Methodology. Rating U.S. Equipment Lease and Loan Securitizations

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1 Methodology Rating U.S. Equipment Lease and Loan Securitizations september 2014

2 contact information Sergey Moiseenko Senior Vice President US & European Structured Finance Tel Chris O Connell Senior Vice President US & European Structured Finance Tel [email protected] Chuck Weilamann Senior Vice President US & European Structured Finance Tel [email protected] Claire Mezzanotte Group Managing Director Global Structured Finance Tel [email protected] Kathy Tillwitz Managing Director Global Structured Finance Tel [email protected] DBRS is a full-service credit rating agency established in Privately owned and operated without affiliation to any financial institution, DBRS is respected for its independent, third-party evaluations of corporate and government issues, spanning North America, Europe and Asia. DBRS s extensive coverage of securitizations and structured finance transactions solidifies our standing as a leading provider of comprehensive, in-depth credit analysis. All DBRS ratings and research are available in hard-copy format and electronically on Bloomberg and at DBRS.com, our lead delivery tool for organized, Web-based, up-to-the-minute information. We remain committed to continuously refining our expertise in the analysis of credit quality and are dedicated to maintaining objective and credible opinions within the global financial marketplace.

3 Rating U.S. Equipment Lease and Loan Securitizations table of contents Scope and Limitations 4 Executive Summary 5 Overview 6 Industry Participants and Equipment Types 6 Lease Types 7 Structural and Legal Matters 9 Risk Isolation and Secured Interests 9 Establishing Cash Flow Certainty 11 Eligibility Criteria 12 Representations and Warranties 12 Additional Structural Issues 12 Valuation of Secured Equipment Contracts 13 Operational Risk Review 15 Originator Review 15 Company And Management 15 Financial Condition 15 Controls and compliance 16 Sales And Marketing 16 Underwriting guidelines 16 Technology 16 Servicer Review 17 Evaluating Credit Enhancement 18 Types of Credit enhancement 18 Rating Approach to Equipment Lease Securitizations 20 Pool Characteristics 20 Portfolio Performance 21 Estimating Expected Losses and Variability 23 Incorporating Obligor Concentration Risk 27 Additional Considerations for Cash Flow Analysis 28 Surveillance 31 Appendix I: Sample U.S. Equipment Lease Originator Review Agenda 32 3

4 Scope and Limitations DBRS evaluates both qualitative and quantitative factors when assigning ratings to a U.S. structured finance transaction. This methodology represents the current DBRS approach for rating equipment lease and loan securitizations issued in the U.S. with equipment collateral originated in the U.S. It describes the DBRS approach to analysis, which includes (1) a focus on the quality of the sponsor/servicer, (2) evaluation of the collateral pool and (3) utilization of historically employed credit evaluation techniques. This report also outlines the asset class and discusses the methods DBRS typically employs when assessing a transaction and assigning a rating. It is important to note that the methods described herein may not be applicable in all cases. Further, this methodology is meant to provide guidance regarding the DBRS methods used in the sector and should not be interpreted with formulaic inflexibility, but understood in the context of the dynamic environment in which it is intended to be applied. 4

5 Executive Summary Equipment-backed secured facilities have been prominent since the earliest days of development in the global structured finance market. Beginning in the mid-1980s with the securitization of computer leases and loans, 1 has become a widely utilized method of financing for the lessors of commercial equipment. Once considered an esoteric asset class, a wide variety of equipment and related loans and leases have been included as collateral for secured transactions. Despite the contractions and dislocations that plagued the financial market during 2008 and 2009, the U.S. equipment finance industry has maintained its fundamental strengths and returned in full force to the capital markets. Equipment finance securitizations transactions have been supported by collateral including micro commercial equipment (such as bank card processing machines), small-ticket commercial equipment (such as computers, furniture, telephone systems and copiers), mid-ticket commercial equipment (such as printing, graphic and industrial equipment, heavy-duty trucks and trailers, servers and large construction and agricultural equipment) and large-ticket assets (such as large medical equipment and large transportation and mining equipment). As such, the sector includes operating assets in the transportation sectors railcars, aircraft and marine containers that are typically treated as separate asset classes and generally would not fall under the scope of this methodology. In particular, operating transportation assets have distinguishing characteristics, such as servicing-intensive operations and remarketing risk. However, even in the case of such operating assets, certain transaction structures, which minimize the exposure to operating risk, may warrant the application of this methodology (e.g., securitizations backed by long-term leases or direct finance lease agreements through their useful life). The issuers within the equipment leasing securitization market also vary in size, with both smaller independent specialty finance companies and large captive finance lessors being active participants in the term securitization market. This report updates the DBRS methodology for rating equipment loan- and lease-backed transactions, which may differ based on asset class and issuer, but generally are subject to a review and analysis of the following key analytical considerations: Quality of originations, underwriting practices and portfolio management; Quality of servicing capabilities; Collateral quality analysis; Capital structure, target ratings and credit enhancement; Cash flow scenario analysis; and Legal structure and opinions. 1. Hereafter, the term lease, when applied in general sense, should be construed to mean both lease and loan unless otherwise specified. 5

6 Overview The equipment leasing sector has utilized securitization to access the capital markets as a source of funds to finance business operations and expansion since it began and represents an attractive cost of capital. Term asset-backed securities (ABS) issuance in the U.S. for the equipment leasing and loan sector (excluding marine containers, railcars and truck leasing) has reached $19.5 billion in 2012, $13.6 billion in 2013 and $7.7 billion during the first half of In addition, the equipment leasing and loan sector continues to benefit from the robust support by lenders for their revolving warehouse funding. The sector also has seen several investments by private equity firms into newly formed specialty finance companies focused on equipment leasing. The continuing development and growing sophistication of the securitization market, as well as the relatively stable performance of the sector during the recession, have allowed, in recent years, for access to the capital markets by equipment ABS issuers: from newly formed small- and large-ticket lessors 3 to the established agricultural and construction equipment captive finance companies with multi-year track records in securitization. Industry Participants and Equipment Types The universe of equipment lessors breaks down into leasing arms of commercial banks, captive leasing companies and independent specialty finance lessors. Independent leasing companies can be further separated into large and usually more diversified lessors and more narrowly focused small lessors. Generally, independent lessors and certain captive finance companies have been the most active users of the ABS market for funding. Captive Leasing Companies A captive leasing company is wholly owned and supported both financially and through a sharing of product expertise by the sponsoring parent entity. Often, however, credit decisions remain under the direction of a captive, who specializes in underwriting credit extensions to potential customers. The primary purpose of these captive leasing companies is to facilitate leasing and financing of the parent s manufactured products. Due to their role of supporting the sponsoring parent s leasing operations, large captive lessors generally offer product options on a narrow but defined market sector, e.g., agricultural, construction or medical equipment. These entities may have investment-grade or non-investment-grade ratings, but typically boast substantial operating history, brand loyalty, low losses with comparatively low variability in performance and a track record of successful securitizations. Some examples of large captive lessors include Caterpillar Financial Services Corporation, CNH Capital Corporation, General Electric Capital Corporation and John Deere Capital Corporation. Independent Specialty Finance Lessors Independent specialty finance lessors can be broadly divided into two categories: Large Independent Leasing Companies: Independent leasing companies are most often vendor-neutral, because they do not have a financing relationship or alliance with any one manufacturer. They compete by offering flexibility and a broad array of products to meet their customers needs. These participants generally have over $1 billion in lease receivables and have a national presence. Typically these entities have large and diversified portfolios with several product lines, a deep bench of managerial talent, substantial operating history and a track record of successful securitizations. Examples include CIT Group, Inc. and Great America Financial Services Source: The Securities Industry and Financial Markets Association (SIFMA). The numbers do not include auto fleet and certain container and railcar ABS. As of Q1 2013, truck leasing is included in the calculation of the aggregate issuance amount. 3. The access of relatively recently formed lessors to securitization financing has been facilitated by a variety of factors, including, but not limited to, availability of comparable industry performance data, industry experience, track record of the management team and structural protections incorporated by the issuer, such as hot backup servicer provisions in the transaction documentation or the use all proceeds available after payment of expenses and interest to pay down principal.

7 Small to Medium Independent Leasing Companies: Independent leasing companies in this category usually have a receivables base of less than $1 billion and generally finance fewer types of equipment than their larger competitors. Participants in this category often specialize in certain types of equipment, e.g., office equipment, trucks or medical devices. These entities may or may not be investment grade, more often than not have an extensive track record of successful securitizations and sometimes have significant equipment concentrations. It is not unusual for these companies to rely on a limited number of key managers and exhibit rapid origination growth. Examples include Marlin Leasing Corporation, LEAF Financial Corporation, Commercial Credit Group, Inc., Nations Equipment Finance, LLC, Navitas Lease Corp., Ascentium Capital LLC and Axis Capital, Inc. Bank Financiers This category encompasses the spectrum of banking institutions from money center and regional banks, to local and community banks. Many financial institutions view leasing as an extension of their finance products offered to customers. Banks had been active in financing large- and mid-ticket equipment, but to date have not been active in publicly securitizing their equipment-backed receivables, typically, because of other competitive funding options like customer deposits available to them. One exception has been Macquarie Equipment Finance, a subsidiary of Macquarie Bank Limited, which has a history of executing ABS issuance in the United States. Participants in the equipment leasing industry may also be categorized by the dollar size of their primary lease transactions, which is often determined by the type of equipment being financed. Categorizing the industry according to the cost of equipment would result in the following breakdown Small-Ticket Equipment: These portfolios are comprised of equipment with an original cost of $15,000 to $100,000, and include larger office equipment, machine tools, small computers systems and servers, small printing equipment, light industrial equipment and light trucks, vans and trailers. Typically, a leasing company leases equipment to a diverse group of lessees in various industries and geographic locations. Mid-Ticket Equipment: These portfolios generally include equipment with an original cost between $100,000 and $500,000. Typically, equipment types are represented by graphic and printing machinery, mainframe computers and large servers, heavy trucks, larger construction and agricultural equipment and certain types of specialized commercial and industrial equipment. Residual value realization and recovery rate upon obligor defaults usually become material factors in the overall rating analysis compared to the small-ticket pools. Large-Ticket Equipment: These portfolios contain equipment that costs in excess of $500,000. Largeticket equipment pools may include large computer systems, magnetic resonance imaging and other medical equipment. The high cost and specialized nature of this equipment will often result in the anticipation of substantial residual values. Lease Types An equipment lease is a contract between a lessor and a lessee that permits a transfer of the right of possession and use of property in return for defined set of scheduled payments. While there are various types, equipment leases can generally be separated into two broad categories: (1) operating leases, where the lessor retains ownership of the leased property and, thus, the risks related to ownership of the equipment, most specifically, the risk related to residual value of the equipment at the conclusion of the lease term and (2) finance leases, where the lessee makes lease payments covering the full value (or a significant portion) of the equipment or leases the equipment for the entire (or a significant portion) useful life, and hence bears the risks associated with the ownership of the equipment. Determination of whether a lease is a finance or an operating (true) lease may be difficult as industry dynamics sometimes produce contracts that exhibit characteristics of both types of obligations. For the purposes of evaluating credit enhancement provided by a collateral pool, the primary difference is the inclusion of the equipment and any expected residual value following the lease term in the collateral sup- 7

8 porting the transaction. In all cases where a transaction seeks to have credit assigned to residual amounts realized during the transaction s life, the equipment is expected to be transferred to a securitization trust under the appropriate terms with related filings made to protect the bondholder interests. Finance leases are also known as full-payout leases because the scheduled payments are structured such that their net present value equals at least 90% of the original equipment costs or fair market value (as the case may be) and term of the lease covers at least 75% of the equipment s useful life. A finance lease also includes a purchase option for the lessee at the conclusion of the lease term for the remaining value not yet paid under the scheduled payments (often manifested either as a below fair market value, 10% of the original equipment cost purchase option or a purchase option for some nominal amount, i.e., a $1 buyout purchase option). Important to the analysis is that the lessee s obligation to make such purchase is set forth under the terms of the lease and that the lease is non-cancelable. Technically, finance leases that necessitate such non-cancelable satisfaction are in essence installment sale or conditional sale agreements with the creation of security interest in favor of the lessor. For bankruptcy purposes, a finance lease is treated as a loan secured by the equipment and related cash flows, making perfection and priority of such security interest a very important issue in rating transactions in the sector. Operating leases are also known as true leases because, consistent with common understanding of the term lease, the lessor retains some interest in the property leased (a residual) and upon completion of the lease term, possession and use of the property revert to the lessor. Classification of a lease as a true lease is dependent on the expectation of the value of the residual retained by the lessor for which the lessor has the responsibility of realizing. For tax purposes, the residual value anticipated for the equipment must have been reasonable at the time the equipment is first leased to a lessee. Leases included in a securitization are typically triple net or hell or high water meaning the underlying leases create an absolute and irrevocable obligation to pay on the part of a lessee, with a lessee also being obligated to pay the costs of maintaining, operating and insuring the asset. The nature of the hell or high water, triple net lease is that there are no exceptions to the obligation to pay rent; even the destruction of the equipment itself will not exempt a lessee from its obligation (although insurance proceeds should cover due amounts). Hell or high water, triple net leases are also common in certain transportation leasing sectors, including railcars, aircraft and shipping containers, which are generally outside the scope of this report. Flexibility within a lease agreement that permits the lessee to modify or cancel a lease may prevent such lease and the related equipment from serving as collateral for a rated securitization. The leases should be standard amongst the lessees for each type of financing and there should be no allowable modifications to the documents. The lease must allow for the sale and assignment of the interests in the cash flows and ownership interest in the equipment, under appropriate circumstances and within legal obligations, to a third party. 8

9 Structural and Legal Matters Risk Isolation and Secured Interests The primary goal of a securitization is to reduce risk related to the subject assets through structural isolation, thus lowering financing costs of the sponsor. Individually, a sponsor may have specific goals for a securitization regarding reduction of risk exposure or recognition of gain through monetization of future payments. A sponsor may also have certain limitations or challenges in achieving these goals presented by the collateral. Consequently, depending on the goals of a sponsor, they will choose one of the general structural models that have been developed by the industry as a starting point for designing a securitization. Transaction Structures Often, the sponsor of a securitization transaction is also the originator and servicer of the lease assets. As described above, the leases are expected to contain a number of characteristics that ensure certainty of payment in order to serve as collateral for a highly rated securitization. To initiate a transaction, leases and rights to related cash flows are sold via a true sale to a special-purpose entity (SPE) under a sale agreement. For transactions involving operating leases, the sale of the collateral also includes the equipment and may include a pledge of rights to anticipated residual value of such equipment. Despite what should be defined within the sale agreement as a sale of the lease assets, the agreement should also include the grant of a backup security interest in the event that the sale was re-characterized as a loan. The originator and SPE also simultaneously enter into a servicing agreement for the assets sold to the SPE. The SPE then (1) pledges the assets as collateral under an indenture to secure bond obligations issued by the SPE or (2) deposits them into a trust in exchange for certificates representing the interests in the trust that the SPE then sells to investors. The SPE uses the proceeds from the sale of the ABS to purchase the lease assets under the sale agreement. Uniform Commercial Code (UCC) filings are typically sought, perfecting the security interests granted to (1) the SPE as a backup to the intended sale from the seller under a sale agreement and (2) the (a) indenture trustee (for the benefit of bondholders) from the SPE under the indenture or (b) SPE as depositor to a securitization trust, in each case, with accompanying legal opinions regarding the actions necessary to perfect. Specific Legal Criteria Like securitizations in general, the equipment lease and loan securitization is conceptually reliant on the isolation of risk, particularly the isolation of the lease or loan cash flows from the bankruptcy risk of the sponsor/originator. By legally separating the cash flows from the sponsor/originator for the purposes of a sponsor/originator bankruptcy analysis, the structure, at least in theory, is dependent on the performance of lessees and is no longer subject to a risk of the insolvency of the originator. Legal isolation of the cash flows is essential to justify the credit analysis based on portfolio losses and/or obligor defaults. Regardless of the type of lease, whether a true lease or a finance lease, the originator perfects its interest through the possession of the original lease, which is chattel paper under the UCC, but also typically makes a precautionary filing of a security interest. These filings are important for informational or precautionary purposes and provide a second method of perfection for the security interest granted, in addition to possession of the chattel paper, which would have priority under the UCC. In cases involving the transfer of ownership interests in the equipment, the intent is to accomplish a true sale of the equipment to the securitization trust; however, it is still typical to receive a grant of a backup security interest in the equipment to protect against re-characterization of the sale into a loan by a trustee-in-bankruptcy reviewing a seller s bankruptcy estate. 9

10 At the heart of the structure is the fact that the collateral is owned by a bankruptcy-remote SPE that is designed for the single purpose of holding the transaction collateral and issuing the related debt. The primary risk related to the sponsor/originator insolvency is a challenge of the true sale of the collateral from the sponsor/originator, as a seller, to the SPE. In this case, the petitioner would likely be a creditor of the sponsor/originator and seek to maximize the possible proceeds from the bankruptcy estate of the sponsor/originator by having the collateral sold to the SPE clawed-back into the bankruptcy estate of the sponsor/originator. In order to prevail, the creditor would need to assert that the collateral was not sold to the SPE on a non-recourse basis, or that the sale to the SPE represents a preferential transfer in contravention of the creditor s interest. To address this concern, transactions are usually structured as true sales of the collateral to the SPE for fair market value as an arm s length transaction. While the collateral is sold to the issuing entity, the true sale analysis does permit a limited amount of repurchase or substitution of equipment and leases related to delinquent and defaulted obligors at the seller s option. The structure may also permit the substitution for leases that are subject to upgrades of equipment permitted by the servicer in order to provide flexibility to a lessee (which is rather common in leasing technologically sensitive equipment). In order to limit this type of recourse to the seller, the issuers may limit substitution (combined with discretionary repurchases) at some predetermined percentage of the collateral (it is typical to see this amount limited to no more than 10% or 15% of the collateral sold to the issuing entity over the life of the transaction). Substitutions can alter the pool performance metrics and may vary over time as the seller circumstances and policies change and, therefore, substitutions are reflected in the credit analysis. For all types of lease securitizations, if a bankruptcy court deems a transaction to be a financing, the automatic stay provisions of the Bankruptcy Code (11 UCC 362) would apply. This could potentially trap the lease payments that, by application of the transaction documents, should be directed to the issuing SPE. Although investors may ultimately get their money as a secured creditor of the seller (assuming the proper backup procedures and UCC filings were made at the time of the sale to SPE), by institution of the automatic stay, there will be a delay in payment to investors. Therefore, amongst other characteristics, two elements are typically incorporated into the legal review: (1) that the transaction structure includes covenants for separateness and bankruptcy remoteness of the issuer to be maintained and (2) any delays in receiving the cash flows are limited in time and can be addressed within the structure through overcollateralization and the reserve account(s). Structures typically incorporate the characteristics of bankruptcy remoteness in any SPE, usually a new corporation, limited partnership or limited liability company, seeking treatment as bankruptcy remote. Bankruptcy remoteness generally is achieved by an SPE adopting the following characteristics: restriction on activities and powers, debt limitations, independent director, no merger or reorganization and separateness covenants provided by the sponsor/originator. The transaction documents should include the aforementioned characteristics as covenants of both the sponsor/originator and the SPE, which, if maintained, would evidence the independence of the SPE. While an SPE may have adopted the requisite criteria of bankruptcy remoteness, there remains the possibility that the insolvency of the issuer s parent may result in the issuer being treated as part of the parent s bankruptcy estate, either through the Bankruptcy Code doctrine of substantive consolidation or through the common law doctrine of piercing the corporate veil. Each of these results stem from over-reaching behavior by the parent in the affairs of its subsidiary essentially, by refusing to abide by the separateness mechanisms referred to immediately above. 10

11 To address the risks related to re-characterization or consolidation of the assets of the issuer with those of its parent (which is usually the originator), legal opinions are requested for any rated transaction covering true sale and non-consolidation. The true sale opinion should address the likelihood that, in the event of a bankruptcy of the originator, the transaction would (or should) not be re-characterized as a financing by the originator and in effect, there has been a true sale of the leases or loans to the SPE that conducts the financing. The non-consolidation opinion should address the likelihood that, in the event of a bankruptcy of the originator, the SPE and the originator would (or should) not be treated as the same entity, i.e., consolidated, for bankruptcy purposes (provided the structure of a transaction has been maintained). Legal opinions should also cover the anticipated treatment of any backup security interests granted and perfected under the terms of the transaction documents. Related opinions typically opine that the intended transfer would not be rejected under review of a bankruptcy court and deemed a sale if effected. Transactions may be afforded limited flexibility in managing these protections if such flexibility is deemed not to compromise the credit profile of the collateral pool. For example, a transaction may only need asset-specific filings to perfect security interests on equipment exceeding a certain value ($25,000 has often been used as a threshold for requiring filings) to ease administrative burdens on the servicer. Establishing Cash Flow Certainty The legal arrangements discussed in the previous section are established by the issuer to ensure structural isolation of cash flows to be allocated according a defined priority of payments. The priority of payments provides the trustee with specific instructions for the allocation of collections on the collateral once they are deposited by the servicer into a collection account. To be an eligible account, the collection account is controlled by the securitization indenture trustee for the purposes of Article 9 of the UCC. Control as defined by Section of the UCC is necessary to ensure that the trustee-in-bankruptcy in an insolvency proceeding of the sponsor/originator would respect the indenture trustee s claim to the funds in the account. Such eligibility criteria are applicable to any account that is included as credit enhancement for the ABS transaction. The priority of payments typically limit distributions senior to interest and principal on the bonds to a transaction s related costs, including but not limited to, trustee, administrative and servicing fees and indemnification payments. In securitization transactions, items paid senior to interest would generally be expected to be well defined and quantifiable, as DBRS incorporates downside or increased cost risk in its cash flow analysis. DBRS qualitatively assesses, on a case-by-case basis, any potential impact of uncapped payments and liabilities like swap termination payments and legal indemnities on the timely payment of the bondholder interest, ultimate principal and senior payments needed for the management and administration of the SPE in order to determine the possible effect on the ratings of any tranche in a transaction and may apply additional stresses in its cash flow modeling analysis for transactions, which do not incorporate caps (or other structural protections) on senior expenses. The obligor payment obligations are also analyzed for features that increase credit risk or modify timing of the anticipated cash flows in order to assess a more accurate quantification. Some financing instruments for equipment may include a large balloon payment from a lessee at the end of the lease. Balloon payments are larger than the periodic payments and may be as high as 30% of the original equipment cost or fair market value for certain types of equipment, and therefore, pose a greater risk of non-payment by the obligor. Where balloon payments are incorporated in the lease terms, they are reviewed to determine whether such payments are included in the anticipated cash flows and to reflect them in the stressed cash flow modeling scenarios. Some industries like construction and agriculture are seasonal and may include seasonally adjusted payment obligations incorporated in the lease terms to match the anticipated cash flows. Other industries (e.g., medical equipment) often have scheduled payments increasing over time. In these cases, the timing of the payments are reviewed as part of the cash flow analysis. 11

12 Eligibility Criteria A typical securitization structure that allows for additions of collateral would also be expected to provide for the ability to design and maintain a consistent collateral portfolio profile for the transaction. This is accomplished by the issuer establishing eligibility criteria for the assets either on a lease-by-lease basis through the sale agreement or by monitoring exposure across the collateral pool through the financing documents. Common examples of criteria for an eligible lease include that the lease (1) is not delinquent, defaulted or with a restricted person (as defined by the Office of Foreign Assets Control), (2) is triple net and non-cancelable and (3) has a certain minimum yield and maximum remaining term. If the lease does not satisfy the eligibility criteria, it is not eligible for sale to the SPE. The seller should be mandated under the sale agreement to repurchase any leases sold to the SPE that are later found not to have been eligible at the time of sale. If a lease is eligible at the time of sale and later becomes ineligible, such lease would not be subject to mandatory repurchase by the seller but would be removed from any determination of collateral support for the outstanding obligations (in revolving transactions). Representations and Warranties Repurchases of collateral by the seller are often triggered by a breach of the representations and warranties made under the sale agreement. In each case, if non-conforming collateral is sold to an SPE, the related representation would be breached and the collateral would be subject to a repurchase obligation on the part of the seller. A common representation made by the seller at the time of sale is that the collateral sold conforms to the eligibility criteria set forth in the transaction documents. Repurchases resulting from collateral non-conformity to the eligibility criteria are mandatory and uncapped, making them clearly distinguishable from voluntary repurchases of non-performing collateral by the seller that are capped for true sale purposes. Other typical representations and warranties include the seller s authority to enter into the transaction and its good title to the equipment sold. Additional Structural Issues Careful determination of the potential risk migration imbedded in the collateral portfolio is important for revolving securitization transactions, structures that permit a portion of the collateral to be prefunded or for structures that are constructed as master trusts. The collateral profile in such transactions is dynamic because it allows addition by the originator of new collateral to support the prefunding or future funding through a revolving warehouse series or the issuance of additional term series of debt. Prefunding permits the issuance of ABS to be eventually secured by the collateral not yet originated by the sponsor/originator. Prefunded amounts are available for a defined period of time and should be maintained in an eligible account and disbursed as additional collateral is sold to the issuing SPE. If prefunded amounts are not used to purchase additional collateral by the conclusion of a defined prefunding period, they would be expected to be used to pay down the outstanding principal of the ABS. Master trust structures use a master indenture and series supplements. Often, the collateral pledged to the trustee under a master trust structure secures obligations for all series of notes issued under the related master indenture. These master trust structures create cross-collateralization across multiple series issuance, which benefits credit enhancement through diversification. While diversity through crosscollateralization will decrease credit risk, it can add an element of uncertainty if risk exposure limits are not incorporated and maintained. This also applies to the revolving warehouse note facilities, which are drawn upon over time as the sponsor originates new business. Since often the main purpose of a warehouse structure is to act as an aggregation facility before critical mass is reached for a term ABS issuance, the principal of such facilities revolves, and the facilities only pay regular interest on drawn amounts and not repay principal outstanding (other than as needed to bring the borrowing base to compliance) until the start of amortization period. Revolving facilities often include step-up payments and amortization triggers, the impact of which must be clearly defined and incorporated into the cash flow analysis when possible. 12

13 The transaction documents for revolving structures would be expected to contain pool-wide concentration limits. These pool-wide limits are designed to contain excessive exposures that may exist with respect to individual or top lessee totals, certain types of equipment or geographic regions. If these concentration limits are exceeded, the related collateral is excluded from the calculation of the eligible borrowing base supporting the outstanding debt. Maintenance of the risk exposures within the concentration limits over time ensures that the collateral pool preserves its desired characteristics and creditworthiness even as exposures in the pool migrate due to the addition and subtraction of assets. The transaction structure is often designed to increase certainty of payment to bondholders through rapid amortization of principal or trapping of cash within the structure upon the occurrence of certain trigger events. These trigger events help address risks related to deterioration of the seller/originator or the collateral. Typical amortization or cash trapping events related to the seller/originator include failure to maintain certain financial ratios, defaults under the servicing agreement and breaches of certain material representations and warranties. Early amortization or cash trapping events related to collateral typically include performance triggers and maintenance of credit enhancement at a level sufficient to avoid a deficiency in the amount of collateral supporting the outstanding ABS debt. Additional stress analysis may be warranted in the structures, which include multiple tranches down to the non-investment-grade level. In many cases, the lower-rated tranches tend to be thinner, which, combined with sequential principal payment priority and an increasingly concentrated obligor base, may expose such tranches to increased back-ended obligor default risk. In addition, in a transaction that relies on residual proceeds for a material portion of the overall credit enhancement, lower-rated tranches may bear an increased share of the residual realization risk. DBRS typically reviews a transaction s collateral profile with respect to remaining lease term, largest obligor and industry concentrations and residual exposure, as well as available cash trapping triggers in order to assess any potentially oversized risk related to the aforementioned factors toward the end of a transaction s life. One key risk element that is present in some equipment-backed transactions is a mismatch between the funding basis of the underlying assets and that of the notes issued by the funding trust. To the extent that a fixed versus floating rate mismatch exists, hedging arrangements need to be entered into to remove this exposure from the trust and ensure that the noteholders have access to the appropriate type of interest cash flows. In the instances when the ABS issuing trust or an SPE is unable to absorb the related risk position, which is subjected to the applicable DBRS LIBOR curve stresses, appropriate hedging arrangements are typically included by the issuer at the inception of the transaction. For further details, please see DBRS methodologies Legal Criteria for U.S. Structured Finance and Unified Interest Rate Model for U.S. Equipment Lease and Loan ABS Transactions. Valuation of Secured Equipment Contracts The collateral supporting repayment of debt obligations under an ABS transaction is valued at the time it is sold to the issuing SPE. This necessitates an understanding of the method used for the collateral valuation, which is generally determined by discounting scheduled and, in some cases, balloon payments under the lease at par or at premium. It is important to understand the discounting method, as the differing methods change the risk profile of a transaction. A valuation at par applies the weighted-average yield on the leases as the discount rate, while the at premium method would use the weighted-average interest rate of the financing obligations (plus the cost of senior items in the priority of payments) as the discount rate. The at par method results in a lower valuation of the collateral since a higher discount rate is applied to the future payments, creating excess spread during the life of a transaction as actual returns are realized. The excess spread acts as an additional form of credit enhancement. The at premium method, which is the more commonly used of the two discounting approaches, uses a lower discount rate based on the weighted-average interest rate of cost (plus the cost of senior items in the priority of payments) for financing the collateral, and results in a higher valuation of collateral. When an at premium method is employed to discount the collateral, risk may be more acute for pro rata payment of the securities, since 13

14 excess spread, which may be necessary to compensate for cash flow fluctuations, is reduced or eliminated through the discounting method. In both cases, since the methods involve averaging future rates to achieve the discount rate, the potential exists for variability if obligations are prepaid or default. The impact of discounting method on a transaction can also be magnified in a senior/subordinate structure. This occurs because of the higher interest rates for the subordinate classes, versus those of the senior classes of securities, and the timing of principal payments to the senior and subordinate securities. Senior/ subordinate structures pay either pro rata or sequentially. In a pro rata senior/subordinated structure, both the senior and the subordinate classes of securities receive principal payments concurrently during the life of the transaction. Regardless of the discounting method used, pro rata structures typically create more risk for a senior class, since the subordinate class is receiving principal payments together with the senior class, and the assets and related cash flows supporting all series are limited. In a sequential pay structure, the marginal rate of interest of a transaction increases over time as the senior classes, with lower interest rates, are paid off. This can have a negative effect on the ability of cash flows to meet obligatory payments in the latter part of the transaction since the weighted-average rate for discounting the collateral would be the weighted-average interest rate for all classes, and thus below the interest rate of the subordinate securities. This could result an inability to pay the subordinate class, once the senior class obligations have been paid. While this concern is present in sequential pay structures where the collateral has been discounted using the at par method, the excess spread created through the discounting method may provide the ability to absorb the higher interest rates carried by the subordinate class still outstanding after the senior class obligations have been satisfied. DBRS reviews the valuation method and the creation of excess spread and potential variability, and integrates them into its risk analysis. DBRS also considers the transaction structure in determining the potential impact of the discounting method to assess the sufficiency of credit enhancement. 14

15 Operational Risk Review ORIGINATOR REVIEW DBRS typically begins the initial originator review process by sending a questionnaire to the company that outlines the topics to be covered during the review, such as organizational charts, financial statements, underwriting guidelines and performance statistics (Appendix I). A date is usually then scheduled to conduct an on-site visit of the company or have a call. During the on-site review and/or call, DBRS meets with senior management to discuss the origination operations, tour the facilities and review system demonstrations, as appropriate. DBRS assesses the information gathered through the review process, along with its surveillance data and industry statistics to determine if an originator is acceptable. In instances where DBRS determines that the originator is below average, issuers may incorporate certain structural enhancements into a proposed transaction, such as additional credit support. In the event that DBRS deems an originator unacceptable, it may decline to rate the transaction. The originator review process typically involves a review and analysis of the following: Company and management, Financial condition, Controls and compliance, Sales and marketing, Underwriting guidelines and Technology. COMPANY AND MANAGEMENT DBRS believes that no origination operation can be successful without a strong seasoned management team that possesses demonstrated expertise in the product(s) they are originating. As a result, DBRS views favorably those originators whose management team possesses greater than ten years of industry experience. Additionally, DBRS believes the participation of the credit risk management, quality control, legal and compliance departments in the origination and underwriting process is important in order to identify and mitigate risk. Furthermore, adequate capacity and resources to handle fluctuations in equipment lease volume are of importance. FINANCIAL CONDITION DBRS typically reviews the originator s financial condition to determine whether the originator has sufficient resources to make the appropriate representations and warranties on the equipment leases being included in a securitization. The financial condition of the entity performing an origination role may be assessed through feedback, an internal assessment (IA) or a private rating from the DBRS Financial Institutions Group or through additional analysis performed in the review of the transaction. Some items that are reviewed as part of this process may include: Company ownership structure, Management experience, Corporate rating of any parent company (if applicable), Internal and external audit results, Revenue sources and lines of credit, Costs to originate, Litigation (past, present and expected), Existing business strategy and strategic initiatives, Recent or planned mergers or acquisitions, Recent or planned transfers or acquisitions and Securitization history and future plans. 15

16 Any financial stress identified can elicit originator problems either immediately, as in the case of a bankruptcy, or lead to a slow degradation of the performance of the collateral. Therefore, the originator s financial condition is typically incorporated in the DBRS analysis of equipment lease transactions, including the evaluation of credit enhancement levels and the presence of structural safeguards. Controls and compliance DBRS believes internal assessments and quality control reviews are important in recognizing procedural errors that may not be easily detectable. These reviews can be used to identify trends, training opportunities and exception practices. Frequent checks can assist management in quickly instituting changes to areas needing improvement, as well as benchmarking those results to performance. In addition to the aforementioned reviews, a monitoring process should be in place to ensure that the originator is in compliance with all applicable laws, rules and regulations and that all employees in customer-facing positions are appropriately trained. DBRS views favorably the participation of the credit risk management, quality control, legal and compliance departments in the origination and underwriting process in order to identify and mitigate attendant risks. DBRS also views favorably those originators that are not the subject of any regulatory or state investigation(s). Minimal or no repurchases due to breaches of representations and warranties are considered, as are the existence of robust procedures for vendor selection and oversight. Additionally, strong controls for managing potential conflicts of interest associated with parties to a transaction are important. SALES AND MARKETING DBRS typically reviews the origination and sourcing channels to assess if the originator has a clearly defined strategy. Sales and marketing practices are also reviewed to evaluate the screening process. Origination practices that include regular performance tracking and quality control reviews are viewed favorably by DBRS. Furthermore, procedures that ensure new account setup accuracy and data integrity are fundamental to ensuring minimal errors. As a result, DBRS views favorably those originators with high levels of automation and strong efforts toward compliance with regulatory guidelines and industry best practices. Underwriting guidelines An originator s appetite for risk and the underlying quality of its underwriting guidelines can have a significant impact on transaction performance. Therefore, DBRS uses both a qualitative and quantitative approach to conduct its originator reviews and make comparisons among originators. Historical lease performance and repurchase volume are just some of the components that are incorporated into determining the quality of an originator. DBRS views favorably those originators that have robust guidelines and use reliable means to accurately assess a lessee s income, employment and assets. Furthermore, sophisticated technology and strong fraud-detection procedures can help prevent early payment defaults as well as accurately determine debtto-income ratios. An originator s exception and override practices can also help to assess the quality of the originations. Additionally, separation of the origination and underwriting functions in addition to a compensation structure that emphasizes quality over loan volume can help to ensure predictable performance. TECHNOLOGY Technology resources are an integral component of the originator review process. While DBRS does not subscribe to specific systems architecture, in reviewing the originator, DBRS considers whether adequate systems controls, consumer privacy protection and backup procedures, including disaster recovery and business continuity plans, are in place. Furthermore, originators must ensure that any offshore vendors are monitored and a backup plan is in place to ensure minimal downtime. 16

17 Over the past few years, leveraging the Internet has enabled many firms to operate effectively in the equipment lease business. Originators have used the Internet for marketing, customer service and the dissemination of pertinent information, such as applications and approvals. As a result, DBRS expects originators to have the appropriate staff and controls in place to ensure website availability, account maintenance and enhancements. Sophisticated technology with robust functionality is viewed favorably by DBRS as it often helps bring large efficiencies to the origination operations, in addition to more predictability in terms of performance. SERVICER REVIEW The servicer review process evaluates the quality of the parties that service or conduct backup servicing on the accounts being securitized. While DBRS does not assign formal ratings to these processes, it typically conducts operational risk reviews to assess if a servicer is acceptable and incorporates the results of the review into the rating and surveillance processes. DBRS typically begins the initial servicer review process by sending a questionnaire to the company that outlines the topics to be covered during the review and includes a list of documents to be provided such as organizational charts, financial statements and performance statistics. A date is usually then scheduled to conduct an on-site visit of the company or have a call. During the on-site review and/or call, DBRS typically speaks with senior management to discuss the servicing operations, tour the facilities and review system demonstrations, as appropriate. The on-site review typically takes one to two days, depending on the product(s) being serviced and number of servicing sites. DBRS assesses the information gathered through the review process, along with its surveillance data and industry statistics to determine if a servicer is acceptable. In instances where DBRS determines that the servicer is below average, issuers may incorporate certain structural enhancements into a proposed transaction, such as additional credit support, dynamic triggers or the presence of a warm or hot backup servicer in order for DBRS to be able to rate the transaction. The servicer review process typically involves an analysis of the following: Company and management, Lease administration, Account maintenance, Customer service, Collections, Remarketing/loss mitigation, Investor reporting and Technology. For details on the servicing review process, please refer to the DBRS methodology Operational Risk Assessment for U.S. ABS Servicers. 17

18 Evaluating Credit Enhancement Types of Credit enhancement Credit enhancement can typically be classified as hard, which are enhancements directly available to support the securitization obligations, or soft, which are enhancements that support the securitization obligations if and when they are available. Typical forms of credit enhancement in equipment lease securitizations include overcollateralization, subordination, reserve accounts and excess spread. Excess Spread Excess spread is typically created in a transaction when the discounting method uses a discount rate that is equal to or greater than the yield on the underlying leases. In other words, if the discount rate is higher than the weighted-average interest rate of the notes plus the costs of items senior to interest in the priority of payments, excess spread is created. Excess spread is a soft form of credit enhancement since it is based on anticipated, but yet uncertain performance of the collateral. Further, it is subject to timing variability and potential future reduction due to prepayments, delinquencies and defaults of underlying obligors. Cash Reserve Accounts Cash reserve account is a form of hard credit enhancement that is available to pay interest, and sometimes principal, on the securitization obligations. Reserve accounts are included in most equipment lease securitizations as set dollar amounts or a percentage of the debt outstanding, and are funded either at the outset of a transaction or over time through the transaction cash flows. Reserved amounts provide additional liquidity to a transaction and may be used to allow it to successfully perform under stressful scenarios. In equipment leasing ABS transactions where principal amortizes over time, reserve accounts may be permitted to decline over time (typically subject to a floor defined as percentage of the initial collateral balance) as the transaction pays down the outstanding principal and the collateral seasons. Similarly, in the revolving securitizations, as the outstanding principal balance of the revolving facility fluctuates from period to period, a portion of the reserve account may be released to the SPE and funded back up on a periodic basis based on the fixed percentage of the outstanding securitization debt. Overcollateralization Overcollateralization is a form of hard credit enhancement that acts as an unrated first loss piece, absorbing obligor default shocks before any payment shortfalls to securitization investors are realized. Overcollateralization is achieved by issuing ABS obligations in an amount less than the value of the balance of the collateral securing those obligations. The sufficiency of overcollateralization is evaluated by DBRS after application of its rating criteria with respect to cash modeling stresses to the proposed collateral pool and evaluation, when applicable, of the impact of the permitted release versus full turbo ABS principal repayment priority in a securitization transaction. In the permitted release transactions, DBRS reviews the existence of overcollateralization floors and the protection afforded since overcollateralization may be diminished as material amounts of collections may be released to an issuing SPE prior to the occurrence of cash trapping event or a significant spike in the collateral losses later in the life of an ABS transaction. The residual value of the equipment, which is available to support the transaction, is among the most challenging forms of overcollateralization to evaluate and quantify. The uncertainty related to residual value amounts and timing of realization of those amounts has resulted in these values often only serving as supplemental or bootstrap credit enhancement. Consequently, such amounts are, on many occasions, not incorporated into the collateral balance for purposes of issuing the securitization obligations. To the extent that credit is requested for residual values pledged to a transaction, the process for setting of such values and the servicer s role in realization is analyzed and discounted as described herein. 18

19 Subordination Subordination is a form of hard credit enhancement that creates an additional cushion for losses in the collateral portfolio for more senior ABS tranches. Subordination is created by issuing a junior class of notes that is subordinate in right to a senior class with respect to amounts available for payment of ABS. The junior classes are available to absorb losses, and therefore act as additional overcollateralization for more senior classes. DBRS analyzes any mechanisms within a transaction that modify the availability of these junior classes to act as credit enhancement for senior classes. In particular, the impact of the priority of payments (i.e., (1) interest/principal/interest/principal versus (2) interest/interest/principal/ principal versus (3) the structures that allow for pro rata principal distributions between the senior and subordinated tranches until the occurrence of a trigger event) is analyzed to assess the effectiveness of subordination in providing additional protection. 19

20 Rating Approach to Equipment Lease Securitizations Pool Characteristics The collateral supporting a securitization often includes thousands of equipment lease contracts with differing terms and obligations to several hundred, or even thousands of lessees. While characteristics may differ somewhat by transaction, the pools generally include certain definable characteristics that aid in the performance of risk analysis. Collateral Evaluation The characteristics of the collateral in a securitization pool need to be definable to facilitate the segregation, quantification and mitigation of risk. The collateral pool is typically segregated into sub-pools with common characteristics to allow for stratifications that permit the analysis of common risks. The stratifications are analyzed by DBRS to assess common characteristics necessary to assist in the risk analysis. Characteristics that are isolated for analysis may vary based on the type of asset and overall composition of the pool, but usually include seasoning, obligor and broker concentrations, geographic concentrations, equipment type and manufacturer. When a lease has some measurable period of performance by the lessee since its origination, it is deemed to be seasoned. History has shown that newly originated leases are statistically more prone to default than those that have experienced some period of performance by a lessee. Seasoning of leases in a collateral pool not only affects the aggregate anticipated loss analysis but the expected timing of those losses. Consequently, the pool s seasoning is reviewed to ensure that it is comparable to pools previously originated by the same originator, thus permitting the appropriate application of a loss curve. Lessee and Broker Concentrations One of the benefits of stratifying the collateral pool is that it permits review and stress analysis for lease obligations concentrated to individual obligors and brokers. A higher degree of credit risk exists in pools where lease obligations are concentrated with one or several large individual obligors. For industries with relatively few players (e.g., shipping containers) it is common to see the largest individual lessees represent more than 10% of the lease obligations in a collateral pool. Even some portfolios comprised of more traditional but larger-ticket or specialized equipment may exhibit relatively high obligor concentrations. The obligor concentration risk can be magnified when a lessee is non-investment grade. For this reason, DBRS typically reviews lessee concentrations for collateral pools and may address heightened credit risk by increasing cash flow stresses and supplement its default and recovery expectation analysis with an examination of the underlying obligors credit and exposure size. In particular, DBRS may utilize methods that are similar to those used in the analysis of middle-market collateralized loan obligation (CLO) transactions. This approach utilizes the DBRS CLO Asset Model to generate the loss probability at various rating levels, based on the lessee credit estimate, concentration level, tenor, industry and expected recovery, and is used as an input in the stressed cash flow analysis. Higher obligor concentrations, which increase risk of the occurrence of higher one-time defaults, may also warrant supplemental recovery value analysis, which may include the assessment of the appraised values of, and the existing resale market for, the underlying equipment when such information is available. In addition, in the case of revolving securitization structures, DBRS evaluates potential obligor concentration and credit quality migration within the proposed transaction limits to analyze the variability in obligor concentration risk over time. 20 Similarly, in the transactions with material broker concentrations, DBRS may assess the differences in underwriting, if any, for the largest respective broker concentrations in the collateral pool. DBRS may also review the variability of the origination volumes related to the largest brokers vis-à-vis the origination volume dynamics in the overall portfolio. Furthermore, the consistency of historical performance of the collateral originated through the largest broker channels may be compared to the trends observed for the originator s overall portfolio.

21 Geographic Concentrations Concentration by geographic region is another risk that is reviewed to ensure accurate assessment of portfolio risk. Geography poses a risk to a transaction when events like weather and regional economic downturn can affect portfolio performance. Concentrations for geography in small-ticket equipment lease securitizations are common and consistent in states with high populations and high economic activity level, but are normally limited to 10% to 20% of the collateral pool. Limitations on geographic concentration in the revolving transaction structures are established at the outset of a transaction and maintained over its life. In addition, stress scenarios may incorporate risk related to unusually high geographic concentrations in the determination of anticipated losses for the transaction. For instance, for particularly high state concentrations, DBRS may review the historical static pool losses for the originations in a particular state vis-à-vis the static pool losses for the overall originator s portfolio. Equipment Types and Manufacturers The type of equipment and its manufacturer may add risk to a transaction if concentrations exist. Certain types of equipment (e.g., computers) are regularly upgraded and may be subject to obsolescence from a performance perspective, hence entire pools of such equipment may compare poorly to a pool of agricultural equipment as collateral for an ABS transaction. Additional risk exists if the lessee does not need the equipment to perform its business, since such a discretionary expenditure may be abandoned by a lessee during a downturn. By contrast, equipment with high value in place, such as sophisticated companywide telecommunication/it systems or data room servers, may result in higher recovery rates despite its relatively low re-sale potential in the open market, due to its essentiality for an existing lessee willing to continue its operations as a going concern. Portfolios of obligations related to equipment from a specific manufacturer also introduce risk to a transaction if the manufacturer is obliged to honor warranties on the equipment it manufactures, which is most often the case with mid- and large-ticket equipment. The manufacturer s business track record, competitive position and strength of its warranty and customer service support may be reviewed by DBRS to assess potential additional risk. DBRS may also analyze concentrations of equipment types and manufacturers and, for some concentrated portfolios, may incorporate this analysis in its determination of the pool s expected loss. Portfolio Performance A portfolio of equipment lease receivables provides various metrics that allow industry participants to track and analyze performance and evaluate risk. With respect to evaluating credit risk of a pool of equipment lease receivables, the key metrics are delinquencies, defaults, recoveries and prepayments. Typically, these metrics are reviewed by DBRS in determining the credit risk related to a particular portfolio. Delinquencies The ability of lessees to make timely payments is an integral part of the cash flow analysis. The servicer needs to demonstrate that it is capable of tracking and properly applying these payments, and that they employ effective procedures to ensure lessee payment performance in accordance with the terms of a lease agreement. In addition, DBRS usually reviews the servicer s policies and procedures with respect to the application of partial payments to delinquencies, as well as contract modification and re-aging provisions. The information provided by the servicer is used to approximate anticipated performance variability. Typically, the servicer is expected to provide a history of receivable aging, specified as 30-days past due aging buckets up to 181+ days delinquent aging bucket. This information is also often used by the ABS sponsors to set the levels for the transaction performance triggers that assist in guarding the portfolio against deterioration. DBRS may use the historical aging information to evaluate the anticipated effectiveness of such performance triggers. 21

22 Defaults and Charge-offs A payment default occurs when the lessee, after any applicable grace period, is either unable or unwilling to make its payment obligation under a lease. Payment default data is one of the most important metrics used in the quantification of expected loss for a collateral pool. DBRS uses the static pool default data to develop its expected loss assumption for the proposed collateral pool, as well as the starting point assessing the appropriate stress scenarios. The analysis begins with a review of the originator s default history and charge-off policies to provide clarity as to how and when defaulted obligations have occurred, and when defaulted obligations are deemed uncollectable. The review should also determine if the information and data are sufficient (in terms of quality and quantity) and from a source or sources reasonably deemed to be reliable so as to allow DBRS to ascertain the suitability of using the data as a basis for loss analysis. While the delinquency level thresholds for charge-offs in the equipment leasing industry vary somewhat, generally policies charge-off amounts deemed to be uncollectable. The uncollectable amounts are typically recognized as the full net book value of the related collateral and the unearned income expected under the related lease, less any amounts expected to be recovered. Application of the policies should be uniform and demonstrate consistency over time. In addition, since future performance is to be governed by the charge-off policy set forth under the transaction documents, the typical policies instituted by the servicer are compared with the definitions of defaulted receivables in the transaction in order to ensure conformity. For purposes of the securitization, the charge-off of a defaulted obligation is typically based on the passage of time related to a delinquency, usually 120 to 180 days past due. To the extent that historical charge-off policies vary materially from those detailed under the transaction, special consideration is typically given to how the new policies may affect the servicer s operations and pool performance. In any event, the transaction documents are expected to be clear and specific with respect to defining defaulted amounts and the timing of loss recognition, and the servicer is expected to agree to manage charge-offs as contemplated therein. Recoveries (Value and Timeframe) Following default under a lease, the servicer s obligations intensify and become those of recovery. Since servicers are often successful in recovering at least a portion of amounts owed by lessees under defaulted leases, DBRS reviews the historical recovery data to determine if credit can be given for anticipated recoveries on defaulted obligations. If sufficient recovery data exists, the process for recovery is analyzed to place the historical information in context. To better understand the anticipated recovery process and timeframe, DBRS reviews the servicer s primary approach to recovery efforts, which may focus on collection calls, legal action, renegotiation with existing lessee and/or repossession, remarketing and resale of the equipment. To the extent a transaction may include repossession and resale of the equipment as a remedy under a lease, the history and experience of the servicer to perform these duties is evaluated. In conjunction with examination of the originator s historical track record with respect to recovery rates, DBRS also assesses the historical size and consistency of such originator s expenses related to its recovery activities. Typically, in ABS transactions, the servicer is entitled to reimbursement of its recovery expenses before any recovery proceeds are available for distribution in accordance with an ABS transaction s priority of payments. The recovery expenses may be comprised of legal, remarketing (e.g., repositioning and installation expenses) and/or liquidation expenses (e.g., collateral repossession expenses, as well as auction and/or broker fees and commissions). For some types of collateral, recovery expenses may be material and, as such, are incorporated into the recovery rate cash flow modeling assumption by DBRS. 22 The servicer s preferred method of recovery activity may affect not only the extent of recoveries but their timing. It may also influence the ease with which servicing activities can be transitioned to a backup, for instance, when repossession and remarketing activity is already largely outsourced by the current servicer to third parties. To the extent the reliance on the servicer for recoveries is material and cannot be easily transitioned or outsourced, the history of non-investment-grade servicers may be discounted in the cash flow analysis in order to incorporate the increased risk of a disruption in managing the portfolio. Finally, the review also includes ensuring that the servicer has the rights under the underlying lease documents

23 to effectuate recovery and the transaction has clear rights to amounts recovered. In determination of its recovery rate and recovery timing lag cash flow modeling assumptions, DBRS may also review the supplemental data, such as the equipment appraisals by reputable independent third-party appraisers, to the extent available and pertinent to the overall analysis. Prepayments Equipment leases usually call for scheduled payments to be made in exchange for the use of the equipment (for operating lease) during a defined period of time or as installments for the effective sale of the equipment (finance leases, conditional sale contracts, etc.). Usually the ability of a lessee to prepay is limited, and when permitted, typically involves the condition to pay the termination payment in full. Consequently, prepayments do not necessarily impair the ultimate payment performance of the collateral. However, the timing of payments and the specific leases that are prepaid can change the anticipated cash flows and pool composition in a manner that can alter the risk for the holders of rated ABS obligations. For example, lessee, asset type and geographic concentrations may increase as lease obligations are prepaid. Of potentially greater importance would be prepayment of leases with yields that are higher than the rate used to discount the future payments for determining the collateral value. In extreme cases, this could result in cash flow compression or even a shortfall. While the prepaid amount would reduce the amount outstanding under the securitization, the remaining portfolio cash flows could be proportionally less than was anticipated in the originally expected cash flow assumptions for the transaction. The risk is more pronounced in the permitted release principal repayment structures, which allow the release of the excess cash flows to the issuing SPE. As the result of the cash flow compression, these risks tend to be magnified toward the end of the ABS transaction and might result in increased risk to the subordinated ABS tranches. The DBRS review covers the underlying lease documentation, concentrations that may exist and analysis of any flexibility a lessee may have to prepay, as well as the prepayment history of the sponsor. Based on that review, prepayment assumptions are applied to securitization cash flows to simulate potential risks. Excess Spread The anticipated cash flows are often structured to support securitization obligations with the excess spread built-in to absorb losses and variability. Excess spread is impacted by each of the aforementioned collateral performance drivers, which could reduce its availability at a given point in a transaction. In addition, in transactions that allow release of the excess collections to the issuing SPE, the credit support provided by excess spread is limited to only one collection period. Estimating Expected Losses and Variability Analysis of historical data can present one of the most valuable tools in evaluating the anticipated performance of a collateral pool and the sufficiency of the credit enhancement for rated equipment-backed securitizations. Historical data is most reliable when there is a large number of leases tracked over multiple origination vintages and a significant amount of diversity exists related to the individual lessees. DBRS evaluates the historical static pool data reflecting gross defaults, recoveries and/or net losses. The ability to compare static pool performance with respect to net losses relative to the gross defaults may provide an additional insight in the business model and operations of an originator and allow for clearer assessment of the potential variability in net losses in the future. If the static pool gross default information is not available or limited, DBRS would expect to receive, at a minimum, performance data with respect to net losses. In some cases, DBRS may rely exclusively on the net loss data in its analysis (for instance, when historical recoveries are deemed immaterial or where the historical experience of an originator/servicer demonstrates predictable and programmatic consistency). Historical data may be analyzed on a managed portfolio or a static pool by origination vintage basis. Analysis of the historical managed portfolio information involves reviewing the originator s owned and managed pool performance period over period without regard to when the underlying collateral was originated. Static pool analysis provides a quantitative method for estimating cumulative expected losses 23

24 for pools of collateral (with such cumulative expected losses typically expressed as the static pool cumulative net loss or CNL). There are limitations as to the effectiveness of quantitative analysis using static pool data. Distortions can be related to several factors (e.g., changes in origination/underwriting standards, changes in technology, economic downturns and geographic concentrations), including relatively higher obligor concentrations that may exist in the ABS collateral pool, which could result in an understatement of credit risk. In addition, some pools backed by lease contracts financing larger-ticket and/or specialized equipment tend to exhibit inherently higher obligor concentrations. For these reasons, DBRS evaluates obligor concentrations and incorporates obligor concentration risk in its analysis when appropriate. In some cases, it may be prudent to adopt a more refined quantitative analysis by analyzing sub-pools in the overall pool to address credit risks in a transaction. Static pool information may be analyzed separately for the broker and the vendor program origination channels and adjusted in accordance with the respective share of these origination channels in the ABS transaction s collateral pool in order to come up with a blended expected loss assumption. Similarly, separate expected loss assumptions may be developed for different equipment types in a collateral portfolio. A blended expected loss assumption for an ABS transaction may be derived using distinct expected loss assumptions for trucks and construction equipment based on the respective share of these equipment sub-pools in a collateral pool. For each transaction, pool information is received that provides a thorough picture on the proposed pool of assets to be sold. This includes scheduled monthly cash flows from the loan and lease payments and any residual payments at the end of a lease, term of underlying obligations, timing of any seasonal, balloon or residual payments due from the obligor, types of assets financed, new versus used equipment, largest obligor exposures by name, geographic breakdown, industry breakdown and the yield generated on the outstanding loans and leases. Static Pool Data and Estimation of Expected Loss The analysis of the historical static pool data to determine the expected loss for a collateral pool begins with the information available from the sponsor/originator. Ideally, the data would include detail regarding any substitutions of equipment (by vintage) permitted under the transaction documents. In addition, the sponsor/originator would be expected to provide the detailed information on any material migration in the asset composition or characteristics over the period covering the static pool origination vintages, such as, for instance, financed equipment types, lease terms and origination channels. For the static pool analysis to be sufficiently comprehensive, the sponsor/originator should provide as much data as possible, and ideally, for the periods covering the anticipated life of the related equipment (i.e., fully seasoned static pools) and/or for the periods covering a full business cycle. In order to extend the size of a reviewed sample and incorporate recent trends in performance, analysis of static pool data provided by the sponsor/originator may include static pools, which cover less than the typical lease term of the related equipment. Ultimate determination of the level of seasoning, which is sufficient to merit the inclusion of the not fully seasoned pools in the sample of reviewed static pools, will depend on originator-specific collateral characteristics, such as business model, financed equipment types and historical obligor payment and delinquency behavior. Depending on volume of originations in each selected vintage, monthly, quarterly or annual static pool data may be used to ensure that each vintage s performance is representative of the originator s broader portfolio; however, more granular data is preferable. 24 Once the historical loss data are provided, DBRS uses the data to assess the expected loss and the loss timing curve for the securitized pool of collateral. The historical vintage data are tracked period over period to determine losses for each vintage in each period following origination. In an example illustrated in the tables below, if a sponsor/manager provides seven periods of data, the analysis would determine losses for all vintages for Period 1 and 2, losses for origination vintages two to six for Period 3, losses for origination vintages two to five for Period 4, losses for origination vintages two to four for Period 5, losses for origination vintages two to three for Period 6 and losses for origination vintages two to two for Period 7. The loss data are reviewed to determine if performance is indicative of represented origination, underwriting and servicing standards and consistent with industry norms.

25 Period-over-period changes for each vintage are aggregated to determine the loss history and project anticipated increases in losses across the pool. The period-over-period loss data are then added to determine the expected loss for a securitization. The period-over-period changes can also be used to develop loss timing curves for the later not fully seasoned vintages, which are still active, to project performance over the remaining life of those vintages. Thus, the application of the loss curve also provides a useful tool in anticipating the timing for losses on a securitization pool. DBRS may supplement the loss curve analysis with the loss-to-liquidation (LTL) method in order to project the full loss expectations for the later vintages. LTL is the measure of a pool s cumulative losses measured as a percentage of the pool s cumulative reduction in outstanding principal balance. DBRS believes that an originator s LTL statistics for origination static pools of similar quality loans in similar economic conditions provides an early indication of the magnitude of losses that can be expected for a pool. Incremental Static Pool Data Analysis Period Pool 1 Pool 2 Pool 3 Pool 4 Pool 5 Pool 6 Pool 7 Loss Curve % 1.01% 0.98% 0.92% 0.89% 0.87% 0.86% 24% % 1.99% 1.86% 1.76% 1.74% 1.72% 1.66% 47% % 2.69% 2.58% 2.47% 2.43% 2.41% 65% % 3.33% 3.12% 3.01% 2.88% 80% % 3.74% 3.54% 3.41% 91% % 3.98% 3.73% 96% % 4.14% 99% % 100% Expected Losses 4.23% 4.16% 3.89% 3.74% 3.61% 3.69% 3.51% Period over Period Losses Period Pool 1 Pool 2 Pool 3 Pool 4 Pool 5 Pool 6 Pool 7 Period Loss Cumulative Loss % 1.01% 0.98% 0.92% 0.89% 0.87% 0.86% 0.94% 0.94% % 0.98% 0.88% 0.84% 0.85% 0.85% 0.80% 0.89% 1.84% % 0.70% 0.72% 0.71% 0.69% 0.69% 0.70% 2.53% % 0.64% 0.54% 0.54% 0.45% 0.56% 3.09% % 0.41% 0.42% 0.40% 0.45% 3.54% % 0.24% 0.19% 0.18% 3.72% % 0.16% 0.14% 3.86% % 0.02% 3.88% The historical loss data are also reviewed on a managed portfolio basis. Review of the managed portfolio s loss data is often helpful in identifying and understanding more global changes to a sponsor/ originator s operations. Managed portfolio reviews highlight the changes that affect all pools and would be evidenced across the underwriter s/servicer s business in the year (or years) following implementation. Changes in underwriting or lessee credit quality are examples of changes, which are usually more visible in the review of the managed portfolio data. However, the effectiveness of the managed portfolio reviews may be limited in the environment when the originations experience material growth, which, at least for a while, may obscure the effects of such changes and their effect on the credit quality of the originator s/ servicer s portfolio. 25

26 Seasoning Adjustment When evaluating a static securitization collateral pool that is materially seasoned, DBRS may take the amount of seasoning into account and may adjust its expected loss analysis to reflect seasoning. DBRS does not typically give any seasoning credit to revolving pools since the amount of seasoning of the underlying collateral is expected to change over time during the revolving period. The basis for seasoning adjustment is that, historically, material portions of losses are realized relatively early in life of the equipment lease collateral pools. If a transaction s collateral pool is seasoned but exhibits loss to date at the time of determination, which is different from what would be suggested by the loss curve, DBRS usually adjusts its expected loss assumption for such transaction. For instance, a pool with an expected loss assumption of 3.00%, pool factor of 80% (i.e., 20% seasoned) and the actual loss to date of 0.75%, an adjusted expected loss of 2.8% could be calculated as follows: (3.00% %) / (100% - 20%) = % The example above assumes the straight-line loss curve. In the event that realized loss information is not available, DBRS determines the amount using its expected loss timing curve. DBRS takes into account the losses incurred to date and a pool factor vis-à-vis the aggregate expected loss and the loss timing curve that it has developed for a securitization collateral pool based on the historical static pool data when deciding whether and how to apply a seasoning adjustment. DBRS may further qualitatively adjust its loss timing curve and/or expected loss assumption if the additional review of the collateral pool for an ABS transaction reveals any material differences in the collateral pool compared to the historical averages (e.g., higher average FICO of the personal guarantors and/or higher share of the collateral supported by personal guarantees). Seasoning adjustment may not always reduce the expected loss for the securitized pool. The potential impact of seasoning on the expected loss depends upon the consistency and strength the originator and servicer, shape of the loss curve and the amount of total amortization of the pool, which is in turn influenced by factors, such as prepayments and servicing practices that impact charge-offs and recovery timing. Depending upon the interplay of all these factors, in some instances, seasoned pools may actually have a higher loss expectation than would a pool of new originations. Stress Multiples for Cumulative Net Losses The expected loss assumption derived by analyzing the historical static pool data serves as the expected loss for a securitization collateral pool. To assess the sufficiency of credit enhancement supporting a rating for an ABS tranche, the expected loss is then stressed by applying a multiple to the expected loss assumption. In order to achieve a given rating, a transaction is expected to maintain credit enhancement sufficient to withstand the stressed multiple of expected losses over the life of the transaction in conjunction with other cash flow stresses, as appropriate. The table below sets forth the typical multiple ranges for the corresponding rating category: Stress Multiples by Rating Category Rating Category Stress Multiples (x) AAA AA A BBB BB B

27 In the absence of significant qualitative and quantitative considerations, DBRS typically applies stress multiple in the middle of the range for each targeted rating category. DBRS considers various quantitative and qualitative factors and may adjust, up or down, from the midpoint of the multiple range based on its assessment. The combination of relevant factors ultimately results in the multiple used to determine the amount of loss coverage necessary to achieve each targeted rating. These factors include, but are not limited to: The absolute level of a proposed securitization pool s expected loss; The industry position and financial condition of the originator and/or servicer; The results of an operational risk assessment of the originator and/or servicer; The quality, sufficiency and consistency of the available historical origination and performance data; and Macroeconomic conditions. Limitations and Variability While the static pool loss analysis and managed portfolio review do yield important insights into performance of a securitization pool, it is important to note certain analytical considerations. Principally, the performance of a newly rated pool will not necessarily be expected to match the performance history of the sponsor/originator. For example, if only five to seven years of historical data is available (and even less for recently established originators), the historical performance data may not provide the most complete insight into how various business cycles may affect performance of a collateral pool. Over time, the sponsor/servicer may modify its servicing and origination practices and standards, which in turn could impact performance. Furthermore, severe downturns in the economy may jeopardize the financial stability of the sponsor/originator or cause it to curtail the financing programs for lessees. Each business cycle is different and some will impact industries more significantly than others. Therefore, ideally, DBRS would expect to review the historical performance data that covers at least two business cycles. However, in some cases, such as with relatively recently established originators, the historical static pool and managed portfolio performance data may be limited. In such cases, DBRS may develop its expected loss assumption using the comparable industry data. Any expected loss assumption derived using the comparable data will be expected to be sufficiently conservative in order to account for the differences between the originators operational capabilities and business models, as well as the variations in the composition of their managed portfolios. Even in the most consistent business, there are always differences from pool to pool, as well as in the general environment at the time such pools had been originated. Consequently, DBRS typically performs a comparative analysis across managed pools and reviews the information used as a comparable for qualitative factors that could affect its quantitative analysis. Incorporating OBLIGOR Concentration Risk One of the limitations of the expected loss analysis occurs when there are material individual lessee concentrations in a collateral pool. In such cases, the true credit risk of a transaction might not be fully captured by a CNL-based approach since default of one or a small group of lessees could materially affect the expected loss for the pool relative to an assumption derived using the information based on more granular static pools or the pools, which had not experienced defaults by large obligors. For captive and large independent lessors, the top lessees in well-diversified portfolios typically represent less than 1% of the related lease payment obligations. In addition, small-ticket equipment pools tend to exhibit higher granularity compared to the larger-ticket and/or specialized equipment collateral. Higher lessee concentrations may also be expected in the collateral pools originated by smaller sponsors with relatively short history of operations. Typically, for pools that are not granular (e.g., where a number of the largest obligors each account for 2% or more of the overall collateral pool), DBRS supplements its expected loss analysis with a lessee concentration risk analysis. To the extent that both analyses are performed, the more conservative approach of the two is typically used to evaluate the sufficiency of the credit enhancement for a transaction based on the ratings sought by its sponsor. In addition, when evaluating revolving warehouse structures, DBRS reviews the accumulation period when assets are being aggregated in order to assess any concentrations that may materially impact the risk profile of a transaction over a significant period of time. 27

28 Large Obligor Analysis Lessee concentrations existing in the portfolio are reviewed by DBRS to determine if the potential for individual lessee or several large lessee payment defaults pose increased credit risk to a transaction. If lessee concentrations present an increased risk to a transaction, it is often appropriate to conduct additional analysis to determine whether the credit enhancement levels are sufficient to support the rating. For the lessee concentration risk analysis, DBRS typically utilizes its proprietary model DBRS CLO Asset Model to estimate losses in an ABS transaction s collateral pool at different statistical confidence intervals that correspond to a given rating level. The DBRS CLO Asset Model has several key inputs including collateral tenor, notional exposure, default probability that is derived from the underlying obligor rating, expected recovery rate for each obligor exposure in a pool (net of estimated recovery expenses) and correlation assumptions among the obligors. Correlation is a function of the obligor industry mix in a collateral portfolio. Default probabilities are derived from the ratings assessments for the obligors, which may be based on available public or private ratings, or DBRS Credit Estimates as discussed in more detail in DBRS methodology Rating CLOs and CDOs of Large Corporate Credit. 4 Given that the collateral pools in the equipment-backed securitizations tend to be relatively granular beyond the largest obligor concentrations, DBRS may determine DBRS Credit Estimates only for the largest exposures accounting for the significant share of a collateral pool (30% to 60%) and extrapolate those to assess rating assumptions for the remainder. Expected respective recovery rates for each obligor exposure are estimated by DBRS based on the analysis of the originator s historical performance and taking into account the historical size and consistency of recovery expenses. Assumed recovery rates may also reflect the independent appraisal value of equipment by third parties, if such information is available. DBRS also reviews the transaction documents to evaluate concentration limits. Furthermore, maintenance of compliance with these levels is typically included in the transaction documents and reported in each period s servicer report. Additional CONSIDERATIONs for Cash Flow Analysis In addition to the analysis discussed in the previous section, the stressed cash flow modeling typically incorporates other items that can materially impact the transaction cash flows. These include quantifiable items, such as the transactional and SPE costs and expenses and the contractual obligations under the interest rate hedge, as well as variable metrics, including delinquency and loss rates, timing of defaults, timing of recoveries, prepayment speeds, residual realization proceeds and availability of excess spread. Each of these items is reviewed by DBRS and incorporated into the stressed cash flow analysis. Cash Flow Modeling The transaction structure should provide for the manager to deposit collections received from lessees into transaction-controlled collection account(s). Once deposited into a transaction collection account, the funds should be distributed according to the priority of payments. The documents may also provide for some modification of cash flow allocation when performance triggers are not maintained or an amortization event occurs. Any modifications that change the payment priority of ABS obligations or trigger payment of revolving or warehouse series obligations are reviewed for their potential impact on the ratings. When possible, impact of these modifications is reflected in the cash flow modeling analysis. Cash flow modeling analysis should also incorporate the provisions defining the movements of funds into and from the reserve accounts, as applicable. Costs and Expenses Transaction expense items that are senior to interest and principal in the priority of payments are reviewed for variability and impact on the cash flow sufficiency for timely payments on rated obligations. These items are generally limited to the operational costs of the transaction and securitization SPE, including trustee fees, administrative fees and costs, custodian fees and servicing and backup servicer fees. U.S. equipment ABS transactions often permit senior payment of trustee indemnities. DBRS expects such items DBRS may, in certain instances, utilize internal assessments as a substitute for the DBRS Credit Estimates.

29 paid senior to interest and principal to generally be well defined and quantifiable, with the maximum allowed amount reflected in the cash flow analysis. When the transaction documentation does not limit the amount of senior expenses, DBRS considers the potential impact of such payments on the variability of the cash flows and may apply additional stresses in its cash flow modeling analysis. DBRS also expects that any material expenses related to the transitioning of the servicing function to another servicer are either funded at closing or sufficiently quantified to be incorporated into its cash flow modeling analysis. In addition, any payments related to the interest rate hedge, as applicable, are analyzed in accordance with the priority of payments defined in the transaction s documentation. Delinquency Rates and Loss Triggers The assessment of the servicer includes a review of its process for managing collections and delinquencies, which impact anticipated cash flow performance. Historical delinquency rates are reviewed for volumes and timing to determine an anticipated range of performance for a collateral pool. To the extent quantifiable, the cash flow modeling analysis for an ABS transaction incorporates its performance triggers. For instance, a breach of the CNL trigger, as defined in the transaction documentation, in the stressed cash flow modeling scenario may result in the accelerated (turbo) repayment of the principal of ABS obligations. Default Timing Review of the static pool and managed portfolio gross defaults and recoveries discussed in the previous sections is particularly useful in developing anticipated timing curves of defaults/losses for the cash flow modeling analysis. Generally, DBRS does not assume a single default/loss curve that is applicable across the varying types of equipment. Consequently, DBRS typically develops multiple default/loss timing curves for each ABS transaction taking into account actual historical experience of the originator with the assets comparable to the mix in the ABS transaction s collateral pool. The actual historical experience provides the basis for the expected default/loss timing curve. This typically also includes front-, mid- and back-loaded curves to test sensitivity of the ABS transaction s cash flows to timing of the default/loss occurrence. Prepayments The anticipated cash flow of a transaction is accelerated by voluntary prepayments, which may change the maturity and the credit risk profile of the related collateral portfolio. The servicer s actual historical experience together with the assessment of the current economic environment provide the basis for determining the anticipated conditional prepayment rate (CPR) of the securitization transaction s collateral pool, which is typically used as the expected prepayment rate assumption in DBRS cash flow analysis. DBRS typically incorporates additional slower and faster pay CPR scenarios to test the transaction cash flows sensitivity to additional variability caused by voluntary prepayments. Recovery Value and Timeframe Following a lessee default, the servicer is expected to seek remedies under the lease to satisfy the related lease obligations. DBRS typically evaluates the potential for providing credit for anticipated recoveries based on the analysis of the servicer s actual historical experience. If the collateral portfolio includes several distinct types of equipment, the analysis may be performed separately for each type. Any credit given to recoveries by DBRS is reflective of its assessment of the expected associated recovery expenses in the stressed environment. Furthermore, credit given to recoveries by DBRS in its cash flow modeling analysis may be limited if the quality or experience of the servicer prevents the provision of sufficient information. In some cases, the anticipated recovery rates may incorporate the appraisal information provided by independent third-party appraisers. Depending on the quality of the servicer, consistency of its underwriting, collection policies and procedures and degree of the variability in the historical performance data with respect to recoveries and recovery expenses, stressed cash flow analysis may include reduction to the anticipated expected recovery rate. Furthermore, based on the analysis of the servicer s historical experience and the assessment of the economic environment and industry outlook at the time of an ABS transaction, as well as the type of the underlying equipment securing the leases in a collateral pool, DBRS typically assumes the recovery timing lag of three to 12 months following default by a lessee. 29

30 Residual Realization Proceeds To the extent booked residual values constitute a significant portion of the overall collateral in a securitization transaction the residual value of equipment can provide credit support to a transaction. However, it may be limited due to relatively high variability of the proceeds at the end of a lease. DBRS reviews the experience of the servicer in setting and realizing residual values and incorporates it into the cash flow analysis. In order to receive credit for any proceeds from the residual values, the servicer would be expected to have significant detail on historical residual realizations. The servicer s accounting and depreciation policies are also reviewed and compared to actual residual realizations. Credit assigned to residual values is assessed for each transaction based on the analysis of the servicer s methods for determining residuals, its experience in realizing residuals and the sufficiency of historical data relating to residual value realization. The analysis reviews the methods of residual realization utilized by the servicer and the typical turnaround time needed for such realization. The servicer s individual experience is also compared to the broader industry. The servicer is also expected to provide information on any programs that it may implement and maintain to assist in realizing the residual. In addition, the equipment collateral pool is evaluated to determine if any residual schedule concentrations exist, which could impact the servicer s ability to realize on the expected residual value. Furthermore, in order to be afforded credit for residual values, it is important that the SPE is the owner of the equipment, is able to demonstrate that it maintains legal access to the equipment and that the interest of the related bondholder is perfected under the UCC. To the extent that a portfolio includes both true leases and finance leases, residual credit is only considered for the equipment transferred and owned by the SPE (which is often the case with equipment subject to a true lease). In addition to these considerations, the analysis also evaluates the sensitivity of a transaction to a servicer disruption event, any significant exposure to individual manufacturers or technology risk, as well as the maintenance obligations for the related equipment. DBRS analyzes the data provided by the servicer and typically applies a reduction to the anticipated residual value and incorporates the reduced residual proceeds into its stressed cash flow analysis based on the schedule of residual collections provided by the servicer. The magnitude of reduction within given range for each rating level is dependent on the servicer s experience and residual realization track record, as well as the amount, quality and consistency of the historical data. Generally, for experienced servicers with available detailed historical information on residual value realization at the end of lease terms spanning a full economic cycle, the credit given to residual proceeds in the stressed cash flow modeling scenarios for a particular rating level is typically as follows: Credit for Residuals Rating Category Residual Credit AAA 30% 50% AA 40% 60% A 50% 70% BBB 60% 80% BB 70% 90% B 80% 90% It is anticipated that the reduction for each targeted rating level will also incorporate the expected residual realization expenses. In addition, in securitizations in which booked residuals constitute a significant portion of the collateral pool (15% and above), DBRS may request additional data supporting the expectation for residual realization, including any associated expenses. Such information may include both the historical experience of particular originator and broader set of data representing industry peers and/or similar types of collateral. 30

31 Legal Final Maturity Each ABS transaction is evaluated to confirm, under the applicable stressed cash flow modeling scenarios, that the collateral, structural enhancements and related cash flows can satisfy timely payment of interest in each period and full repayment of principal for each tranche of the ABS securities by the legal final maturity date set forth in the transaction documentation. The legal final maturity date for a transaction can vary based upon the asset type and transaction structure, but is typically within 12 to 24 months following the last payment on the underlying leases in the collateral pool. Surveillance DBRS discusses its surveillance methodology in the DBRS Master U.S. ABS Surveillance Methodology. 31

32 Appendix I: Sample U.S. Equipment Lease Originator Review Agenda The originator risk review typically includes an assessment of the items noted below, as well as any other relevant factors related to the issuer. Company and Management Company history, ownership and operating experience. Financial condition/profitability. Ability to provide representations and warranties. Portfolio size and composition. Strategic initiatives. Recent or planned mergers or acquisitions. Risk management practices. Management experience. Number of employees and underwriters. Staffing, training and retention rates. Use of outsourcing, temporary staff and offshore resources. Securitization history and future plans. Historical performance by origination channel. Controls and Compliance Quality control and internal audit procedures. Internal and external audit results. Efforts to ensure regulatory compliance. Have you been or are you now the subject of a regulatory or state investigation? If so, discuss any findings. Have you ever been terminated or not in good standing with any federal or state regulatory body? (If so, please explain.) Repurchases due to breaches of representations and warranties ($ and #). Litigation (past, present and expected). Controls for managing potential conflicts of interest associated with parties to a transaction. Procedures for vendor selection and oversight. Storage and updating of policies and procedures. Sales and Marketing Origination strategy and channels. Sales and marketing practices. Use of dealers and brokers. Approval and monitoring processes for lessees. Delegated underwriting practices and policies. Procedures for ensuring new loan setup accuracy and data integrity. Exception and trailing documentation management, i.e., UCC. Post-closing quality reviews. 32 Underwriting Guidelines Underwriting policies and procedures by product and lease type. Is underwriting centralized? Recent or planned changes to underwriting guidelines. Approval process for potential lessees.

33 Qualifying rate and ratios. Documentation obligations. Insurance conditions and verifications. Use of credit scoring, automated underwriting and other technology. Underwriter compensation structure. Authority levels. Exception and override process/practices. Process for completing data integrity checks. Fraud detection procedures and systems. Closing and funding process. Technology Core origination system strengths and weaknesses (including reporting capabilities). Capacity remaining in the origination system. Website availability, usage and security. Security measures employed to ensure compliance with consumer privacy laws. Procedures for vendor selection and oversight. Disaster recovery/business continuity plans and success of last test. Frequency of full-system backup. Future initiatives. 33

34 Note: All figures are in U.S. dollars unless otherwise noted. Copyright 2014, DBRS Limited, DBRS, Inc. and DBRS Ratings Limited (collectively, DBRS). All rights reserved. The information upon which DBRS ratings and reports are based is obtained by DBRS from sources DBRS believes to be accurate and reliable. DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance. The extent of any factual investigation or independent verification depends on facts and circumstances. DBRS ratings, reports and any other information provided by DBRS are provided as is and without representation or warranty of any kind. DBRS hereby disclaims any representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability, fitness for any particular purpose or non-infringement of any of such information. In no event shall DBRS or its directors, officers, employees, independent contractors, agents and representatives (collectively, DBRS Representatives) be liable (1) for any inaccuracy, delay, loss of data, interruption in service, error or omission or for any damages resulting therefrom, or (2) for any direct, indirect, incidental, special, compensatory or consequential damages arising from any use of ratings and rating reports or arising from any error (negligent or otherwise) or other circumstance or contingency within or outside the control of DBRS or any DBRS Representative, in connection with or related to obtaining, collecting, compiling, analyzing, interpreting, communicating, publishing or delivering any such information. Ratings and other opinions issued by DBRS are, and must be construed solely as, statements of opinion and not statements of fact as to credit worthiness or recommendations to purchase, sell or hold any securities. A report providing a DBRS rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. DBRS receives compensation for its rating activities from issuers, insurers, guarantors and/or underwriters of debt securities for assigning ratings and from subscribers to its website. DBRS is not responsible for the content or operation of third party websites accessed through hypertext or other computer links and DBRS shall have no liability to any person or entity for the use of such third party websites. This publication may not be reproduced, retransmitted or distributed in any form without the prior written consent of DBRS. ALL DBRS RATINGS ARE SUBJECT TO DISCLAIMERS AND CERTAIN LIMITATIONS. PLEASE READ THESE DISCLAIMERS AND LIMITATIONS AT ADDITIONAL INFORMATION REGARDING DBRS RATINGS, INCLUDING DEFINITIONS, POLICIES AND METHODOLOGIES, ARE AVAILABLE ON

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