New Issue: VCL Master Residual Value S.A., Compartment 2

Transcription

1 New Issue: VCL Master Residual Value S.A., Compartment Million Asset-Backed Floating-Rate Notes (Including A Million Unrated Subordinated Loan) Primary Credit Analyst: David Tuchenhagen, Frankfurt ; david.tuchenhagen@standardandpoors.com Secondary Contact: Vedant Thakur, London; vedant.thakur@standardandpoors.com Table Of Contents Transaction Summary Notable Features Rating Rationale Strengths, Concerns, And Mitigating Factors Transaction Structure Collateral Description Credit And Cash Flow Analysis Scenario Analysis Monitoring And Surveillance Related Criteria And Research NOVEMBER 25,

2 New Issue: VCL Master Residual Value S.A., Compartment Million Asset-Backed Floating-Rate Notes (Including A Million Unrated Subordinated Loan) Ratings Detail Class Rating* Amount (mil. ) Available credit enhancement (%) Interest (%) A AAA (sf) One-month EURIBOR plus 0.90 A AAA (sf) One-month EURIBOR plus 0.90 A AAA (sf) One-month EURIBOR plus 0.90 A AAA (sf) One-month EURIBOR plus 0.90 A AAA (sf) One-month EURIBOR plus 0.90 A AAA (sf) One-month EURIBOR plus 0.90 B A+ (sf) One-month EURIBOR plus 1.70 B A+ (sf) One-month EURIBOR plus 1.70 B A+ (sf) One-month EURIBOR plus 1.70 Subordinated loan NR One-month EURIBOR plus 3.50 Legal final maturity Sept. 25, 2022 Sept. 25, 2022 Sept. 25, 2022 Sept. 25, 2022 Sept. 25, 2022 Sept. 25, 2022 Sept. 25, 2022 Sept. 25, 2022 Sept. 25, 2022 Sept. 25, 2022 *Standard & Poor's ratings address timely payment of interest and ultimate principal. Based on current issuance amount Includes subordination, overcollateralization, and a cash reserve sized at its target level of 2.92% of discounted pool balance during amortization. NR--Not rated. EURIBOR--Euro interbank offered rate. Transaction Participants Seller and servicer Co-arrangers Lead manager Security trustee Expectancy rights trustee Corporate services provider Bank account provider and cash administrator Principal paying agent, calculation agent, interest determination agent, and custodian Data protection trustee and subordinated lender Volkswagen Leasing GmbH Volkswagen Financial Services AG and HSBC Bank PLC HSBC Bank PLC Wilmington Trust SP Services (Frankfurt) GmbH Wilmington Trust (London) Ltd. Wilmington Trust SP Services (Luxembourg) S.A. The Bank of New York Mellon, Frankfurt Branch The Bank of New York Mellon, London Branch Volkswagen Bank GmbH NOVEMBER 25,

3 Transaction Participants (cont.) Swap counterparties for the class A series of notes Swap counterparties for the class B series of notes Crédit Agricole Corporate and Investment Bank, HSBC Bank PLC, Skandinaviska Enskilda Banken AB (publ) Crédit Agricole Corporate and Investment Bank, DZ BANK Deutsche Zentral-Genossenschaftsbank Frankfurt am Main Supporting Ratings Institution/role The Bank of New York Mellon, Frankfurt Branch* as servicer collection account provider and transaction account provider Crédit Agricole Corporate and Investment Bank as interest rate swap counterparty (series A , A , and B ) DZ BANK Deutsche Zentral-Genossenschaftsbank Frankfurt am Main as interest rate swap counterparty (series B , and B ) HSBC Bank PLC as interest rate swap counterparty (series A , A , and A ) Skandinaviska Enskilda Banken AB (publ) as interest rate swap counterparty (series A ) *Based on the ratings on the parent company, The Bank of New York Mellon. Rating AA-/Stable/A-1+ A/Negative/A-1 AA-/Stable/A-1+ AA-/Stable/A-1+ A+/Negative/A-1 Transaction Key Features Closing date Nov. 25, 2015 Collateral Principal outstanding (mil. ; discounted lease residual value balance)* Country of origination Transaction structure Initial replenishment period (months) Redemption profile Credit enhancement Cash reserve description *As of the final pool cut-off date on Oct. 31, Leased vehicles' residual values Germany Revolving true sale Sequential pro rata, subject to compliance with certain credit enhancement increase conditions under the transaction documents Provided by subordination, initial and additional overcollateralization, and a cash reserve At closing, a euro-denominated amount equal to 3.5% of the initial discounted asset balance, which will amortize after September 2016 subject to a floor (minimum level) of 2.5% of the maximum discounted asset balance. The reserve mitigates liquidity shortfalls during the transaction's life and provides credit enhancement to the notes at the end of the transaction. 10 Transaction Summary Standard & Poor's Ratings Services has assigned its credit ratings to VCL Master Residual Value S.A., Compartment 2's series A , A , A , A , A , A , B , B , and B asset-backed floating-rate notes. At closing, VCL Master Residual Value, Compartment 2 also issued an unrated subordinated loan. The notes securitize a portfolio of German auto lease residual values, which Volkswagen Leasing GmbH originated and sold to the issuer. The transaction has an initial 10 month revolving period, during which the originator can sell further expectancy rights to the issuer. NOVEMBER 25,

4 The class A notes rank senior to the class B notes, and each class of notes ranks pari passu among themselves. Under the transaction documents, amortization is sequential, but will switch to pro rata once the class-specific overcollateralization (OC) target levels are reached, assuming no specific triggers have been breached. The notes may switch to sequential payment again, once certain credit enhancement increase conditions have been met. If the servicer were to become insolvent at any point in the transaction's life, the notes would permanently switch to sequential amortization. Once the transaction as a whole begins to amortize, the paying agent allocates payments made under the waterfall sequentially between the classes, and pro rata among the corresponding series, until the class-specific target OC levels are reached (52% and 40% for the class A and B notes, respectively). This means that the paying agent can only make amortization payments toward the class B notes once the class A notes reach their target OC levels. The subordinated loan can only repay once the class A and B notes reach their target OC levels. Furthermore, when the corresponding series for a class of notes is simultaneously revolving or amortizing, the target OC level remains at the tranche's overall level. Therefore, if the class B notes were to pay down before the class A notes, the available credit enhancement for the class A notes would remain at the same level. A combination of subordination, initial and additional OC, and a cash reserve provide credit enhancement to the rated notes. The transaction does not have a principal deficiency ledger mechanism. On Oct. 12, 2015, Standard & Poor's lowered to 'A-/A-2' from 'A/A-1' its long- and short-term credit ratings on Volkswagen AG (VW) and Volkswagen Financial Services AG (see "German Automaker Volkswagen Ratings Lowered To 'A-/A-2' On Governance; L-T Ratings Remain On Watch Neg On Ongoing Risks" and "Volkswagen Financial Services Ratings Lowered To 'A-/A-2'; Still On CreditWatch Negative"). At the same time, our long-term ratings remain on CreditWatch negative. The downgrade and continued CreditWatch placement reflect our view that VW continues to face wide-ranging negative credit consequences, following its admission that it installed software designed to manipulate diesel engine exhaust emissions in relation to nitrogen oxides (NOx) in 11 million passenger cars and commercial vehicles and the related global recall of these vehicles. On Nov. 3, 2015, VW announced that internal investigations have identified irregularities related to CO2 levels and fuel consumption levels. VW's initial estimate of the cost of the irregularities is approximately 2.0 billion (see "Volkswagen Ratings Currently Unaffected By CO2 Irregularities As Long-Term Rating Already On CreditWatch Negative," published on Nov. 4, 2015). We understand that these irregularities have been identified in about 800,000 passenger cars globally. At closing, Volkswagen Leasing GmbH (VW Leasing) clearly identified about 430,000 cars out of the 800,000, all from the 2016 model year. According to the data provided, out of these 430,000 affected vehicles, 3,700 vehicles are in the closing pool (total discounted balance of million). Hence, this leaves uncertainty about any additional exposure that the transaction may have to affected vehicles that were not clearly identified at closing. At closing, VW Leasing funded a dedicated reserve to mitigate the risk from leased vehicles that are subject to irregularities related to CO2 emissions. VW Leasing sized the reserve based on the actual exposure to the known portion of vehicles affected plus an estimate for the currently unknown exposure. In our view, this reserve fully mitigates the transaction's exposure to the portion of affected vehicles in the pool. NOVEMBER 25,

5 In our view, the recent events could ultimately affect VW's asset-backed securities (ABS) transactions in a number of areas: potential decline of the resale value of vehicles backing the transactions, potential dilution of the loan or lease receivables backing the transactions as a result of vehicle owner claims against VW, and potential increase in the operational risk associated with VW (see "Recent Volkswagen Announcement Has Potential To Affect Related ABS Transactions," published on Oct. 2, 2015). At this stage, we consider that the stressed recovery rate assumptions in VCL Master Residual Value, Compartment 2 also cover the potential for recoveries to deteriorate due to any reduction in resale values. VCL Master Residual Value, Compartment 2 is exposed to residual values, hence there is, in our view, additional direct residual value risk in this transaction. We have increased our base market value decline assumptions by 4% for all rating levels, to account for the idiosyncratic market value decline risk derived from the affected vehicles (by the manipulation of NOx emissions) but also the non-affected portion. As part of our ongoing monitoring of VW's VCL transactions, we will seek information regarding the extent to which vehicle owners may be entitled to compensation claims or similar remedies against VW. They may use these claims to reduce the amount of their securitized lease receivable. As we gain a better understanding of the relevant facts and their potential legal and practical consequences, we will assess whether, in our view, the available credit enhancement remains sufficient, along with other factors, to support the ratings on each class under various stress scenarios. Since we assigned preliminary ratings to this transaction, certain material structural changes have been made, notably VW Leasing has funded a dedicated reserve at closing to mitigate the risk from leased vehicles that are subject to irregularities related to CO2 emissions. Notable Features This is VW Leasing GmbH's third residual value transaction. The assets sold comprise solely expectancy rights; the portfolio does not contain any lease contracts or lease installments. Along with the purchase of the assets, the issuer enters into a repurchase agreement with Volkswagen Leasing to sell the vehicles at maturity back to Volkswagen Leasing at their contractual residual value. The assets effectively pay a fixed interest rate, as they are purchased at their net present value (NPV), not the nominal value. Swaps in place for each series of notes hedge the interest rate risk between the fixed-rate assets and floating-rate notes. The transaction has an initial 10-month revolving period, during which the originator can sell further residual values to the issuer. The issuer offers a high level of flexibility, as it allows for subsequent tap issuances up to a certain amount and/or the extension of the initial replenishing period for each class of notes. This includes adjustments to the spreads and/or swap rates upon extension. Vehicles sold into the transaction correspond solely to the lease contracts initially securitized in VCL Master S.A., Compartment 1. The two special-purpose entities are not cross-collateralized. The transaction's capital structure is similar to its rated predecessor, VCL Master Residual Value S.A., Compartment 1. However, this transaction has higher credit enhancement for the class A and B notes. Credit enhancement for the class NOVEMBER 25,

6 A notes (including the cash reserve at its target level during amortization, which is 4.32% of the class A and B notes' balance) is 47.42% for VCL Master Residual Value, Compartment 2, compared with 44.46% for VCL Master Residual Value, Compartment 1 as of the September 2015 renewal. Credit enhancement for the class B notes is 35.42% for VCL Master Residual Value, Compartment 2, compared with 34.46% for VCL Master Residual Value, Compartment 1 as of the September 2015 renewal. The potential reduction in resale values of the vehicles affected by manipulation of CO2 emissions is mitigated by a dedicated reserve, which VW Leasing funded at closing. Rating Rationale Operational risk VW Leasing has underwritten auto leasing contracts in Germany since Our ratings on the class A and B notes reflect our assessment of the company's origination policies, as well as our evaluation of VW Leasing's ability to fulfill its role as servicer under the transaction documents. Our structured finance operational risk criteria do not impose any cap on the maximum achievable rating due to operational risks (see "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published on Oct. 9, 2014). Economic outlook In our base-case scenario, we forecast that Germany will record GDP growth of 1.7% in 2015, 2.0% in 2016, and 1.8% in 2017, compared with 1.6% in At the same time, we expect unemployment rates to stabilize at historically low levels. We forecast unemployment to be 4.8% in 2015, 4.6% in 2016, and 4.6% in 2017, compared with 5.0% in 2014 (see "Eurozone Economic Outlook: Steady For Now, Despite Slower World Trade," published on Sept. 30, 2015). In our view, changes in GDP growth and the unemployment rate largely determine portfolio performance. We set our credit assumptions to reflect our economic outlook. Our near- to medium-term view is that the German economy will remain resilient and record positive growth. Credit risk The portfolio consists of residual values, which are subject to market value decline risk. We based our analysis on our view of potential market value declines at various rating levels. We made adjustments for transaction- and originator-specific parameters, resulting in an adjusted market value decline assumption of about 43% at a 'AAA' rating level. About 13% of the pool (by volume) relates to cars equipped with diesel engines affected by the manipulation of NOx exhaust emissions. We increased our base market value decline assumptions by 4% for all rating levels, to account for the idiosyncratic market value decline risk derived from the affected vehicles by the manipulation of NOx emissions, but also the non-affected portion. In our view, a dedicated reserve fully mitigates any potential risks for vehicles affected by the manipulation of CO2 exhaust emissions. In addition to market value decline risk, the transaction is also exposed to lessee default risk, as the recovery proceeds from selling the car are split between lease receivable and residual value claims. Our net loss base-case assumption for the securitized pool is 1.15%, which is in line with that applied to the preceding residual value transaction, VCL Master Residual Value, Compartment 1. Our net loss base-case assumptions reflect our view of the German economy's continued stabilization. NOVEMBER 25,

7 Additionally, we have taken the transaction's revolving nature into account, as well as its limited replenishment criteria. We increased our base-case multiples to 4.2 and 2.7 at the 'AAA' and 'A+' rating levels, respectively, to account for increased uncertainty in light of the current situation regarding VW's manipulation of engines. We have also acknowledged that the multiples of the predecessor transactions were the lowest for any German originator and were also well below those of the other, non-german VW auto ABS transactions. Further, we sized stressed recoveries of 40% for all rating levels based on recovery data provided for previous VCL transactions and a peer comparison with other German auto leasing transactions. At this stage, we consider that the stressed recovery rate assumptions in VCL Residual Value, Compartment 2 also cover the potential for recoveries due to any reduction in resale values. We have analyzed credit risk by applying our criteria for European auto ABS, using historical loss data for VW Leasing's book and performance data from previous VCL Leasing transactions (see "Methodology And Assumptions For European Auto ABS," published on Oct. 15, 2015). Cash flow analysis We have assessed the transaction's documented payment structure. The issuer can extend the transaction's initial 10-month revolving period several times, each time for one year. Once the revolving period ends, the transaction amortizes sequentially until certain OC targets for the class A and B notes are reached. However, the amortization between the class A and B notes and the subordinated loan switches to pro rata amortization from sequential if certain conditions (e.g., the credit enhancement increase condition) are fulfilled, or when class-specific target OC levels are reached. Our analysis indicates that the available credit enhancement for the class A and B notes is sufficient to withstand the credit and cash flow stresses that we apply at the respective rating levels. Counterparty risk We consider the transaction's exposure to counterparty risks to be adequately mitigated through its documented replacement mechanisms. The transaction is exposed to The Bank of New York Mellon, Frankfurt branch as bank account provider and Crédit Agricole Corporate and Investment Bank, DZ BANK Deutsche Zentral-Genossenschaftsbank Frankfurt am Main, HSBC Bank PLC, Skandinaviska Enskilda Banken AB (publ) as swap counterparties. We have analyzed counterparty risk by applying our current counterparty criteria (see "Counterparty Risk Framework Methodology And Assumptions," published on June 25, 2013). The final swap agreements are in line with our current counterparty criteria. Legal risk We believe the transaction may be exposed to commingling and trade tax risk. If Volkswagen Leasing were to become ineligible, an advance mechanism would be triggered, partially mitigating commingling risk. We have sized the unmitigated exposure as an additional loss. We consider the issuer to be a bankruptcy-remote entity, in line with our European legal criteria (see "Europe Asset Isolation And Special-Purpose Entity Criteria--Structured Finance," published on Sept. 13, 2013). The legal opinion at closing confirmed that the sale of the assets would survive the seller's insolvency. Rating stability We analyzed the effect of a moderate stress on the credit variables and their ultimate effect on our ratings on the notes (see "Scenario Analysis: Gross Default Rates And Excess Spread Hold The Answer To Future European Auto ABS NOVEMBER 25,

8 Performance," published on May 12, 2009). We ran two scenarios and the results are in line with our credit stability criteria (see "Methodology: Credit Stability Criteria," published on May 3, 2010). Strengths, Concerns, And Mitigating Factors Strengths We consider that defaults under transactions backed by leases to commercial retail customers are sensitive to the economy. The German economy is performing relatively well and our baseline forecast of unemployment levels is at 4.6% for 2016 and Further, we expect the German economy to record positive GDP growth of 2.0% in 2016 and 1.8% in The seller has a strong market position as one of the largest leasing companies in Europe, with more than 40 years' business experience. The portfolio is granular and diversified, comprising 63,119 vehicles and 41,303 lessees. The largest single lessee concentration is approximately 349,000, (0.04% of the portfolio), while the top 20 lessees comprise approximately 0.69% of the portfolio. The structure benefits from an amortizing liquidity reserve, initially sized at 3.5% of the initial discounted pool balance, which was fully funded at closing. The liquidity reserve serves primarily as liquidity support to mitigate any cash strains. Ultimately, it is available to repay the notes at the end of the life of the transaction. Concerns and mitigating factors About 13% of the pool (by volume) relates to cars equipped with diesel engines (EA 189 EU5 engines) affected by the manipulation of exhaust emissions in relation to NOx. We increased our base market value decline assumptions by about 4% for all rating levels, to account for the idiosyncratic market value decline risk derived from the affected vehicles but also the non-affected portion. In addition, we increased our base-case multiples to 4.2 and 2.7 at 'AAA' and 'A+' rating levels, respectively, to account for increased uncertainty in light of the current situation regarding VW's manipulation of engines. At closing, VW Leasing clearly identified about 4.9% (by volume) of the pool that related to vehicles affected by the manipulation of exhaust emissions in relation to CO2. It calculated an additional portion of 4.0% (by volume) of further potentially affected vehicles, which it could not clearly identify at closing. In our view, the potential risk associated with the affected vehicles is mitigated by a reserve of million, which the issuer funded at closing. The assets are not interest-bearing and each vehicle produces only a single cash flow at maturity, resulting in lumpy cash flows. The first significant cash flows are not scheduled before September 2016, after which periods of limited scheduled cash flows can reach up to six months. The cash reserve reduces to 2.92% of the discounted pool balance from 3.5% after the 10-month revolving period with a floor of 2.5% of the maximum discounted pool balance. The portfolio is revolving, which means that the issuer can substitute repaid assets. This means that the portfolio's quality could deteriorate during the revolving period. We have taken the transaction's revolving nature into account, as well as its limited replenishment criteria when sizing our net loss base case. We have not received recovery data from the originator. We have therefore made a conservative recovery assumption because there is no recovery data. The initial buffer rate provides a certain element of excess spread in the transaction, matching the issuer's expenses plus an initial buffer (of 2.49%) to account for potential future adjustments of the swap rates and/or note margins. However, at a later point in time the note spreads and/or swap rates can be adjusted by using the buffer (either fully or partially). We did not give credit to the initial buffer rate in our cash flow analysis to account for the potential deterioration of excess spread over the transaction's life due to adjustments of the swap rates and/or note margins. NOVEMBER 25,

9 The payment structure is not fully sequential throughout the transaction's life: Once certain target OC levels are reached, the issuer pays the principal for notes and the subordinated loan pro rata, subject to certain triggers. Pro rata redemption of the subordinated loan would reduce the available credit enhancement in absolute terms. We have stress-tested appropriate cash flows for each rating level, which included modeling the potential switch from pro rata to sequential payment. The transaction is exposed to commingling risk through a collection account, which is in the originator's name, and German trade tax risk. We incorporated into our cash flow analysis the remaining losses arising from commingling and potential German trade tax risk. At closing, the cash reserve amounted to more than 12 months' senior fees and interest on the notes. The reduced level of 2.92% of the discounted pool balance after September 2016 will amount to at least 12 months' senior fees and interest on the notes. In addition to the funded cash reserve, a mechanism calculates the future expected liquidity needs based on the then-current schedule. This mechanism would then top up the reserve, which ranks senior in the waterfall, if it is not high enough to cover the aforementioned liquidity needs. Triggers are in place to stop the revolving period if performance deteriorates (see "Revolving period"). Additionally, during the replenishment period, the issuer will apply a further purchase price haircut of 7% on all newly purchased residual values, which builds up additional OC during the revolving period. In addition to the subordinated loan and the cash reserve, the 3% initial OC provides credit enhancement. The servicer advances the expected residual value claims for a given month, six business days before the start of that month. Transaction Structure At closing, the issuer bought a pool of leased vehicle residual values with a net present value to be determined (see chart 1). The lease receivables are discounted at a fixed rate of 4.338%, comprising: The weighted-average interest due to the swap counterparty under the terms of the swaps on the notes (totaling 0.82%), administrative expenses, and a yearly servicing fee of 1.03%; and A buffer of 2.49% to cover potential future adjustments of the swap rates and/or note margins, if the revolving periods are extended. The buffer amount is part of the available funds distributed according to the priority of payments. During the revolving period, the issuer may also acquire further residual values if there are available funds. The NPV of these assets is calculated using the same discount rate as was used for the initial portfolio at closing. The purchase price equals the net present value, reduced by a haircut (discount) of 7% until the class A and B notes' OC (calculated as the excess of assets over outstanding notes) increases to 49.0% from 44.5% at closing, and to 37.0% from 32.5% at closing, respectively. NOVEMBER 25,

10 Priority of payments For principal and interest payments, the class A notes rank pari passu with each other, and senior to the class B notes and the subordinated loan. The class B notes rank pari passu with each other, and senior to the subordinated loan for principal and interest payments. The class A and B notes pay interest monthly in arrears at a rate of one-month European interbank offered rate (EURIBOR) plus a margin. Amounts in the priority of interest and principal payments for the notes include taxes payable by the issuer and servicing expenses, all of which we sized for in our cash flow analysis. The first interest payment date (IPD) is on Dec. 28, 2015, with the legal final maturity of the notes falling in September On each monthly IPD, the issuer applies to the priority of payments any asset collections, net swap receipts, amounts available for the purchase of further receivables, and amounts drawn from the cash reserve from the previous month, in the order outlined in table 1. NOVEMBER 25,

11 Table 1 Priority Of Payments (Simplified) 1 Taxes and payments to the trustee. 2 Senior fees, including payments to the corporate services provider, data protection trustee, and servicer. 3 Payments to the account provider. 4 Payments to the swap counterparty (except termination payments, if the swap counterparty is the defaulting party). 5 The class A notes' interest. 6 The class B notes' interest. 7 Top up the cash reserve (only if previously drawn upon). 8 The class A notes' principal in each amortizing series (sequential or pro rata); The remainder (if any, i.e., during the revolving period only) as accumulation amount for the purchase of new assets up to the target overcollateralization amount. 9 The class B notes' principal in each amortizing series (sequential or pro rata); The remainder (if any, i.e., during the revolving period only) as accumulation amount for the purchase of new assets up to the target overcollateralization amount. 10 Unpaid payments to the swap counterparty outlined in point 4 above. 11 Interest on the subordinated loan. 12 Principal on the subordinated loan. 13 All remaining amounts due to Volkswagen Leasing. Revolving period During the revolving period, the originator can sell further residual values to the issuer. The initial revolving period started on the closing date and ends on Sept. 25, It will end earlier if and when any of the following early amortization events, among others, occur: There is a foreclosure event (e.g., the issuer's insolvency); The amount available but not used for the purchase of further residual values exceeds 10% of the portfolio volume on three consecutive payment dates; If the servicer is replaced, or if Volkswagen Leasing becomes insolvent; Volkswagen Leasing does not honor its obligation under the repurchase agreement for the repurchase of vehicles; or OC of the class A and B notes falls below the level of 44.15% and 32.15%, respectively, on any payment date. In addition to the above, any of the following factors, among others, would lead to an early amortization event for VCL Master, Compartment 1. This, in turn, would result in an early amortization of VCL Master Residual Value, Compartment 2: The amount available but not used for the purchase of further receivables in VCL Master, Compartment 1 exceeds 10% of the discounted portfolio volume on two consecutive payment dates; Cumulative net losses in VCL Master, Compartment 1 exceed: (i) 0.45% if the portfolio's weighted-average seasoning is up to 12 months; (ii) If they exceed 1.2%, with a weighted-average seasoning of 12 (exclusive) and 24 months; (iii) 1.75%, with a weighted-average seasoning of up to 24 (exclusive) and 36 months; (iv) 2.25%, with a weighted-average seasoning of more than 36 months; or Late delinquencies in VCL Master, Compartment 1 (i.e., more than six overdue installments) exceed 1.75% before Sept. 25, 2016, or 2.5% on any payment date thereafter. According to the transaction documents, assets added to the portfolio during revolving period need to comply with the same eligibility criteria as the assets purchased at closing. During the revolving period, concentration limits for used cars, non-volkswagen brands, and Volkswagen Nutzfahrzeuge (light commercial vehicles) sold to VCL Master Residual NOVEMBER 25,

12 Value, Compartment 2 cannot be exceeded. Repayment of the notes Once amortization begins, the issuer can use available funds to repay the notes. The issuer pays principal pro rata to the noteholders and the lender of the subordinated loan when OC (calculated as the excess of total assets over the outstanding notes) has reached 52% for the class A notes and 40% for the class B notes of total assets: Plus 750 basis points (bps) for the class A notes and 749 bps for the class B notes compared with the closing level; and Plus 300 bps for both classes of notes compared with the target level during the replenishment period (see above). The percentage of OC for the notes remains constant as long as the transaction's credit enhancement increase condition is not met. This condition is met once: The servicer is replaced or if Volkswagen Leasing becomes insolvent; Volkswagen Leasing does not honor its obligation under the repurchase agreement; or The cash reserve falls below 1.3% of the outstanding notes' balance. VCL Master, Compartment 1's portfolio's performance stays within the predetermined boundaries. Amortization would switch permanently to sequential repayment if the cumulative net loss ratio in VCL Master, Compartment 1 exceed: (i) 0.45%, if the portfolio's weighted-average seasoning is up to 12 months; (ii) If they exceed 1.2%, with a weighted-average seasoning of between 12 (exclusive) and 24 months; (iii) 1.75%, with a weighted-average seasoning of between 24 (exclusive) and 36 months; (iv) 2.25%, with a weighted-average seasoning of more than 36 months. Consequently, amortization would switch permanently to sequential payment. Cash reserve The issuer deposited million (3.5% of the initial discounted portfolio balance) into a general cash reserve at closing. The reserve will reduce to million (2.92% of the discounted portfolio balance with a floor of 2.5% of the maximum discounted portfolio balance) after September It can pay more than 12-months' senior fees and interest on the notes for the initial period up to September 2016, and at least 12 months thereafter. Amounts deposited in the general cash reserve account are available to mitigate liquidity shortfalls in the payment of senior costs as well as expenses and interest on the notes. On the scheduled maturity date, the cash reserve can also pay for any principal shortfalls on the notes. Each month, the maximum future potential liquidity needs are recalculated based on the then-current payment schedule for the portfolio's remaining life. If the result is a number higher than the then-current reserve, future cash flows will be trapped senior in the waterfall to top up the reserve to the calculated level. After all of the lease receivables and notes are repaid, Volkswagen Leasing is entitled to any outstanding balance in the cash collateral account. Reserve for vehicles affected by manipulation of CO2 emissions The issuer deposited million (10.70% of the initial discounted pool balance) into a dedicated reserve at closing. The issuer can use the reserve to mitigate potential risks associated with vehicles that are affected by the manipulation of exhaust emissions in relation to CO2. NOVEMBER 25,

13 Over the transaction's life, the required amount of the reserve can either increase, e.g., when the discounted value of lease residual value reaches its nominal value over time, or decrease, e.g., when such lease residual value is repurchased by VW Leasing over time. Any excess of the reserve will be released to VW Leasing outside of the payments waterfall. Collateral Description As of Oct. 31, 2015, the collateral backing the notes comprises about 63,119 vehicles linked to lease contracts with about 41,303 lessees. The largest single discounted vehicle value is less than 67,900 (0.01% of the portfolio). The largest single lessee concentration is 0.04%, and the top 20 lessees comprise about 0.69% of the portfolio. Of the portfolio, 96.07% comprises new vehicles. In this respect, we consider the portfolio to be diversified. Table 2 Collateral Distribution Of The Pool Pool characteristics Principal outstanding (mil. )* Discount rate (%) Initial buffer rate (%) Discount rate minus buffer rate (%) Average remaining discounted residual value balance* 13,205 Weighted-average original term (months)* Weighted-average remaining term (months)* Weighted-average seasoning (months)* 7.14 Percentage of pool discounted principal balance (%)* Share of new vehicles Share of private customers Closed-end contract 99.3 Open-end contract 0.7 Affected contracts with EA 189 EU5 engines (no.) 15.8 Affected contracts with EA 189 EU5 engines (volume) 12.6 Affected contracts (volume) in relation to manipulated CO2 emissions (clearly identifiable) 4.9 Affected contracts (volume) in relation to manipulated CO2 emissions (estimated) 4.0 Manufacturer distribution (%) Audi Volkswagen Volkswagen Nutzfahrzeuge Skoda 9.12 Seat 2.27 Other 0.1 *Based on the pool as of Oct. 31, The geographical distribution shows a diversified pool, reflecting the residential distribution in Germany. The highest NOVEMBER 25,

14 geographical concentration by discounted principal balance is approximately 22.20% for lessees resident in Nordrhein-Westfalen (see chart 2). The transaction documents set out the eligibility criteria for the pool's receivables. Simplified, these state that: Contracts are legally valid and binding agreements and enforceability is not impaired; The seller may freely dispose of the residual values; None of the lessees is an affiliate of Volkswagen AG, Family Porsche Stuttgart, or Family Piech Salzburg Group; Contracts are governed by the laws of Germany; Lessees have their registered office/place of residence in Germany; At least two lease installments have been paid; Lease contracts require monthly payments to be made within 12 to 60 months after origination; Lease contracts do not include lease contracts with mileage settlements (Kilometerabrechnung) entered into before NOVEMBER 25,

15 Oct. 1, 2013; The total amount of residual value due from one vehicle does not exceed 80,000; The total amount of residual value due from one vehicle does not exceed 65% of the total amount of its lease receivable and residual value balance; Not more than 6% of the vehicles are used vehicles and not more than 22% of the vehicles are Volkswagen Nutzfahrzeuge; and Where applicable, contracts comply with the requirements of the German Civil Code (Bürgerliches Gesetzbuch) on consumer financing. Nature of the leases A lease contract comprises two elements. The first, typically the regular lease installments, relates to the payments from the lessee covering the vehicle's value deprecation for the contract's duration. The second relates to the vehicle's residual value when the lease contract expires. The issuer will only purchase the residual value installments, and not the regular installments. If a lessee defaults, the recovery proceeds from the sale of the vehicle are shared pro rata between the outstanding remaining regular installments and the residual value. Two different types of lease contracts are used: Open-end and closed-end contracts. In a closed-end contract (approximately 99.3% of the pool), the dealer bears the risk that the actual vehicle's market price when the contract expires is lower than its estimated residual value at origination. In an open-end contract (about 0.7% of pool), the lessee bears this residual value risk. The seller prefunds the value-added tax (VAT) due at the time of the asset purchase, as the corresponding VAT amount is deferred and is only due once the issuer has received a VAT refund from the tax authorities. Credit And Cash Flow Analysis Our rating analysis includes an assessment of the credit risk inherent in the transaction and the risk of market value decline for vehicles by analyzing the effect that various stress scenarios would have on the collateral. We analyze various stress scenarios and their effects on the notes' cash flows by applying our European consumer finance criteria. Market value decline analysis The issuer faces the risk of loss on residual values if and when: The vehicle's market value falls below the purchase price (loss severity); and If a third party covering the loss defaults (risk frequency). Combining loss severity and risk frequency results in a residual value loss rate. We only apply this residual value loss rate to residual values that reach their contractual maturity in our cash flow model, i.e., we apply this loss rate to the assets after prepayments and defaults. These two parameters are set as follows for this transaction: Loss severity. We assumed a base market value decline (i.e., loss severity) of between 40% and 45% of the vehicles' undiscounted residual value at a 'AAA' rating level. This assumption builds mainly on the European used car prices, which are currently below their long-term average, the fact that the portfolio is 100% residual values only, and the NOVEMBER 25,

16 lumpy cash flows. We increased our base market value decline assumptions by 4% for all rating levels to account for the idiosyncratic market value decline risk derived from the affected vehicles in relation to NOx, but also the non-affected portion. Risk frequency. The portfolio comprises the following underlying lease contract types: Open-end and closed-end contracts. Due to the revolving feature of the transaction, we assume that 100% of the pool comprises closed-end contracts, as we assume higher loss severity for these contract types. For open-end contracts (0.7% of pool), the lessee is still liable to the issuer for any market value decline. In an unstressed scenario, the contractual residual value is typically close to the observed market value at lease contract maturity. On the other hand, a stressed scenario results in a payment shock for the lessees, as a sharp drop in market values exposes them to an additional payment to be made at lease contract maturity. For closed-end contracts (99.3% of the pool), the dealer assumes the market value risk. As the corresponding repurchase option of Volkswagen Leasing with the dealers is not transferred, we assume that the issuer does not have any enforceable claim against dealers, i.e., we do not give benefit to any dealer obligation. We give marginal benefit to the fact that some lessees might take over the car at lease contract end by paying the contractual residual value. Based on these assumptions for closed-end contracts, the total risk frequency for the portfolio is 90%. Combining loss severity and risk frequency results in a residual value loss rate of about 43% and 31% at the 'AAA' and 'A+' rating levels, respectively. We only apply this residual value loss rate to residual values that reach their contractual maturity in our cash flow model, i.e., we apply this loss rate to the nominal value of the assets after prepayments and defaults. Credit risk analysis The portfolio only includes vehicles from securitized lease contracts. If a lessee defaults, recoveries are split pro rata between VCL Master Residual Value Compartment 2 and VCL Master, Compartment 1. As a result, VCL Master Residual Value Compartment 2 is not only exposed to a potential market value price decline of the leased vehicles at lease contract maturity, but also to the credit risk of the underlying lessees. We received monthly static net loss data, showing cumulative net losses (i.e., actual write-offs after recoveries) as a percentage of the volume of the originator's entire lease book. The data range from September 2004 to September The originator did not provide us with separate recovery or prepayment data. To arrive at a gross loss proxy, we "gross up" the net loss data, using a recovery rate assumption of 60%. We observed that performance in the originators' books has significantly improved from 2004 to It has stabilized at low levels since then. Performance also remained stable during the economic downturn observed in 2008 and NOVEMBER 25,

17 Chart 3 We also analyzed performance data from the originator's existing and matured transactions. Volkswagen Leasing has already exercised its clean-up call option for transactions originated in and before As a result, performance data is not available for the tail period of those transactions. NOVEMBER 25,

18 Chart 4 Similar to the loss data from the originators' books, the performance of Volkswagen Leasing's previous transactions has improved from 2003 to 2007, having stabilized since then, displaying lower absolute loss levels. In our view, this difference in absolute levels between performance in the originators' books and the transactions' portfolios can be explained by the positive selection bias under the eligibility criteria. The exercise of the clean-up call option supports the transaction, as Volkswagen Leasing also repurchases delinquent and terminated receivables. This, without the clean-up call option, would eventually translate into additional losses. We do not incorporate such call options or their effect on asset performance in our analysis because the call may not be exercised in the future. Based on the stable performance of the receivables and of the outstanding VCL transactions throughout the economic downturn, we sized an average net loss pool of 1.15% for the whole pool. Table 3 Base-case assumptions (%) Net loss 1.15 Recovery rate (for gross up) NOVEMBER 25,

19 Table 3 Base-case assumptions (cont.) Gross loss (grossed up) 2.88 Table 4 Stress Assumptions Rating level Gross loss (%) Recovery (%) Prepayment (%) AAA to A to We modeled the transaction's amortization phase in our cash flow modeling. We applied stressed losses equally for a period of 26 months. We stressed the prepayment rates and ran interest rate scenarios at current levels (down to 0%, and up to 12%). The model incorporates the notes' potential pro rata amortization, and the cash reserve's amortizing features. Additionally, we modeled the uncovered commingling risk and potential German trade tax payments as a loss. The ratings scenarios address not only the availability of funds for full payment of interest and principal, but also the timeliness of these payments in accordance with the terms of the rated securities. Scenario Analysis This scenario analysis section incorporates: A description of our methodology and scenario stresses, Results of the effects of the stresses on our rating, and Results of the effects of the stresses on our cash flow analysis. Methodology When rating European auto and consumer ABS transactions, we have developed a scenario analysis and sensitivity-testing model framework. This demonstrates the likely effect of scenario stresses on our ratings in a transaction over a one-year outlook horizon. For this asset class, we consider scenario stresses over a one-year horizon to be appropriate, given the relatively short weighted-average life of the assets backing the notes. For these types of securities, there are many factors that could cause the downgrade and default of a rated note, including asset performance and structural features. However, for the purposes of this analysis, we focused on the three fundamental drivers of collateral performance, namely: Gross loss rate, Recovery rate, and Prepayment rate. Given current economic conditions, the proposed stress scenarios reflect negative events for each of these variables. Increases in gross default rates could arise from a number of factors, including rises in unemployment and company insolvencies, together with falls in house prices and a reduction in the availability of credit. In addition, these effects would most likely cause collateral recovery rates to fall as the structural imbalance between supply and demand leads NOVEMBER 25,

20 to reductions in asset prices. In this environment, we also expect prepayment rates to fall as fewer refinancing options leave obligors unable to prepay finance agreements and demand for replacement vehicles falls. For this analysis, we have included two stress scenarios to demonstrate the transition of a rating on a note (see below). Table 5 Scenario Stresses Rating variable Scenario 1 (relative stress to base-case assumptions) Scenario 2 (relative stress to base-case assumptions) Gross loss rate (%) Recovery rate (%) (30.0) (50.0) Constant prepayment rate (%) (20.0) (33.3) Market value decline (15.0) (22.0) Our base-case assumptions for each transaction are intended to be best estimates of future performance for the asset portfolio. Our approach in determining these base-case assumptions would take account of historically observed performance and an expectation of potential changes in these variables during the life of the transaction. The sensitivity of rated notes in each transaction will differ depending on these factors, in addition to structural features of the transaction including its reliance on excess spread, payment waterfalls, and levels of credit enhancement at closing. For each proposed scenario stress, we separate the applied methodology into three distinct stages. In the first stage, we stress our expected base-case assumptions over a one-year period to replicate deviations away from our expected performance over the stress horizon. We assume that the stresses that we apply occur at closing, and apply gross losses based on our expectation of a cumulative default curve for the pool. The second stage applies our usual rating methodology, including revising our base-case assumptions at the one-year horizon to reflect the assumed deviations as a result of the stressed environment. In the final stage of the analysis, we re-rate the transaction at the one-year horizon, after revising our base-case assumptions and applying our standard credit and cash flow stresses at each rating level. The output of the analysis shows the likely rating transition of the rated notes, given the applied stresses and the value and timing of any forecasted principal and interest shortfalls under the most stressful scenario. Scenario stress and sensitivity analysis When applying scenario stresses in the manner described above, we intend the results of this modeling to be a simulation of what could happen to our rating on the notes. For the purposes of our analysis for this transaction, we applied the two scenarios described above in our cash flow modeling. Table 6 Scenario Stresses 12-Month stress horizon Rating variable Base-case assumptions Scenario 1 Scenario 2 Gross loss rate (%) Stressed Recovery rate (%) NOVEMBER 25,