DBRS Morningstar Assigns Provisional Ratings to Starwood Mortgage Residential Trust 2020-2

DBRS, Inc. (DBRS Morningstar) assigned provisional ratings to the following Mortgage Pass-Through Certificates, Series 2020-2 (the Certificates) to be issued by Starwood Mortgage Residential Trust 2020-2 (STAR 2020-2 or the Trust):

-- $381.9 million Class A-1 at AAA (sf)
-- $32.4 million Class A-2 at AA (sf)
-- $42.0 million Class A-3 at A (sf)
-- $36.8 million Class M-1 at BBB (low) (sf)
-- $30.3 million Class B-1 at BB (low) (sf)
-- $24.2 million Class B-2 at B (low) (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 certificates reflects 34.55% of credit enhancement provided by subordinate certificates. The AA (sf), A (sf), BBB (low) (sf), BB (low) (sf), and B (low) (sf) ratings reflect 29.00%, 21.80%, 15.50%, 10.30%, and 6.15% of credit enhancement, respectively.

This transaction is a securitization of a portfolio of fixed- and adjustable-rate prime, expanded prime, and nonprime first-lien residential mortgages funded by the issuance of the Certificates. The Certificates are backed by 890 mortgage loans with a total principal balance of $583,501,955 as of the Cut-Off Date (April 30, 2020).

The originators for the mortgage pool are HomeBridge Financial Services, Inc. (HomeBridge; 40.6%); Luxury Mortgage Corp. (Luxury; 27.0%); Impac Mortgage Corp. (Impac; 20.9%); and other originators, each comprising less than 10% of the mortgage pool. The Servicer of the loans is Select Portfolio Servicing, Inc. (SPS).

Although the mortgage loans were originated to satisfy the Consumer Financial Protection Bureau’s (CFPB) Qualified Mortgage (QM) and Ability-to-Repay (ATR) rules where applicable, they were made to borrowers who generally do not qualify for agency, government, or private-label nonagency prime jumbo products for various reasons. In accordance with the QM/ATR rules, 80.0% of the loans are designated as non-QM. Approximately 20.0% of the loans are made to investors for business purposes and, hence, are not subject to the QM/ATR rules, including 0.4% investor loans with cash out used for consumer purposes.

Starwood Non-Agency Lending, LLC is the Sponsor and the Servicing Administrator of the transaction. The Sponsor, Seller, Depositor, and Servicing Administrator are affiliates of the same entity.

Wells Fargo Bank, N.A. (rated AA with a Stable trend by DBRS Morningstar) will act as the Master Servicer Securities Administrator, and Certificate Registrar. Wilmington Savings Fund Society, FSB will serve as the Trustee. Deutsche Bank National Trust Company will serve as the Custodian.

The Sponsor, directly or indirectly through a majority-owned affiliate, is expected to retain an eligible horizontal residual interest consisting of the Class B-3 and Class XS certificates, representing at least 5% of the Certificates, to satisfy the credit risk-retention requirements under Section 15G of the Securities Exchange Act of 1934 and the regulations promulgated thereunder.

On or after the earlier of (1) the distribution date in May 2023 or (2) the date when the aggregate stated principal balance of the mortgage loans is reduced to 30% of the Cut-Off Date balance, Starwood Non-Agency Securities Holdings, LLC as Optional Redemption Holder may redeem all outstanding certificates (Optional Redemption) at a price equal to the greater of A) unpaid balances of the mortgage loans plus accrued and unpaid interest and the fair market value of all real estate owned (REO) properties, and B) the sum of the remaining aggregate balance of the Certificates plus accrued and unpaid interest, and any fees, expenses, and indemnity payments due and unpaid to the transaction parties, including any unreimbursed servicing advances (Optional Clean-Up Call Price).

Additionally, if on any date on which the unpaid mortgage loan balance and the value of REO properties has declined to less than 8% of the initial mortgage loan balance as of the Cut-off Date, the Master Servicer will also have the right to purchase at the Optional Clean-Up Call Price all of the mortgages, REO properties, and any other properties from the Issuer. However, following receipt of notice of the Master Servicer’s intent to exercise the Optional Clean-Up Call, the Servicing Administrator will have 30 days to exercise an Optional Redemption.

The Seller (SMRF TRS LLC) will have the option, but not the obligation, to repurchase any mortgage loan that becomes 90 or more days delinquent under the Mortgage Bankers Association (MBA) method (or in the case of any mortgage loan that has been subject to a forbearance plan related to the impact of the Coronavirus Disease (COVID-19) pandemic, on any date from and after the date on which such loan becomes more than 90 days delinquent under the MBA Method from the end of the forbearance period) at the repurchase price (par plus interest), provided that such repurchases in aggregate do not exceed 10% of the total principal balance as of the Cut-Off Date (excluding any loan repurchased by the Seller related to a breach of a representation and warranty).

Unlike the prior Starwood non-QM securitizations where the Servicer funds advances of delinquent principal and interest (P&I) until loans become 180 days delinquent or are deemed unrecoverable, for this transaction, the Servicer will not fund advances for delinquent P&I. The Servicer, however, is obligated to make advances with respect to taxes, insurance premiums, and reasonable costs incurred in the course of servicing and disposing properties.

That said, the transaction does include a Liquidity Backstop Account, which will hold an amount of $3.0 million or approximately three months of interest payments on Class A-1 and A-2 certificates as of the Closing Date. Until the account termination date, distributions of interest will be made from the account to Class A-1 and A-2 certificates, to the extent needed after using interest and principal remittance amounts, as described in the related report so that the certificateholders receive full and timely interest payments. The account will be available until the earlier of a) the first Distribution Date six months from the Closing Date on which the 30-days or more delinquency rate according MBA method (including loans in foreclosure and properties in REO) falls below 20% of the collateral balance or b) Class A-1 and A-2 certificates are paid off.

Unlike the prior Starwood non-QM 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 senior certificates before paying principal to the outstanding senior certificates sequentially (IIPP). For subordinated certificates, the principal will be paid to the most senior bonds outstanding to pay any unpaid current interest or interest shortfalls before any payments are applied as principal on the bonds. Additionally, 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.

The coronavirus pandemic and 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 arise in the coming months for many residential mortgage-backed securities (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 (IO) or higher debt-to-income (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, slower voluntary prepayment rates, 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: Implications for Credit Ratings, published on April 16, 2020), for the non-QM asset class DBRS Morningstar assumes a combination of higher unemployment rates, lower voluntary prepayment rates, and more conservative home price assumptions than what DBRS Morningstar previously used. 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 loan-to-value ratio (LTV) 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 (CARES) Act, signed into law on March 27, 38.9% 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 Starwood Non-Agency Lending, LLC (SNAL), 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 several, typically six, months. During the repayment period, the borrower needs to make regular payments and additional amounts to catch up on the missed payments. DBRS Morningstar had a conference call with SPS and SNAL regarding their approach to the forbearance loans and understood that 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 SNAL, may offer a repayment plan or other forms of payment relief, such as deferral of the unpaid principal and interest amounts or a loan modification, in addition to pursuing other loss mitigation options.

For the loans, 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) no servicing advances on delinquent P&I. These assumptions include:

1. Increasing delinquencies to generally two times the forbearance percentage as of the closing date for the AAA (sf) and AA (sf) rating levels for the first 18 months,
2. Increasing delinquencies to generally 1.5 times the forbearance percentage as of the closing date for the first nine months for the A (sf) and below rating levels,
3. Assuming no voluntary prepayments for the first 18 months for the AAA (sf) and AA (sf) rating levels.
4. Delaying the receipt of liquidation proceeds during the first 18 months for the AAA (sf) and AA (sf) rating levels.

For more information regarding rating methodologies and the coronavirus, please see the following DBRS Morningstar press releases: 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: Implications for Credit Ratings, dated April 16, 2020.

The ratings reflect transactional strengths that include the following:

-- improved underwriting standards,
-- robust loan attributes and pool composition,
-- a satisfactory third-party due-diligence review,
-- a strong servicer,
-- a transaction structure and liquidity reserve fund, and
-- compliance with the ATR rules.

The transaction also includes the following challenges:

-- borrowers on forbearance plans,
-- nonprime, non-QM, and investor loans,
-- bank statement loans to self-employed borrowers,
-- a representations and warranties framework, and
-- servicer advances of delinquent P&I.

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 info@dbrsmorningstar.com.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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