DBRS Morningstar Finalizes its Provisional Ratings on Angel Oak Mortgage Trust 2020-3

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following Mortgage-Backed Certificates, Series 2020-3 (the Certificates) to be issued by Angel Oak Mortgage Trust 2020-3 (the Trust):

-- $368.6 million Class A-1 at AAA (sf)
-- $39.5 million Class A-2 at AA (sf)
-- $38.5 million Class A-3 at A (sf)
-- $30.2 million Class M-1 at BBB (sf)
-- $10.6 million Class B-1 at BB (sf)
-- $11.9 million Class B-2 at B (sf)

The AAA (sf) rating on the Class A-1 Certificates reflects 30.50% of credit enhancement provided by subordinated Certificates. The AA (sf), A (sf), BBB (sf), BB (sf), and B (sf) ratings reflect 23.05%, 15.80%, 10.10%, 8.10%, and 5.85% of credit enhancement, respectively.

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

This securitization is a portfolio of primarily first-lien fixed- and adjustable-rate nonprime and expanded prime residential mortgages funded by the issuance of the Certificates. The Certificates are backed by 1,356 loans with a total principal balance of $530,343,036 as of the Cut-Off Date (June 1, 2020).

Angel Oak Mortgage Solutions LLC (79.4%), Angel Oak Home Loans LLC (AOHL; 8.4%), and Angel Oak Prime Bridge, LLC (0.04%) (collectively, Angel Oak) originated approximately 87.9% of the pool while third-party originators (TPO) contributed the remaining 12.1% of the pool. Angel Oak originated the first-lien mortgages primarily under the following nine programs: Bank Statement, Platinum, Portfolio Select, Investor Cash Flow, Non-Prime General, Non-Prime Recent Housing, Non-Prime Foreign National, Non-Prime Investment Property, and Asset Qualifier. For more information regarding these programs, see the related rating report.

In addition, second-lien mortgage loans make up 1.8% of the pool. The TPO originated all but four of the second-lien loans. Angel Oak originated the remaining four loans under the guidelines established by Fannie Mae and overlaid by Angel Oak.

Select Portfolio Servicing, Inc. (SPS) is the Servicer for all loans. AOHL will act as Servicing Administrator and Wells Fargo Bank, N.A. (rated AA with a Negative trend by DBRS Morningstar) will act as the Master Servicer. U.S. Bank National Association (rated AA (high) with a Negative trend by DBRS Morningstar) will serve as Trustee, Paying Agent, and Custodian.

Although the applicable mortgage loans 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 nonagency prime products for various reasons. In accordance with the CFPB Qualified Mortgage (QM)/ATR rules, 1.7% of the loans are designated as QM Safe Harbor, 0.8% are designated as QM Rebuttable Presumption, and 80.7% are designated as non-QM. Approximately 16.8% of the loans are made to investors for business purposes and are thus not subject to the QM/ATR rules.

The Servicer will generally fund advances of delinquent principal and interest (P&I) on any mortgage until such loan becomes 180 days delinquent. The Servicer is also obligated to make advances in respect of taxes, insurance premiums, and reasonable costs incurred in the course of servicing and disposing of properties.

The Seller will have the option, but not the obligation, to repurchase any nonliquidated mortgage loan that is 90 or more days delinquent under the Mortgage Bankers Association method at the Repurchase Price, provided that such repurchases in aggregate do not exceed 10% of the total principal balance as of the Cut-Off Date.

On or after the three-year anniversary of the Closing Date, Angel Oak Mortgage Trust I, LLC (the Depositor) has the option to purchase all outstanding certificates (Optional Redemption) at a price equal to the outstanding class balance plus accrued and unpaid interest, including any cap carryover amounts and any outstanding Pre-Closing Deferred Amounts. After such purchase, the Depositor then has the option to complete a qualified liquidation, which requires a complete liquidation of assets within the Trust and the distribution of proceeds to the appropriate holders of regular or residual interests.

The transaction employs a sequential-pay cash flow structure with a pro rata principal distribution among the senior tranches. Principal proceeds can be used to cover interest shortfalls on the Class A-1 and A-2 Certificates sequentially (IIPP). For more subordinate Certificates, principal proceeds can be used to cover interest shortfalls as the more senior Certificates are paid in full. Furthermore, excess spread can be used to cover realized losses and prior period bond writedown amounts first before being allocated to unpaid cap carryover amounts to Class A-1 down to Class M-1.

Coronavirus Disease (COVID-19) Impact
The coronavirus 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 residential mortgage-backed security (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. They range from high-FICO, high-income borrowers who opt for interest-only or higher debt-to-income 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 Form W-2, Wage and Tax Statements, 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, loans on forbearance plans, and 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 its moderate scenario, (see 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 it 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 that loans originated to (1) borrowers with recent credit events, (2) self-employed borrowers, or (3) higher loan-to-value (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, 18.2% of the borrowers are on forbearance plans because the borrowers reported financial hardship related to coronavirus. These forbearance plans allow temporary payment holidays, followed by repayment once the forbearance period ends. SPS, in collaboration with Angel Oak, 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 to go on a repayment plan to catch up on missed payments for a maximum generally of six months. During the repayment period, the borrower needs to make regular payments and additional amounts to catch up on the missed payments. For Angel Oak's approach to forbearance loans, SPS would attempt to contact the borrowers before the expiration of the forbearance period and evaluate the borrowers’ capacity to repay the missed amounts. As a result, SPS, in collaboration with Angel Oak, may offer a repayment plan or other forms of payment relief, such as deferrals of the unpaid P&I amounts or a loan modification, in addition to pursuing other loss mitigation options.

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

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

For more information regarding rating methodologies and the coronavirus, please see the following DBRS Morningstar press releases and commentary: “DBRS Morningstar Provides Update on Rating Methodologies in Light of Measures to Contain Coronavirus Disease (COVID-19),” dated March 12, 2020; “DBRS Morningstar Global Structured Finance Rating Methodologies and Coronavirus Disease (COVID-19),” dated March 20, 2020; and Global Macroeconomic Scenarios: June Update, dated June 1, 2020.

The ratings reflect transactional strengths that include the following:

-- Improved underwriting standards;
-- Robust loan attributes and pool composition;
-- Satisfactory third-party due diligence review;
-- Faster prepayments across non-QM;
-- Compliance with ATR rules; and
-- A strong servicer.

The transaction also includes the following challenges:

-- Borrowers on forbearance plans;
-- Representations and warranties framework and provider;
-- Nonprime, QM Rebuttable Presumption, or non-QM loans; and
-- Servicer advances of delinquent P&I.

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

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