Cronos Containers Program I Ltd. (Series )

Transcription

1 Presale: Cronos Containers Program I Ltd. (Series ) Primary Credit Analysts: Alexander Dennis, CFA, Chicago (1) ; alexander.dennis@standardandpoors.com Tracy Xie, New York (212) ; tracy.qian.xie@standardandpoors.com Corporate & Government Credit Analyst: Betsy R Snyder, CFA, New York (1) ; betsy.snyder@standardandpoors.com Legal Contact: Natalie Abrams, New York (1) ; natalie.abrams@standardandpoors.com Table Of Contents $207 Million Fixed-Rate Asset-Backed Notes Series Rationale Transaction Strengths Transaction Weaknesses Mitigating Factors Industry Characteristics: Sector Outlook Transaction Structure Related Corporate Entities Portfolio Characteristics Cash Flow Assumptions Utilization AUGUST 7,

2 Table Of Contents (cont.) Utilization Rate Assumptions Lease Rates Useful Life And Residual Cost Operating Expenses Lessee Defaults And Container Loss Cash Flow Results Payment Priority Events Of Default Early Amortization Events Legal Matters Surveillance Standard & Poor's 17g-7 Disclosure Report Related Criteria And Research AUGUST 7,

3 Presale: Cronos Containers Program I Ltd. (Series ) $207 Million Fixed-Rate Asset-Backed Notes Series This presale report is based on information as of Aug. 7, The ratings shown are preliminary. This report does not constitute a recommendation to buy, hold, or sell securities. Subsequent information may result in the assignment of final ratings that differ from the preliminary ratings. Preliminary Rating As Of Aug. 7, 2014 Series Preliminary rating(i) Preliminary amount (mil. $) A (sf) (i)the rating is preliminary and subject to change at any time. Profile Expected closing date August Legal final payment date Collateral Structuring agent and sole bookrunner Issuer Seller Manager Indenture trustee Manager transfer facilitator August An approximately $848 million (net book value) portfolio containing 182,524 containers. This collateral will be shared with series and issued by Cronos Containers Program I Ltd. Cronos Containers Program I Ltd. has the right to net lease revenues from the portfolio and any residual cash flows from the sale of containers. Deutsche Bank Securities. Cronos Containers Program I Ltd. CRX Intermodal Bermuda Ltd. Cronos Containers (Cayman) Ltd. Wilmington Trust N.A. ABN AMRO Bank N.V. Rationale The preliminary rating assigned to Cronos Containers Program I Ltd. s fixed-rate asset-backed notes series reflects our view of: The likelihood that timely interest and ultimate principal payments will be made on or before the legal final maturity date. The initial and future lessees' estimated credit quality. The transaction's structure. The portfolio characteristics, including the asset quality and lease terms. The manager's experience and management team. Certain compliance tests, concentration limitations, and early amortization events included in the transaction documents. AUGUST 7,

4 Transaction Strengths We consider the following to be transaction strengths: The container leasing market's relatively high utilization rates; despite the recent modest growth in global trade, container production is still below historical averages, causing relatively tight supply. The young age of the containers included in the portfolio. The manager's experience and management team. The performance tests, such as the asset-base compliance, concentration limitations, and early amortization event tests. Concentration limitations include refrigerated containers (reefers) and related equipment (40% of the portfolio), tank containers (30%), dry freight special containers (30%), single lessee (20%), top three lessees (45%), finance leases (25%), and finance lease single lessee (5%). If any of the concentration limitations are breached, the excess concentration will not be included the asset base. The early amortization events, which include a manager default, the weighted average equipment age equal to or exceeding nine years, an issuer EBIT to issuer cash interest expense ratio of less than 1.10x, and the outstanding notes' aggregate amount exceeding the asset base. Approximately 83.0% of the portfolio comprises long-term leases and direct finance leases (DFLs), which are shielded from rate reductions during a downturn. Diversification based on different marine cargo container types, most of which benefit from relatively stable demand. The restricted cash account, which amounts to nine months of note interest due. Lessees that are diversified across multiple industries and may have higher credit quality than a container deal, with a customer base comprising mostly shipping lines. Transaction Weaknesses We consider the following to be transaction weaknesses: Approximately 47.1% of the pool is held by the 10 biggest customers, the performance of which may affect the issuer's revenue receipts. Regional or local economic downturns could reduce the issuer's revenue because containers are leased worldwide. The default of a customer located in a foreign country could prevent the issuer from recovering container assets in that country. The issuer will rely on Cronos Containers (Cayman) Ltd. to manage the transaction's inventory, billing, and rental payment collections. The DFLs could potentially be "recharacterized" as secured debt if the lessee files for bankruptcy. Because lessors and secured lenders have different rights and remedies as creditors in a bankruptcy, a debtor may seek to re-characterize a lease to take advantage of these distinctions. Mitigating Factors We believe the following factors partly mitigate the transaction's weaknesses: The stress scenarios we apply to the utilization rates can typically incorporate 60% of lessee defaults during the AUGUST 7,

5 lease term for a three-year operating lease that is subject to six months of downtime between lessees. We incorporated the stress scenarios we apply to the cash flow modeling for fleet utilization, lease rates, and operating expenses through two sector downturns--the first is four years long and the other is three years long--over the fleet's life. Our scenario analysis uses an 'A' stress, which will occur after the transaction closes, even though we believe the sector is in a recovery cycle. The transaction documents include manager default events, some of which are based on Cronos Containers (Cayman) Ltd.'s financial performance, whereby if the manager default events are triggered, the transition manager will, among other duties, identify a prospective manager to act as a replacement manager for this transaction. The transaction also has a liquidity account to cover nine months of note interest throughout the transaction's life and while a replacement manager is sought. Based on our findings that indicate shipping lines have not attempted to recharacterize DFLs as secured debt, we use recovery delay assumptions consistent with other business loan-backed securitizations. In those cases, for 'A' category ratings, we assume a two-year delay in our sensitivity test. We will monitor the proportion of the pool subject to DFLs according to our usual surveillance procedures. We model the loss of container assets following lessee defaults in one of our sensitivity tests. Industry Characteristics: Sector Outlook Demand for marine cargo containers is primarily based on the level of world trade, which correlates with economic cycles. We believe other factors affecting demand include the needs of shipping lines (marine cargo containers' major customers), the available supply and cost of equipment, and the availability of capital to purchase or lease the needed equipment. At the end of 2013, marine cargo container lessors owned and managed approximately 48% of the global marine cargo container fleet. Through 2008, world trade had historically grown every year. However, in 2009, for the first time in recent history, trade volumes for marine cargo containers declined by 10%, which resulted in reduced demand and lowered utilization of leased cargo containers and reduced lease rates. These declines, in turn, led to higher direct costs (e.g., storage) for marine cargo container lessors. During that downturn, some shipping companies did not have access to capital and, therefore, defaulted on or restructured their obligations; some even closed down their operations. However, the dollar amount of write-offs the marine cargo container lessors experienced remained modest, and they were able to recover most, if not all, of their equipment. During the same period, marine cargo container lessors substantially reduced their capital spending, adding minimal numbers of new containers to their fleets and minimizing the downturn's effect on their utilization rates. Since 2010, the global demand for goods has increased, causing container trade volume to increase. In 2013, the marine cargo container lessors added modestly to their dry freight container fleets to meet weak demand and also because shipping lines began to acquire more containers on their own to take advantage of favorable pricing. This reversed the recent trend in which lessors acquired most of the new containers. However, some shipping companies are still facing liquidity constraints and leasing provides more financial flexibility relative to the capital investment necessary to outfit a fleet. For 2014, the growth is estimated to be approximately 4%--still below the historical average--with weakness earlier in the year offset by stronger demand later in the year. During the year, demand AUGUST 7,

6 continued to be negatively affected by persistent weakness in Europe and the slow recovery in the U.S.--two of the largest export markets for manufactured goods. In this environment, we believe the cost of capital is still lower for the container lessors, based on the spate of asset-backed securities (ABS) financing that they have taken advantage of, than it is for the mostly less-creditworthy shipping lines. Historically, the leased container fleet has accounted for around 45% of the total fleet, a trend we expect to be maintained despite the shipping lines adding more containers on their own. We expect stable-to-improving market conditions in 2014, based on modestly improving global economies and the ongoing retirement of older equipment, which should result in relatively stable utilization and modestly higher lease rates. Nonetheless, if the marine cargo container lessors see demand weakening, they can reduce capital spending fairly quickly because the lead times to order equipment tend to be one to three months. We believe that this, along with the multiyear leases that cover approximately 75% of the marine cargo container lessors' fleets, allows the industry to manage its utilization levels, even in periods of weak demand. For more information on our current view on container lessors, please see "Lessors Of Marine Cargo Containers Can Endure A Sluggish Global Economy," published June 19, As of June 30, 2013, the aggregate dry container utilization rate was hovering at its historical average of the past seven years, during which the segment saw a sharp decline during the last global recession and an even sharper rebound when world trade recovered, only to find limited container supply because production completely shut down in 2009 (see chart 1). This statistic is based on portfolios totaling approximately 3.5 million 20-ft. equivalent units (TEUs) that support 31 Standard & Poor's Ratings Services-rated container ABS transactions. AUGUST 7,

7 Chart 1 Transaction Structure Cronos Containers Program I Ltd., the issuer, is a bankruptcy-remote, limited liability company organized under the laws of Bermuda. The issuer acquires, owns, and disposes of marine cargo containers. The issuer will grant a security interest in the leased containers and leases, along with the rights under the related agreements and accounts, to the indenture trustee for the benefit of each series' noteholders. According to the transaction documents, the issuer's portfolio includes 182,524 units that comprise various different marine cargo container types. The trustee will pay principal and interest due on each series' notes from the underlying lessees' payments, the earnings from any invested funds, the proceeds from any container dispositions, the insurance proceeds, and the amounts on deposit in the specified cash accounts. AUGUST 7,

8 Related Corporate Entities The Cronos Group (Cronos Holding Co. Ltd., together with its subsidiaries) is the successor to Intermodal Equipment Associates (IEA) and Leasing Partners International (LPI). IEA, one of the first marine cargo container leasing companies formed, began managing and leasing dry cargo containers in 1978, primarily under master leases. LPI was organized in 1983 to manage and lease refrigerated marine cargo containers. In 1990, LPI acquired IEA, and the two companies combined their operations under the Cronos Group name. Cronos Group completed an IPO in December 1995 and operated as a public company through August 2007, when the company went private in a buyout led by an affiliate of Fortis Bank S.A./N.V. (BNP Paribas Fortis) and Cronos Group management. In July 2010, the Kelso Funds acquired a majority interest in Cronos Group. BNP Paribas Fortis increased its equity investment in Cronos Group, contributed the investment to a fund organized jointly with Transportation Capital Group (TCG), and became a 99% limited partner in the TCG Fund (see chart 2). TCG Fund is a Cayman Islands limited partnership. BNP Paribas Fortis owns 99.4% of TCG Fund, and TCG owns the remaining 0.6% and serves as the general partner. As of July 14, 2014, Bohai Leasing and Seaco SRL have entered into a memorandum of understanding with Cronos Holding Co. Ltd. regarding a potential acquisition by Bohai from Cronos Holding Co. Ltd. of an 80% interest in their Cronos Holding Co. Ltd. subsidiary. We will continue to monitor the progress of any acquisition, but at this time do not expect it to affect the ratings on the outstanding series of notes issued by either Seaco's Global SC Finance II SRL or Cronos Containers Program I Ltd. Cronos Containers (Cayman) Ltd. is the fifth-largest container leasing company in the world, based on cost-equivalent units (CEUs). It has an estimated market share of approximately 8.0% by CEUs. As of June 30, 2014, Cronos's combined fleet of containers (both managed and owned) consisted of approximately 1,668,481 CEUs and 822,854 TEUs, with an approximate net book value (NBV) of $2.6 billion. AUGUST 7,

9 Based on the NBV, approximately 78.9% of Cronos's owned fleet was leased through long-term leases and DFLs. The average remaining term was approximately three years, including short-term leases. Approximately 30.63% of Cronos's fleet is dry containers, the most widely used type of equipment, and 41.29% is reefers, 15.42% is tanks, and 12.67% is special containers. Portfolio Characteristics The issuer's portfolio includes 182,524 units that comprise nine different marine cargo container types. Of the 182,524 units, 172,077 units are currently out on lease or a new factory unit and 10,447 are not currently leased. The initial fleet, based on a $848.5 million NBV, includes 40-ft. high-cube dry containers (14.12%), 40-ft. high-cube reefer containers (32.43%), tank containers (16.16%), and 20-ft. standard dry containers (17.27%), all of which benefit from relatively stable demand (see table 1). The remaining balance (20.02%) comprises special containers, 20-ft. standard reefers, 40-ft. standard dry containers, 45-ft. high-cube dry containers, and 45-ft. high-cube refrigerated containers. The fleet's average age in this transaction is 4.2 years, which is relatively young for assets that typically have 15-year useful lives (except for tank containers, which have 20-year useful lives). The issuer's fleet comprises 70.0% long-term leases, 13.0% DFLs, 11.54% master leases, and 5.47% off-hire (by NBV). Table 1 Container Categories Equipment type Dry-freight containers Refrigerated containers (reefers) Tanks Specials Open-top containers Cellular pallet-wide containers Bulk containers Half-height containers Flat-rack containers Rolltrailers Typical use Manufactured goods, furniture, appliances, clothing, raw materials, and agricultural produce. Frozen and chilled food products, meat, fish, fruit, and vegetables. Industrial chemicals and potable liquids, such as fruit juices and wines. Plate glass, marble slabs, plasterboard sheets, large machines, and motor vehicles. Palletized cargoes -particularly in Europe. Grains. Bulk mining products or manufactured industrial goods like steel coils. Oversized cargo, such as large industrial vehicles, logs, steel coils, or some food products (e.g., onions) that need constant ventilation. Large heavy machine parts. The Cronos portfolio compares favorably to other similar ones seen in recent Standard & Poor's-rated ABS transactions (see table 2). Specifically, it is a young fleet with a high average per diem rate. It also has a high percentage of tank and special containers (such as rolltrailers and flat racks). We believe this diversification among container types can help mitigate a potential decline in global trade in any single segment (see the Cash Flow Assumptions section). AUGUST 7,

10 Table 2 Advance Rates Among Container Transactions Transaction Cronos Containers Program I Ltd. (Series ) Global SC Finance II SRL (Series ) CLI Funding V LLC (Series ) TAL Advantage V LLC (Series ) Global Container Assets 2013 Ltd. Dong Fang Container Finance (SPV) Ltd. (Series ) Textainer Marine Containers III Ltd. (Series ) CLI Funding V LLC (Series ) Global SC Finance II SRL (Series ) Total NBV ($) 848,473,973 1,413,667,511 1,289,462,737 1,172,571, ,044, ,955, ,650,075 1,063,071,696 1,014,784,657 Total units 182, , , , , ,022 96, , ,333 Weighted-average age (by NBV) Weighted-average per diem rate (by unit) ($) Lease type (%) Long-term Direct finance leases Master Off-hire Container type (%) Dry Reefer Tank Special (including gensets) Senior advance rate (%) Standard & Poor's rating TBD A (sf) A (sf) A (sf) A (sf) A (sf) A- (sf) A (sf) A (sf) Closing date TBD 30-Jul Jun May Oct Sep Sep Nov Nov-13 NBV--Net book value. N/A--Not applicable. TBD--To be determined. Portfolio distribution by equipment type and age Table 3 shows a breakdown of the issuer's fleet by major equipment category as of June 30, Table 3 Portfolio Distribution By Equipment Type And Age Equipment type No. of units % of units NBV ($) % of NBV Weighted avg. age (years) 40-ft. HC dry 38, ,767, ft. HC reefer 19, ,146, ft. standard dry 85, ,491, Tank containers 7, ,110, Special containers 22, ,745, ft. standard reefer 2, ,529, ft. standard dry 3, ,677, AUGUST 7,

11 Table 3 Portfolio Distribution By Equipment Type And Age (cont.) 45-ft. HC dry 2, ,621, ft. HC reefer , Total/weighted avg. 182, ,473, NBV--Net book value. HC--High-cube. Portfolio distribution by contract type Table 4 details the breakdown of the pool's issuer containers by lease type as of June 30, Table 4 Portfolio Distribution By Lease Type Lease type NBV ($) % of NBV Long-term lease 594,162, Direct finance lease 109,999, Master lease 97,878, Off-lease 46,434, Total 848,473, NBV--Net book value. Portfolio distribution by customer Table 5 details the issuer's expected lessee exposure by NBV for the pool of containers as of June 30, Table 5 Portfolio Distribution By Customer Customer No. of units % of units NBV ($) % of NBV 1 23, ,276, , ,741, , ,821, , ,312, , ,500, , ,825, ,182, , ,217, , ,868, , ,278, Other(i) 119, ,139, (i)other lessees, factory units, and off-hire units. NBV--Net book value. Portfolio distribution by remaining term to maturity of the fleet term leases Table 6 shows the expected portfolio distribution of leases by expiration year as of June 30, Table 6 Distribution Of The Collateral By Lease Expiration Year Lease expiration year NBV ($) % of NBV ,539, AUGUST 7,

12 Table 6 Distribution Of The Collateral By Lease Expiration Year (cont.) ,762, ,700, ,621, or later 310,415, Off-lease 46,434, Total 848,473, NBV--Net book value. Portfolio distribution by utilization, per diem rate, and original equipment cost (OEC) Table 7 shows the expected portfolio distribution of containers by utilization, per diem rate, and OEC as of June 30, Table 7 Portfolio Distribution By Utilization, Per Diem Rate, And OEC Equipment type No. of units OEC ($) Utilization (%) Weighted avg. per diem 40-ft. HC dry 33, ,441, ft. HC reefer 16, ,251, ft. standard dry 59, ,099, Tank containers 6, ,500, Special containers 14, ,589, ft. standard reefer 2,524 34,445, ft. standard dry 2,064 7,564, ft. HC dry 2,220 12,181, Total/weighted avg. 182,524 1,089,906, (i)based on the TEUs, the utilization excludes factory stock. (ii)weighted by units. OEC--Original equipment cost. HC--High-cube. TEU--20-ft. equivalent unit. Cash Flow Assumptions The series transaction's cash flows depend on a number of key inputs, some contractual (e.g., lease rates) and some modeled based on historical performance, rating-dependent economic scenarios, and our expectations of the containers' life spans. We have incorporated our stresses for each of those components into two sector downturns (the first is four years long and the other is three years long) over the fleet's life. The depth, length, and starting time of the downturns are rating-dependent, which means that to assign a higher rating, we assume deeper and longer downturns within a shorter time frame. Our internal cash flow model includes input assumptions, among them: Fleet utilization; Lease rates (both long-term and per diem); Operating expenses (repair, and storage); Container useful life and residual value; Lessee defaults; Container loss rate upon lessee defaults; AUGUST 7,

13 DFL buyback rates; and DFL recharacterization risk for pools where this risk is significant. Under our stress assumptions for the preliminary rating assigned, we expect that the series transaction will pay timely interest and full principal by the final maturity date. Beginning with the TAL transaction that closed in February 2014, we introduced a few incremental refinements to our stress assumptions. While keeping the overall stress level approximately the same, as measured by the amount of cash flow reduction under our break-even stress runs, we believe these refinements will more closely align the assumptions with recent container collateral performance trends. For example, we are seeing lower lease rates, particularly for the reefer containers. On the other hand, container residual value, particularly for the dry vans, are holding up well and at levels considerably above what we assumed in our stress scenarios. The updated assumptions, outlined below, reflect these trends. Among the key adjustments we made are: Loss of containers following lessee default; Higher residual value for dry vans; and Lower re-leasing rate for reefer containers. Utilization Utilization is one of the most important performance metrics for a container fleet. When a container is off-lease it ceases to generate income while incurring storage and other expenses. The utilization rate for containers depends largely on the rate of world trade and economic growth. Economic downturns in the U.S., Europe, Asia, and other countries with consumer-oriented economies could reduce world trade volume and demand for leased containers. Other general factors affecting utilization include : Competitive pressures and consolidation in the container shipping industry; The availability and terms of container financing; and Over/under-capacity or consolidation of container manufacturers. Utilization Rate Assumptions For short-term leases, we assume a 90% starting point base utilization, and we apply all stresses using this base utilization. During a downturn, we assume that fleet utilization steps down to, and then recovers from, depressed levels between mid-40% and mid-60% for the 'A' rating stress scenario. The severity of the stress curves depends on the container type, with reefers subjected to less stressful curves than dry boxes. During a four-year downturn, we assume beginning (year one) and ending (year four) utilizations to be halfway between the bottom and base levels. During the recent sector downturn, certain container types saw utilizations dip briefly below 60%. In our view, stressing utilization at similar levels lasting two years is commensurate with an 'A' stress scenario. Fleet utilization is a function of several operating parameters, among them lease term, downtime in transit between lessees, and assumption about lessee defaults. AUGUST 7,

14 Chart 3 shows the utilization stress curves (haircuts to the base short-term utilization rate) assumed for a 40-ft. high-cube reefer and a 40-ft. high-cube dry box. Chart 3 Lease Rates Container leasing businesses such as Cronos compete mostly on price and the availability of containers. We believe lease rates for containers depend on many factors, including: The availability of containers in the market, including containers for lease by other competitors; The price of new containers; Lessors' general financing and interest rates; Container age; The lease's type and length; and Whether the container is in a high- or low-demand location. Because containers are generally commoditized products, we believe that one container leasing business' lease rates are heavily influenced by those of its competitors. For example, to determine our lease rate assumptions for Cronos Series , we considered its current and average lease rates, as well as the historical lease rates charged by other AUGUST 7,

15 container leasing businesses. For short-term (per diem) rates, we generally use a five-year average taken from a number of lessors. These rates, in our view, are a good approximation of what "market rates" will likely be when we assign our preliminary ratings. We calculate these rates for all major containers and set them as constants for the remainder of the transaction. This set of rates forms our base case. We have observed that after gradual, long-term secular declines over the past 20 years, per diem rates have stabilized. For the 'A' stress scenario, we lower per diem rates by 35% during the two downturns. During the first and last year of the downturn we modeled, the rate steps down to between the base and bottom levels. We also modeled a six-month lag between the drop in utilization and in short-term rates (see chart 4 for the stress curve for the per diem rates of a 20-ft. dry box). Chart 4 For long-term rates, or the rates lessors charge on an operating lease with a lease term longer than one year, we model the starting rates as they are for the initial portfolio. For the 'A' stress, we default up to 15% of the lessees on a long-term lease per year for four years during the first recession. Half of the defaulted leases will then become short-term leases and will be subject to the utilization and lease-rate stresses. The other half will enter into a three-year AUGUST 7,

16 term lease subject to up to a 30% haircut in lease rate. If the original long-term lease expires during a recession, the expired lease will be renewed under the same terms as those of the defaulted leases. Outside of a recession, in scenarios where we assume long-term leases are renewed after expiration, they are renewed at our base long-term lease rate. We assume that the renewed term will be three years if renewed in a recession and five years if renewed outside of a recession. Useful Life And Residual Cost Most containers--dry vans and reefers--generally have an economic life considerably shorter than their physical lives; many retired containers have found alternative uses that last years, or even decades, beyond their useful lives as shipping containers. Most leasing companies begin to consider selling containers after 10 years of service because the accumulated effects of salt water corrosion and rough handling begin to make the containers uneconomical to maintain. The price paid for container fleets, according to various industry sources (for example, Drewry Maritime Research: Container Leasing Market 2012), ranged from slightly more than book value during weak market conditions to more than 1.5 times book value during strong market conditions. Individual and small lots of containers showed greater price variability. The residual value on containers can be a significant portion of cash flows: A container sold toward the end of its useful life can typically be sold at 35% of its OEC depending on the type of container (see table 8 for the expected recovery from the sale of containers from ). Table 8 Comparison Of Container OECs And Possible Resale Values New-build dry freight container prices (US$) Year 20-ft. dry 40-ft. dry 40-ft. dry HC ,450 2,320 2, ,350 2,160 2, ,400 2,240 2, ,850 2,960 3, ,100 3,360 3, ,850 2,960 3, ,950 3,120 3, ,350 3,760 4, ,950 3,120 3, ,500 4,000 4, ,700 4,320 4,600 Annualized resale prices for standard dry freight containers (US$) Year 20-ft. dry 40-ft. dry 40-ft. dry HC ,100 1,150 AUGUST 7,

17 Table 8 Comparison Of Container OECs And Possible Resale Values (cont.) ,120 1, ,100 1, ,000 1,280 1, ,150 1, ,200 1,480 1,620 Mid ,400 1,750 1,900 Residual value as a percent of OEC for standard dry freight containers (%) Year 20-ft. dry 40-ft. dry 40-ft. dry HC OECs--Original equipment costs. HC--High cube. For our assumptions, we used straight-line depreciation with a 20% OEC residual value for dry vans and 10% OEC residual value for all other container types in our model. Containers are typically sold during a specific time period toward the end of a 15-year useful life, except tank containers, which are assumed to have a 20-year useful life. Sales during a recession are subject to the per diem lease rate stress. Performing DFL containers are not sold, but remain in the pool until the buyout option is exercised. Operating Expenses Operating expenses typically include maintenance, storage, and repositioning and handling expenses (i.e., when customers drop off containers at depots around the world and those containers need to be moved to other locations), among others. Generally, operating expenses are directly related to the fleet's size but inversely related to the utilization rate. In our cash flow modeling exercise, we separate the storage expenses from the remaining operating expenses. For storage, we model these expenses for short-term leases at $0.40 per day for 20-ft. boxes and $0.80 per day for 40-ft. boxes. Because the historical data show storage expenses to be inversely correlated to the utilization rate, storage costs will rise and utilization rates will fall in our modeling assumptions during downturns. AUGUST 7,

18 During downturns in our models, when a higher level of container returns would lead to higher maintenance, repair, and reposition costs, other operating expenses also tend to increase. In our cash flow modeling, we assume an 8% base-level operating expense to revenue ratio, which is in line with the historical average of the past five years. This level doubles to approximately 15% at the peak of a downturn for the 'A' rating stress. We do not model operating expenses on DFLs, as such expenses are borne by the lessee of each lease contract. Lessee Defaults And Container Loss Both long-term leases and DFLs are subject to the risk of lessee default. Short-term leases are less susceptible to this risk as the lessee can simply return the container. The risk of short-term lease default is essentially covered in our utilization assumptions; however, for long-term and finance leases we model lessee defaults at 60% cumulative default rates for the 'A' scenario, based on our view of the initial and the future lease pool's lessee credit quality. In our cash flow model, half of the containers that experience a long-term lease or DFL default are assumed to roll into the short-term lease pool. For operating leases, the other half are assumed to continue on a long-term lease paying a reduced rate until the earlier of the expiration of the defaulted lease and 36 months. When the period with rate reductions ends, we assume these containers will have the same characteristics as containers on non-defaulted long-term lease. Container leasing data have shown that, historically, lessee default will sometimes lead to loss of equipment--our data analysis shows that on average the container recovery following lessee default (as measured by equipment units) is around 88%. For the 'A' stress scenario, losses for long-term leases are 20% and 47% for finance leases. The lower recovery assigned to finance leases reflects our assumption that they face recharacterization risk in a lessee's U.S. bankruptcy filing where the container owner can be treated as a secured creditor. Cash Flow Results 'A' stress scenario and sensitivity analysis We ran a number of stress tests in which we stressed cash flow through economic downturns, where both fleet utilization and re-leasing rates decrease while operating expenses increase. The magnitude of these stresses is rating-dependent, as described in the Cash Flow Assumptions section above. For our cash flow runs, we grossed up the portfolio to account for the prefunding account. Given that the prefunding account will be used to purchase containers newly received from the factory, we assumed that these containers are new. We modeled all stresses assuming that all of the buyouts are taken. Under all stress scenarios, the bonds paid timely interest and ultimate principal according to the payment priority (see table 9). AUGUST 7,

19 Table 9 Series Flow Results Description Roll stress case DFL stress case Stress modeled 60% applied default rate. Cut utilization to between 50% and 75%, reduce the base-case lease rates by 35%, and increase operating expenses by up to 15% during two sector downturns. 20% loss of containers following lessee default. No operating expenses on DFLs. 90% ST utilization rate. 20% final depreciated value for dry boxes, 10% for others. Residual haircut only happens during downturns, haircut level follows the same pattern as reduced re-lease rate. 75% LT leases roll to ST leases. 60% applied default rate. Cut utilization to between 50% and 75%, reduce the base-case lease rates by 35%, and increase operating expenses by up to 15% during two sector downturns. 47% loss of containers under DFLs, 20% loss of containers under operating leases. No operating expenses on DFLs. 90% ST utilization rate. 20% final depreciated value for dry boxes, 10% for others. 30% LT leases roll to ST leases. Residual haircut only happens during downturns, haircut level follows the same pattern as reduced re-lease rate. 24-month default delay for FL containers. Maximum haircut/cost increase where noteholders are paid in full Timely interest and ultimate principal paid Timely interest and ultimate principal paid DFL--Direct finance lease. ST--Short-term. LT Long-term. FL--Finance lease. Break-even analysis We also performed break-even tests to provide information about the transaction's cash flow to the key stress factors discussed above (see table 10). Table 10 Series Break-Even Results Description Utilization stress break-even analysis Re-lease rate break-even analysis Stress modeled Cut performance figures using the roll stress, with the additional stress to the utilization rate Cut performance figures using the roll stress, with the additional stress to the re-lease rate Maximum haircut/cost increase where noteholders are paid in full 7% haircut utilization 6% haircut to re-lease rate Payment Priority The collections will be allocated to each series' account according to the series collection allocation percentage. This percentage takes into account each series' initial or current principal balance, each series' restricted cash amount, and each series' required overcollateralization amount. On any payment date before an early amortization event and an event of default, the trustee will distribute the amounts in the series account according to the payment priority in table 11. Table 11 Payment Waterfall Priority Payment 1 Indenture trustee (not to exceed $40,000 annually per series). 2 Management fees (including any in arrears). 3 Unreimbursed manager advances, if any. 4 Issuer expenses, if any (not to exceed $100,000 annually). 5 Manager transfer facilitator fees and administrative agent fees, if any. AUGUST 7,

20 Table 11 Payment Waterfall (cont.) 6 Hedge agreement payments (not termination payments). 7 Note interest. 8 Restricted cash amount to restricted cash account. 9 Minimum note principal. 10 Scheduled note principal. 11 Supplemental note principal, if any. 12 Remaining hedge agreement payments. 13 Indemnity payments and remaining amounts due on notes. 14 Unpaid indenture trustee fees and indemnities. 15 Unpaid officer and director indemnities. 16 Unpaid manager indemnities. 17 Any remaining amounts to the issuer. Payment priority after an early amortization event If an early amortization event has occurred but no event of default is continuing, collections will be distributed according to the payment priority outlined in table 12. Table 12 Payment Waterfall After An Early Amortization Event Priority Payment 1 Indenture trustee (not to exceed $40,000 annually per series). 2 Management fees (including any in arrears). 3 Unreimbursed manager advances, if any. 4 Issuer expenses, if any (not to exceed $100,000 annually). 5 Manager transfer facilitator fees and administrative agent fees, if any. 6 Hedge agreement payments (not termination payments). 7 Note interest. 8 Restricted cash amount to restricted cash account. 9 Minimum note principal. 10 Scheduled note principal. 11 Principal on notes until paid in full. 12 Remaining hedge agreement payments. 13 Indemnity payments and remaining amounts due on notes. 14 Unpaid indenture trustee fees and indemnities. 15 Unpaid officer and director indemnities. 16 Unpaid manager indemnities. 17 Any remaining amounts to the issuer. Payment priority after an event of default If an event of default occurs, collections will be distributed according to the payment priority outlined in table AUGUST 7,

21 Table 13 Payment Waterfall After An Event Of Default Priority Payment 1 Indenture trustee reimbursement of costs in enforcing remedies and all remaining fees and indemnified amounts. 2 Management fees (including any in arrears). 3 Unreimbursed manager advances, if any. 4 Issuer expenses, if any (not to exceed $100,000 annually). 5 Manager transfer facilitator fees and administrative agent fees, if any. 6 Hedge agreement payments (not termination payments). 7 Note interest. 8 Note principal until paid in full, except for any accelerated series for which note principal is paid pari passu with remaining hedge agreement payments for such series until paid in full. 9 Indemnity payments and remaining amounts due on notes. 10 Remaining hedge agreement payments. 11 Unpaid indenture trustee fees and indemnities. 12 Unpaid officer and director indemnities. 13 Unpaid manager indemnities. 14 Any remaining amounts to the issuer. Events Of Default Under the transaction documents, each of the following constitutes an event of default: A default of note interest or principal payments. A default of indenture trustee fees for more than five business days or any amounts due on the notes other than principal and interest for more than 30 days. The issuer or seller breaches a covenant under the transaction agreements that has a material adverse effect and it is not remedied for 60 days. The issuer or seller's representation or warranty under the transaction agreements is materially incorrect and not remedied for 30 days. The issuer's involuntary insolvency. The issuer's voluntary insolvency. A replacement manager is not appointed within 60 days following a manager default. The indenture trustee does not maintain the first-priority perfected security interest in the collateral, and it is not cured within 15 days. The aggregate note balance exceeds the asset base calculated assuming a 90% advance rate. The issuer is required to register under the Investment Company Act of Certain events occur related to the Employee Retirement Income Security Act. Early Amortization Events Under the transaction documents, an early amortization event will occur if any of the following events or conditions occurs on a payment date (and has not been cured): AUGUST 7,

22 An event of default has occurred and is continuing. The unpaid principal balance of all outstanding notes exceeds the asset base and that amount remains unremedied for 60 days. The issuer EBIT to issuer cash interest expense ratio is less than 1.10x. The weighted average age of the eligible containers is equal to or exceeds nine years. The asset base is less than $25 million and that amount remains unremedied for 10 days. A manager default has occurred and is continuing. Any additional early amortization event in any series documents. Legal Matters In rating this transaction, Standard & Poor's will review the legal matters that it believes are relevant to its analysis, as outlined in its criteria. Surveillance We use surveillance data to perform periodic reviews on all rated container securitizations to identify potential and emerging trends. Our ratings reflect our opinion of the transaction's ongoing risk profile. Our surveillance group undertakes a number of steps to determine whether the ratings assigned to a transaction continue to reflect our view of that transaction's performance. These steps include, among others: Analyzing the servicer reports that detail the underlying collateral's performance. Making periodic telephone calls and holding meetings with the issuer's and servicer's key management personnel to identify any emerging trends or changes in servicing standards. Monitoring the supporting ratings on a transaction. Remaining informed of related industry developments and events that may affect a rated transaction's overall performance. Our surveillance group will continue to develop and provide performance information, research, and analysis to increase the level of transparency, as well as information on our methodology, ratings, and rated transactions' performance. Standard & Poor's 17g-7 Disclosure Report SEC Rule 17g-7 requires an NRSRO, for any report accompanying a credit rating relating to an asset-backed security as defined in the Rule, to include a description of the representations, warranties and enforcement mechanisms available to investors and a description of how they differ from the representations, warranties and enforcement mechanisms in issuances of similar securities. The Standard & Poor's 17g-7 Disclosure Report included in this credit rating report is available at AUGUST 7,

23 Related Criteria And Research Related Criteria Revised Methodology And Assumptions For Global Railcar And Container Lease Securitizations, June 21, 2010 Related Research Global Structured Finance Scenario And Sensitivity Analysis: Understanding The Effects Of Macroeconomic Factors On Credit Quality, July 2, 2014 Lessors Of Marine Cargo Containers Can Endure A Sluggish Global Economy, June 19, AUGUST 7,

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