Property Tax Lien. U.S. Structured Finance. ABS Rating Methodology. Analytical Contacts: Patrick McShane, Director

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1 U.S. Structured Finance ABS Rating Methodology Property Tax Lien ABS Rating Methodology Analytical Contacts: Patrick McShane, Director Anthony Nocera, Managing Director Lenny Giltman, Senior Director September 19, 2014

2 Table of Contents Market Overview... 3 Lifecycle of Delinquent Property Tax Liens... 5 Originator Review... 6 Servicer Review... 7 Collateral Analysis... 7 LTV Ratio... 8 Amount of Tax Lien... 8 Penalty and Interest Rate Accruals... 8 Property Type... 8 Lien Age... 9 Subsequent Liens... 9 Bankruptcy Status of Property Owner... 9 Redemption Curve Analysis... 9 Historical Loss Coverage... 9 Cash Flow Modeling Stress to Redemption Curve Timing of Subsequent Liens Lien Administration Expenses Foreclosure Period and REO Proceeds Interest Rate of Notes Legal Structure and Analysis Evaluation of Bankruptcy Remoteness Transaction Structural Diagram Transaction Documents Back-Up Servicer Perfection of Security Interests Legal Final Determination Surveillance Appendix I: Sample Information Request Appendix II: Sample Agenda for Originator/Servicer Review Appendix III: Example of Documentation Provisions Property Tax Lien ABS Rating Methodology Page 2 September 19, 2014

3 Executive Summary This report describes Kroll Bond Rating Agency s ( KBRA ) rating methodology for property tax lien assetbacked securities ( tax lien ABS ). KBRA s rating of a tax lien ABS transaction incorporates an analysis of: (1) the quality and projected performance of the underlying collateral, (2) the originator s business strategy, (3) the servicer s operational strength and (4) the transaction s terms, including capital structure, credit enhancement and legal structure. KBRA assigns ratings to tax lien ABS using its shortterm and long-term rating scales depending on the securities being rated. For more information about KBRA s rating scales, please see KBRA s Rating Scale and Definitions. When rating a tax lien ABS transaction, KBRA generally analyzes the underlying collateral pool, as well as the historical redemption rates of property tax liens in the jurisdictions in which the properties related to the collateral is located. KBRA typically performs an operational assessment of the originator and the servicer and incorporates the results into its rating analysis. KBRA notes that the credit analysis of tax lien ABS transactions can vary by transaction, not only due to collateral characteristics and transaction structure, but also to local legal provisions. KBRA believes that due to the variability of tax lien ABS collateral, a qualitative and quantitative assessment that incorporates the originator s collection history and overall strategy is critical in determining a transaction s ratings. Typically, tax lien ABS transactions are comprised of residential and commercial properties. Therefore, KBRA may reference its relevant RMBS and CMBS methodologies, where applicable, when evaluating a transaction s lien-to-value ratio ( LTV ratio ). In addition, KBRA reviews a tax lien ABS transaction s legal structure, transaction documents and legal opinions. A transaction s capital structure is tested by applying stressed assumptions in KBRA s cash flow analysis to determine whether the proposed credit enhancement is sufficient. Market Overview In many states, local taxing authorities impose annual charges upon property holders, generally referred to as property taxes. Property taxes are typically calculated based on a fixed percentage of a property s assessed value. In addition, many municipalities collect fees that are linked to services provided by the municipality, such as water, sewer and sanitation services. These fees and other related charges are used to fund general administrative expenses of the municipality as well as schools, police and fire departments. In many jurisdictions, when a property owner fails to pay the property taxes or charges associated with the property, the taxing authority creates a tax lien certificate on the property. According to the National Tax Lien Association, an estimated $21 billion of real estate property taxes become delinquent annually and approximately $4 billion to $6 billion in unpaid property taxes are offered for sale to the private sector each year. These tax lien certificates are subsequently sold to investors at an auction. At a tax lien auction, the winning bidder is determined by either the lowest declared interest rate or the highest cash bid. The winning bidder is required to pay the municipality the delinquent taxes owed by the property owner for the relevant tax year. This process enables the municipality to collect the property taxes of the delinquent property owner, while the investor is entitled to recover interest and penalties that are set by the auction and/or statute. The rate of interest and penalties vary from state to state, but the statutory rate is typically set at a punitive rate to discourage continued delinquency. In addition to tax lien auctions, several municipalities elect to sell tax lien certificates in bulk through competitive bidding processes to a single purchaser. Property Tax Lien ABS Rating Methodology Page 3 September 19, 2014

4 Other states such as Nevada and Texas permit tax lien transfers. Tax lien transfers involve a third party ( tax lien transferee ) who pays a property owner s delinquent tax bill. The tax lien transferee receives a tax lien certificate in exchange for paying the property owner s delinquent tax bill. The property owner agrees to repay his/her tax lien obligation over time to the tax lien transferee at an agreed upon rate of interest not to exceed a specified statutory rate. Unlike tax liens purchased at auction or in bulk sales, this type of tax lien transfer has elements of receivable finance. The holder of the tax lien certificate is given a super-priority lien position, superior to all previous liens including a mortgage. Typically, the purchaser of the initial tax lien certificate is entitled to a right of first refusal with respect to purchases of all subsequent tax lien certificates. In many states, this right of first refusal enables the tax lien certificate holder to maintain its priority status. A jurisdiction s treatment of subsequent tax liens will be one factor in KBRA s analysis of the collateral in a proposed transaction. A tax lien certificate may be redeemed by the property owner or a third party, such as a subordinate lien holder, within a statutory redemption period. The redemption period varies by state, but is typically two to three years in length. If the tax lien certificate is not redeemed by the end of the redemption period, the tax lien certificate holder has the right to obtain title to the property by obtaining a deed through foreclosure. Once a deed is obtained, the property will become part of an originator s Real Estate Owned ( REO ) portfolio. After a deed is obtained, the tax lien certificate holder may dispose of or maintain the property and recover all proceeds associated with the property. KBRA notes that the typical business strategy of originators that issue tax lien ABS transactions is to purchase liens that are redeemed within the statutory period in order to limit the number of REO properties that require an asset management and disposition strategy. Tax Lien ABS Historically, the majority of tax lien ABS issuance relates to tax liens levied by large municipal issuers, such as New York City. However, in recent years, new sponsors of tax lien ABS have entered the market with expertise in states such as Florida, Illinois, Maryland, New Jersey, New York and Texas. Recently rated tax lien ABS transactions feature a single tranche structure, with all excess cash flow after payment of expenses and note interest utilized to repay principal. These transactions feature collateral originated in a single state or municipality, as well as tax lien certificates from multiple states and municipalities. In addition, the use of redemption proceeds to purchase subsequent tax liens on properties within the collateral pool is often permitted. In its review of tax lien ABS transactions, KBRA notes the limited occurrence of losses on tax lien certificates. KBRA largely attributes this to the low relative LTV ratio of tax lien originators portfolios, as well as strong upfront diligence processes from most sponsors in the tax lien ABS sector. Property Tax Lien ABS Rating Methodology Page 4 September 19, 2014

5 Lifecycle of Delinquent Property Tax Liens The diagram below illustrates a typical lifecycle of a property tax lien: Property Owner Delinquent on Property Taxes MUNICIPALITY Tax Lien Certificate Issued Tax Lien Certificate Sold by Municipality Tax Lien Certificate Fails to be Purchased by Investor Investor Purchases Tax Lien Certificate Tax Lien Certificate Redeemed upon Payment of Delinquent Property Taxes and Penalties Failure of Tax Lien Certificate to Redeem Foreclosure Investor Takes Title to Property Typically, a tax lien certificate may be redeemed by the property owner or a third party, such as a subordinate lienholder, within the statutory redemption period. On many occasions, the statutory redemption period varies by state and property type. In most jurisdictions, the statutory redemption period is two to three years. If a tax lien certificate is not redeemed by the end of the redemption period, the tax lien certificate holder typically has the right to obtain title to the property by obtaining a deed in lieu foreclosure. After a deed is obtained, the tax lien certificate holder may dispose of or maintain the property and recover all proceeds associated with the property. As part of its rating process, KBRA will review a tax lien purchaser s historical data as it pertains to historical foreclosure rates and associated expenses. Historical data reviewed by KBRA indicates that a large proportion of tax liens included in tax lien ABS transactions are redeemed prior to entering the foreclosure process. As part of the rating process, KBRA will review the historical redemption data for each state and municipality in which the properties related to the tax lien collateral are located. Property Tax Lien ABS Rating Methodology Page 5 September 19, 2014

6 Originator Review KBRA generally performs an operational review of each tax lien originator to determine its purchasing and diligence capabilities, as well as its overall business strategy. KBRA generally focuses on how an originator competes within the tax lien industry, along with its operational capabilities and financial condition. Each of these factors may impact the collateral performance of a tax lien ABS transaction. KBRA typically reviews an originator s overall bidding strategy and compliance program. A tax lien originator s history and consistency within geographic regions, as well as the property types to which the tax liens relate are key determinants in KBRA s analysis of a tax lien ABS transaction. KBRA believes that local market knowledge and experience is critical to the selection and maintenance of a collateral pool. KBRA generally focuses on the following aspects of a tax lien originator s business: Corporate Overview o Company history o Corporate organization o Management experience o Strategy o Financial performance and condition Portfolio Selection and Historical Performance o Diligence process prior to tax lien purchases o Tax lien bidding procedures and compliance measures o Historical redemption rates o Subsequent tax lien purchases o REO history and loss experience Technology o Overview of software of origination and servicing systems o Disaster recovery plan KBRA typically begins its originator review process with an information request to the company that is often customized for a particular review, based on the originator s strategy and states/municipalities. A sample information request is shown in Appendix I. KBRA normally conducts an assessment that covers each aspect of the company s operations and management, which is used to determine KBRA s view of the expected impact of the originator on collateral performance. A sample agenda for an originator/servicer review is included in Appendix II. KBRA s operational review typically includes management meetings to discuss the company s history, ownership structure, business model and financial performance and condition. Management s experience and strategic plan are critical determinants in KBRA s assessment of the originator. This information will be considered in the context of overall business conditions, including the firm s competitive and regulatory environment. KBRA typically reviews the organization structure, including staffing, training, controls and procedures in place for managing a successful tax lien management platform. KBRA may also review internal audit and compliance policies to ensure strong oversight is in place. This assessment often includes the review of organizational resources, formal procedures and reporting processes. Property Tax Lien ABS Rating Methodology Page 6 September 19, 2014

7 Servicer Review Frequently, tax lien originators also act as servicer of the collateral pool in an ABS transaction, although occasionally a third party servicer is engaged to manage the redemption process for a tax lien ABS transaction. Since each jurisdiction s redemption process is governed by unique statutory and regulatory requirements, it is critical to have the presence of a servicer with strong local market knowledge and experience. During KBRA s servicer review process, a servicer s experience within the relevant jurisdictions is examined, as well as its staffing levels and overall financial strength. Formal back-up servicing provisions will also be factored into KBRA s rating of a tax lien ABS transaction. As previously noted, the tax lien originator may have the option to purchase subsequent tax liens in order to maintain its super-priority position or obtain additional collateral at attractive penalty or interest rates. As a result, a servicer must also have the ability to closely monitor and preserve the senior position of the collateral pool. KBRA will typically examine a servicer s customized servicing platform to understand its integration with the origination process. For jurisdictions where physical redemption of tax lien certificates is required, KBRA will evaluate the servicer s procedures for such redemptions to ensure that procedures are in place to minimize the risk of loss during the transfer of the tax lien certificate from the servicer to the municipal authority. While KBRA notes that a majority of tax lien certificates within tax lien ABS transactions redeem prior to the conclusion of the statutory redemption period, KBRA will assess a servicer s capabilities to manage REO properties. The REO mitigation and disposal strategies of each servicer are reviewed in order to develop certain stress case assumptions as part of KBRA s cash flow analysis, as are the historical foreclosure costs and duration of the foreclosure process in the jurisdictions applicable to the collateral in the transaction. Collateral Analysis KBRA generally analyzes the characteristics of the collateral in the proposed pool to understand the credit profile of the tax liens in a proposed securitization. KBRA typically compares the characteristics of the initial collateral pool to the originator s historic originations to ascertain the similarities of the proposed pool to an originator s prior experience. The extent of the similarities will determine whether the historical redemption data is an appropriate proxy to use in the projection of redemption curves for the collateral pool. In addition, KBRA may compare the collateral characteristics of the initial collateral pool to the characteristics of other tax lien originators to gauge whether the expected redemption levels of the proposed pool are comparable to those of the originator s competitors. KBRA typically reviews the following collateral characteristics: Lien to Value (LTV) Ratio Amount of Tax Lien Penalty or Interest Rate Accruals Property Type (i.e., residential, commercial, agricultural, vacant land) Lien Age Subsequent Liens Bankruptcy Status of Property Owner Property Tax Lien ABS Rating Methodology Page 7 September 19, 2014

8 LTV Ratio KBRA believes the LTV ratio is the primary factor driving the likelihood that a property owner or subordinate lienholder will redeem a property tax lien certificate. Higher LTV properties provide little incentive for these parties to pay the delinquent property taxes and often force the tax lien certificate holder to recover the value of the certificate through the foreclosure process. When reviewing a tax lien ABS transaction, KBRA calculates the initial collateral pool s weighted average LTV ratio. This ratio is calculated as the aggregate sum of outstanding tax liens on a single property, divided by the property s assessed value as determined by the relevant local taxing authority. KBRA notes that assessed values may differ from market values and may conduct further analysis to better understand how often assessed values are updated and determined. In its LTV analysis, KBRA references its Residential Mortgage Default and Loss Model Methodology published on January 9, KBRA requires that residential mortgage backed securities ( RMBS ) be able to withstand a 50% home price decline stress scenario to qualify for an AAA rating. For RMBS pools with high concentration risk, as often occurs in tax lien ABS transactions, KBRA uses a 60% home price decline level for the AAA rating level. During times of severe economic stress, KBRA notes that price declines for commercial properties and other property types may be more severe and volatile than those for residential properties. KBRA may reference its commercial mortgage backed securities methodologies when evaluating the impact of including certain non-residential properties in a tax lien ABS transaction. Amount of Tax Lien KBRA views highly granular pools with limited exposure to any single property as favorable for the composition of a tax lien ABS collateral pool. The presence of large tax liens attached to a single property may result in a reduction in the overall credit given to the tax lien as part of the transaction s credit enhancement. Depending upon the jurisdiction, the purchase of subsequent tax liens may place further stress upon the liquidity of the transaction, due to the concentrated nature of the subsequent lien purchases, and may require additional credit or liquidity enhancement. Penalty and Interest Rate Accruals KBRA evaluates the reliance of a transaction s cash flow generation on penalty and interest rate accruals, which can vary greatly by jurisdiction. The timing of redemptions is a key factor in the projection of total excess spread, since the penalty and interest rate accruals are realized only upon redemption. KBRA usually applies redemption timing sensitivities to assess the impact of penalty and interest rate accruals as a result of varying redemption speeds. Property Type The composition of property types in a tax lien transaction is considered in KBRA s analysis of each transaction. KBRA typically seeks to analyze redemption data by property type as well as vintage. Since redemption periods can vary by property type, KBRA also seeks to analyze a pool based upon these statutory parameters. In its analysis of tax lien ABS transactions, KBRA notes that low LTV tax liens relating to residential properties exhibit a higher redemption rate than those of other property types. In addition, if the tax lien is not redeemed within the statutory redemption period, certain property types may be more difficult to liquidate due to their limited range of uses. For agricultural, commercial, and industrial properties as well as vacant land, KBRA examines a tax lien originator s diligence process for limiting environmental liability. Prior to the acquisition of legal title to a property and transfer to REO, KBRA believes it is critical for a servicer to perform certain environmental Property Tax Lien ABS Rating Methodology Page 8 September 19, 2014

9 due diligence, including but not limited to completion of a Phase I environmental assessment to assess potential environmental claims or liabilities. Lien Age For each jurisdiction included in a proposed securitization, KBRA reviews the relevant statutory provisions governing the redemption cycle. For tax liens that are past or approaching the end of the statutory redemption period, KBRA may limit the credit given in the analysis to these tax liens due to the likelihood that recovery must be achieved through the foreclosure process and subsequent sale of the property. Subsequent Liens KBRA factors in the ability of the originator to purchase subsequent tax liens in an ABS transaction. On the positive side, purchases of subsequent tax liens permit the noteholders to retain the sole security interest in the property subject to the tax lien. However, subsequent tax liens also expose noteholders to increased risk to a property owner that, at the time of the purchase of the subsequent tax lien, is even more delinquent in paying taxes than when the initial tax lien certificate was originated. KBRA will review historical subsequent lien purchases for each jurisdiction included in the securitization and assess their impact upon the transaction s cash flows. Bankruptcy Status of Property Owner While certain jurisdictions provide limitations upon the modification of tax liens, it is often difficult to assess the judicial outcome. As a result, KBRA does not give credit in its analysis for properties in which the owner is currently bankrupt or in bankruptcy proceedings. Redemption Curve Analysis Within the tax lien industry, redemption periods can differ due to statutory regulations and other market factors. KBRA reviews a company s redemption performance data since inception and examines the stability of redemptions across vintages. Based upon this analysis, KBRA will develop a base case redemption curve for each jurisdiction factoring in quantitative and qualitative considerations. KBRA may review the historical data of other competitors in reference to a proposed transaction for a similar jurisdiction. Collectively, KBRA seeks to assess a transaction s sensitivity to slower redemption rates, higher costs and a greater number of REO foreclosures. KBRA reviews these quantitative and qualitative factors as part of its determination of the transaction s rating levels. Historical Loss Coverage A company s historical loss history will be incorporated as part of KBRA s stress case sensitivity analysis. Typically, loss coverage consists of overcollateralization, excess spread and amounts on deposit in the cash reserve accounts and other cash accounts. Property Tax Lien ABS Rating Methodology Page 9 September 19, 2014

10 Cash Flow Modeling Credit enhancement in tax lien ABS transactions varies depending upon the individual transaction structure. In recent transactions, credit enhancement was provided by overcollateralization, cash reserve accounts, subsequent tax lien cash accounts and excess spread. KBRA s modeling assumptions are used to examine the timing of the collateral s cash flows relative to when timely interest and ultimate principal is paid to the noteholders. KBRA considers the following factors in its cash flow modeling of a tax lien ABS transaction: Stress to redemption curve Timing of subsequent liens Lien administration expenses Foreclosure period and REO Proceeds Interest rate of notes Stress to Redemption Curve KBRA assesses the sensitivity of the tax lien pool s base case redemption curves for all jurisdictions related to a transaction. KBRA will evaluate a company s historical experience in each jurisdiction, as well as the number of years for which data is available. Based upon its analysis and the requested rating levels, KBRA will apply certain stresses to the redemption curves to test the sensitivity of the transaction s capital structure to an overall decline in the pace of tax lien redemptions. Due to the low LTV of the collateral pools exhibited in recent tax lien ABS transactions, KBRA believes that the application of stress to the redemption curves represents a key factor in evaluating tax lien ABS transactions. Timing of Subsequent Liens KBRA will review a company s historical experience relative to the level of anticipated subsequent lien purchases. Since rules regarding the timing of issuing subsequent lien certificates vary by jurisdiction, KBRA will assess the timing and amount of these factors. KBRA notes that the purchase of subsequent liens may slow the overall de-leveraging of a transaction, but in many cases may protect the collateral position of noteholders. Lien Administration Expenses Each jurisdiction has certain statutory and filing requirements for holders of tax liens. KBRA will review the typical associated expenses incurred to maintain the collateral s security interest and enforcement rights. In its rating analysis, KBRA may apply stresses to these administrative expenses to reflect periods in which redemption rates slow, resulting in increased levels of administrative expenses. Foreclosure Period and REO Proceeds For tax liens that reach the end of the statutory redemption period, foreclosure proceedings may be necessary to obtain full repayment of the outstanding balance of the tax lien. Certain states require judicial foreclosure for certain property types, while others may require only non-judicial proceedings. KBRA will review a company s history of foreclosure experience and length of the foreclosure process by state and apply appropriate stresses to examine the impact of prolonged periods of foreclosure proceedings. As part of its cash flow analysis, KBRA will examine a company s history of REO proceeds and apply appropriate stresses. Property Tax Lien ABS Rating Methodology Page 10 September 19, 2014

11 Interest Rate of Notes KBRA will apply a stressed LIBOR curve for any floating rate securities in a transaction. When a transaction is structured with interest rate hedges, KBRA assumes that these hedges are in place at closing and that they will not be renewed or replaced when they expire. Legal Structure and Analysis Evaluation of Bankruptcy Remoteness A key feature of asset-backed securitizations is the isolation of the assets in the securitization from the originator or seller of those assets to avoid certain bankruptcy or insolvency related risks. As part of the rating process, KBRA typically reviews the sale of the assets to the issuer to determine whether appropriate steps were taken to minimize the risk that the assets would be considered part of the estate of the seller in a bankruptcy or insolvency proceeding. In addition, KBRA may evaluate the corporate structures of the depositor and the issuing entity to ensure they are organized in a manner that minimizes the risk of the depositor or the issuer being consolidated with an affiliated entity in the event of a bankruptcy or insolvency proceeding involving such affiliate. As part of its assessment, KBRA typically reviews the true sale and non-consolidation opinions provided by counsel to the issuing entity and the asset seller. Transaction Structural Diagram In a typical tax lien ABS transaction, the assets are either sold directly to the issuer, or may be transferred first to a special purpose entity, such as a depositor, and then subsequently transferred to the issuer. The chart below depicts a typical amortizing tax lien ABS structure: Tax Certificates Proceeds Property Tax Lien ABS Rating Methodology Page 11 September 19, 2014

12 Transaction Documents KBRA generally reviews the transaction documents to evaluate: The transaction structure, including the payment waterfall Performance triggers or rapid amortization events Representations and warranties provided by the transaction parties and the enforcement mechanisms for a breach thereof, including, in the case of collateral-related representations, any cure or repurchase requirements Servicing standards Other obligations of the seller, servicer, trustee and other transaction parties Events of default Investor rights and remedies The content of the operative agreements are usually evaluated in conjunction with the overall transaction analysis, including KBRA s originator and servicer evaluations and the capital structure. To the extent any provisions in the transaction documents are materially weaker than market standards or do not provide protections consistent with KBRA s expectations for the applicable type of transaction and there are no adequate compensating factors, KBRA may consider the absence of such protections in its overall credit quality assessment. Back-Up Servicer Tax lien ABS transactions normally have servicing termination events which enable the trustee to terminate and replace the servicer in accordance with the criteria set forth in the transaction documents. The rationale for including a back-up servicer is to minimize the impact of a potential servicing transfer if the primary servicer s financial condition declines or if it is no longer able to adequately service the portfolio. An example of a typical set of servicer termination events is included in Appendix III. Within tax lien ABS transactions, KBRA generally considers the inclusion of the back-up servicer in its overall assessment of the credit strength of a transaction. Due to the specialized nature of tax liens, for transactions without a named back-up servicer, KBRA generally believes that a detailed transition plan is a vital component of a transaction s terms and conditions. Perfection of Security Interests KBRA generally reviews whether the transaction documents require the issuer (or a party on behalf of the issuer) to take all steps necessary to perfect the trustee s security interest in the underlying tax liens upon the transfer of such assets to the issuer. KBRA typically reviews the security interest opinion to confirm that the trustee s security interest in the underlying tax liens will be perfected on or shortly after the securitization closing date. Legal Final Determination KBRA will evaluate the legal final maturity date to ensure that such date is not prior to the tenor of the longest receivable in the pool plus the maximum amount of extensions of the redemption period, plus a period reflective of the company s historical foreclosure period experience and REO liquidation history. KBRA generally incorporates the maximum extensions into the legal final determination to ensure that the tax liens do not extend beyond the transaction s legal final maturity date. Property Tax Lien ABS Rating Methodology Page 12 September 19, 2014

13 Surveillance KBRA views the assignment of an initial rating as the starting point of an analytical process that continues for the duration of the transaction. KBRA views ongoing transaction surveillance as critical to maintaining the accuracy of existing ratings and providing insights into asset, servicer, and transaction performance that can inform the new issue rating process. KBRA s rating of the notes represents a blended analysis of the key credit risk determinants. Events that may result in a rating change to the ABS transaction include but are not limited to the following: Changes to the originator s or servicer s business strategy, management team, ownership structure or operations that cause KBRA to reassess its view of the company or servicer Deterioration in the transaction s asset performance that exceeds the company s historical experience Significant regulatory or legislative changes to the tax lien industry Modifications of the transaction s structure After the initial rating is assigned, KBRA will continue to monitor the transaction until the securities are fully repaid. Ongoing surveillance of the notes is critical to maintaining the value of the rating. KBRA s surveillance process for tax lien securitization transactions involves a periodic review of the following: Servicing reports to determine if all payment obligations are met and the transaction is in compliance with all triggers Trends in collateral performance relative to historical experience Originator s or servicer s financial performance and condition State of the competitive landscape of the tax lien industry The information gathered during regular surveillance will indicate whether or not a more thorough review is warranted. Additional information may be requested if KBRA believes the credit quality of the transaction has changed from the time of the initial rating assignment or the most recent review. If warranted, KBRA will conduct an in-depth surveillance review that may result in a change to the transaction s rating and publish commentary explaining the analysis. Property Tax Lien ABS Rating Methodology Page 13 September 19, 2014

14 Appendix I: Sample Information Request Company Data Last three years financial statements Management biographies Terms of warehouse funding/liquidity facilities Managed portfolio data o Redemption rates o REO experience o Foreclosure costs and expenses Origination Strategy Tax lien purchase activity by jurisdiction Overview of purchasing strategy Diligence process Use of third parties in origination process Historical purchases by property type and vintage Historical Data Redemption curves by year and property type where available Historical loss rates Foreclosure experience Lien administration expenses and legal expense history Organizational charts and staffing levels by department Charge-off policies and procedures Property Tax Lien ABS Rating Methodology Page 14 September 19, 2014

15 Appendix II: Sample Agenda for Originator/Servicer Review Corporate Overview Company History and Business Model Ownership and Management o Ownership o Organizational charts o Management experience o Recent changes in ownership or management Strategy o Competitive position o Goals and targets o Strategic initiatives Financial Profile o Ownership o Capital structure (both equity and debt providers) o Financial performance o Funding strategy o Historical portfolio performance and prepayment rates o Major accounting policies o Outstanding litigation o Inquiries from federal and state authorities Internal Audit, Quality Control and Compliance Originations Overview of bidding process Pre-bidding due diligence procedures Environmental screening procedures for industrial, commercial and vacant properties Bidder training/compliance procedures regarding state and federal antitrust laws Technology in place for online bidding process Tax lien auction procedures/guidelines o Overview of how bid levels/ranges are generated for properties o Bidding authority and exceptions approval o Bidding procedures for purchasing subsequent liens Funding process of initial tax lien purchases Collateral custody chain from county clerk s office to collateral custodian Servicing Procedures Department overview and organization o Staffing levels o Overview of redemption strategies o Policies and procedures o Recent changes in policies and procedures/strategies and impact Redemption Process o Timeline for redemption of certificates o Procedures for physical redemption of tax lien certificates (as applicable) Property Tax Lien ABS Rating Methodology Page 15 September 19, 2014

16 o o o Reconciliation process between servicer s expected redemption amount and municipality s redemption amount Description/listing of deposit accounts for redemption checks Discussion of utilization of third parties to dispose of outstanding tax lien certificates Subsequent lien purchases and loss mitigation o Tracking and funding of subsequent liens o Write-off policies o Loss reserve allocations to properties Foreclosure/REO Overview o Procedures for initiation of foreclosure proceedings o Management of REO inventory Technology Overview of software applications and purpose Disaster recovery plans and last test Planned changes to systems Property Tax Lien ABS Rating Methodology Page 16 September 19, 2014

17 Appendix III: Example of Documentation Provisions An example of documentation provisions regarding priority of payments, events of default and servicer termination events for a sample tax lien ABS transaction is provided below. Tax lien ABS transactions are typically structured with a full turbo pay structure with one note class. These examples are for illustrative purposes only. KBRA analyzes each proposed transaction based on the individual merits of the transaction, including the documentation and structural provisions. Priority of Payments Trustee fees and expenses up to a specified cap Servicer and Back-up cer fees and expenses Interest Amount necessary to expense re e account to reach required level Amount necessary to working capital rve account to reach required level Amount to the subsequent tax lien account to reach maximum amount Principal until paid in full Remaining Trustee fees and expenses in excess of the specified cap Any remaining funds to the Issuer Property Tax Lien ABS Rating Methodology Page 17 September 19, 2014

18 Events of Default Events of Default typically include the following: 1) To the extent funds are available, failure to make any payments pursuant to the priority of payments within a specified period of time; 2) Failure to make any required payment of interest on the securities within a specified period of time; 3) Material breach of any other indenture covenants and such default continues for a specified period of time; 4) Failure to take certain corrective actions relating to representations and warranties made on the tax liens within a specified period of time, or any other issuer representation or warranty proves to be incorrect in any material respect as of the time it was made and is not cured within a specified period of time; 5) Certain insolvency events occur with respect to the issuer; 6) Final judgments in excess of a specified cap that are not insured against are entered against the issuer and are not satisfied or discharged within a specified period of time; 7) The issuer is subjected to registration as an investment company under the Investment Company Act of 1940; 8) Issuer fails to cure, substitute for, or repurchase defective tax liens; 9) Any transaction document is terminated or ceases to be in full force and effect; 10) Any license or approval necessary to enable the issuer to comply with its obligations under the transaction documents is revoked or withdrawn; 11) The issuer assigns its rights under any transaction document to which it is a party (other than in accordance with the document s terms); 12) The trustee fails to have a first priority, perfected security interest in the collateral; or 13) The issuer fails to pay all principal and interest due on the securities by their maturity date. If an event of default (other than an event of default involving an insolvency event with respect to the issuer) occurs and is continuing, the majority security holders or the trustee may declare the securities to be immediately due and payable, and upon such declaration the unpaid principal of the securities and all accrued interest thereon are immediately due and payable. If an insolvency event occurs with respect to the issuer, then all principal and accrued interest on the securities will be immediately due and payable. Servicer Events of Default Servicer Events of Default typically include the following: 1) Failure to remit or transfer any funds received that are required to be remitted to the issuer within a specified period of time; 2) Failure to remedy any servicer representation or warranty that is false, incorrect or misleading in any material respect within a specified period of time; 3) Failure to perform or observe any other covenant required under the servicing agreement and such breach or default is not cured within a specified period of time; 4) Failure to either cure, substitute for, or repurchase defective tax liens with a specified minimum aggregate redemptive value; 5) Certain insolvency events occur with respect to the servicer; or 6) Final judgments in excess of a specified cap that are not insured against are entered against the Servicer and are not satisfied or discharged within a specified period of time. Property Tax Lien ABS Rating Methodology Page 18 September 19, 2014

19 Copyright 2014, Kroll Bond Rating Agency, Inc., and/or its licensors and affiliates (together, "KBRA ). All rights reserved. All information contained herein is proprietary to KBRA and is protected by copyright and other intellectual property law, and none of such information may be copied or otherwise reproduced, further transmitted, redistributed, repackaged or resold, in whole or in part, by any person, without KBRA s prior express written consent. Ratings are licensed by KBRA under these conditions. Misappropriation or misuse of KBRA ratings may cause serious damage to KBRA for which money damages may not constitute a sufficient remedy; KBRA shall have the right to obtain an injunction or other equitable relief in addition to any other remedies. The statements contained in this report are based solely upon the opinions of KBRA and the data and information available to the authors at the time of publication of this report. All information contained herein is obtained by KBRA from sources believed by it to be accurate and reliable; however, KBRA ratings are provided AS IS. No warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability, or fitness for any particular purpose of any rating or other opinion or information is given or made by KBRA. Under no circumstances shall KBRA have any liability resulting from the use of any such information, including without limitation, for any indirect, special, consequential, incidental or compensatory damages whatsoever (including without limitation, loss of profits, revenue or goodwill), even if KBRA is advised of the possibility of such damages. The credit ratings, if any, and analysis constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. KBRA 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. Property Tax Lien ABS Rating Methodology Page 19 September 19, 2014