Drug Royalty III L.P. 1 (Series )

Transcription

1 Presale: Drug Royalty III L.P. 1 (Series ) This presale report is based on information as of May. 22, 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 Ratings Class Preliminary rating(i) Preliminary amount (mil. $)(ii) Interest rate Overcollateralization (%) A-1 BBB (sf) Floating 41(ii) A-2 BBB (sf) Fixed 41(ii) (i)the rating on each class of securities is preliminary and subject to change at any time. (ii)based on the present value of projected royalty revenue under S&P Global Ratings' base-case sales scenario. Profile Expected closing date June Collateral Issuer Drug Royalty III L.P. 1. Originator Drug Royalty III L.P. 2. Indenture trustee Servicer Backup servicer Currency hedge counterparty Consultant sales forecast provider Royalty revenue from 12 royalty streams on 11 patent-protected drugs and technologies. Wells Fargo Bank N.A. DRI Capital Inc. Portfolio Financial Servicing Co. Wells Fargo Bank N.A. FR Life Sciences Inc. Primary Credit Analysts: Jay Srivats, San Francisco (1) ; jay.srivats@spglobal.com Yalan Tao, New York ; yalan.tao@spglobal.com See complete contact list on last page(s) MAY 22,

2 Rationale The preliminary 'BBB (sf)' ratings assigned to Drug Royalty III L.P. 1's $150 million senior secured class A-1 floating-rate and class A-2 fixed-rate notes series reflect our view of: The likelihood that timely interest and ultimate principal payments will be made on or before the legal final maturity date. The drug marketers' and distributors' estimated credit quality. The expected value of the collateral's cash flow, which consists of royalty payments from products approved by the U.S. Food and the Drug Administration (FDA) and European Medicines Agency (EMA). The transaction's legal and payment structures. DRI Capital Inc.'s (DRI's) servicing ability. The currency hedge and interest rate cap with Wells Fargo Bank N.A. The reserve account, which will have a target balance of the maximum of six months' interest payments or $1 million. The overcollateralization, which provides credit support to the notes. Transaction Strengths We consider the following to be transaction strengths: The strong cash flow generated by a portfolio of patent-protected drugs. The variety of conditions treated by these drugs. The structural features that protect against poor asset performance, such as a loan-to-value (LTV) adjustment mechanism with a forward-looking cash flow test and a 2:1 debt service coverage ratio. An independent third-party consultant that will provide us with pharmaceutical sales forecasts on an ongoing basis. If royalty payments received during the previous four quarters are at least 15% lower than those in the sales forecasts, the servicer must revise the sales forecasts and determine if an early amortization event has occurred. The experienced originator and servicer have a successful track record in acquiring assets and forecasting pharmaceutical sales. The drugs' generally leading market and category positions. The marketers' credit quality, the majority of which have investment-grade ratings. The geographic diversity of the cash flows. Transaction Weaknesses We consider the following to be transaction weaknesses: Product concentration risk is relatively high, with the top three drugs--keytruda, Odefsey, and Eylea--representing approximately 35.8%, 17.1%, and 14.5%, respectively, of the aggregate discounted asset values of all assets as of the closing date. The manufacturing and sale of the products could be impaired by withdrawal risk (that the drug could be withdrawn from the market), product liability lawsuits, and loss of patent protection. Drug prices could become compressed due to the current pricing/reimbursement environment in the major North MAY 22,

3 American and European markets. A bankruptcy of either the product manufacturer or marketer (licensee) or developer or patent holder (licensor) under a license agreement could adversely affect the rights of the related royalty assets' purchaser. Geographic diversity could expose the transaction to currency fluctuations. DRI's underwriting process permits the acquisition of drugs that may be subject to patent litigation. The issuer may, in the future, acquire the rights to royalties on products that are not yet approved by a regulatory body but are in late-stage clinical trials. Mitigating Factors We believe the following factors mitigate the transaction's weaknesses: The transaction benefits from the historical and projected strong cash flows, which, even under various stress scenarios, we expect will be sufficient to make scheduled interest and ultimate principal payments by the legal maturity date. The product concentration risk is generally mitigated due to the relatively strong market positions of the respective products and the critical care nature of the diseases treated. Thus, patient compliance is typically high and drug switching is relatively low for satisfied patients. The market withdrawal of a drug is relatively rare, estimated at less than 2% of marketed drugs. The issuer's portfolio consists mainly of drugs that have been on the market for many years and have an established safety track record, further limiting the risk that the FDA recalls them. The issuer's portfolio comprises many biologic-based drugs, which typically face less competition and pricing pressure, and have not experienced a permanent safety recall. The drugs in the portfolio mainly treat chronic conditions, lending additional predictability to the company's revenues/royalty streams. Generic competition is less of a concern, given the remaining patent life on the drugs, the uncertain regulatory approval process for generic biologics in the U.S., and the general difficulty in manufacturing them. We ran cash flow sensitivities limiting the amount of funds received by the issuer for certain products. All of the royalties that constitute part of the series collateral have been approved by a regulatory body. Additional assets acquired by the issuer for the issuance of an additional series will be subject to rating agency condition. In our analysis, we reviewed and identified what we consider to be the transaction's credit and structural risks and mitigating factors by applying our structured finance criteria and focusing on the health care industry's business fundamentals and growth prospects, as well as the transaction's projected cash flows and legal framework (see "Principles Of Credit Ratings," published Feb. 16, 2011). Transaction Overview The series notes will consist of floating- and fixed-rate amortizing notes with an April 15, 2027, final maturity. The notes will pay interest quarterly on each Jan. 15, April 15, July 15, and Oct. 15, beginning July 15, The series issuance will be out of the Drug Royalty III L.P. 1 master trust, which issued the series issuance. Both series will be pari passu with each other. The floating- and fixed-rate notes issued under series will rank pari passu with each other. MAY 22,

4 To hedge the interest rate risk on the class A-2 floating-rate notes, the issuer will enter into an interest rate cap agreement with Wells Fargo Bank N.A., whereby Wells Fargo will bear the risk of the three-month LIBOR going over a set rate of 3%. To hedge currency risk, the issuer has entered into a hedge agreement with Wells Fargo Bank N.A. Under the hedge agreement, Wells Fargo must pay the issuer, on certain dates, if the value of the applicable currency in U.S. dollars is lower than the fixed strike value. The ratings on the notes will be weak-linked to Wells Fargo such that a downgrade on Wells Fargo below the ratings on the notes will result in a downgrade on the notes. The principal will be repaid according to two schedules: minimum amortization, according to which the notes will be amortized in full at the January 2026 payment date, and scheduled amortization. If there are sufficient funds after paying the minimum principal amount each period, the additional funds will be used to pay down the principal according to the scheduled amortization, according to which the notes' principal will be paid in full at the July 2021 payment date. If the notes are accelerated after an additional series is issued, the principal payments will be allocated pari passu according to the outstanding principal balance of the senior notes in each series. Additional principal could also be paid down if an updated forecast reduces the discounted asset value so that the LTV is higher than 70%. If the LTV is higher than 70%, supplemental principal payments will be made until the LTV is less than 70%. The series also includes a contingency reserve account payment in the normal flow of funds to pay a milestone contingent payments that may be due under the Zytiga purchase agreements. Pharmaceutical Industry Outlook Pharma industry fundamentals remain solid and will continue to benefit from favorable demographics, still relatively good pricing power, and generally strong cash flow. As macroeconomic growth trends are mixed globally, we believe the industry's revenue drivers will be independent of global GDP, and will more reflect disease patterns, population, and lifestyle-related trends. However, companies are facing increasing scrutiny over pricing at the same time that they need to invest to rebuild and broaden their portfolios to stay competitive. But they have also been aggressively cutting costs and outsourcing over the past five years to preserve margins. Given the increasingly competitive environment and the trend for payors around the world to set drug prices based on perceived value, we believe the credit quality of companies that are overly reliant on a small number of products and prospects could be constrained. Companies that broaden their pipelines increase their chances of finding that "best in class" product. We revised our outlook on the pharmaceutical industry to stable from negative on April 7, 2017 (see "The S&P Pharma Dose Newsletter: The Pharma Industry Outlook Is Revised To Stable From Negative As M&A Momentum Slows"). We based our revision on what we believe will be a further return to sales and EBITDA growth for a number of Big Pharma and biotech companies, improving product pipelines that bode well for growth, a likely more-muted M&A environment for pharma in 2017, and still significant capacity for acquisitions at the current rating. Despite the continued political rhetoric, we also considered a mostly benign legislative environment thus far. We believe any major regulatory changes that could have a negative impact on pharma companies, such as drug pricing controls, will be at least a few months away. However, despite our overall stable industry outlook, we acknowledge the challenges the generic and MAY 22,

5 specialty pharma subsectors continue to face, such as public scrutiny on drug pricing and pricing pressures. Some key takeaways include: After heavy M&A activity in past years, many companies are now focusing on de-levering and integrating those transactions (Johnson & Johnson, Pfizer Inc., AbbVie Inc., and Mylan N.V. are among that group). Many of the companies that had been relatively quiet on the acquisition front and that could pull the trigger on a large transaction over the next few months have significant capacity at their current ratings to fund transactions (in the range of $10 billion to $15 billion or more). We believe that Big Pharma has more firmly returned to top-line growth, and we are projecting EBITDA margin improvements for the industry. This supports our stable outlook for the industry and lessens the pressure for M&A in the near term. Despite the headlines regarding the new administration, the impact of the White House on pharmaceutical companies has been muted. We expect any changes implemented over the next couple of years to have a neutral impact on credit quality. However, we think the specialty and generic subsectors will be more circumspect regarding M&A compared with previous years because many of these companies are saddled with debt and will likely remain on the M&A sidelines. We based our previous negative outlook on the industry mainly on the continued high pace of acquisitions in the pharmaceutical industry. Over the past few years, companies sought out additions to their near-term product pipelines to ensure future growth. As a result, the high EBITDA multiples that quality research and development (R&D) assets required caused their credit profiles to deteriorate. Companies had to forgo their once traditionally very conservative financial policies to bid on the few quality assets available, which resulted in downgrades. We lowered ratings as a result of M&A, including on AbbVie, Teva Pharmaceutical Industries Ltd., and Abbott Laboratories. However, we believe the negative pressure on ratings has lessened due to the factors mentioned above. Recent industry developments President Trump's nomination of Dr. Scott Gottlieb as the next commissioner of the FDA has been largely welcomed by the pharmaceutical industry. A former deputy commissioner under President George W. Bush in 2005 and board member for several pharmaceutical companies, Dr. Gottlieb has expressed a desire to speed up the FDA approval process by lowering regulatory hurdles, a main goal of President Trump and a clear credit-positive for pharmaceutical companies. Dr. Gottlieb has also been a proponent of faster generic drug approvals as a way to lower drug costs, which we believe is a positive for the branded pharmaceutical companies because it helps to defuse some of the drug pricing controversy. However, it would be a mixed to slightly negative development for the generic drug industry. Such a move would make it easier for generic drug makers to get their products to market, but would heighten competition and lead to even more aggressive generic drug price deterioration, a challenge the industry is already facing. Merck & Co. Inc. (AA/Stable/A-1+) received another indication for its immune-oncology franchise, Keytruda, which now is used to treat a variety of cancers, such as head and neck and lung, and recently received approval for non-small cell lung cancer for previously untreated patients. Keytruda is Merck's biggest growth driver, and we project annual sales of the drug to approach $4 billion in 2017, up from $1.4 billion in The latest approvals add to the drug's sales potential. We believe continued sales growth of this immune-oncology drug is key for Merck's growth prospects because the company's near-term product pipeline is relatively light and a number of its major franchises are entering MAY 22,

6 or are already in the decline phases of their lifecycle. In the wake of the clinical trial setback of its flagship immune-oncology drug Opdivo for the first-line treatment of non-small cell lung cancer, Bristol-Myers Squibb Co. appointed a new chief scientific officer. The problems with the clinical trial bolstered the sales outlook of rival Merck's Keytruda and has given newer, competing products, such as Roche's Tecentriq, time to catch up. How Bristol-Myers' strategic direction and R&D priorities shift remains to be seen, especially when it comes to Opdivo and efforts to expand its indications. We see this change as a neutral credit development. Servicer DRI, a Canadian corporation formerly named Drug Royalty Corp. Inc., was founded in It is one of the largest global privately held investment management companies that focuses on the health care industry. DRI evaluates and advises funds acquiring royalty interests in commercialized pharmaceutical products by targeting inventors, universities, hospitals, biotech firms, pharmaceutical companies, and other parties that own royalty interests in pharmaceutical products. DRI's managed funds typically purchases all or a portion of a seller's royalty assets. The royalty assets entitle the product's license holders to a specific percentage of, or a payment based on, the product's sale proceeds. The royalty and the contractual contingent payments are made by the drug marketer or the institution that receives the royalty payments from the marketer. Whether the payments are made to the royalty assets' owner directly from the marketer or through another institution depends on the underlying licensing agreement's terms. DRI employs more than 30 investment professionals and a number of support staff. The investment professionals are broadly divided between: The business development team, which consists of individuals with track records in the pharmaceutical, biotechnology, and investment banking industries with advanced degrees in science, law, and business; and The deal underwriting team, which consists of individuals with legal, scientific, and/or financial backgrounds. Backup Servicer If the servicer resigns or is terminated, Portfolio Financial Servicing Co. (PFSC, the backup servicer) will become the successor servicer and assume the servicer's responsibilities, duties, and liabilities within 60 days. PFSC is expected to receive data files from DRI. The Underwriting Process DRI focuses on developing relationships with royalty assets owners by networking and marketing directly to pharmaceutical and academic communities. DRI maintains this broad network to source potential deals and obtain investment advice. DRI may provide unsolicited offers and approach royalty asset owner directly when targeting investments when DRI does not have an existing relationship. The targeted opportunities can have common traits, including: MAY 22,

7 The related pharmaceutical product must be approved by a regulatory body or there is an expectation that approval will be granted; The drug must be critical for treating an illness or injury; The investment should, in the servicer's opinion, result in an acceptable level of exposure to the intermediaries' credit risk (therefore, DRI may avoid entities that have extremely low credit quality); The drug or technology underlying the investment should be patent-protected and/or other regulatory protection or be nearing patent protection; The drug should be marketed by a sound, strong, well-known marketing company; and The drug should not have serious safety issues that could result in its withdrawal. Once a drug meets the above characteristics, DRI initiates a preliminary due diligence process that includes drafting and negotiating the indicative terms and conditions for the investment. DRI then initiates and completes a comprehensive due diligence process. If the results are positive, DRI will ultimately submit its recommendation to its investment committee for approval. DRI's comprehensive due diligence process begins with a review of industry analysts' sales forecasts for the specific drug. DRI develops its own forecast, which is based on inputs such as patient population, disease incidence and prevalence rates, physician diagnosis practices, and physician treatment practices. DRI runs scenario and discounted cash flow analyses that focus on determining and simulating base-, worst-, and best-case scenarios for the specific drug under consideration. DRI also engages consultants to assist in the development of each drug's forecast and to prepare independent forecasts. DRI performs scientific and competitive due diligence that focus on understanding and validating the appropriate science associated with a product. This process focuses on the drug's safety and efficacy, and competitive products that are in clinical trials or already on the market. The company engages external consultants to assist in the scientific and competitive due diligence process. DRI's legal due diligence process for each drug focuses on the intellectual property associated with the royalty asset and is conducted internally and by external counsel. During the legal process, DRI reviews patent filings, ownership, and any factors (such as litigation) that may affect the patent protection or ownership. After DRI completes the due diligence process, it submits a prospective royalty investment to the DRI investment committee for approval. If the committee approves the transaction, it is submitted to a managed fund's board of directors for consideration. Portfolio Characteristics The collateral supporting the series issuance consists of 12 royalty streams on the 11 patent-protected drugs listed in table 1. Table 1 Collateral Backing Series Product % of portfolio's discounted asset value(i) Keytruda 35.8 Odefsey MAY 22,

8 Table 1 Collateral Backing Series (cont.) Product % of portfolio's discounted asset value(i) Zytiga 13.6 Eylea I 9.6 Stelara 6.8 Simponi 5.2 Eylea II 4.9 Complera 3.4 Edurant 2.8 Ilaris 0.6 Arzerra 0.1 Ampyra(ii) 0.0 (i)discounted asset value as of March 31, 2017, using a discount rate of 7% based on the sales forecast. Values do not add up to exactly 100% due to rounding. (ii)see the Legal Risks Related To Certain Royalties section. The issuer owns cash flows associated with all of these drugs. An affiliate of the issuer had acquired cash flow rights associated with these drugs and transferred these rights to the issuer. Credit Enhancement Credit support for the series transaction is provided by the following: The 41% initial overcollateralization (determined by how much the aggregate discounted asset value exceeds the outstanding notes' principal balance as a percentage of the aggregate discount asset value). An initial reserve account, which will be maintained at the greater of six months' interest or $1 million. The performance-based triggers that result in all cash being accumulated and/or allocated to pay down the notes. One trigger is the supplemental principal payment amount, which allows for the notes to be paid down faster if the notes' outstanding principal balance is higher than 70% of the royalty cash flows' discounted asset value plus the reserve account balance. The discounted asset value is the net present value (NPV) of the consultant royalty forecast, discounted by 7%. An early amortization event will occur if the required debt service coverage ratio is less than 2:1. The required debt service coverage ratio accounts for the coverage multiple of the cash collections versus the payments, including minimum principal, and expenses due on the liabilities each period and on a rolling four-quarter basis. The assets in the pool offer diversity in terms of remaining lifespan, geography, payment frequency, and revenue level (see tables 2-4). Table 2 Years Remaining In The Purchase Agreement's Term(i) Remaining life One year or less More than one year but less than or equal to five years More than five years but less than or equal to seven years Product None. Arzerra, Complera, Edurant, Keytruda, and Odefsey. Ilaris, Simponi, and Stelara. MAY 22,

9 Table 2 Years Remaining In The Purchase Agreement's Term(i) (cont.) Remaining life More than seven years Product Eylea I, Eylea II, and Zytiga. (i)each purchase agreement's remaining term is calculated from March 31, The expected ending dates are based on when key patents or license terms for the relevant products expire. Table 3 Geographic Split Of Royalties % of portfolio's discount value % of 2016 royalties related to U.S. sales Currency exposure hedged Comments Ampyra(i) EUR Ex-U.S. royalties derived from sales in Europe and other countries. Arzerra EUR Ex-U.S. royalties derived from sales in Europe and other countries. Complera EUR Ex-U.S. royalties derived from sales in Europe and other countries. Edurant EUR Ex-U.S. royalties derived from sales in Europe and other countries. Eylea I and II EUR, JPY Ex-U.S. royalties derived from sales in Europe, Japan, and other countries. Ilaris EUR, JPY Ex-U.S. royalties derived from sales in Europe, Japan, and other countries. Keytruda EUR, JPY Ex-U.S. royalties derived from sales in Europe, Japan, and other countries. Odefsey EUR Ex-U.S. royalties derived from sales in Europe and other countries. Simponi EUR, JPY Ex-U.S. royalties derived from sales in Europe, Japan, and other countries. Stelara EUR Ex-U.S. royalties derived from sales in Europe and other countries. Zytiga (ii) EUR, JPY All royalties derived from sales in Europe, Japan, and other countries. (i)see the Legal Risks Related To Certain Royalties section. (ii)all royalties from sales outside the U.S. EUR--Euros. JPY--Japanese yen. Table 4 Revenue Payment Frequency Royalty payment Annual Semiannual Quarterly Product None. Keytruda, and Zytiga. Arzerra, Complera, Edurant, Eylea I, Eylea II, Ilaris, Odefsey, Simponi, and Stelara. Scenario Analysis Modeling All of the royalty assets in the portfolio currently generate royalty revenues from approved drugs or patent-protected technologies. Modeling future royalty revenues for each drug involves examining the current patient populations and penetration rates (the percentage of the potential patient population that actually receives the drug), the related growth and/or decline of those patient populations and penetration rates, the drug's current and expected future dosage MAY 22,

10 levels, and the drug's current and future cost-per-dosage expectations during the transaction's term, as well as currency-exchange and event risks. In our analysis, we stressed future royalty revenues based on each of those factors for each royalty asset and the portfolio (in aggregate). We tested the supplied capital structure that the issuer provided to us using a 'BBB' stress. In our analysis, we did not assume that any of the assets' patent protection will be extended, and we used a number of key inputs for our stress scenario testing, as described below. Base case Each royalty asset has a forecast revenue stream for the remainder of the royalty contract. We derived the forecasts by analyzing data provided by the issuer and an independent consultant (see scenario 1 in the Summary Of Scenario Analysis Cash Flow Results section below for the base-case scenario cash flow results). Stress levels based on prospective credit rating We applied 'BBB' scenario haircuts to the base-case sales forecast. The assumptions integrate feedback from our corporate rating team, which considered current and future competition that resulted from the introduction of new and improved alternative drugs, deteriorating sales, and product obsolescence (see scenario 2 in the Summary Of Scenario Analysis Cash Flow Results section below for the cash flow results utilizing 'BBB' haircuts to the base case with interest rate stresses, and scenarios 3, 5, and 6 for the cash flow results utilizing 'BBB' haircuts to the base case coupled with interest rate, currency or licensee bankruptcy risk). Currency Risk All royalty payments are payable in U.S. dollars, but the products can be sold in other currencies. In other words, if foreign currencies depreciate against the U.S. dollar and the exposure is unhedged, the U.S. dollar sales revenues, and consequently the royalties expected to be received by the issuer, could decrease. The cash flow analysis included depreciating the forward foreign exchange curves for the euro, yen, and all currencies other than the U.S. dollar, per our foreign exchange criteria, "Methodology And Assumptions For Foreign Exchange Risk In Structured Finance," published April 21, The transaction has hedged exposure by entering into multiple currency hedge agreements with Wells Fargo Bank. The currency hedge agreements include one or more series of options, each with a size, an expiration date, and a settlement date corresponding to a portion of the expected royalty-related payments. The options are arranged so the issuer receives funds as the U.S. dollar appreciates against the foreign currencies and hits a series of strike rates. The issuer has already paid all applicable premiums for each currency hedge agreement, and there are no further payment obligations except for the contingent payments if the U.S. dollar depreciates beyond the barrier values. According to S&P Global Ratings' counterparty criteria, the series notes' performance is linked to the issuer credit rating on Wells Fargo Bank. Therefore, if we lower our rating on the counterparty below the ratings on the class A notes, we may also lower the ratings on the notes. Currently, Wells Fargo Bank has a long-term issuer credit rating of 'AA-'. MAY 22,

11 Interest rate risk We ran various LIBOR scenarios along with the LIBOR forward curve during the transaction's life. The interest rate curves are based on the Cox-Ingersoll-Ross (CIR) Interest Rate Model, a stand-alone Excel application that simulates interest rate curves at various confidence levels (expressed as percentages) under multiple predefined scenarios to project future interest rate movements (for more information on the model, see "CIR (Cox-Ingersoll-Ross) Interest Rate Model," published Nov. 3, 2010). After running all five scenarios, we did not see a large fluctuation in the cash flow results depending on the interest rate curve used. In our modeling, we took into account the 3% three-month LIBOR interest rate cap provided by Wells Fargo Bank (see scenario 3 in the Summary Of Scenario Analysis Cash Flow Results section below for the cash flow results stressing interest rate risk). Product Concentration Risk Other risks related to Drug Royalty III L.P. 1's portfolio are a sudden steep drop in sales or the outright withdrawal of the drug from the market due to safety concerns, manufacturing issues, or the launch of newer competing treatments that have significantly better efficacy/side-effect profiles. Any of the above-mentioned risks could lower the royalty cash flow the issuer receives on any of the assets. This transaction has a certain amount of concentration risk in Keytruda and Odefsey. To address this risk within our scenario analysis, we defaulted all Keytruda royalty payments after one year while applying a euro, yen, and rest of the world depreciation stress. This resulted in a 35.6% decline in the NPV of collections in S&P Global Ratings' base case, but still allowed the deal to pay timely interest and ultimate principal (see scenario 4 in the Summary Of Scenario Analysis Cash Flow Results section below for the cash flow results stressing product concentration risk from the base-case assumptions). Bankruptcy Risk With Regard To The Licensee And Licensor The collateral securing the notes includes primarily the rights to receive payments due under patent licenses or other contingent payment agreements, both of which generally can be categorized as executory contracts. Executory contracts are those for which performance remains due from both contracting parties, and a bankrupt party may reject these contracts under the U.S. Bankruptcy Code. If the licensee becomes a debtor in a case under the Bankruptcy Code, it may be able to reject the license agreement, assume the license agreement, or assume and assign the license agreement. If the licensee rejects the license agreement under Section 365(a) of the Bankruptcy Code, the licensee's rights to the licensed intellectual property would terminate, as would its obligation to perform under the license agreement, including its obligation to pay royalty payments under the license agreement. This would cut the royalty stream of cash flows to the issuer. A majority of the licensees are rated investment grade (see table 5). To stress the risk of the license's rejection by the licensee, the cash flow assumptions include a default by all licensees rated 'BBB' and lower, starting one year from the closing date. Consequently, all cash flow associated with products that are solely marketed by these defaulted licensees will be terminated in this stress scenario as of one year from the closing date. Certain royalties related to Ampyra and Eylea are affected by the marketers' default analysis (see the Summary Of Scenario Analysis Cash Flow Results section below). MAY 22,

12 Table 5 Product Marketer/Licensee Product marketer(s) Marketer long-term credit rating(s)(i) Ampyra Arzerra Complera Edurant Eylea Keytruda Odefsey Simponi Stelara Zytiga Ilaris Acorda Novartis Gilead J&J Regeneron(i) Merck Gilead J&J J&J J&J Novartis Biogen J&J Bayer J&J Merck Mitsubishi Tanabe Pharma(ii) Santen Mitsubishi Tanabe Pharma(ii) AstraZeneca NR AA- A AAA AA- AA A AAA AAA AAA AA- A- AAA A- AAA AA A+ A- NR A+ (i)egan-jones Rating. (ii)rated by Japan Credit Rating Agency. J&J--Johnson & Johnson. NR--Not rated. If the licensor files for bankruptcy, for royalty assets directly derived from patent licenses, section 365(n) of the U.S. Bankruptcy Code provides that although the bankrupt licensor can reject intellectual property licenses, the licensee can choose to continue to use the intellectual property under the license and pay the royalties. It is expected that if the sales of and/or profit from the related drug are healthy, the licensee would likely opt to continue using the patent, regardless of the bankrupt licensor's rejection of the license (see scenario 5 in the Summary Of Scenario Analysis Cash Flow Results section below for the cash flow results after terminating all cash flows from unrated licensees; scenario 5 also includes 'BBB' haircuts to the base-case assumptions for all other products). Legal Risks Related To Certain Royalties Acorda, the marketer for Ampyra, has been or is currently involved in patent infringement litigation related to Ampyra with several companies in the U.S. On March 31, 2017, the U.S. District Court for the District of Delaware issued its decision in the consolidated patent litigation. The District Court held that the asserted claims of four of the five listed patents for Ampyra were invalid. The asserted claims of the fifth patent for Ampyra, which expires July 30, 2018, were upheld. As a result of this decision, the discounted asset value for Ampyra is deemed to be $0, per the definition in the transaction documents. However, our base-case analysis gives credit for royalties from Ampyra until mid-2018 because the issuer expects to receive these cash flows until then. We ran a sensitivity test terminating all cash flows from Ampyra (see scenario 7 in the Summary Of Scenario Analysis Cash Flow Results section). Product Correlation Risk Three of the four new drugs added to the collateral pool are Human Immunodeficiency Virus (HIV)-related drugs. All three drugs primarily address similar conditions, and any innovations or changes made in the HIV-related medical arena could affect cash flows from all three drugs. Additionally, HIV-related medication is not used for a long period of time given the nature of the illness treated. We ran a sensitivity analysis terminating all cash flows from these three MAY 22,

13 drugs after the second year to address event risk associated with these drugs (see scenario 8 in the Summary Of Scenario Analysis Cash Flow Results section). Summary Of Scenario Analysis Cash Flow Results We summarize our scenario analysis of the cash flow results in table 6. Table 6 Stress Test Scenarios Scenario Comment Result Scenario 1: base-case revenues Scenario 2: 'BBB' haircuts to base-case revenue Scenario 3: 'BBB' haircuts to base-case revenues plus currency stress and interest rate stress Scenario 4: concentration risk, base-case revenues plus currency stress Scenario 5: licensee bankruptcy (Santen) risk plus 'BBB' haircuts to base-case revenue Scenario 6: licensee bankruptcy (Acorda) risk plus 'BBB' haircuts to base-case revenue Scenario 7: patent litigation risk related to Ampyra, 'BBB' haircuts to base-case Scenario 8: event risk with three related HIV drugs (Complera, Edurant, and Odefsey) Each royalty asset has a forecast revenue stream for the remainder of the royalty contract. The forecasts were derived by looking at different pharmaceutical industry forecasting firms Applied 'BBB' haircuts to revenue streams Applied 'BBB' haircuts to revenue streams, ran the five interest rate scenarios, and depreciated euro, yen, and rest of world currencies Base-case revenues, depreciated euro, yen, and rest of world currencies and terminate all royalties related to Keytruda after year one 'BBB' haircuts to base-case assumptions coupled with the termination of royalties after one year from Japanese sales of Eylea in yen and rest of world currencies 'BBB' haircuts to base case for all products plus termination of royalties from U.S. sales of Ampyra after year one, and depreciated euro, yen, and rest of world currencies. 'BBB' haircuts to base case for all products plus termination of all royalties from Ampyra, and depreciated euro, yen, and rest of world currencies. 'BBB' haircuts to base case for all products plus termination of all royalties from Complera, Edurant, and Odefsey after year two, and depreciated euro, yen, and rest of world currencies. Timely interest and ultimate principal payment on or before the legal final maturity date Timely interest and ultimate principal payment on or before the legal final maturity date Timely interest and ultimate principal payment on or before the legal final maturity date Timely interest and ultimate principal payment on or before the legal final maturity date Timely interest and ultimate principal payment on or before the legal final maturity date Timely interest and ultimate principal payment on or before the legal final maturity date Timely interest and ultimate principal payment on or before the legal final maturity date Timely interest and ultimate principal payment on or before the legal final maturity date After applying each scenario outlined in table 6, the series notes were paid in full at a 'BBB' rating level. Note that the cash flow stress scenarios represent only one factor in our overall credit opinion. Payment Priority If no indenture event of default occurs, which could lead to an acceleration of the notes, the cash flow on the collateral will be allocated on each payment date (see table 7). Table 7 Payment Priority If No Event Of Default Occurs Priority Payment 1 Fees and expenses of the general partner's independent managers, the indenture trustee, and the backup servicer. 2 Servicing fee, successor servicer fee, and transition fee, if applicable. 3 Pro rata, interest on all of the issuer's senior notes and any interest rate net hedge payments. MAY 22,

14 Table 7 Payment Priority If No Event Of Default Occurs (cont.) Priority Payment 4 Pro rata, interest on the senior subordinated notes (none currently). 5 Any deposits to the contingency reserve account. 6 Any deposits to the reserve account, unless an amortization event has occurred. 7 Pro rata among senior notes, the minimum principal payment amount for all senior notes in the series. 8 Pro rata among senior notes, the scheduled principal payment amount for all senior notes in the series, unless an early amortization event has occurred, in which case the senior notes' aggregate outstanding principal balance. 9 Pro rata among senior notes, any supplemental principal payment amount for all senior notes in each series. 10 Pro rata among senior subordinated notes, the scheduled principal payment for all senior subordinated notes (none currently), unless an early amortization event has occurred, in which case pro rata based on the senior subordinated notes' aggregate outstanding principal. 11 Pro rata, any supplemental principal payment amount for any senior subordinated notes in the series (none currently). 12 Pro rata, interest on the subordinated notes in the series (none currently). 13 Pro rata, the scheduled principal payment for all subordinated notes (none currently), unless an early amortization event has occurred, in which case pro rata based on the senior subordinated notes' aggregate outstanding principal. 14 Pro rata, any make-whole payments due. 15 Pro rata, any other amounts due to each hedge counterparty including termination payments. 16 Pro rata, any indemnity amounts and additional expenses due. 17 Any unreimbursed servicer advances. 18 Pro rata, any additional issuer expenses due to the originator and the initial servicer. 19 Any indemnity amounts in connection with the royalty agreements. 20 Any remaining amounts to the issuer. If there is no event of default from the series account, the series notes will be paid in the order of priority shown in table 8. Table 8 Payment Priority If No Event Of Default Occurs Priority Payment 1 Interest due and payable on the series notes, including any interest that remains unpaid from a prior payment date, for distribution to the class A-1 and A-2 noteholders, pro rata. 2 On a pro rata basis, the class A-1 and A-2 minimum principal payment amounts. 3 On a pro rata basis, the class A-1 and A-2 scheduled principal payment amounts due on the payment date for distribution to the class A-1 and A-2 noteholders, respectively; or if an early amortization event occurred, pay the class A-1 and A-2 notes' outstanding principal balance. 4 The series supplemental principal payment amount, if any, with respect to such payment date for distribution to the class A-1 and A-2 noteholders, pro rata. 5 Any make-whole payments due and payable on the class A-1 and A-2 notes with respect to such payment date, pro rata. 6 To the collection account, any remaining amounts in the series series account. Event Of Default Waterfall After a default event has occurred, collections will be distributed in the order of priority shown in table 9. MAY 22,

15 Table 9 Payment Priority After An Event Of Default Occurs And Notes Have Been Accelerated Priority Payment 1 Pro rata, the general partner's independent manager's fees, indenture trustee fees, and the backup servicer fees for the payment date and unpaid amounts plus indemnity to the trustee. 2 Pro rata, the servicing fee, successor servicing fee, if any, and the transition fee. To the successor servicer, all unpaid indemnity amounts and additional expenses up to a total of $250, Pro rata, to the series account for the senior notes of each series, all interest due and payable and any net hedge payment. 4 Pro rata, to the series account for the senior notes of each series, the senior notes' outstanding principal balance. 5 Pro rata, transfer to the series account for each series accrued and unpaid interest due on the senior subordinated notes of the series, including any interest unpaid from a previous payment date. 6 Pro rata, transfer to the series account for each series, as applicable, the senior subordinated notes' outstanding principal balance. 7 Pro rata, transfer to the series account for each series accrued and unpaid interest due on the subordinated notes of the series, including any interest unpaid from a previous payment date. 8 Pro rata, transfer to the series account for each series, as applicable, the subordinated notes' outstanding principal balance. 9 Pro rata, transfer to the series account for each series all make-whole payments on the senior notes of that series. 10 Pro rata, transfer to the series account for each series all make-whole payments on the senior subordinated notes of that series. 11 Pro rata, transfer to the series account for each series, all make-whole payments on the subordinated notes of that series. 12 Pro rata, to the hedge counterparty all amounts, including any termination payments. 13 Pro rata, to each party entitled under the transaction documents (other than the originator, the initial servicer, or any affiliate) any indemnity amounts and any additional expenses due and payable by the issuer; and for the successor servicer, to the extent not paid in item To the servicer, an amount equal to any unreimbursed servicer advances. 15 Pro rata, to the originator, the initial servicer, and any affiliate, any additional expenses due and payable by the issuer to that participant. 16 Pro rata, to each participant entitled to or otherwise in connection with the royalty agreements, any indemnity amounts owed by the issuer. 17 Deposit into the contingency reserve account, any unpaid contingent funding amount. 18 To the issuer, any remaining amounts. If an indenture event of default has occurred, on each payment date the indenture trustee will distribute funds then on deposit in the series series account in the order of priority shown in table 10. Table 10 Payment Priority Upon An Indenture Event Of Default And Notes Have Been Accelerated Priority Payment 1 Pro rata, all interest due on the series notes on the payment date, including any interest that remains unpaid from a previous payment date for distribution to the class A-1 and A-2 noteholders. 2 Pro rata, the class A-1 and A-2 notes' aggregate outstanding principal balances. 3 Pro rata, all make-whole payments on the class A-2 notes. 4 To the collection account, any remaining amounts then on deposit in the series account. MAY 22,

16 Early Amortization Events The transaction documents include the following early amortization events: The forecast royalty amounts, as calculated using the consultant sales forecast, are insufficient to meet the required debt service coverage ratio as calculated based on the rolling four-quarter collections and rolling four-quarter debt service through the stated final maturity date of such last maturing series of notes then outstanding; The failure to meet the required debt service coverage ratio as of any determination date; A servicer default occurs; Any transferred eligible asset no longer satisfies the eligibility criteria, was a nonqualified eligible asset on the date the originator transferred the eligible asset to the issuer, and the originator has not repurchased the nonqualified eligible asset according to the sale agreement's terms; or The issuer fails to make any contingent payment when due, and the nonpayment remains unremedied according to the applicable royalty agreement, or any equity asset's issuer fails to pay according to the purchase agreement. After an early amortization event occurs, the scheduled principal payment amount for each outstanding series of notes will be increased to the then-outstanding principal balance of that series of notes. Events Of Default Each of the following constitutes an event of default (in some cases, after notice and cure period): The issuer fails to pay interest when due, principal payments before the legal final maturity date, any make-whole payment when due, and/or any voluntary or mandatory prepayment amount when due; The issuer files for bankruptcy (voluntary or court-ordered); The issuer becomes an association that is taxable as a corporation; The issuer makes a false representation or warranty that is material; The transaction documents cease to be in full force; The indenture trustee fails to have a first-priority perfected security interest in the collateral; A servicer default has occurred and the servicer has not been replaced with a successor servicer for more than 90 days; The issuer or originator fails to comply with the material covenants and obligations included in the transaction documents; Any event which is an "event of default" under any series of indebtedness issued by the issuer occurs and continues; and One or more judgments are made against the issuer or general partner for more than $100,000 and such judgment is not stayed, paid, or discharged. Surveillance We use surveillance data to perform periodic reviews on all rated pharmaceutical royalty securitizations to identify potential and emerging trends. Our ratings reflect our opinion of the related transaction's ongoing risk profile. Our surveillance group undertakes a number of steps to determine whether the assigned rating continues to reflect our MAY 22,

17 view of the related transaction's performance. These steps include: 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; and Keeping 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 transparency level. We will also continue to provide information on our methodology, ratings, and rated transactions' performance. Related Criteria And Research Related Criteria Criteria - Structured Finance - General: Foreign Exchange Risk In Structured Finance--Methodology And Assumptions, April 21, 2017 General Criteria: Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012 General Criteria: Principles Of Credit Ratings, Feb. 16, 2011 General Criteria: Understanding Standard & Poor's Rating Definitions, June 3, 2009 Legal Criteria: Legal Criteria For U.S. Structured Finance Transactions: Special-Purpose Entities, Oct. 1, 2006 Related Research Global Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016 The S&P Pharma Dose Newsletter: The Pharma Industry Outlook Is Revised To Stable From Negative As M&A Momentum Slows, April 7, 2017 The Rating Outlook for the Global Pharma Sector Remains Negative, Despite Favorable Industry Prospects, April 29, 2016 In addition to the criteria specific to this type of security (listed above), the following criteria articles, which are generally applicable to all ratings, may have affected this rating action: "Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'?," March 23, 2015; "Global Framework For Assessing Operational Risk In Structured Finance Transactions," Oct. 9, 2014; "Methodology: Timeliness of Payments: Grace Periods, Guarantees, And Use of 'D' And 'SD' Ratings," Oct. 24, 2013; "Counterparty Risk Framework Methodology And Assumptions," June 25, 2013; "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," Oct. 1, 2012; "Methodology: Credit Stability Criteria," May 3, 2010; and "Use of CreditWatch And Outlooks," Sept. 14, Analytical Team Primary Credit Analysts: Jay Srivats, San Francisco (1) ; jay.srivats@spglobal.com Yalan Tao, New York ; yalan.tao@spglobal.com MAY 22,