DBRS Morningstar Assigns Provisional Ratings to Angel Oak SB Commercial Mortgage Trust 2020-SBC1

DBRS, Inc. (DBRS Morningstar) assigned provisional ratings to the following classes of certificates to be issued by Angel Oak SB Commercial Mortgage Trust 2020-SBC1:

-- Class A1 at AAA (sf)
-- Class A2 at AA (sf)
-- Class A3 at A (sf)
-- Class M1 at BBB (sf)
-- Class B1 at BB (sf)
-- Class B2 at B (sf)

All trends are Stable.

The initial balances of the Class A1, A2, A3, M1, B1, and B2 are approximate and may be adjusted up to plus or minus 5.0%.

Coronavirus Disease (COVID-19) Overview

With regard to the coronavirus pandemic, the magnitude and extent of performance stress posed to global structured finance transactions remain highly uncertain. This considers the fiscal and monetary policy measures and statutory law changes that have already been implemented or will be implemented to soften the impact of the crisis on global economies. Some regions, jurisdictions, and asset classes are, however, feeling more immediate effects. DBRS Morningstar continues to monitor the ongoing coronavirus pandemic and its impact on both the commercial real estate (CRE) sector and the global fixed income markets. Accordingly, DBRS Morningstar may apply additional short-term stresses to its rating analysis, for example by front-loading default expectations and/or assessing the liquidity position of a structured finance transaction with more stressful operational risk and/or cash flow timing considerations.

For more information regarding rating methodologies and the coronavirus, please see the following DBRS Morningstar press releases: https://www.dbrsmorningstar.com/research/357883 and https://www.dbrsmorningstar.com/research/358308.

The collateral consists of 236 individual loans secured by 236 commercial, multifamily, and single-family rental (SFR) properties, as defined by DBRS Morningstar, with an average (unless noted otherwise, average refers to straight average) loan balance of $765,050. The transaction is configured with a sequential pay pass-through structure. DBRS Morningstar applied its “North American CMBS Multi-Borrower Rating Methodology” (the CMBS Methodology) for this transaction.

Of the 236 individual loans, three have a fixed interest rate for the 30-year loan term. The remaining 233 loans structured with interest rate floors ranging from 5.125% to 10.125% with an weighted average of 7.436% and interest rate caps ranging from 5.00% to 6.00% with an average of 5.99%. DBRS Morningstar applied a stress to the index (six-month Libor) that corresponded to the remaining fully extended term of the loans and added the respective contractual loan spread to determine a stressed interest rate over the loan term. DBRS Morningstar looked to the greater of the interest rate floor or the DBRS Morningstar stressed index rate when calculating stressed debt service. There are 235 loans that will amortize on a 360-month basis and one loan that will amortizes on a 300-month basis, all with term lengths ranging from 10 to 30 years. When the cut-off loan balances were measured against the DBRS Morningstar net cash flow (NCF) and their respective actual constants or stressed interest rates, there were 25 loans, representing 10% of the pool, with term debt service coverage ratios above 1.80 times (x) a threshold which is indicative of a lower likelihood of midterm default.

The pool has an average original term length of 337 months or 28.1 years with an average remaining term of 322 months or 26.8 years. Based on the current loan balance and the appraisal at origination, the pool had a weighted-average (WA) loan-to-value ratio (LTV) of 61.5%. DBRS Morningstar applied a pool average LTV of 62.7%, which reflects adjustments made to values based on implied cap rates by market rank. Furthermore, all but 26 of 236 loans fully amortize over their respective remaining loan terms, resulting in 90.7% expected amortization; this does not represent typical CBMS conduit pools, which have substantial concentrations of interest-only and balloon loans. DBRS Morningstar research indicates that, for CMBS conduit transactions securitized between 2000 and 2019, average amortization by year has ranged from 7.5% to 22.0% with an overall median of 12.5%.

Of the 236 loans, DBRS Morningstar identified five loans, representing 1.2% of the trust balance, are secured by an individual or a portfolio of SFR properties. The CMBS Methodology does not currently contemplate ratings on SFR properties. To address this, DBRS Morningstar severely increased the expected loss on these loans by approximately 3.2x over the average non-SFR expected loss.

The transaction has several positive attributes. The pool is relatively diverse based on loan size, with an average balance of $765,050 and a concentration profile equivalent to that of a pool of 119 equal-sized loans. Increased pool diversity helps to insulate the higher-rated classes from event risk. Furthermore, the loans are secured by traditional property types (i.e., retail, multifamily, office, and industrial), with no exposure to higher-volatility property types, such as hotels. The pool generally represents lower leverage financing as evidenced by the strong WA DBRS Morningstar LTV of 62.7%. Unlike typical CMBS conduit pools, all but 26 of the 236 loans fully amortize over their respective remaining loan terms, resulting in 90.7% expected amortization. Given the relatively small balance of the loan amounts, the pool has a relatively high concentration of properties located in markets DBRS Morningstar considers more urban in nature. DBRS Morningstar concluded that 22.5% of the pool has a DBRS Morningstar Market Rank of 5, 6, or 7. Properties located in urban markets typically benefit from higher levels of liquidity in times of stress compared with smaller markets. Furthermore, 25.4% of the pool is located in metropolitan statistical area (MSA) Group 3, representing eight of the 25 largest MSAs that historically have outperformed all other top 25 MSAs.

The pool also has several challenging factors for which DBRS Morningstar has addressed. Of the 49 loans DBRS Morningstar sampled (performed an exterior site inspection and/or reviewed third-party photographs), 24 loans, representing 41.7% of the DBRS Morningstar sample, were modeled with Average - to Poor property quality. DBRS Morningstar increased the probability of default (POD) for these loans to account for the elevated risk. Furthermore, DBRS Morningstar modeled any uninspected loans as Average -, which has a slightly increased POD level.

Limited property-level information was available for DBRS Morningstar to review. The origination policies executed by Cherrywood Mortgage, LLC do not provide for terrorism insurance or earthquake insurance, nor do they require that a Property Condition Report or a Phase I environmental report be prepared by an accredited engineer. DBRS Morningstar received a long- or short-form appraisal for loans in its sample, which DBRS Morningstar used in the NCF analysis process. Phase I environmental reports were only performed on four loans representing 3.0% of the pool and desktop environmental radius search reports were conducted on all assets. DBRS Morningstar applied a penalty to the loss severity to mitigate any potential future environmental risk. Engineer-created property condition reports were provided; however, DBRS Morningstar used capital expense estimates in excess of its guideline amounts and its assessment of the sampled property quality to stress the NCF analysis.

The sponsors of small balance loans are generally less sophisticated operators of CRE with limited real estate portfolios and experience. DBRS Morningstar was provided limited borrower information, net worth or liquidity information, and credit history. Each mortgage loan is full recourse to the related borrower. Furthermore, DBRS Morningstar modeled loans with Weak borrower strength, which increases the stress on the default rate. DBRS Morningstar was provided a 24-month pay history on each loan. Any loan with more than one late pay within a 12-month period was modeled with additional stress to the default rate. This assumption was applied to 59 loans, representing 25.3% of the pool balance. Two loans, representing 1.1% of the trust balance, listed in the AMC Guideline review with outstanding judgements were modeled with increased default rates. Finally, a borrower FICO score as of loan origination was provided on 233 of the 236 loans with an average FICO score of 700. While the CMBS Methodology does not contemplate FICO scores, the “RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology” does and would characterize a FICO score of 700 as near-prime, where prime is considered greater than 750. A borrower with a FICO score of 700 could generally be described as potentially having had previous credit events (foreclosure, bankruptcy, etc.), but it is likely that these credit events were cleared about two to five years ago.

DBRS Morningstar was provided limited information regarding the effects of the impact of the coronavirus pandemic on individual property occupancy or cash flow. Of the 236 loans, 52 loans (27.4% of the trust amount) have recently exited forbearance or the borrowers have inquired about forbearance for coronavirus pandemic-related reasons. DBRS Morningstar applied a 5.0% stress to the NCF variance for all loans as a mitigant against reduced income from the coronavirus. Of these 52 loans, 37 loans (16.8% of the trust amount) have deferred balances. While, these loans are current, DBRS Morningstar applied elevated default rates to account for the increased risk.

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.

All ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

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

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is the North American CMBS Multi-Borrower Rating Methodology (August 7, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria. For a list of the structured-finance-related methodologies that may be used during the rating process, please see the DBRS Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.com in the Commentary tab under Regulatory Affairs. Please note that not every related methodology listed under a principal structured finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

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.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The rated entity or its related entities did not 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. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS Morningstar long-term rating scale definition indicates that ratings of CCC or lower are assigned when the bond is highly likely to default or default is imminent, thereby prevailing over a sensitivity analysis.

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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