What Is Fix-and-Flip Securitization and Why Has SEC Penalized Angel Oak Capital?

The U.S. SEC has penalized Angel Oak Capital and its portfolio manager Ashish Negandhi for misleading investors. The case pertains to a $90 million flix-and-flip loan securitization. What is fix-and-flip securitization and why has the SEC imposed a penalty on Angel Oak Capital?

To begin with, we should understand the process of securitization. The term gained popularity in the 2008-2009 global financial crisis where it played a key role. In simple terms, securitization is the process of converting illiquid loans into marketable securities that can then be sold to investors.

The loans extended by financial institutions sit as assets on their balance sheets. However, they also block capital for future lending. One way banks and other financial institutions can put these assets to work and free up capital is by securitizing these loans.

A group of loans is pooled together and is converted into an asset-backed security. These are broken down into smaller tranches and sold to investors. While the process helps financial institutions turn “asset light,” investors also earn much higher returns than traditional debt instruments. But then, with higher returns also come higher risks.

Let’s first understand home "flippening," a business that Zillow exited in 2021. In the usual model, a real estate broker, either online or offline, brings the buyer and seller together to facilitate the transaction. However, at times, companies buy the homes directly from sellers, hoping to sell them to a buyer later. This process is known as flippening.

At times, the company or individual buying the home for flippening also makes improvements to the home (which is the “fix” in “fix-and-flip”). The expectation here is that the home would be sold in a short time, usually a few months, for a profit.

However, to buy and renovate the home, the buyer may need funds. This is where fix-and-flip loans come into the picture. These are usually short-term in nature, since holding the home for too long would defeat the very purpose of home flippening.

A fix-and-flip securitization is simply a securitization deal where the asset are fix-and-flip loans

Angel Oak Capital Advisors completed a $90 million securitization that was backed by flix-and-flip loans. The loans were originated by an affiliate company called Angel Oak Prime Bridge.

The average underlying loan balance in the pool was $199,052 and had an original loan term between 6 months to 1 year. However, in the securitization, there was an 18-month revolving period where old collateral was to be replaced with new collateral.

According to the SEC, as part of the securitization deal, Angel Oak had the obligation to return capital to some investors if the delinquencies reached a pre-decided level. However, the SEC said, “Angel Oak and Negandhi artificially reduced delinquency rates by improperly diverting funds ostensibly held to reimburse borrowers for renovations made to the mortgaged properties, to instead pay down outstanding loan balances.”

Because of this misrepresentation, an inaccurate view of the delinquencies was provided to investors. Under the agreement with the SEC, Angel Oak and Negandhi have respectively agreed to pay a penalty of $1.75 million and $75,000 and settle the charges.