Basis in Abx Tabx Bespoke SF Cdos

Tranche ABX and Basis
Risk in Subprime RMBS

Structured Portfolios
Kevin Kendra
February 20, 2007
Introduction
What are structured subprime RMBS portfolios?

What is basis risk?
Why is basis risk between these structures important
now?
What are structured subprime RMBS portfolios?

>
Portfolio exposure to subprime Residential Mortgage-Backed Securities

(RMBS) can be obtained using various structures:
Structured Finance Collateralized Debt Obligations (SF CDOs)
>
>
>
Cash SF CDOs
Bespoke SF CDOs
Hybrid SF CDOs
ABX.HE Indices
Tranche ABX.HE (TABX) Indices
www.derivativefitch.com
What is basis risk?

>
Basis risk describes the risk that offsetting investments in a hedging strategy
will not experience cash flow or price gains in the same manner.
>
Basis risk has the potential to create an excess gain or loss and therefore is
not directional. The amount of basis risk in a hedging strategy describes the
how much risk is left behind due to imperfect correlation between the two
investments.
>
Basis risk in subprime RMBS portfolios generally arises from:

Performance differences in the underlying portfolio assets
Structural differences in portfolio instruments
Liquidity differences in the different secondary markets
Timing of expected cash flows from the portfolio instruments
Why is basis between these structures important

now?
>
>
Standard tranches of the ABX.HE Index commenced trading on Feb. 14, 2007
Index tranches promise to provide:
Liquidity
Transparency
Standardization
Market Consensus
>
Motivations for TABX participation:

Hedging
Relative Value Trading
Benchmarking
Leveraged Market Positions
Framework for Understanding Basis Risk in

Subprime RMBS Portfolios
>
>
Subprime RMBS 101

Credit Default Swaps on Subprime RMBS
Credit Default Swaps 101
ISDA Pay-As-You-Go Template 101
Subprime RMBS AFC Risk
>
Typical Subprime RMBS Portfolio Structures

Structured Finance CDOs 101
ABX.HE and TABX.HE Indices 101
>
Basis Risk between TABX.HE and Other Structures
Subprime RMBS Overview
Subprime RMBS 101
Subprime RMBS 101

>
Typical Subprime Borrower and Loan Characteristics

FICO credit score 650 and below
Prior mortgage delinquencies are acceptable
Bankruptcy filing within the last 3 to 5 years are acceptable
Foreclosure within the last 3 to 5 years are acceptable
Debt-to-Income (DTI) ratios of 40% or higher
Loan-to-Value (LTV) ratios greater than 80%
Subprime RMBS 101

>
Typical Subprime Loan Types

Hybrid Adjustable-Rate Mortgages (ARMs)
>
2/28 Mortgage is fixed for the first two years and then switches to
adjustable rate for the remaining 28 years
>
Other common Hybrid ARMs 3/27 and 5/25 terms
Hybrid Interest Only (IO) ARMs

40-Year Hybrid ARMs
Piggyback Second Liens
Limited Documentation Loan Programs
Subprime RMBS 101

Sample Subprime RMBS Structure
Mortgage
Pools
Individual Mortgages
REMIC
Trust
RMBS
Bonds
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 M39 M40
M41 M42 M43 M44 M45 M46 M47 M48 M49 M50
M51 M52 M53 M54 M55 M56 M57 M58 M59 M60
Special
Purpose
Vehicle
(RMBS
Trust)
M61 M62 M63 M64 M65 M66 M67 M68 M69 M70
M71 M72 M73 M74 M75 M76 M77 M78 . . .
M
2000
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M31 M32 M33 M34 M35 M36 M37 M38 . . .

M
1000
AA
RMBS
A
RMBS
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
AAA
RMBS
2/28
Hybrid ARM
Mortgage
Pool
Fixed Rate
Mortgage
BBB
RMBS
BBB-
RMBS
Residual
10
Subprime RMBS 101

$P
Sample Subprime RMBS Payments

Monthly Mortgage
Payments
$I
REMIC
Trust
Accounts
Interest
Payments
Principal
Payments
Scheduled
Principal
&
Prepayments
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 M39 M40
AAA
L + % or Net WAC
M41 M42 M43 M44 M45 M46 M47 M48 M49 M50
$I
M51 M52 M53 M54 M55 M56 M57 M58 M59 M60
AAA
Interest
Servicer
M61 M62 M63 M64 M65 M66 M67 M68 M69 M70
M
2000
AA
L + % or Net WAC
AA
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
A
L + % or Net WAC
BBB
L + % or Net WAC
BBB
BBB-
L + % or Net WAC
BBB-
Residual
Excess Interest
Residual
M71 M72 M73 M74 M75 M76 M77 M78 . . .
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 . . .
M
1000
$
$P
Scheduled
Principal
&
Prepayments
11
Subprime RMBS 101

>
Standard Structural Features of Subprime RMBS

Subordination serves as credit enhancement to account for credit risk
Interest rate instruments to hedge interest rate risk
Performance test at three year mark
>
If test fails then the priority of payments remains unchanged with the
senior notes receiving all principal proceeds
>
If test passes then principal proceeds repays subordinated notes until

targeted subordination is met.
Defaulted loans worked out by servicers
>
Each Subprime RMBS will have somewhat unique performance profiles
12
Subprime RMBS 101

Principal Waterfalls
Sequential pay
>
All scheduled principal and prepayments go to repay the senior bond holders
first until paid-in-full, then to the next senior note holder, etc.
>
Subprime RBMS are initially sequential pay for the first three years and will
remain sequential pay if the performance tests fail
Credit Enhancement (CE) Step Downs, if performance tests pass
>
If overcollateralization (OC) targets have been met, the CE is stepped down by

repaying subordinate bond holders.
>
OC targets are set to double the original subordination, ie. If the original AAA
bond subordination is 7.5% then the target is 15%
>
Test senior note target for compliance first and if passing then check the next
senior bond and so on.
>
Over periods of rapid prepayments all bonds may be meeting the OC targets,
then principal prepayments become inverse sequential pay.
13
Sample Principal Waterfalls

Scenario 1: Sequential Principal Repayment
Scenario 2: Performance Test Passes the Credit

Enhancement Steps Down by Paying Principal
to Subordinated Notes
$P
$P
Accounts
Scheduled
Principal
&
Prepayments
Principal
Payments
Payments
Before Step Down
Accounts
Principal
Payments
Scheduled
Principal
&
Prepayments
Payments
Before Step Down
After Step Down
AAA
AAA
AA
A
BBB
BBB-
Residual
AA
A
BBB
BBB-
After Step Down
Residual
14
Subprime RMBS 101

Interest Waterfalls
Regular interest
>
Paid sequentially to bonds, capped at weighted average mortgage

rate net of expenses (Net WAC) or available funds cap (AFC)
Excess Interest
>
Excess interest is the remaining interest proceeds in the interest

collection account after paying bondholders regular interest above
>
>
First, excess interest is used to recover realized collateral losses
>
Finally, the remaining excess interest goes to the residual bond holder
Second, excess interest is used to recover any interest shortfalls

created where Net WAC is lower than the stated bond coupon
15
Sample RMBS Interest Waterfall

Step 1 Interest
Paid Sequentially
to Bonds, Capped
at AFC
Step 2 Excess
Interest to
Cover Collateral
Losses
Step 3 Remaining
Excess Interest to
Pay AFC Shortfalls
Interest
Payments
Principal
Payments
Interest
Shortfalls
$I
Accounts
Scheduled
Principal
&
Prepayments
AAA
L + % or Net WAC
AAA
Interest
AA
L + % or Net WAC
AA
A
L + % or Net WAC
BBB
L + % or Net WAC
BBB
BBB-
L + % or Net WAC
BBB-
Residual
Excess Interest
Residual
Losses
L + % - Net WAC
L + % - Net WAC
Step 4 Remaining
Excess Interest to
Residual Holder
16
Subprime RMBS 101

AFC Interest Shortfall
AFC Shortfall is the difference between the stated bond coupon and the
Net WAC
AFC Shortfalls accrue over time and may be recoverable
AFC Shortfalls manifest themselves in times of rising interest rates
>
>
Typical subprime RMBS deals have 75% hybrid ARM mortgages
>
If short-term LIBOR interest rates rise during the 2- or 3-year fixed rate
period then the interest coupon from the mortgages is insufficient to
pay the RMBS bond holders LIBOR plus the stated spread
RMBS bonds are generally floating rate bonds based on the London
InterBank Offering Rate (LIBOR)
AFC shortfalls may be unrecoverable if excess interest is eroded.
17
Credit Default Swaps on Subprime

RMBS
Credit Default Swaps (CDS) 101
ISDA Pay-As-You-Go (PAUG) Template 101

Protection Seller
Receives CDS premium payment and reimbursement payments in
exchange for providing protection payments if a credit event occurs.
CDO note holders are protection sellers in a synthetic CDO.
Protection Buyer
Pays CDS premium in exchange for protection payments if a credit event
occurs.
CDS Swap Counterparty is the protection buyer in a synthetic CDO.
Calculation Agent
Determines the amount of the protection payment upon a credit event per
the terms of the credit default swap
Usually the Protection Buyer serves this role
19

Collateral or Eligible Investment
Highly rated, highly liquid financial instruments purchased from the sales
proceeds of the initial CDO notes.
Provides the index portion of the note coupon
Provides protection payments or the return of principal to note holders
Reference Entity and Reference Obligation
Reference entities are security issuers like a corporation or sovereign
Reference obligations are securities with specific debt seniority levels
>
Reference obligations in a corporate CDS is usually informational to

establish the seniority of debt to be valued if a credit event occurs
>
Reference obligations in CDS of structured finance assets or

leveraged loans or in total return swap structures
20

Sample Credit-Linked Note (CLN) using a CDS
Protection
Buyer
CDS Premium
(bps)
CDS Swap
Counterparty
Credit Default
Swap
Credit-Linked
Note Trust
LIBOR
(L)
Protection
Seller
CLN Proceeds
($)
Protection
Payments ($)
Reference
Entity or
Obligation
Note Coupon
(L + bps)
Protection
Seller
CLN
Proceeds
($)
Collateral or
Eligible
Investments
21

Credit Events
Applicable credit events will vary by CDS
Typical credit events may include:
>
>
>
>
>
Bankruptcy
Failure to Pay (FTP)
Restructuring
Repudiation/Moratorium, usually emerging markets and sovereigns only
Obligation Acceleration, usually emerging markets sovereigns only
Once a credit event has been called and settled then the credit default swap
is terminated
22

Settlement and Valuation Procedures
Protection Buyer calls a credit event by sending notice to the Protection
Seller what credit event has occurred
Settlement method is determined by the CDS contract
>
Physical settlement means the Protection Buyer gives the Seller the
reference obligation, or equivalent, in return for cash par amount
>
Cash settlement means the parties look to the market value of the
reference obligation to determine the net protection payment
Fitchs preferred valuation process includes:
>
>
Dealer poll of at least 5 dealers, not including the Protection Buyer

Polls typically held 30 to 60 days after credit event notification
23

>
ISDA PAUG template is designed to replicate the cash flow profile of the cash
bond with a credit default swap (CDS) contract
>
CDS contracts for corporate and sovereign issuers are insufficient to replicate
the payment profile of a structured finance bond
>
ISDA PAUG template was introduced in the U.S. in XXXX 2005 for RMBS and
CMBS securities for CDO securities in June 2006
>
Introduces the concept of floating payments

Floating payments are paid by the Protection Seller in the event of an AFC
Interest Shortfall
Floating payments may be reimbursed by the Protection Buyer if the AFC
Interest Shortfall is ultimately recovered
24

Sample CLN using a PAUG CDS
Floating
Payments
Protection
Buyer
CDS Premium
(bps)
CDS Swap
Counterparty
Credit Default
Swap
Credit-Linked
Note Trust
LIBOR
(L)
Protection
Seller
CLN Proceeds
($)
Protection
Payments ($)
Reference
Obligation
Note Coupon
(L + bps)
Protection
Seller
CLN
Proceeds
($)
Collateral or
Eligible
Investments
25

PAUG Credit Events
Failure to Pay (FTP) Principal
Writedown
Distressed Rating Downgrade (CCC or below)
FTP Interest for CDO reference obligations only
PAUG Floating Amount Events
Interest Shortfalls
Principal Shortfalls
Writedown Amounts
>
Protection Buyers typically have an option whether to call a credit event or a

floating amount event
26

PAUG Settlement
The secondary market for structured finance securities is not liquid and
therefore valuation procedures are not applicable
Floating payments are designed to replicate the actual loss amounts
If a credit event occurs then the Protection Buyer has the option to physically
deliver all or part of the notional amount to the Seller
>
>
If the entire notional is physically settled then the CDS is terminated

If a portion of the notional is settled then the CDS continues on the
remaining amount
27

Interest Shortfalls
RMBS reference obligations are called AFC shortfalls
CMBS reference obligations are called WAC shortfalls
CDO reference obligations are called PIK-ing shortfalls
Interest Shortfall Cap Options

Fixed Cap: Floating payments are limited to the amount of the CDS premium
Variable Cap: Floating payment are limited to LIBOR + premium
No Cap: No limit to the floating rate payments
>
>
Completely replicates the payments of the cash bond or total return swap
May require principal to be liquidated to pay interest shortfall
28

>
Available Funds Cap (AFC) Risk

REMIC law limits a floating rate RMBS bond pass-through rate to the
lesser of:
>
>
Bond spread plus some index (typically 1 month LIBOR), or

Underlying mortgage collateral pools weighted average coupon, net
of expenses (Net WAC).
AFC Risk varies by RMBS transaction based on:
>
>
>
Actual prepayment speeds of underlying mortgages

Effectiveness of interest rate hedges in the RMBS structure
Short-term interest rate increases before Hybrid ARM mortgages
switch to floating interest rate payments
29

>
>
Unrecovered AFC Interest Shortfalls can be prevalent by vintage

Unrecovered AFC Interest Shortfalls can be present across all rating categories
30
Key Risks AFC Risk

>
>
Unrecovered AFC Interest Shortfall amounts have been small

Difference in CDS premium required for No Cap protection may exceed the
actual unrecovered AFC interest shortfalls experience in the cash bond market
31
Subprime RMBS Portfolio

Structures
ABX.HE and TABX.HE 101

>
Generic Types of SF CDOs

Cash SF CDOs
Bespoke SF CDOs
Hybrid SF CDOs
33

Sample Cash SF CDO Structure
CDO
Trust
CDO Portfolio
RMBS RMBS RMBS RMBS
Bond 1 Bond 2 Bond 3 Bond 4
RMBS
Bond 5
RMBS RMBS RMBS RMBS RMBS

Bond 6 Bond 7 Bond 8 Bond 9 Bond 10
Note Coupon
(L + bps)

Bond Coupons
(L + bps)

RMBS RMBS RMBS
Bond 36 Bond 37 Bond 38
...
CDO
CDO
CDO
CDO
RMBS
Bond 80
CDO
Bond 5
CDO
CDO
CDO
CDO
CDO
CDO
Bonds
Proceeds
($)
Special
Purpose
Vehicle
(CDO
Trust)
AAA
CDO
Proceeds
($)
AA
CDO
A
CDO
BBB
CDO
Preferred Shares
or Equity
34

>
Cash SF CDO Asset Portfolio Highlights

Portfolios contain between 60 and 140 bonds
Assets may be diversified by market sector, however recent vintage SF
CDOs have been concentrated in subprime RMBS
Assets may be diversified by risk profile (intial ratings)
Assets may be diversified by vintage
Asset acquisition and selection
>
>
Asset manager warehouses bonds prior to issuing CDO notes
>
Initial portfolio is typically fully ramped within 6 months of CDO note

issuance
CDO notes typically issued when asset manager has accumulated

approximately 60-80% of the target portfolio
35

>
Managed vs Static Portfolios

Static portfolios are typically fully ramped at closing and principal proceeds
are used to amortize the senior notes
Managed portfolios are typically partially ramped at closing and principal
proceeds are typically reinvested for a finite period between 3 and 6 years
>
If the portfolio experiences negative credit migration then discretionary

trading is limited to maintain or improve credit quality
>
If the portfolio significantly under performs then the transactions may

shift to a static portfolio
36

>
Cash SF CDO Note Highlights

Credit enhancement comes from subordination and excess spread
Interest is paid sequentially to note holders
Overcollateralization (OC) and Interest Coverage (IC) performance tests
are checked prior to distributions to subordinate notes
Excess interest may be used to:
>
>
>
If tests are passing then distributed to Preferred Shares or Equity

A portion may be used to repay mezzanine notes
If tests are failing then distributions may be used to cure the tests
Purchase new assets
Pay down senior notes
37

Sample Bespoke SF CDO Structure
CDO
Trust
Reference Portfolio
RMBS RMBS RMBS RMBS
CDO
Structure
RMBS
Bond 5

CDS
Premium
Unfunded
Super-Senior
Revolver
Special
Purpose
Vehicle
(CDO
Trust)
CDS Swap
Counterparty
Protection
Payments
Note
Coupon
(L + bps)

RMBS RMBS RMBS
...
Proceeds
($)
RMBS
Bond 80
LIBOR
(L)
Unfunded
CDS
AAA
Note
First Loss
Unfunded
CDS
Proceeds
($)
Collateral or
Eligible
Investments
38

>
Bespoke SF CDO Asset Portfolio Highlights

Portfolios reference between 60 and 100 securities
Assets may be diversified by market sector but typically have a
concentration in subprime RMBS
Assets may be diversified by risk profile (initial ratings
Assets may be diversified by vintage
Asset selection
>
Portfolio is negotiated between the Bespoke CDO note holder and the
CDS Swap counterparty
39

>
Bespoke SF CDO Note Highlights

Attachment points define the amount of portfolio losses the structure
needs to sustain before a protection payment would be made
Detachment point defines the maximum amount of protection payments
that the notes could be required to make
Credit enhancement comes solely from subordination
40

Sample Hybrid SF CDO Structure
CDO
Trust
CDS Portfolio
RMBS
CDS 1
RMBS
CDS 2
RMBS
CDS 3
RMBS
CDS 4
RMBS
CDS 5
RMBS
CDS 6
RMBS
CDS 7
RMBS
CDS 8
RMBS
CDS 9
RMBS
CDS 10
CDS Premium
CDO
Structure
CDS Premium

CDS 11 CDS 12 CDS 13 CDS 14 Bond 15
RMBS RMBS RMBS
CDS 16 CDS 17 CDS 18
CDO
CDS 1
CDO
CDS 2
CDO
CDS 3
...
RMBS
CDS 20
CDO
CDS 4
CDO
CDS 5
Special
Purpose
Vehicle
(CDO
Trust)
Bond Portfolio
RMBS RMBS RMBS RMBS
RMBS
Bond 5

Super-Senior
Protection
Payments
Protection
Payments
Note Coupon
(L + bps)
...
CDO
CDO
CDO
CDO
RMBS
Bond 20
CDO
Bond 5
Unfunded
CDS
AAA
CDO
AA
CDO
Bond Coupons
(L + bps)
A
CDO

RMBS RMBS RMBS
Unfunded
Super-Senior
Revolver
BBB
CDO
Proceeds
($)
Proceeds
($)
Funded
Notes
Preferred Shares
or Equity
41

>
Hybrid SF CDO Asset Portfolio Highlights

Portfolio assets may be in a cash or synthetic form
Portfolios contain between 60 and 140 bonds or CDS
Asset attributes similar to the cash SF CDO portfolios
Portfolios are typically managed
>
Asset managers can find relative value on the same asset between
cash and synthetic markets
>
Asset managers can use the synthetic market to access collateral

from vintages that are not available in the secondary market
>
Asset managers can use the synthetic market to get full exposure to
cash bonds where they received a partial allocation
42

RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS
10
8
9
4
6
7
11
2
3
5
1
...
RMBS
20
AAA
RMBS
AAA
RMBS
AAA
RMBS
AAA
RMBS
AAA
RMBS
AAA
RMBS
AAA
RMBS
AAA
RMBS
AAA
RMBS
AAA
RMBS
AAA
RMBS
...
AAA
RMBS
ABX.HE.AAA
AA
RMBS
AA
RMBS
AA
RMBS
AA
RMBS
AA
RMBS
AA
RMBS
AA
RMBS
AA
RMBS
AA
RMBS
AA
RMBS
AA
RMBS
...
AA
RMBS
ABX.HE.AA
A
RMBS
A
RMBS
A
RMBS
A
RMBS
A
RMBS
A
RMBS
A
RMBS
A
RMBS
A
RMBS
A
RMBS
A
RMBS
...
A
RMBS
ABX.HE.A
BBB
RMBS
BBB
RMBS
BBB
RMBS
BBB
RMBS
BBB
RMBS
BBB
RMBS
BBB
RMBS
BBB
RMBS
BBB
RMBS
BBB
RMBS
BBB
RMBS
...
BBB
RMBS
ABX.HE.BBB
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
BBB-
RMBS
...
BBB-
RMBS
ABX.HE.BBB-
...
Residual
Residual Residual Residual Residual Residual Residual Residual Residual Residual Residual Residual
43

>
ABX.HE Asset Portfolio Highlights

Portfolios reference 20 bonds
Assets are all subprime RMBS
Assets are homogenous by risk profile (intial ratings)
Assets are originated in a 6 month time frame
Asset selection
>
>
>
Aggregate a list of the largest volume subprime RMBS issuers

Select two representative transactions from each issuer
Index participants vote on transactions to be included in each index
44

TABX.HE.BBB
Reference Obligations
TABX.HE.BBB
Tranches
ABX.HE.BBB ABX.HE.BBB
06-2 Portfolio 07-1 Portfolio
BBB
RMBS 1
BBB
RMBS 1
BBB
RMBS 2
BBB
RMBS 2
BBB
RMBS 3
BBB
RMBS 3
BBB
RMBS 4
BBB
RMBS 4
BBB
RMBS 5
BBB
RMBS 5
BBB
RMBS 6
BBB
RMBS 6
BBB
RMBS 7
BBB
RMBS 7
BBB
RMBS 8
BBB
RMBS 8
.
.
.
.
.
.
BBB
RMBS 20
BBB
RMBS 20
35 100%
20 35%
12 20%
7 12%
3 7%
0 3%
45

>
TABX.HE Asset Portfolio Highlights

Portfolios reference 40 bonds from two ABX.HE indices
Assets are all subprime RMBS
Assets are homogenous by risk profile (intial ratings)
Assets are originated in a one year time frame
46
Conclusions
ABX.HE and TABX.HE Conclusions

>
The ABX.HE has proven to be effective in providing market transparency in an

otherwise opaque market
Allows market participant to express market views
>
The TABX.HE promises to provide similar benchmarking and relative value

views for the Bespoke SF CDO market
>
TABX.HE will be less effective in benchmarking for cash and hybrid SF CDOs
Portfolios have significantly different portfolio characteristics
Portfolios are typically managed in SF CDOs
TABX.HE is equally weighted by the largest issuers whereby SF CDOs
portfolios are typically selected by an asset manager
48
New York
One State Street Plaza
New York, NY 10004
Tel. +1 212 908 0500
London
101 Finsbury Pavement
London EC2A 1RS
Tel. +44 (0) 20 7862 4000
Hong Kong
Suite 3902, Tower Two, Lippo Centre
89 Queensway, Hong Kong
Tel. +852 2263 9963

Basis in Abx Tabx Bespoke SF Cdos

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Tranche ABX and Basis

Risk in Subprime RMBS

What are structured subprime RMBS portfolios?

What are structured subprime RMBS portfolios?

Portfolio exposure to subprime Residential Mortgage-Backed Securities

What is basis risk?

Basis risk in subprime RMBS portfolios generally arises from:

Why is basis between these structures important

Motivations for TABX participation:

Framework for Understanding Basis Risk in

Subprime RMBS 101

Typical Subprime RMBS Portfolio Structures

Basis Risk between TABX.HE and Other Structures

Subprime RMBS Overview

Subprime RMBS 101

Subprime RMBS 101

Typical Subprime Borrower and Loan Characteristics

Subprime RMBS 101

Typical Subprime Loan Types

Other common Hybrid ARMs 3/27 and 5/25 terms

Hybrid Interest Only (IO) ARMs

Subprime RMBS 101

M31 M32 M33 M34 M35 M36 M37 M38 . . .

Subprime RMBS 101

Sample Subprime RMBS Payments

M71 M72 M73 M74 M75 M76 M77 M78 . . .

Subprime RMBS 101

Standard Structural Features of Subprime RMBS

If test passes then principal proceeds repays subordinated notes until

Defaulted loans worked out by servicers

Each Subprime RMBS will have somewhat unique performance profiles

Subprime RMBS 101

Credit Enhancement (CE) Step Downs, if performance tests pass

If overcollateralization (OC) targets have been met, the CE is stepped down by

Sample Principal Waterfalls

Scenario 2: Performance Test Passes the Credit

After Step Down

Subprime RMBS 101

Paid sequentially to bonds, capped at weighted average mortgage

Excess interest is the remaining interest proceeds in the interest

First, excess interest is used to recover realized collateral losses

Second, excess interest is used to recover any interest shortfalls

Sample RMBS Interest Waterfall

Subprime RMBS 101

Typical subprime RMBS deals have 75% hybrid ARM mortgages

AFC shortfalls may be unrecoverable if excess interest is eroded.

Credit Default Swaps on Subprime

Credit Default Swaps 101

Credit Default Swaps 101

Reference obligations in a corporate CDS is usually informational to

Reference obligations in CDS of structured finance assets or

Credit Default Swaps 101

Credit Default Swaps 101

Credit Default Swaps 101

Fitchs preferred valuation process includes:

Dealer poll of at least 5 dealers, not including the Protection Buyer

ISDA Pay-As-You-Go (PAUG) Template 101

Introduces the concept of floating payments

ISDA Pay-As-You-Go (PAUG) Template 101

ISDA Pay-As-You-Go (PAUG) Template 101

Protection Buyers typically have an option whether to call a credit event or a

ISDA Pay-As-You-Go (PAUG) Template 101

If the entire notional is physically settled then the CDS is terminated