THINKING ABOUT NON-AGENCY RMBS CREDIT

September 2009
STRICTLY PRIVATE AND CONFIDENTIAL

John Sim (212) 834-3124 john.sim@chase.com Abhishek MistryAC (212) 834-4662 abhishek.a.mistry@jpmorgan.com

Agenda
Page The originate to distribute model pre-2008 1

Boom and bust

8

Key terminology

13

Loss Fundamentals

19

THINKING ABOUT NON-AGENCY RMBS CREDIT

Government steps in

28

Re-REMICS: Restoring the securitization market?

41

1

Securitization
Securitization – the process of pooling mortgage loans and converting them into packages of securities with various credit ratings.

Originators sell whole loans (packages via a flow program) to a Wall Street Dealer or directly into a trust, Trust issues rated, registered securities, which the dealer distributes to investors acting as securities underwriter,
THE ORIGINATE TO DISTRIBUTE MODEL PRE-2008

AAA rating is achieved through senior/subordinate structure, whereby a portion of the pool is subordinated to the rest with respect to realized losses, Dealer works with investors to structure various cash-flows to meet investor needs and requirements (reverse inquiry), Trust receives cash flows from underlying loans and distributes monthly to investors according to distribution rules, Dealers provide secondary trading liquidity, valuation and analysis.

2

Standard securitisation technology
Represent ownership interest in a pool of assets sold by originators into a special purpose vehicle Are typically secured by homogeneous assets with relatively predictable cash flows Repayment of debt is derived from cash flow generated by the underlying assets Assets are legally separated from the seller/servicer, limiting investor exposure to the seller/servicer Credit enhancements are applied to cash flows to create tailored credit ratings

THE ORIGINATE TO DISTRIBUTE MODEL PRE-2008

Illustrative diagram Illustrative diagram Structured finance securities Structured finance securities Monthly principal & interest payments Assets Mortgages Pools/Loans Seller/servicer Banks Finance Co Vehicle Master Trust REMIC Credit enhancement Internal Excess spread Subordination Reserve fund Spread account Overcollateralisation External Insurance Payout events/ performance triggers

“True sale”

investors

3

A typical prime non-agency CMO structure
Class Size (% of collateral) Credit Support (% of collateral)

96.50 %

3.50 %

AAA

Seniors

Mortgage
THE ORIGINATE TO DISTRIBUTE MODEL PRE-2008

Pool
1.50 % 0.70 % 0.40 % 0.40 % 0.30 % 0.20 %
Source: JP Morgan Securities Inc.

2.00 % 1.30 % 0.90 % 0.50 % 0.20 % 0.00 %

AA A BBB

AA

Investment Grade Subordinates NonInvestment Grade Subordinates

BBB-

BB B NR

4

the bond will de-lever as the senior bond pays down faster than subordinates Many Alt-A deals featured excess spread (interest received from mortgage payments is greater than debt interest payable).Additional protection: lockout and over-collateralization Subordinate bonds are typically locked out of principal payments for a number of years (three years on average. but can be affected by delinquency triggers) Senior bonds will receive a disproportionate amount of prepayments Over time. This amount is added to a reserve account called overcollateralization (OC) that serves as a buffer against losses THE ORIGINATE TO DISTRIBUTE MODEL PRE-2008 AAA Mortgage Pool AA A BBB BBOC 5 .

money managers. 38% Bank/ GSE. pension funds and money managers B-piece buyers 2005 Participation by Investor Type 2005 Participation by Investor Type IO AA A BBB BBBTHE ORIGINATE TO DISTRIBUTE MODEL PRE-2008 Hedge Fund. hedge funds.Who invested in Securitized Products? Typical buyers by bond ratings Typical buyers by bond ratings Class rating AAA Typical buyers Insurance companies. insurance companies. government sponsored entities and banks Insurance companies and hedge funds Money managers and insurance companies CBO/CDO issuers. 10% Other. 24% BB B NR Money Manager. pension funds. 25% 6 . 3% Insurance/Pe nsion Fund.

40 % 0.Credit support example Thickness (% of collateral) Credit Support (% of collateral) Suppose 1% of the pool defaults next month.50 % 0.30 % 0.00 % M1 B1 B2 AA What if losses next month are 150bps? If lifetime losses are 500bps.20 % 0.50 % 3.40 % 0. resulting in 40bps of losses.50 % 1A1 THE ORIGINATE TO DISTRIBUTE MODEL PRE-2008 1.00 % 1.20 % Source: JP Morgan Securities Inc. Which tranches are written down? 96. 2.50 % 0. which tranches are eventually written down? BBB- B3 B4 B5 Credit Waterfall 7 .90 % 0.30 % 0.70 % 0.

Agenda Page The originate to distribute model pre-2008 1 Boom and bust 8 Key terminology 13 Loss Fundamentals 19 THINKING ABOUT NON-AGENCY RMBS CREDIT Government steps in 28 Re-REMICS: Restoring the securitization market? 41 8 .

400 1. 2000-present Gross issuance of non-agency RMBS.000 800 600 400 200 0 2000 Subprime ARM Subprime Fixed Option ARM Alt-A Hybrid Alt-A Fixed Prime ARM Prime Fixed Zero issuance in 2009 64 63 62 61 60 1968 1973 1978 1983 1988 1993 1998 2003 2008 2001 2002 2003 2004 2005 2006 2007 2008 BOOM AND BUST Source: JPMorgan.200 Gross Issuance ($ bn) 1. Loan Performance. 2000-present Homeownership rate (%) soared to historic highs Homeownership rate (%) soared to historic highs 70 69 68 67 66 65 1. US Census 9 2009 .Affordability products exploded during the housing boom as originators scrambled to gain market share Gross issuance of non-agency RMBS.

The credit crisis started with delinquencies growing faster than expected… Subprim e ARM DQ60+ (%CB) 60 2007 2006 50 2005 2004 40 DQ60+ Pct 2003 Alt-A ARM DQ60+ (%CB) 45 40 35 30 DQ60+ Pct 25 20 15 10 5 2007 2006 2005 2004 2003 30 20 10 0 0 10 20 30 40 WALA 50 60 70 80 0 0 10 20 30 40 WALA 14 12 10 Prim e ARM DQ60+ (%CB) 2007 2006 2005 2004 2003 50 60 70 80 Underwriting standards expanded each year BOOM AND BUST DQ60+ Pct 8 6 4 2 0 0 10 20 30 40 WALA 50 60 70 80 10 .

vs S&P 500 index and vs JPM Global High Yield index Prime AAA fixed-rate prices (2006/2007 originations).Non-agencies plummeted along with other assets Prime AAA fixed-rate prices (2006/2007 originations). vs S&P 500 index and vs JPM Global High Yield index 105 100 95 90 85 80 75 70 65 60 55 Fe b 08 Aug 08 Prime Px S&P 500 Index 15 00 14 00 13 00 12 00 1100 10 00 90 0 80 0 70 0 60 0 105 100 95 90 85 80 75 70 65 60 55 Feb 08 Aug 08 Prime Px JPM Glo bal HY Index 280 270 260 250 240 230 220 210 200 190 180 Feb 09 Aug 09 Feb 09 A ug 09 BOOM AND BUST Source: JPMorgan 11 .

FICO 740.Sep 09 Prime and Alt-A prices. $100 origination.5% WAC . Full Doc 6.Sep 09 Economics of Securitization Economics of Securitization 6. LTV 60. Jan 08 . LTV 60. $100 origination.5% WAC . FICO 740. Full Doc Price 100 Yield 80 AAA 97-00 6% 60 Prime Alt-A 40 Jan-08 May -08 Sep-08 Jan-09 May -09 10% Subordination Required Mezz 70-00 20% No buyers other than distressed bid BOOM AND BUST $94-10 execution Source: JPMorgan 12 . Jan 08 .Issuance stopped in 2008 as execution became prohibitive Prime and Alt-A prices.

Agenda Page The originate to distribute model pre-2008 1 Boom and bust 8 Key terminology 13 Loss Fundamentals 19 THINKING ABOUT NON-AGENCY RMBS CREDIT Government steps in 28 Re-REMICS: Restoring the securitization market? 41 13 .

Loan modification Bank takes possession Home is sold Current KEY TERMINOLOGY 30 60 90 F/C REO 14 .Key Terms Delinquency: 30day. Essentially. Prime tends to use MBA while non-prime tends to use OTS. 90day. a borrower that misses one payment is current under the OTS method and 1month delinquent under the MBA method. Foreclosure. 60day. OTS: a borrower is considered 30days delinquent that month if payment is not made by the end of business of next month’s due date. Real Estate Owned (REO) Borrower has missed (or late) payments Two conventions: MBA and OTS MBA: a borrower is considered 30days delinquent that month if payment is not made by the end of business one day prior to the due date.

Voluntary Speed / Constant Repayment Rate (CRR) – Annualized rate of non-default related prepayments (eg. Often. turnover) KEY TERMINOLOGY 15 . 120days past due or in foreclosure/REO process Liquidation – home is sold and proceeds are returned to investors CDR: much like CPR. servicers may advance principal and/or interest payments to the Trust.Key Terms (continued) Default – Generally. is defined as the annualized default rate. Loss Severity – Once the property is liquidated. curtailments. the percent of balance not recovered is quoted as a “Severity %” Recovery Lag – Time from default to liquidation Servicer Advancing – During the recovery process. a certain amount of principal is recovered.

thus providing a level of insurance to the senior bond KEY TERMINOLOGY 16 . Front DTI is the ratio of mortgage payment plus property tax to monthly income 60+ DLQ – Percent of loans in a pool that are 60 days or more delinquent. The credit enhancement is the percentage of the deal which is junior to a given bond. including loans in foreclosure or are real estate owned Credit Support or Credit Enhancement (C/E) – Level of insurance against losses provided by subordination. This is the ratio of loan balance to home price FICO – A borrower credit score based on a system developed by Fair Isaacs DTI – Debt to income. and hence will absorb losses first Senior bond – in a non-agency CMO.Key Terms (continued) LTV – Loan to value. a bond that incurs losses only after other bonds in the deal have been written down to zero Mezzanine or subordinated bond – A bond that incurs losses before senior bonds.

76 4.2 4.5 742 KEY TERMINOLOGY At 60% Severity 0 CPR 9.82% 5 CPR 11.85% 8.0 0.0 60+ Orig LTV Lim Doc FICO 10.33% 16.9 1 CDR 6.7 7.3 0.2 15.6 0 CDR 0.34% 11.77% 10.7 1.2 0.0 11.2 19.20 6.23 3.7 3 CDR 15.34% 13.62% 11.82% 12.50% 9.22 5.68% 20 CPR 17.0 2.5 0.3 11.32% 7.28 4.2 10.2 1.5 9.36 10.9 3.64% 9.81% 17.52 4.45 3.6 9.36% 10 CPR 13.31 5.5 14.8 4.88% Orig C/E Hist 3M CRR Hist 3M CDR 18.13 7.34% 18.12% 12.86 16.40% 15.05 8.34 6.34% 15.24 10.9 6.9 68.92 9.06% 13.5 7.59 4.21 11.17 7.15 13.92% 17.54 5.1 7 CDR 26.0 1. 6.98 6.56% Yield Avg Life Proj Cum Yield Avg Life Proj Cum Yield Avg Life Proj Cum Yield Avg Life Proj Cum Yield Avg Life Proj Cum Loss Loss Loss Loss Loss 17 .83 3.73% 15 CPR 15.46 10.34% 9.05 3.8 5 CDR 22.33% 10.90 15.Putting it all together: example prime bond JPMMT 2005-A7 1A4 Prime 5/1 SSNR.00% 14.

pick the category with greater risk of losses to the investor 70% LTV 650 FICO 20% DTI 3% 60+ DLQ 10% C/E 90% LTV 750 FICO 40% DTI 10% 60+ DLQ 20% C/E KEY TERMINOLOGY 18 .Risk in non-agencies For each of the following.

Agenda Page The originate to distribute model pre-2008 1 Boom and bust 8 Key terminology 13 Loss Fundamentals 19 THINKING ABOUT NON-AGENCY RMBS CREDIT Government steps in 28 Re-REMICS: Restoring the securitization market? 41 19 .

economy.Home price appreciation (depreciation) is a major driver of defaults Case-Shiller home price index and JPMorgan forecast Case-Shiller home price index and JPMorgan forecast Case-Shiller 200 180 160 140 120 100 Mar-00 LOSS FUNDAMENTALS Case-Shiller forecast Housing flat in 2010 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Source: JPMorgan.com 20 .

6% Increase in Unemployment 21 Hardest hit > 4.4%— 2.4% <2.7% -11.4% Source: Case-Shiller home prices mid-2006 to 1Q09.7 . esp. with the middle of the country avoiding much of the bubble Unemployment pressures home prices.5. on the coasts Employment weak but housing stable Northeast: surging unemployment to take its toll Texas: Limits on cash-out refis prevented bubble LOSS FUNDAMENTALS Housing Decline <-11. Bureau of Labor Statistics Unemployment Rate 06Q2-09Q1 .6% >5. OFHEO.The coasts are hardest hit.4% 4.

WALAs between 24-36 months. Loan Performance 22 . observed in 2007 and 2008 35 30 25 CDR (%) 20 15 10 5 0 LOSS FUNDAMENTALS 2008 2007 50 60 70 80 90 100 110 120 130 140 150 CLTV (%) Source: JPMorgan.The default optionality curve CDR (90-day DQ) of 2005-06 vintage Alt-A fixed.

No Doc CLTV>80. Not Full Doc 23 . FICO<720.Full Tier 3 – CLTV>80. FULL Borrowers with little down payment and weak FICO or no documentation of income Jan-04 Jan-06 Jan-08 LOSS FUNDAMENTALS Tier 1 – CLTV<80 Tier 2 – CLTV>80. Full Tier 4 – CLTV>80. FICO>720. FICO>720. FULL CLTV<80 CLTV>80. FICO<720.Other borrower characteristics driving performance Alt-A ARMs 60+ day delinquency (%CB) by risk tier Alt-A ARMs 60+ day delinquency (%CB) by risk tier 50 45 40 35 30 25 20 15 10 5 0 Jan-00 Jan-02 CLTV>80.

LOSS FUNDAMENTALS 24 .

REO Vol Prepay Default Current 30 Day 60+ Day Fore REO X X X X X X X X X X X X X The following variables are used to model credit rolls/cures and prepays: – Loan Age LOSS FUNDAMENTALS – – – – – – Months In State FICO Combined LTV Occupancy Documentation Purpose – – – – – – – 25 Prepayment Penalty/Term Payment Shock Number of Missed Payments Past Delinquency Rate Incentive (WAC – Benchmark Rate) Time To Reset ( Reset Effects ) Loan Size .Transition model of default The models help project the expected Delinquency Pipeline Likelihood of defaulting or curing given the current delinquency state is modeled Uses updated information such as pay history to project an event with a short horizon Current 30 Day 60+ Day Fore.

0 74.88 8.5 Cum Loss 1.5 3.0 3.16 2.69 0.7 1.62 27.8 84.6 60.0 72.8 Proj Sev 32.0 76.0 70.61 Prime Hybrid ARM Orig Year 2003 2004 2005 2006 2007 Combined Orig Orig WALA %CA %Inv %Full FICO CLTV LTV 72 61 48 37 26 49 43.04 -5.0 69.3 1.29 4.89 0.8 50.59 13.2 82.30 0.76 0.7 50.2 0.3 0.24 0.15 0.7 14.8 42.7 73.86 6.45 12.21 4.4 26.68 5.0 1M 1M Accum Est 60+ Factor CPR CDR Loss CHPA 1.2 0.49 0.3 45.0 14.6 -30.71 18.4 1.21 13.7 -35.3 34.29 1.28 12.7 -35.5 18.0 -29.56 Alt-A Hybrid ARM Orig Year 2003 2004 2005 2006 2007 Combined LOSS FUNDAMENTALS Orig Orig WALA %CA %Inv %Full FICO CLTV LTV 71 60 48 36 27 42 41.8 19.2 50.37 0.7 51.3 74.6 1.9 22.65 14.JPMorgan Loss Expectations Prime Fixed 30yr Orig Year 2003 2004 2005 2006 2007 Combined Orig Orig WALA %CA %Inv %Full FICO CLTV LTV 73 61 48 36 26 47 44.7 61.63 0.5 13.5 74.5 18.4 14.1 30.7 40.5 17.0 70.25 0.9 10.6 73.23 26.3 0.6 0.6 38.0 58.19 0.30 11.1 -31.4 5.1 14.7 71.17 0.0 34.9 38.9 26.3 54.8 28.6 51.43 1.8 4.9 -28.4 40.9 2.1 2.0 50.7 709 709 713 711 718 712 78.82 0.1 -31.4 0.2 5.7 Cum Loss 0.28 17.7 -32.5 8.7 18.9 54.42 2.8 53.0 1M 1M Accum Est 60+ Factor CPR CDR Loss CHPA 3.0 1M 1M Accum Est 60+ Factor CPR CDR Loss CHPA 5.1 2.0 70.7 48.21 6.45 38.2 739 739 742 743 745 742 67.5 -16.5 7.1 16.2 0.6 3.8 51.1 73.67 20.4 83.6 30.5 16.3 22.50 1.0 51.1 42.8 27.75 31.2 61.2 4.0 69.9 7.6 5.21 10.65 0.32 0.37 5.93 0.0 38.0 75.31 1.4 13.43 12.2 75.7 2.2 14.3 1.4 6.25 0.0 76.0 17.40 4.6 -29.08 10.8 BondStudio Sev Neg* Proj Cum Sev Loss 27.0 71.33 3.5 71.76 8.3 Proj Sev 28.0 69.58 0.33 0.77 0.2 -17.4 52.63 1.06 0.45 Alt-A Fixed 30yr Orig Year 2003 2004 2005 2006 2007 Combined Orig Orig WALA %CA %Inv %Full FICO CLTV LTV 72 60 48 36 27 45 35.6 52.05 0.3 78.7 38.2 733 735 741 740 741 737 68.7 37.8 67.7 58.6 -30.2 58.0 47.4 0.8 4.79 16.66 0.5 47.1 55.3 12.2 74.33 6.07 6.69 0.6 48.8 21.8 0.7 51.41 7.46 4.0 0.3 76.7 8.9 76.3 76.7 33.1 0.12 2.3 67.2 711 710 713 706 713 710 74.7 76.7 82.13 17.7 15.51 0.3 -19.0 72.3 37.7 Cum Loss 1.8 14.51 5.3 62.8 51.7 16.8 30.87 Source: JPMorgan.0 25.79 21.4 44.3 61.0 76.1 -32.2 1.1 24.4 -33.0 69.4 23.03 30.5 16.9 52.77 0.0 -31.7 25.2 17.1 72.3 Proj Sev 36.0 76.36 0.6 83.8 38.7 54.4 4.0 1M 1M Accum Est 60+ Factor CPR CDR Loss CHPA 10.9 10.7 71.1 53.4 0.35 0.93 7.5 7.37 -3.85 2.0 73.92 0.6 -29.5 69.3 -19.09 18.0 -28.0 -31.0 69.1 23.0 73.76 4.25 0.85 7.5 3.13 4.0 2.52 8.0 24.7 26.22 0.3 2. Loan Performance 26 .58 28.1 19.23 -2.02 28.02 0.5 1.60 23.16 0.61 37.9 1.0 37.35 0.3 2.7 0.0 74.78 0.8 37.4 52.8 53.

6 53.8 2.12 0.8 17.86 7.54 7.4 -27.00 0.5 71.0 72.96 0.4 67.3 86.2 69.7 1.0 0.2 5.0 11.0 79.8 55.5 2.5 15.92 0.09 55.66 0.0 75.7 29.60 0.9 65.0 1M 1M Accum Est 60+ Factor CPR CDR Loss CHPA 20.0 81.3 24.5 77.2 70.7 13.1 -34.8 3.0 81.7 82.4 Proj Sev 36.5 7.0 58.45 8.9 14.5 -31.4 11.00 44.3 -35.0 5.92 24.0 75.0 5.66 4.7 -29.2 68.2 70.0 74.99 47.71 57.0 1M 1M Accum Est 60+ Factor CPR CDR Loss CHPA 14.30 0.85 41.18 42.1 12.2 70.3 9.31 3.7 2.13 27.5 55.04 49.7 6.6 16.2 -26.0 4.0 65.9 Proj Sev 41.49 9.97 6.10 0.9 4.2 55.3 6.0 80.1 78.66 0.9 70.8 -16.3 16.6 -29.5 26.8 4.39 0.39 53.7 54.0 7.0 65.91 -2.20 -5.5 1.4 -29.0 82.96 31.54 4.9 -29.55 Subprime Fixed 30yr Orig Year 2003 2004 2005 2006 2007 Combined Orig Orig WALA %CA %Inv %Full FICO CLTV LTV 71 60 48 36 28 47 24.4 7.3 64.88 12.51 9.0 77.2 1.4 1.2 -22.0 2.77 3.5 86.0 57.17 0.1 10.45 13.2 614 619 626 624 621 622 83.2 11.46 0.3 702 706 709 709 715 709 71.0 20.6 Proj Sev 45.36 24.5 87.9 5.2 79.23 17.9 71.9 1.9 81.8 85.9 3.4 65.7 83.4 79.0 79.7 25.49 0.9 69.02 -4.0 15.0 24.24 22.5 2.74 * projected losses (including losses that have already occurred) LOSS FUNDAMENTALS Source: JPMorgan.4 18.2 55.7 Cum Loss 2.80 0.0 82.2 641 641 639 635 622 638 79.62 35.1 12.3 8.1 57.21 40.2 71. Loan Performance 27 .9 55.54 2.9 12.JPMorgan Expectations (cont) Option ARM Orig Year 2003 2004 2005 2006 2007 Combined Orig Orig WALA %CA %Inv %Full FICO CLTV LTV 69 58 47 36 27 38 52.7 6.69 0.19 35.5 3.25 60.8 -33.37 37.44 5.41 45.5 22.24 0.80 25.0 0.2 82.0 79.8 68.6 -36.4 72.5 21.21 29.0 82.4 17.1 57.27 2.6 85.5 5.3 25.0 81.3 25.0 1M 1M Accum Est 60+ Factor CPR CDR Loss CHPA 40.5 -27.9 24.5 74.79 3.8 Cum Loss 3.11 0.6 16.68 36.22 0.26 0.52 8.8 Cum Loss 5.5 15.3 1.20 13.0 61.1 2.0 28.0 66.8 79.97 47.3 5.9 49.0 5.5 73.63 8.8 7.3 12.12 47.48 33.50 55.21 Subprime Hybrid ARM Orig Year 2003 2004 2005 2006 2007 Combined Orig Orig WALA %CA %Inv %Full FICO CLTV LTV 71 59 47 36 28 41 9.0 74.0 -16.17 6.0 81.9 2.2 1.9 5.

Agenda Page The originate to distribute model pre-2008 1 Boom and bust 8 Key terminology 13 Loss Fundamentals 19 THINKING ABOUT NON-AGENCY RMBS CREDIT Government steps in 28 Re-REMICS: Restoring the securitization market? 41 28 .

Government programs GOVERNMENT STEPS IN 29 .

Government programs (continued) GOVERNMENT STEPS IN 30 .

For borrowers who don’t qualify.Key programs Federal Housing Administration Hope for Homeowners (H4H) – provides FHA refinancing of loans if lender agrees to write down the loan to 90% of the current home price. Only 51 loans closed under the program to date Treasury (with Troubled Asset Relief Program funds) Making Home Affordable Modification Program (HAMP) – Provides servicer incentives to modify loans to meet affordability criteria. provides incentives to use short sales or deeds-in-lieu Treasury Public/Private Investment Partnership (PPIP) – Treasury invests in MBS alongside private investors and provides leverage Federal Reserve GOVERNMENT STEPS IN Term Asset-Backed Securities Lending Facility (TALF) – Provides no-recourse loans to purchase legacy securities. Not currently extended to RMBS 31 .

The foreclosure prevention programs: HAMP and H4H H4H Lender writes down loan to 90% LTV. FHA provides government guarantee. This is likely to be reached Bulk of servicer focus in terms of modifications 32 GOVERNMENT STEPS IN . FHA will not guarantee the loan Complexity – eg. some servicers do not originate loans Capacity and Timing HAMP Servicer reduces interest rate and/or principal to bring borrower’s monthly payment below 38% of income.000 modifications by end of October. Borrower must share any future profits from selling the home with the government Epic Fail: Only 51 loans closed to date Reasons for failure Second Liens – must be extinguished Early pay defaults (EPD) – if a borrower defaults on the first payment. Treasury subsidizes a portion of the reduction and provides cash incentives for each loan modified Goal of 500.

Types of modifications Capitalization of arrearage – missed payments added to loan balance Term extension – reamortize the loan to 40-year fixed Creation of IO period – pay interest only for 5 years Rate reduction – reduce interest rate for 5 years. then gradually increase Principal forbearance – convert a portion of principal to a balloon payment and eliminate interest on that part Principal forgiveness – reduce the amount the borrower owes GOVERNMENT STEPS IN 33 .

GOVERNMENT STEPS IN 34 .

65 350 460 131% New NPV Loss Incurred 328 132 Borrower Re-defaults Addtl HPA Net Sale Proceeds NPV of Sale & Pmts at 7.00% 1% 80 5% 15% -30% 20% Rate Modification Target LTV 131% New Balance Rate Reduction 460 3.The modification decision Loan Information Orig Loan Bal Orig Home Value Rate Annual Prop Tax Annual Income Current Conf Rate NegAm Housing Environment CHPA BPO Haircut + costs DTI Current DTI 31% DTI Payment New Home Value Unpaid Bal Current LTV GOVERNMENT STEPS IN 400 500 5.87 Assumed Redefault Modification Value 53% $ 59.0% NPV Loss From New Discount Rate Principal Forgiveness WAC Reduction 153 -46 29 Pay for Success (1k /yr for 3yrs) Servicer Incentive 3.94 35 .50% Price Breakeven Re-default -20% 224 230 Recovery Value $ 71.6 Borrower Pays to Maturity 38% 1.02 49% Foreclosure Net Sale Proceeds Lender Recovery 280 $ 60.20 $ 50.

A mortgage loan made in 2006 for $300. The home can be sold in foreclosure for $140.000 in a year.000 36 .000 = $24.000 but the redefault probability is now 20%.000 in present value.To mod or not to mod? Consider the following scenario. Is the NPV positive from modification? What if the redefault rate were 70%? GOVERNMENT STEPS IN Suppose you forgive principal. There is a 50-50 chance the borrower redefaults in a year.000 – 140. Assuming the borrower is modified and successfully pays to maturity.000 + 20% x 100. the lender can recover $200.000 is now delinquent. The most the lender can now recover is $180. Is the NPV positive? 80% x 180.000 right now or $100. otherwise the borrower pays to maturity.

At virtually every node. both the servicer and the borrower are being asked to make decisions and choices that represent significant changes from the choice menu of the pre-crisis regime.The complex HAMP decision tree: Modify. that is because it is. short sale or foreclosure? Meets Minimum Eligibility Yes No Qualifies for Mod (NPV+)* Yes No If it looks complex. H4H. Eligible for H4H Yes No Offer H4H and Mod Offer Mod Only Missed Payments Try Short Sale Failure / Deed-in-Lieu Success GOVERNMENT STEPS IN Successful Mod/Refi Lower Severity Foreclosure We calculate the NPV as NPV = (Prob of Redefault × Value from Future Liquidation + Prob of Cure × PV of borrower paying to maturity) − Value of Liquidation Source: JPMorgan 37 .

633.333.26 1.Modifications may prevent up to 4 million foreclosures… Modifications by product type.010 44.170.263 % Refinanceable % Obama Mod 15% 1% 4% 1% 7% 3% 1% 5% 0% 4% 8% 8% 2% 11% % Forbearance 3% 6% 11% 19% 9% 20% 19% 1) Refinanceable: These loans are A+ (no missed payments in 12 months).8 3% 9% 0.78 2.206. Source: JPMorgan.848 SUBPRIME FIXED 1. Loan Performance 38 . is owner occupied. We use redefault rates based on prior delinquency status. This represents a streamlined alternative to the Obama plan. GOVERNMENT STEPS IN 2) Obama Modifiable: The loan is not refinanceable.60 Forbearance Amount 35. has balance less than $729.894. prime includes conforming loans Current LTV 86 89 94 110 113 93 110 Rate Reduction 1.500. We adjust the mortgage rate for loan size (conforming.3 26% 39% 0.3 5% 29% 0.004 76.182 Option ARM 1.674 SUBPRIME ARM 2.040 13.38 2.886 51.793 % Modded Potential to Date All Mods Mods 2% 6% 1.2 9% 36% 0. and the NPV from modification is positive.531 PRIME ARM 5. owner occupied.8 4.288 ALT-A FIXED 1.155 28.37 2.3 3% 18% 0. jumbo conforming and jumbo) and assume that IO/negam borrowers will have to refinance into a fixed-rate fully amortizing loan.0 Product Type # Loans PRIME FIXED 43.86 2.018.154. 3) Forbearance Modifiable: The loan is not refinanceable or Obama modifiable.962 32.20 2. and their refinanced payment is lower than the current payment.295 ALT-A ARM 1. above water. and the NPV from forbearance to 95LTV and rate modification to 2% is positive.3 22% 52% 0. is owner occupied.

Redefault rates for loan modifications are not promising Redefault by product type Current Pre-Mod 30% 25% 60+ Delinquency (%) 60+ Delinquency (%) Alt-A ARM Option ARM Prime Fixed Subprime Fixed Alt-A Fixed Prime ARM Subprime ARM 60+ Pre-Mod 80% 70% 60% 50% 40% 30% 20% 10% 0% Alt-A ARM Option ARM Prime Fixed Subprime Fixed Alt-A Fixed Prime ARM Subprime ARM 20% 15% 10% 5% 0% 0 2 4 6 Mod Age 8 10 12 0 2 4 6 Mod Age 8 10 12 GOVERNMENT STEPS IN Source: JPMorgan. Loan Performance 39 .

with modifications Foreclosure inventory (# loans).000.000.500.000.000 0 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 0 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Source: JPMorgan.000 4.000.000.500. with modifications Cumulative liquidations (# loans).000.000 500.500.000 0 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Agency Prime Jumbo Alt-A Subprime Cumulative liquidations (# loans).000 1.000 6.000 2. without modifications Cumulative liquidations (# loans). without modifications 3.000 Agency Prime Jumbo Alt-A Subprime Agency Prime Jumbo Alt-A Subprime 4.000.000. without modifications 10. Loan Performance 40 .000 500. with modifications 2.000 8. with modifications 6.000 2.000 GOVERNMENT STEPS IN Cumulative liquidations (# loans).000.000.000 0 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Agency Prime Jumbo Alt-A Subprime Foreclosure inventory (# loans).000.000 1.000 2.000 2.000.000 1.500.Although we project a second wave of defaults.000.000 3. overall foreclosures should be lower due to modifications Foreclosure inventory (# loans).000 2.500.000 1. without modifications Foreclosure inventory (# loans).

Agenda Page The originate to distribute model pre-2008 1 Boom and bust 8 Key terminology 13 Loss Fundamentals 19 THINKING ABOUT NON-AGENCY RMBS CREDIT Government steps in 28 Re-REMICS: Restoring the securitization market? 41 41 .

the support bond accrues interest but receives no payments until the super/senior has paid off Source: JPMorgan 42 . the super/senior ReREMIC bond can be exchanged for a new bond with greater enhancement Mezz 30% Cash flows from underlying security are passed through to the Re-REMIC structure Support bond is locked out from principal payments until the super/senior is paid off Any writedowns to the underlying are first absorbed by the subordinated security In a Z structure.How it works Example of a Re-REMIC structure Example of a Re-REMIC structure RE-REMICS: RESTORING THE SECURITIZATION MARKET? Downgraded Security Super/ Senior AAA 70% Exchange AAA 65% 5% Mezz In many deals if the underlying performance is worse than expected.

Bloomberg 43 .Prime re-securitizations have surged in 2009 Re-REMIC deals by quarter Re-REMIC deals by quarter 35 30 RE-REMICS: RESTORING THE SECURITIZATION MARKET? 1H09 volume of activity 1H09 volume of activity 8 7 Re-REMIC volume ($bn) 6 5 4 3 2 1 0 Jan09 Feb09 Mar09 Apr09 May09 Jun09 Prime Alt-A 25 # of Deals 20 15 10 5 0 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 Source: JPMorgan.

Bloomberg 44 .Underlying bonds have been at risk of downgrades and writedowns Current credit rating of Re-REMIC underlying bonds by year of Re-REMIC issuance Current credit rating of Re-REMIC underlying bonds by year of Re-REMIC issuance 30 25 # of Deals 20 15 10 5 0 AAA AA A 2008 2009 Median RE-REMICS: RESTORING THE SECURITIZATION MARKET? BBB BB Credit Rating B CCC CC Source: JPMorgan.

RE-REMICS: RESTORING THE SECURITIZATION MARKET? 45 .

2CDR 24mo / 7CDR.Highly enhanced Re-REMIC super/seniors provide excellent downside protection but cap the upside Price by scenario and structure for Re-REMIC super/senior and underlying Price by scenario and structure for Re-REMIC super/senior and underlying 100 95 90 Price 85 80 75 70 Stress/5CPR Worse/10CPR Base/15CPR Better/20CPR RE-REMICS: RESTORING THE SECURITIZATION MARKET? 30/Z ReREMIC 15 ReREMIC 30/Z Underlying 15 Underlying Assumptions Assumptions Bond JPMRR 2009-5 1A1 BCAP 2009-RR2 A1 CSMC 2009-7R 1A1 JPMRR 2009-6 1A1 Mezz Type SEQ Z SEQ Z 3M Base Default Stress Default C/E 60+ CPR Scenario Scenario 32 16.5 20.6CDR.2CDR. 15 CPR 7CDR 24mo / 5. 5 CPR 15 11.0 6CDR 24mo / 4CDR.6 8CDR 24mo / 5CDR.2 14. 15CPR 11. 5CPR 33 13. 15 CPR 5.4CDR 24mo / 5.6 5CDR 24mo / 4CDR.2 22.6 17.8 4CDR 24mo / 3CDR.6CDR.6CDR 24mo / 4. 5 CPR 15 8. 15 CPR 8. 5 CPR Source: JPMorgan 46 .

Mezzanine investors seeking to benefit from improving economy must weigh downside risk Price by scenario and structure for Re-REMICs super/senior and mezz Price by scenario and structure for Re-REMICs super/senior and mezz 100 95 RE-REMICS: RESTORING THE SECURITIZATION MARKET? 60 50 40 Typical Yields Super/Senior Mezz 7% 20% Price 90 85 80 Stress/5CPR Worse/10CPR Base/15CPR Better/20CPR 30/Z 30 30 Mezz (right) 30/Z Mezz (right) 30 20 10 0 Source: JPMorgan 47 .

Analyzing Re-secs Between the following. what type of bond is better for a bank or insurance company? 15% C/E Super/Senior 30% C/E Super/Senior How about these two? RE-REMICS: RESTORING THE SECURITIZATION MARKET? 30% C/E Super/Senior 30% C/E Mezzanine What about for a hedge fund? 48 .

J. Over the next six to twelve months. J. Information herein is believed to be reliable but JPMorgan does not warrant its completeness or accuracy.P.P. Deteriorating+ (D+) The issuer’s long-term credit rating likely falls to junk over the next six to twelve months. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. we expect this bond to outperform the average total return of the bonds in the analyst’s (or analyst’s team’s) coverage universe. Deteriorating (D) The issuer’s long-term credit rating likely falls over the next six to twelve months. we expect this bond to underperform the average total return of the bonds in the analyst’s (or analyst’s team’s) coverage universe. Morgan Futures Inc. J.P. Morgan Securities Ltd. In other European Economic Area countries. Morgan Securities Asia Private Limited is regulated by the MAS and the Financial Services Agency in Japan.P. This document must not be acted on or relied on by persons who are not relevant persons. Morgan Securities Singapore Private Limited is a member of Singapore Exchange Securities Trading Limited and is regulated by the Monetary Authority of Singapore (“MAS”). J. and its subsidiaries and affiliates worldwide. Past performance is not indicative of future results. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. JPMorgan uses the following recommendation system: Overweight. advisor or lender to such issuer. Morgan plc are authorized by the FSA. J. (JPMSL). Over the next six to twelve months. the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction. Stable (S) The issuer’s long-term credit rating likely remains the same over the next six to twelve months. Morgan Chase & Co. Morgan Europe Limited and J. JPMorgan and/or its affiliates and employees may hold a position.K.. Defaulting (F) There is some likelihood that the issuer defaults over the next six to twelve months. is a member of the NFA. Clients should contact analysts at and execute transactions through a JPMorgan entity in their home jurisdiction unless governing law permits otherwise. Underweight. Opinions and estimates constitute our judgment and are subject to change without notice. Neutral. Over the next six to twelve months. Morgan Securities Inc.P. and (2) no part of my compensation was. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated by the Hong Kong Monetary Authority. All rights reserved. in the U.P. Additional information is available upon request. The investments and strategies discussed here may not be suitable for all investors. Copyright 2009 J. J. This report should not be distributed to others or replicated in any form without prior consent of JPMorgan. 38. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument.. Morgan Chase & Co. RE-REMICS: RESTORING THE SECURITIZATION MARKET? 49 . may undertake or have already undertaken an own account transaction or act as market maker in the financial instruments of any issuer discussed herein or any related financial instruments.P. placement agent. JPMorgan is the marketing name for J.Analyst certification: The strategist denoted by “AC” certifies that: (1) all of the views expressed in this research accurately reflect my personal views about any and all of the subject securities or issuers. or will be directly or indirectly related to the specific recommendations or views expressed herein. The investments discussed may fluctuate in price or value. J. or act as underwriter.P. is. J. we expect this bond to perform in line with the average total return of the bonds in the analyst’s (or analyst’s team’s) coverage universe.Morgan Australia Limited (ABN 52 002 888 011) is a licensed securities dealer. This report has been issued. This report should not be distributed to others or replicated without prior consent of JPMorgan. only to persons of a kind described in Article 19 (5). JPMorgan uses the following rating system: Improving (I) The issuer’s long-term credit rating likely improves over the next six to twelve months. 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (all such persons being referred to as “relevant persons”). J.P. Changes in rates of exchange may have an adverse effect on the value of investments.P.P. if you have any doubts you should consult your investment advisor. is a member of NYSE and SIPC. JPMorgan Chase Bank is a member of FDIC.P.

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