.

The Coronavirus Disease (COVID-19) pandemic and the resulting isolation measures have caused an economic contraction, leading to sharp increases in unemployment rates and income reductions for many consumers. DBRS Morningstar anticipates that delinquencies may continue to rise in the coming months for many RMBS asset classes, some meaningfully.

The non-QM sector is a traditional RMBS asset class that consists of securitizations backed by pools of residential home loans that may fall outside of the CFPB’s ATR rules, which became effective on January 10, 2014. Non-QM loans encompass the entire credit spectrum and range from high-FICO, high-income borrowers who opt for interest-only or higher DTI ratio mortgages, to near-prime debtors who have had certain derogatory pay histories but were cured more than two years ago, to nonprime borrowers whose credit events were only recently cleared, among others. In addition, some originators offer alternative documentation or bank statement underwriting to self-employed borrowers in lieu of verifying income with W-2s or tax returns. Finally, foreign nationals and real estate investor programs, while not necessarily non-QM in nature, are often included in non-QM pools.

As a result of the coronavirus, DBRS Morningstar expects increased delinquencies and loans on forbearance plans as well as a potential near-term decline in the values of the mortgaged properties. Such deteriorations may adversely affect borrowers’ ability to make monthly payments, refinance their loans, or sell properties in an amount sufficient to repay the outstanding balance of their loans.

In connection with the economic stress assumed under the moderate scenario in its commentary, Global Macroeconomic Scenarios: June Update, published on June 1, 2020, for the non-QM asset class, DBRS Morningstar applies more severe market value decline (MVD) assumptions across all rating categories than what was previously used. Such MVD assumptions are derived through a fundamental home price approach based on the forecasted unemployment rates and GDP growth outlined in the aforementioned moderate scenario. In addition, for pools with loans on forbearance plans, DBRS Morningstar may assume higher loss expectations above and beyond the coronavirus assumptions. Such assumptions translate to higher expected losses on the collateral pool and correspondingly higher credit enhancement.

In the non-QM asset class, while the full effect of the coronavirus may not occur until a few performance cycles later, DBRS Morningstar generally believes loans originated to (1) borrowers with recent credit events, (2) self-employed borrowers, or (3) higher LTV ratio borrowers may be more sensitive to economic hardships resulting from higher unemployment rates and lower incomes. Borrowers with prior credit events have exhibited difficulties in fulfilling payment obligations in the past and may revert to spotty payment patterns in the near term. Self-employed borrowers are potentially exposed to more volatile income sources, which could lead to reduced cash flows generated from their businesses. Higher LTV borrowers, with lower equity in their properties, generally have fewer refinance opportunities and therefore slower prepayments. In addition, certain pools with elevated geographic concentrations in densely populated urban metropolitan statistical areas may experience additional stress from extended lockdown periods and the slowdown of the economy.

In addition, for this transaction, as permitted by the Coronavirus Aid, Relief, and Economic Security Act, signed into law on March 27, 2020, 36 mortgage borrowers (7.5% of the aggregate pool balance, as of June 1, 2020) are on forbearance plans because of financial hardship related to coronavirus. The forbearance plan allows temporary payment holidays followed by repayment once the forbearance period ends. The Servicer, in collaboration with the Sponsor, is generally offering borrowers a three-month payment forbearance plan. Beginning in month four, the borrower can repay all of the missed mortgage payments at once or opt for other loss mitigation options. Prior to the end of the applicable forbearance period, the Servicer will contact each related borrower to identify the options available to address related forborne payment amounts. As a result, the Servicer, in conjunction with or at the direction of the Sponsor, may offer a repayment plan or other forms of payment relief, such as deferral of the unpaid P&I amounts or a loan modification, in addition to pursuing other loss mitigation options.

For these loans, DBRS Morningstar applied additional assumptions to evaluate the impact of potential cash flow disruptions on the rated tranches, stemming from (1) lower P&I collections and (2) limited servicing advances on delinquent P&I. These assumptions include:

(1) Increasing delinquencies on the AAA (sf) and AA (sf) rating levels for the first 12 months and on the A (sf) and below rating levels for the first nine months,
(2) Assuming no voluntary prepayments for the first 12 months for AAA (sf) and AA (sf) rating levels, and
(3) Delaying the receipt of liquidation proceeds during the first 12 months for the AAA (sf) and AA (sf) rating levels.

The ratings reflect transactional strengths that include the following:
-- Substantial borrower equity, robust loan attributes, and pool composition,
-- Compliance with ATR rules,
-- Satisfactory third-party due diligence review,
-- Current loans, and
-- Satisfactory loan performance to date.

The transaction also includes the following challenges:
-- Foreign borrowers with no FICO score,
-- R&W framework and provider,
-- Nonprime, non-QM, and investor loans,
-- Servicers’ advance of delinquent P&I,
-- Servicers’ financial capability, and
-- Borrowers on forbearance plans.

The full description of the strengths, challenges, and mitigating factors is detailed in the related presale report.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodology is RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology (April 1, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

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 [email protected].

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

DBRS, Inc.
140 Broadway, 43rd Floor
New York, NY 10005 USA
Tel. +1 212 806-3277