hard · Asset-Backed Securities
Two equipment-lease ABS pools are identical in WAC, term, and expected default rate, but Pool A's leases carry large contractual residual values (lessee may walk at maturity) while Pool B's are full-payout (no residual). Modeling both with the same default and recovery assumptions, the residual structure of Pool A most critically requires the analyst to:
- Model residual realization as a separate, equipment-value-driven cash flow whose shortfall is a loss even with zero lessee defaults, because the booked residual may not be recovered at lease end
- Apply a higher default probability to Pool A, since lessees with a walk-away option default more frequently during the lease term
- Discount Pool A's cash flows at a higher rate because residual cash flows are subordinated within the trust waterfall
- Treat Pool A's residual as a guaranteed balloon payment, since the lessee is contractually obligated to purchase the equipment at the stated residual
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