Fixed Income Research

Topics in ABCP Conduits

October 23, 2007 ABCP conduits have been the focus of much investor attention in recent weeks, as
concerns that CP would not roll over surfaced. After examining the data, we have
Prasanth Subramanian
concluded that the risk of potential asset sales is slim. The direst consequence of current
212-526-8311
psubrama@lehman.com market conditions is a decreased appetite for marginal investment given the risk of assets
coming on balance sheets.
Olga Gorodetsky
212-526-8311 In this document, we compile our publications on these issues from the past month. For
ogorodet@lehman.com the individual publications, please click below:
• Where Has All the Capital Gone? (published August 13, 2007)
• A Closer Look at Liquidity Put Providers in the ABCP Market
(published August 27, 2007)
• Will Banks Be Marginal Buyers of AAAs? (published September 14, 2007)
• Recent Developments in the ABCP Market (published September 21, 2007)

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 24
Lehman Brothers | U.S. Securitized Products Research

WHERE HAS ALL THE CAPITAL GONE?

Published August 13, 2007. Revised October 23, 2007.
As recently as two months ago, market consensus seemed to be that there was too much
capital chasing too few assets. We have come 180 degrees over a remarkably short time
period. Focusing just on the mortgage market, what started as credit repricing earlier in
the year has turned into a full-blown liquidity crisis. It is no longer a subprime BBB
pricing issue—the spread widening has spilled over into prime mortgages, as well as to
the senior part of the capital structure. AAAs backed by good quality mortgage loans are
trading—no, scratch that—being offered at spreads of L + 75 bp and wider. What would
have seemed a great buying opportunity two months ago is being met with nervous
apprehension. The question is: where has all the capital gone?
Capital cannot simply disappear. It can be lost due to mark-to-market and/or actual
losses. In addition, the buying power of capital can decline because of reduced ability to
leverage and/or higher financing costs. In this article, we try to isolate these components
of loss in buying power. Our main conclusions:

No Meaningful Turnaround in Mortgage Credit Pricing in the Near Term

We estimate that mark-to-market losses due to credit repricing total around $85 billion
for the mortgage market over the course of 2007. These losses are fairly significant in the
context of the amount of capital invested in the credit space, and there is no easy or quick
resolution to this problem. Outside capital needs to come into the sector to provide
stability to the market. Given the uncertainty in the credit markets, picking mortgage
credit assets still requires a bottoms-up approach, and new capital is unlikely to have this
expertise. We therefore expect the return of stability to be a long, drawn-out process.

Concerns about Financing Risk May Be a Tad Overblown

The past month has seen a pullback in lending in the repo markets through higher
haircuts and financing levels. However, the repo market is still functional. Also, given
the widening in spreads on AAA assets, the amount of leverage required to generate the
same ROE as levels back in June or earlier this year is a lot lower. This, in itself, is akin
to an injection of liquidity to the market.

The Spectre of ABCP Conduits

The market is concerned about potential ABCP unwinds and the risk they pose to AAA
spreads. The conduits at the most risk of unwinds are SIVs with a disproportionate
allocation to the residential mortgage sector, as well as single-seller conduits backed by
sponsors with lack of other sources of funding. We think the potential magnitude of sale
of mortgage assets is on the order of $20 billion. The question really boils down to
timing. If unwinds of this magnitude were to happen over the course of a month, the
potential impact on liquidity and spreads should be limited.

Great Buying Opportunity at the AAA Level

For investors willing to hold these assets without much leverage, at L+75 bp, the yield on
the asset is, in itself, attractive. Also, with AAA creation volumes expected to decline,
we think the longer term picture looks fairly positive. Given current spread levels, we

October 23, 2007 2

Lehman Brothers | U.S. Securitized Products Research

think the assets look cheap and are willing to take the risk of a nastier scenario unfolding
in conduits.

THE CAPITAL DESTRUCTION COMPUTATION

We isolate the loss of capital
due to credit and liquidity
related losses
The widening in senior parts of
the capital structure causes
liquidity related losses
The widening of assets due to
changes in credit assumptions
causes credit-related losses
Capital cannot simply disappear. It can be lost due to mark-to-market and/or actual
losses. In addition, the buying power of capital can decline because of reduced ability to
leverage and/or higher financing costs. Starting with the first component, which is the
loss of capital due to losses, we split the reduction in investing capital into two parts. We
make an artificial distinction between investing capital that is assigned to credit risk and
that assigned to liquidity/financing risk. To take an example, investment in BBB tranches
would be capital invested in credit risk, and investment in AAA prime floaters would be
capital invested in liquidity/financing risk. In reality, of course, the split is not very clean.
But this serves as a useful guide. We then need to estimate the amount of capital losses in
the mortgage sector on the credit side and the liquidity side to determine its effect on
these two sources of capital. To estimate these losses, we apply a bottoms-up approach of
aggregating losses across sectors, vintages, and classes of securities.
Liquidity-Related Losses: We assume that mark-to-market losses due to widening in
AAA/AA tranches are for liquidity-related reasons. In order to estimate these losses, we
split the mortgage universe into its various sectors (agencies, jumbo, alt-A, alt-B, and
subprime). Within these sectors, we look at the outstanding securities at a AAA and AA
level and calculate the total mark-to-market on these classes. We extrapolate the losses
on securities to the loans outstanding in the sector. For the agency universe, we use the
excess returns of the MBS Index versus Treasuries to estimate liquidity-related losses.
These losses are then aggregated back for the whole universe.
Credit-Related Losses: To estimate credit-related losses, we use the pricing of CDS on
BBB tranches in subprime mortgages to obtain a point estimate of market-implied losses
across vintages. We do this based on pricing as of the end of 2006, end-June, and the first
week of August. Based on the market’s assumptions of credit losses on these CDS, we
tease out a market-implied rate of home price appreciation. We use a credit model
calibrated to historical home price appreciation and projected levels of losses to achieve
this. This market-implied assumption about home prices is used to project losses on other
collateral types such as alt-A and jumbo collateral across vintages. The losses due to
credit repricing are assumed to be the change in the present value of credit losses across
time.

Figure 1. Estimated Losses to Capital Invested in the Mortgage Market

June 30 to August 7 YTD
Sector (Loans Outstanding Credit Liquidity Credit Liquidity
and Securities) ($ bn) Losses Losses Losses Losses
Agency 3,900 0.1% 0.8% 0.1% 1.4%
Jumbo 2,400 0.1% 1.4% 0.1% 2.1%
Alt-A 950 0.4% 1.5% 0.8% 2.3%
Alt-B 200 1.1% 2.3% 3.0% 2.8%
Subprime 1,250 2.9% 5.2% 5.5% 5.3%
Total 8,700 0.7% 1.7% 1.1% 2.3%
Total Losses ($B) 8,700 45 billion 147 billion 85 billion 197 billion
Source: Lehman Brothers estimates based on pricing in the CDS markets. All losses are shown as a change in the
period of comparison. Credit losses are on both securities and loans. Liquidity losses are due to the widening in
spreads on AAA and AA securities.

October 23, 2007 3

 Lehman Brothers | U.S. Securitized Products Research
A significant amount of capital
allocated to the mortgage credit
space has been wiped out on a
mark to market basis
For stability to return, fresh
capital needs to come in, but
the problem is uncertainty
about performance
October 23, 2007
NO MEANINGFUL TURNAROUND IN
MORTGAGE CREDIT PRICING IN THE NEAR TERM
Based on our methodology, we find that, in aggregate, the mortgage market has lost
around $85 billion over the course of the year because of changes in assumptions about
credit performance (Figure 1). Almost half of these losses were incurred in July alone.
The subprime market is obviously the biggest casualty, having lost around 6% of its
value, or close to $70 billion, because of changes in credit loss assumptions. For
subprime securities, the losses are around $55 billion, with the remainder coming from
losses on loans. These mark-to-market credit losses are rather large in the context of the
investment capital. The biggest outlet for mortgage credit in the past 2 ½ to 3 years has
been through CDOs. Given the credit repricing that has occurred, we estimate that CDOs
are sitting on mark-to-market losses on the asset side of around $30 billion, roughly 10%
of the total outstanding (Figure 2). Given the expectation of losses, these buyers of
mortgage credit who brought homogeneity to credit pricing are essentially out of the
market. Because CDOs have been the largest source of demand for mortgage credit, the
residual credit losses in this space not allocated to CDOs are fairly large in relation to the
capital behind them.
Fresh Investment Capital Needs to Find Its Way
For stability to return to credit pricing in the mortgage space, fresh capital needs to enter
the market to replace the capital lost due to losses. The credit repricing in the subprime
market has caused even seasoned credit investors to be caught off sides. Any new capital
coming into the sector outside of the traditional participants is unlikely to be backed by
the expertise to invest in mortgage credit, essentially because there is still a lot of
uncertainty about where mortgage credit performance could end up. Extraneous variables
such as the strength of the housing market, the level of rates, and credit availability,
which are all uncertain, will determine the level of losses. In addition, idiosyncratic
factors such as structures, triggers, or the potential effect of loan modification can affect
the valuation of credit assets significantly.
Figure 2. Estimating Mark-to-Market Losses on ABS CDOs
Outstanding ($ bn) MTM Loss - CDS Pricing ($ bn)
Issue Year HG Mezz HG Mezz Total
2005 60 33 1.6 2.7 4.1
2006 91 89 4.4 14.1 18.2
2007 YTD 55 48 1.4 7.7 8.9
Total 205 170 7.3 24.5 31.3
Source: Lehman Brothers. Subprime assets estimated to be sitting in CDOs are repriced using the pricing in the
CDS market. Based on pricing as of August 9.
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Lehman Brothers | U.S. Securitized Products Research

New Capital May Lack the Expertise for Credit Investing

Picking mortgage credit assets
still requires a bottoms-up
approach; new capital may not
have this expertise
To reinforce the point about the uncertainty in credit pricing, in Figure 3, we look at our
base case yield projection for the ABX 07-1 index and the projected returns in a series of
stress scenarios. In a base case scenario assuming flat home prices for the next two years,
we project fairly attractive yields of around 14% on the BBBs. Stressing these
assumptions by factoring in a stress to the borrowers at reset, as well as stressing the
excess spread in the structure, can knock this yield down to 2%. For some specific
deals/loan characteristics/structures, even these stress scenario returns on investment will
look attractive. However, given all the uncertainty, picking credit assets for investments
still requires a bottoms-up approach, looking at collateral characteristics, structure,
subordination levels, etc. We do not think the market is yet at a stage at which credit
exposure across the board looks attractive. It will take time for any new capital coming
into the market to develop the sophistication required to do this cherry-picking of
investments. We therefore believe that a return to stability in mortgage credit pricing is
still a ways away, and this is likely to be a long, drawn-out process.

Figure 3. Yields on ABX Subordinate ABX Tranches with Stressed Assumptions

Yields on Tranches
HPA, Reset HPA, Reset,
Index Rating Mkt Price Base HPA stress Stress XS Stress
07-1 BBB 38.0 14% 9% 7% 2%
07-1 BBB- 36.0 14% 10% 8% 4%
Index Cumulative Loss
07-1 Index 9.6 11.7 14.8 14.7

For a description of these scenarios, see Mortgage Strategy Weekly, July 2 2007. Base case assumes flat home
price appreciation for the next two years. The HPA stress scenario assumes a 10% market value decline in housing
in this period. The third scenario assumes that current underperformance in early stage performance is extrapolated
for life. The last scenario stresses excess spread in the structure by speeding prepayments, which is likely in a Fed
easing scenario or a bailout of performing borrowers.

October 23, 2007 5

 Lehman Brothers | U.S. Securitized Products Research
In aggregate, the losses due to
liquidity are manageable
While funding rates and
haircuts have gone up, the repo
markets are still functional
October 23, 2007
ARE CONCERNS ABOUT FINANCING A TAD OVERBLOWN?
Getting back to the issue of the aggregate losses to capital invested in mortgage assets,
we estimate that the widening in senior parts of the capital structure has resulted in mark-
to-market losses of close to 2 points on the aggregate market. Given the widening in
securities at the AAA level, with AAA floaters offered in the L+75 bp range, we do think
the mark-to-market losses are enough to cause a reluctance to buy AAA assets. Also, it is
a lot easier for fresh capital to come into this space, as investing in AAAs, in our mind, is
not really a credit issue. Investing here is more of a top-down decision, as opposed to
cherry-picking individual assets. That said, the market for AAA assets has seized up over
the past three weeks. The ability to leverage up securities has declined because of a
pullback from the repo markets. Also, more important, the market is concerned about the
potential unwind of ABCP conduits and the spread widening that could entail.
Repo Markets Are Still Functioning
The past month has seen an increase in margins, as well as funding costs, in the repo
market, but the market is still functioning. The pullback from the repo market has been
predominantly for more credit-sensitive assets. The repo market is still available for
funding AAA positions. As a proxy for the availability of financing here, we look at net
primary dealer positions in credit securities (includes non-agency mortgages) funded
through the repo market (Figure 4). While the pace of growth in securities being funded
seems to have slowed, the positions data do not indicate any distress in the repo
financing space.
Figure 4. Net Dealer Positions in Corporates Funded through Repo
260
240
220
200
180
160
140
120
100
80
Jan-06 A pr-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
Source: Federal Reserve Bank of New York. Corporate securities include non-agency mortgages
6
Lehman Brothers | U.S. Securitized Products Research

The Amount of Leverage Necessary Is Lower

Wider spreads inject liquidity
by themselves, as less leverage
is required today
Given the widening in spreads on mortgage assets, assets require less leverage today to
achieve the same return on equity. This, in itself, reduces the dependence on the repo
markets because of lower borrowing needs. Figure 5 estimates the amount of leverage
needed to achieve a 15% ROE on an alt-A AAA passthrough. Given the widening in
spreads, using less than half the leverage used at the end of June would result in the same
ROE as before.

Figure 5. Leverage Required on Alt-A Fixed Rate AAAs to Achieve 15% ROE

15
14
13
12
11
10
9
8
7
6
5
Jan-06 A pr-06 Jul-06 Oct-06 Feb-07 May-07
Leverage Required to A chieve 15% ROE A verage Levels Jan 06 - Jun 07

Source: Lehman Brothers. We convert the alt-A price drop into an equivalent yield on alt-A collateral. This is
assumed to be funded at LIBOR, and we solve for the leverage required to achieve a 15% ROE.

October 23, 2007 7

Lehman Brothers | U.S. Securitized Products Research
The big overhang in the market
is potential unwinds from
ABCP conduits
Of the $1.3 trillion in ABCP
conduits, mortgage exposure is
around $250 billion
Multi-seller conduits do not
have a significant risk of a fire
sale because of the existence of
liquidity providers
October 23, 2007
THE SPECTER OF ABCP CONDUITS
The biggest overhang hampering liquidity in the AAA market is related to asset-backed
commercial paper (ABCP) conduits. The market is concerned that there could be a
forced sale of mortgage assets from ABCP vehicles. The resulting supply in an already-
illiquid market could lead to very nasty technicals. To understand the risk from potential
unwinds, we look at the composition and structural features of ABCP vehicles.
An Introduction to ABCP Conduits
ABCP vehicles come in various flavors (Figure 6), and the total outstanding in ABCP
paper is around $1.3 trillion. The commercial paper (CP) market has been used by
conduits as both a funding diversification strategy and a funding arbitrage strategy.
Conduit programs would fall into the first category, where CP is typically used as
another means of funding the assets, which are typically mortgage, auto, or credit card
loans, receivables, etc. In the case of structured investment vehicles (SIVs) and security-
arbitrage (sec-arb) conduits, the CP market is used to fund longer maturity assets,
typically securities with CP. In aggregate, ABCP vehicles hold an estimated $260 billion
in mortgage assets, both loans and securities. The biggest risk to the ABCP market
currently is the inability to roll existing CP. The provisions that come into play in such an
event vary across the various vehicles.
Characteristics of ABCP Vehicles
Multi-Seller Conduits: The largest segment of the ABCP market is the traditional multi-
seller conduits, which account for close to 60% of the market today. These programs
have mortgage assets of around $70 billion, most of which are in whole loans. In the case
of multi-seller programs, the risk that the CP issued cannot be rolled is mitigated in
almost all cases by the existence of a liquidity put provider. These are typically large,
well-capitalized banks that step in to either purchase the assets or fund the assets in case
the CP is not rolled over. In these vehicles, which account for a bulk of the market, the
risk is really from a sale of assets by the liquidity provider if the CP does not roll over.
This is likely to be done in an orderly fashion and does not pose a major risk of a fire sale
of assets.
Figure 6. Size of ABCP Vehicles and Estimated Mortgage Holdings
U.S. Residential
Type Outstanding, $bn CP Issued Assets
Multi Seller Conduits 750 713 68
Single Seller Conduits 230 219 72
Security Arbitrage Conduits 196 186 59
Structured Investment Vehicles 350 105 18
CDOs with CP 45 45 45
Others 15 15 -
Total 1,586 1,282 261
Souce: Lehman Brothers, Moody’s, S&P. The aggregate residential exposures are estimates based on asset
composition from rating agency reports. U.S. residential assets include both loans and securities.
8
Lehman Brothers | U.S. Securitized Products Research

Single-seller conduits Single-Seller Conduits: This category of the ABCP market accounts for around 20% of
have a risk of unwinds the CP outstanding. In aggregate, single-seller conduits hold around $70 billion in
and sale of assets mortgage assets, mostly as loans. This means of financing is typically used by single
sponsors to fund their mortgage loan pipelines. Unlike multi-seller conduits that have a
liquidity provider in the event of an inability to roll over existing CP, these programs
often have an extendible feature instead. The CP can be extended past the initial maturity
date in case of an inability to roll over. The assets of the conduit need to be auctioned if
the CP is extended and no new financing is found before the end of the extension period.
There is a risk that such an auction could generate a lower amount of funds than needed
to redeem the CP outstanding. CP holders are protected from this risk by the existence of
a market value swap provider. These entities make up for any shortfall in the proceeds
from asset sales. In most single-seller conduits, the market value swap provider executes
the swap with the ABCP program and also swaps the risk back with the program
sponsor. The market value risk, therefore, ultimately lies with the sponsor. We think the
risk of mortgage asset sales due to the inability to roll over CP is around $20 billion from
this category. We estimate this based on the liquidity positions of various plan sponsors
and identifying the programs in which the availability of alternate funding for assets is
limited.
These are mark to market Security Arbitrage Conduits and Structured Investment Vehicles: SIVs and security
entities. Losses in aggregate arbitrage conduits together hold U.S. mortgage assets of around $80 billion. Unlike the
are not at levels that would conduit programs, SIVs are mark-to-market entities. In these structures, the risk to the
cause systemic unwinds CP holders from adverse moves in asset prices is mitigated by the existence of capital
notes that are subordinated to the interests of the CP investors. These vehicles typically
need to unwind if a mark-to-market impairment is greater than 50% of the capital notes.
In most sec-arb conduits, there is typically a liquidity put provider (Figure 7). Similar to
multi-seller conduits, they assume the CP debt or purchase the assets in case the CP is
not rolled over. We therefore ignore these vehicles in calculating the potential sale of
mortgage assets. The risk of a forced sale of assets is stronger in the SIV market, as there
is typically no liquidity put provider. In SIVs, the risk of an inability to roll CP is
mitigated by the existence of liquidity provision. These are typically bank liens that can
be tapped if the CP market is not accessible. Given the widening in spreads across asset
classes, we estimate an aggregate mark-to-market loss of about 70-80 bp on SIVs with a
composition similar to the industry average. This, in itself, is not enough to cause an SIV
unwind. Specific SIVs with a composition skewed to mortgage/ABS CDOs could be
forced to unwind. The total US mortgage assets in SIVs is around $20 billion and the
potential risk of a sale of assets is around $5 billion.

Figure 7. Protection in the Event of Distress

Extendible CP/ Liquidity
Type CP Issued Mkt Value Swap Put Provider Provision
Multi Seller Conduits 713 - 750 -
Single Seller Conduits 219 180* - -
Security Arbitrage Conduits 186 20* 166 -
Structured Investment Vehicles 105 - - 88*

CDOs with CP 45 - 45 -
Others 15 - - -
Total 1,282 200 943 88

Souce: Lehman Brothers, Moody’s. The distribution of extendible CPs protection across vehicles is an estimate.
The bulk of the extendible CP protection is in the single-seller conduit space. The size of liquidity providers for SIVs
is also an estimate

October 23, 2007 9

Lehman Brothers | U.S. Securitized Products Research

Potential Effect of ABCP Unwinds

What If Incremental Mortgage Financing through ABCP Is Not Possible?

If the ABCP market were to
disappear for incremental
mortgage assets, it would
not be a disaster
The ABCP market has been financing around $250 billion in mortgage exposure. What if
the market is not available to fund any incremental assets? While ABCP conduits have
seen tremendous growth in the past few years (Figure 8), this growth has not been
outsized. The mortgage market in aggregate has grown at a fast pace similar to the ABCP
market. Assuming that 20% of ABCP assets are in mortgages historically, we estimate
that the share of mortgages held in ABCP conduits as a proportion of the overall market
has remained at 2%-3% over the past 4-5 years (Figure 9). In contrast, the mortgage
holdings of domestic banks are almost 20 times as high, accounting for close to 40% of
the outstanding mortgage debt. If the CP market stops providing liquidity for incremental
mortgage financing, we do not think this is a disaster scenario. In an environment of
reduced mortgage originations, we think the rest of the investing community will be able
to pick up the slack in six months or so. Specifically, commercial banks could issue
unsecured CP to fund the additional mortgage supply that used to be funded through the
ABCP market.
Impact from Asset Sales

There is a risk of about
$25 billion in assets being
unwound—in a month, this is
not a big risk
We believe the biggest risks of assets sales from the ABCP market are from single-seller
conduits and SIVs. Between the two programs, we think there is a potential for around
$25 billion of mortgage asset liquidations. These are largely the risk from one-off SIV
transactions with more concentrated assets in the mortgage space, where mark-to-market
losses could trigger unwinds. On the single-seller side, these represent potential unwinds
from sponsors with weak liquidity. The risk to the market from any such unwinds boils
down to timing. In a scenario in which the assets are unwound over the course of a
month after the CP fails to roll over, we do not think there is a big risk to valuations.
First, the assets of single-seller conduits are typically mortgage loans, which would have
found their way to the securitization markets in due course in any case. Also, we expect
new issue supply of mortgage securities to decline by around $300 billion in the next six
months (Figure 10). An incremental supply of $20 billion of supply in a month could be
very easily absorbed in this environment.

Figure 8. Growth in Asset Backed CP ($ billion) Figure 9. ABCPs Finance Only a Fraction of the Market

1400 50% 4.0%

1200 46%
3.0%
1000
42%
800 2.0%
38%
600 1.0%
34%
400
30% 0.0%
200 01-98 03-01 05-04

0 Bank Mortgage Holdings/Total Market

01/98 04/01 08/04 A BCP Mortgage Holdings/Total Market

Source: Federal Reserve Source: Lehman Brothers, Federal Reserve. Assumes mortgage assets are
25% of the ABCP market, which is the approximate composition as of today.

October 23, 2007 10

Lehman Brothers | U.S. Securitized Products Research

What If the ABCP Market Unwinds Entirely?

Clearly, the biggest risk from the ABCP market is if the entire sector, or a bulk of it,
were to unwind in the coming months. In this scenario, the overall liquidation of close to
$1.2 trillion in assets will be a big issue not just for mortgages but across the broad
capital markets. This is a risk with a miniscule probability, in our view, but very severe
consequences if it materializes. In some sense, it is a risk that cannot be priced; it is
similar to pricing the risk that an earthquake will hit New York tomorrow. Clearly, this is
not a base case expectation, it is a disaster scenario.

AAA Exposure Looks Attractive on a Risk/Return Basis

In spite of the overhang from ABCP conduits, we think AAA non-agency assets are
attractive at current levels. For investors willing to hold these assets without much
leverage, at L+75 bp, the yield on the asset is, in itself, very attractive. There is a risk of
temporary dislocation in the markets due to ABCP unwinds. In the backdrop of reduced
supply (Figure 10) and because the bulk of these unwinds are likely to be loans that
would have reached the market anyway, we do not think this should be an issue if it
happens over the course of a month. There is also the risk of ABCP funding disappearing
for mortgage assets. In aggregate, the CP market has been funding less than 3% of all
mortgage assets, and in this scenario, while the adjustment process may take longer, it is
not going to cause any major disruption. Given current spread levels, we think another
risk is that investors could miss an opportunity to add solid AAA assets at extremely
cheap levels. Ignoring the risk from an extreme scenario of a complete meltdown in the
ABCP market, we believe this is a great opportunity to add to AAA assets.

Figure 10. Estimated Issuance across Mortgage Sectors, $ billion

Half Yr Agency Jumbo Alt-A Subprime Total

1H05 410 127 165 240 815

2H05 519 151 210 246 975

1H06 411 122 204 259 874

841
2H06 423 105 194 224

1H07 489 135 173 175 837

2H07* 380 100 85 75 541

These are issuance volumes and are lower than total loan originations. Source: Lehman Brothers, Loan
Performance, FN and FH data.

October 23, 2007 11

 Lehman Brothers | U.S. Securitized Products Research
We had estimated $20-25
billion of potential asset sales
Multi-seller conduits are mostly
backed by banks
Single seller conduits are at the
most of risk of unwinds
Security arbitrage conduits
have liquidity provisions, SIV
have unwind risks
October 23, 2007
A CLOSER LOOK AT LIQUIDITY PUT PROVIDERS IN THE ABCP MARKET
Published August 27, 2007. Revised October 23, 2007.
The asset-backed commercial paper (ABCP) market, at the centre of the liquidity crisis
in the capital markets has shrunk by close to 10% in the last two weeks. The total
outstanding declined from a high of $1170 billion on August 8th to $1052 billion as of
August 22 (Figure 1). The average term of CP issued in the ABCP market has also
declined sharply (Figure 2). Given the risk profile of CP investors, these are not
surprising outcomes. With the negative headlines around the sector and concerns around
mortgage/subprime exposures of conduits, CP investors are essentially boycotting ABCP
paper. Instead, they have been choosing the relative security of non-financial CP or T-
Bills instead.
In aggregate, ABCP conduits were financing around $250 billion in mortgage assets as
of the end of July. This is roughly a quarter of all the assets of ABCP conduits. If
incremental financing for mortgage assets through the ABCP market were to disappear,
we do not think this is a terrible scenario. The ABCP market in effect finances less than
3% of the total mortgage market of close to $9 trillion. In comparison, U.S. domestic
banks finance close to 40% of the market. If commercial banks decided not to provide
incremental financing for the sector, that would be a scenario to be worried about. As we
see it, the issue for the mortgage market is not whether CP can be rolled over, it is the
potential sale of assets if liquidity through the CP market disappears for existing
conduits.
Most Conduits Have a Bank Backing
We had expected the amount of forced unwinds of mortgage assets because of an
inability to fund through the ABCP market to be only $20-$25 billion (Mortgage
Strategy Weekly, August 10). This was primarily because of the presence of backstop
liquidity facilities for most U.S. conduits. We review the backstop facilities in the
various ABCP programs below.
Multi-seller conduits: More than 70% of the ABCP in the market is in multi-seller
conduits. These are primarily intended as a way for customers of banks to finance their
loans, securities, receivables, and other similar assets through the CP market. The bank
backs these conduits in case of an inability to fund through the CP market and earns fee
income in the process. For the most part, the CP investors are not concerned about the
assets in the conduits as they are implicitly buying short-term credit of the bank.
Singe-Seller Conduits: Unlike the multi-seller conduits, the single seller conduits from
which the bulk of mortgage asset sales in the last couple of weeks have occurred do not
typically have any bank backing. In many of these vehicles, if the sponsor is unable to
roll CP over, the CP extends to give enough time for the issuer to find alternative
financing or to sell assets and redeem the CP. We had expected around $20 billion of
asset sales from these conduits. These essentially represented the mortgage holdings of
sponsors with weak liquidity positions.
Security Arbitrage and Structured Investment Vehicles: The third category of ABCP
conduits is security arbitrage conduits. These vehicles are similar to the multi-seller
conduits in that they have a bank backing in most case. We did not think there is a major
risk of a fire sale of assets from this category. The last category of conduits is the
structured investment vehicles (SIVs). These are mark-to-market entities. The inability to
rollover CP does not necessarily cause asset sales from SIVs as they typically have
12
Lehman Brothers | U.S. Securitized Products Research
The exposure of U.S. banks is
limited to large institutions
Bulk of the exposure is with
non-U.S. banks—even here the
institutions are large
October 23, 2007
backup liquidity facilities through bank liens or letters of credit which can be drawn for a
certain period of time. However, mark-to-market losses can cause these structures to
unwind. These structures held a total of around $18 billion in U.S. mortgage assets and
we had expected around $5 billion in mortgage asset sales from these vehicles. These
represent the assets owned by conduits with the most risk of unwinds due to mark-to-
market losses.
What if the Banks Decide to Sell?
U.S. Banks—$350 Billion of ABCP Exposure
In almost all these cases we had ignored scenarios where the conduit is backed by a bank.
We were assuming that in the scenario of liquidity provisions being drawn down, banks
do not necessarily have to engage in a fire sale of the assets. Banks with sizeable balance
sheets are unlikely to be distress sellers of these assets. Also banks with experience in
investing in these assets are less likely to sell them at distress levels. It is essentially
banks with weak balance sheets as well as those with not enough experience in investing
in the assets behind the conduits that are more likely to sell assets. The total amount of
liquidity provisions to ABCP conduits from banks is to the tune of around $900 billion
(see MBS Strategy Weekly, August 10 2007). In the case of most U.S. banks, the amount
of protection written is less than 4% of the assets of the bank (Figure 3). Moreover, the
Fed announced on Friday that ABCP notes where a bank is the liquidity provider are
eligible collateral for the discount window. Banks should therefore have no difficulty in
funding these assets. Therefore, even if these assets were to come to bank balance sheets,
we do not think there is a risk of sale of assets from U.S. banks due to liquidity
provisions being exercised.
Figure 3. Liquidity Provision Exposures of U.S. Banks*
CP Protection Written Total CP Liquidity/
as % of Assets Number of Banks Total Bank Assets Credit Provisions
1-2% 2 758 9
2-4% 2 1993 69
4-6% 5 3136 148
6-12% 2 1449 90
>12% 2 159 32
Source: FFIEC Call Reports, FDIC
*Please note this table was modified on August 28, 2007
Non-US Banks—$500 Billion of ABCP Exposure
Of the close to $900 billion in ABCP liquidity provisions provided by banks, only $350
billion is from U.S. banks. The bulk of the facilities are provided by European/Asian
banks. In a recent conference call 1, Fitch estimates that the total exposure of these banks
to liquidity facilities in the U.S. ABCP market is close to $500 billion. They estimate that
of the 44 banks in Europe that have provided liquidity facilities, only three banks have
exposures in excess of 10% of their assets. This is similar to the U.S. banks, where the
bulk of the liquidity is being provided by large, well-capitalized banks. From a capital-
ization standpoint, we do not think a fire sale of assets by banks is of great concern.
The inability to rollover CP should not lead to significant asset sales by themselves. Most
CP programs have liquidity backstop provisions from large banks. In aggregate the
1
Asset Backed Commercial Paper & Global Banks, Fitch Teleconference, Aug 23 2007,
http://www.fitchratings.com/web_content/sectors/subprime/ABCP_Banks_Fitch_Aug_23.pdf
13
Lehman Brothers | U.S. Securitized Products Research

banking industry has no need to sell these assets in case liquidity provisions are drawn
down. Most of the liquidity providers are large well capitalized institutions. There is a
risk of a few banks choosing to liquidate mortgage assets. The holdings of mortgage
assets backed in conduits backed by non-U.S. banks are likely to be smaller than those of
U.S. bank conduits. However, it is from non-U.S. banks that the risk of a sale of assets is
highest. This is primarily because they may be less comfortable holding on to these
assets than the U.S. banks.

October 23, 2007 14

Lehman Brothers | U.S. Securitized Products Research

WILL BANKS BE MARGINAL BUYERS OF AAA?

Published September 14, 2007.

Banks as a Marginal Buyer of Non-Agency Paper

Given the wide spreads that continue to plague the top part of the capital structure in the
non-agency sector, we explore whether banks could emerge as the marginal bid for these
assets. We answer this question in two parts.
1. Do they have the necessary funding and capital to add more assets in non-agency
form today?
2. Do they have flexibility in their balance sheet to sell other assets (e.g., agency
passthroughs) to buy fundamentally sound but distressed assets such as non-agency
AAAs?

Making Room for ABCP Assets

Money markets are stabilizing,
but in an extreme scenario,
ABCP assets could end up
with banks
One of the big concerns about banks today is the potential for ABCP assets of conduits
for which they have written liquidity protections to end up on balance sheet. In an earlier
publication (A Closer Look at Liquidity Put Providers in the ABCP Market), we took a
look at the exposure of banks to ABCP conduits. We found that the total exposure of
U.S. banks to ABCP conduits was around $350 billion in assets. Also, the bulk of the
exposure was in the hands of the largest commercial banks. We therefore concluded that
there was a limited risk of any fire sale of assets, assuming that these assets did end up on
bank balance sheets. This week, stability seemed slowly to return to the money markets,
as evidenced by lower LIBOR settings, as well as a reduction in the pace of decline of
the ABCP market. However, in an extreme scenario, it is conceivable that banks could
end up holding all the ABCP assets on which they have written protection. If banks were
preparing for such a scenario, their appetite for other assets in the interim could be low.
We explore this issue in more detail.

Figure 1. Historical Leverage Ratios— Figure 2. Potential Effect of ABCP Consolidation

Commercial Banks on Bank Balance Sheets

11% 12/ 98 12/ 01 12/ 04 Today

Total Risk Weighted Assets 4218 5074 6292 8107

10%
Tier-1 Capital 400 501 631 777

Tier-1 Capital Ratio

9%

1. Historical 9.5% 9.9% 10.0% 9.58%

8%
Tier 1 Capital/Risk Weighted A ssets
All ABCP Comes
Equity Capital/Total A ssets to Balance Sheet.
2. 9.50%
7% No Losses on CP
Potential Tier-1 Ratio if A BCP Assets
A ssets Come on Balance Sheet
6% All ABCP Comes
12/92 11/95 10/98 09/01 08/04 06/07 3. to Balance Sheet 9.29%
5% Loss on Assets

Source: FDIC, Statistics on Depository Institutions. Includes only U.S. Source: FDIC, Statistics on Depository Institutions. Includes only U.S.
commercial banks. commercial banks. Today’s assets and equity are as of 2Q07 filings. Effect of
ABCP assumes a 20% risk weighting on ABCP assets consistent with the
assets’ being predominantly AAA in nature.

October 23, 2007 15

Lehman Brothers | U.S. Securitized Products Research

ABCP Conduits Could Keep Banks on Sidelines…

Leverage ratios, while still
healthy, could be adversely
affected; this has potential to
cause banks to conserve
balance sheet
In Figure 1, we look at historical equity/assets ratios of banks. Compared with the past, the
equity/total assets ratio of commercial banks is at a healthy level today. However, over the
past two quarters, the aggregate Tier 1 capital ratio (Tier 1 equity/risk-weighted assets) has
been declining. The Tier 1 capital ratio is more important from a regulatory capital
standpoint. To estimate the potential effect that ABCP assets could have on this ratio, we
show some pro forma leverage ratios in Figure 2. Most of the conduit assets to which banks
have exposure are AAA rated. We assume that they could potentially come onto balance
sheet with a 20% risk weighting. This adds to the denominator of the Tier 1 ratio. The
numerator is the total Tier 1 equity of banks. If the ABCP assets have any mark-to-market
losses, the equity could be written down as well. In a scenario in which there are no losses,
we think the Tier 1 ratios could go down by 10 bp. The ratio could go down to 30 bp
assuming 5% losses on the ABCP assets. While both these ratios are still fairly healthy and
the banking industry is still overcapitalized, the ratios are at the low end of the historical
range (based on data from December 1992). The potential for compression in capitalization
could cause banks to conserve balance sheet in the current environment.

… It’s Probably a Matter of Time

Our pro forma capitalization ratios do not account for additions to equity through earnings.
One or two quarters of earnings can easily improve the capitalization ratios back to current
levels, even assuming that all ABCP assets come on balance sheet with 5% losses.

On the Liability Side: Deposit Rates Are Going Up

Bank CD rates have gone up
significantly; deposit growth
may have become difficult
On the liability side of the equation, bank deposit growth rates, which were negative in the
first quarter of the year, seem to have picked up pace in the second quarter (Figure 3).
However, bank deposit rates (as measured by secondary market CD rates) are up 50 bp
over the past month (Figure 4). The increase is probably being driven by the need for
funding to tide over potential problems in conduits. Given that deposit rates are rising, we
think banks are unlikely to use these additional funds to invest in mortgage assets. This is
especially so given competition for balance sheet from C&I loans, as we discuss next.

Figure 3. Quarterly Deposit Growth Rates Figure 4. Bank Secondary CD Rates Are up 50 bp
(All U.S. Banks)

25% 6.00

20%
5.75
15%
CD Rates up 50bp

10% 5.50

5%
5.25
0%

-5% 5.00
12/02 09/03 06/04 03/05 12/05 09/06 06/07 Jun-07 Jun-07 Jul-07 Jul-07 A ug-07 Sep-07
Source: FDIC, Statistics on Depository Institutions. Deposit growth rates are Source: Federal Reserve, selected interest rates. Shows rates on 1-month
annualized. Includes both commercial and savings banks. Bank CDs

October 23, 2007 16

 Lehman Brothers | U.S. Securitized Products Research

On the Asset Side: Competition from C&I Loans

There is still significant
competition for mortgage assets
from C&I loans
Apart from potential for ABCP assets to come on balance sheet, the biggest competition for
mortgage assets remains commercial and industrial loans (C&I loans). Growth rates of C&I
loans are still running at close to 10% on an annualized basis (Figure 5). Unless the housing
recession and credit conditions tip the economy into recession, the loan growth here should
stay fairly strong. This does not bode well for potential bank demand for mortgage securities.

Asset Substitution: Why Not Sell FN 5s to Buy Non-Agencies?

Substituting agency assets for
non-agencies will probably
require a 20-30 bp rally in rates
ABCP assets and C&I loans could prove to be solid competition for any marginal mortgage
assets added by banks. However, commercial banks can always substitute agency
mortgages for non-agency paper. Commercial banks have close to $800 billion invested in
agency mortgages. Given the attractive yield pickup in buying AAA assets, this would
seem a great opportunity for banks to substitute agency assets and pick up an additional
100 bp in spread. The biggest roadblock is possibly the fact that the agency securities
portfolios are still under water. Figure 5 plots the losses on AFS portfolios of banks (the
majority of which is mortgages) versus the price of the Lehman Brothers MBS index. The
index needs to get to a dollar price of around 99.25 before AFS losses reach levels seen in
September/October of last year—the last period that saw significant agency passthrough
sales by banks. This essentially requires 10-year notes to get to around 4.20.

Overweight AAAs for Spread Tightening in the Medium Term

In the near term, banks are
going to be on the sidelines;
hard to time the trade,
and we recommend adding
exposure now
With the current uncertainty about conduits and given strong growth in C&I portfolios,
banks are unlikely to be buyers of non-agency assets. Substituting agency paper for non-
agencies would also be difficult at current rate levels. However, if stability continues to
return to the money markets, we think banks are more likely to add mortgage assets in
non-agency form. This could happen through either Fed actions or possibly just the
passage of time as bank earnings help in improving aggregate capitalization ratios. We
think there is a high probability that this will occur in the next 3-6 months. In order to
avoid risk in the timing of the trade, we recommend an overweight to non-agency AAAs
versus agency mortgages. While spreads may not return to the L+20 levels of three
months ago, we do expect spreads to tighten to at least an L+50 range.

Figure 5. C&I Loan Growth of Banks Running Strong Figure 6. Securities Portfolios Still in Losses

(%) $ Billion $
30% 5 100
0
99
20%
-5
-10 98
10%
-15 97
0% -20
96
-25
-10% -30 95
06-06 09-06 12-06 03-07 05-07 08-07
-20%
Losses on A FS Portf olio (Lef t)
06-00 06-01 06-02 06-03 06-04 06-05 06-06 06-07 Price of Lehman MBS Fixed Rate Index (Right)
Source: Federal Reserve. Based on monthly increase in C&I loans of domestic Source: Lehman Brothers, Federal Reserve. Losses on AFS portfolios shown
commercial banks. Growth is annualized. only for large commercial banks.

October 23, 2007 17

Lehman Brothers | U.S. Securitized Products Research

RECENT DEVELOPMENTS IN THE ABCP MARKET

We are encouraged by signs of
life—the level of outstanding
CP is stabilizing, and rates on
ABCP paper are converging
with those on financial CP
Published September 21, 2007. Revised October 23, 2007.
The pace of decline in the ABCP market appears to be stabilizing, just as the liquidity
freeze has started to thaw a bit after the Fed rate cuts (Figure 1a). In other signs of a
return to stability, the rates on ABCP paper, which was clearing 50 to 60 bp higher than
LIBOR, have moved closer to rates on financial CP. If the return to stability in the
money markets continues, we should see a reduction in the liquidity premiums assigned
to AAA non-agency assets. Over the past month, we have examined the events in the
ABCP market across a number of dimensions. This article is a compilation of our
thoughts.
Our conclusions:
• Contrary to popular perception, the share of mortgage assets in ABCP conduits is
only around 25% in aggregate.
• The risk of a fire sale of assets from ABCP conduits if paper cannot be rolled over is
limited. Most of the market is in the form of multi-seller conduits that have a strong
bank backing.
• The risk of a fire sale of assets from banks is limited even if the assets end up on
balance sheet. This is primarily because most of the liquidity providers for conduits
are large banks and the share of conduit assets in comparison to their balance sheets
is rather small
• As the money markets stabilize, banks are likely to add to their mortgage portfolios
in whole loan or non-agency securities form rather than with agency passthroughs.
• We continue to recommend an overweight to AAAs in the non-agency space. While
there is a risk that valuations widen from here, we think the bigger risk is missing
out on the trade today if valuations do snap back.

Figure 1a. The Rate of Decline of ABCP Outstanding Figure 1b. 1-Month Commercial Paper Rates versus 1-
Is Stabilizing Month LIBOR (bp)

$1,200 80
Billions

60
$1,150
40
$1,100 20

0
$1,050
-20
$1,000 -40

-60
$950
-80
$900 06-07 07-07 08-07 09-07
Jan-07 May-07 Sep-07 A A A BCP A A Financial CP

Source: Federal Reserve. Shows outstanding amounts in ABCP. Source: Federal Reserve

October 23, 2007 18

Lehman Brothers | U.S. Securitized Products Research

The following pages provide a summary of the ABCP market and features of structured
vehicles compiled from articles we have published in the past month. Links to the
original publications are provided where possible.

Structured Vehicles: Market Size and Composition

ABCP vehicles come in a
variety of forms, each with
unique features
The total size of the ABCP market today is roughly $1 trillion, a decline of roughly $250
billion since the peak in early August 2007. ABCP vehicles come in a variety of forms,
including multi-seller conduits, single-seller conduits, security arbitrage conduits, and
SIVs. The commercial paper (CP) market has been used by conduits as both a funding
diversification strategy and a funding arbitrage strategy. For a more comprehensive
discussion of different types of ABCP vehicles, please read Where Has All the Capital
Gone?
Conduit programs would fall into the first category, in which CP is typically used as
another means of funding the assets, which are typically mortgage, auto, or credit card
loans, receivables, etc.
• Multi-seller conduits: This is the largest segment of the ABCP market, representing
close to 60% of the outstanding universe. Roughly 10%, or $70 billion, of their
assets are residential credit, most of which are whole loans.
• Single-seller conduits: This category of the ABCP market accounts for around 20%
of the CP outstanding. In aggregate, single-seller conduits hold around $70 billion in
mortgage assets, mostly as loans. This means of financing is typically used by single
sponsors to fund their mortgage loan pipelines.
Structured investment vehicles (SIVs) and security-arbitrage (sec-arb) conduits use
the CP market to fund longer maturity assets, typically securities with CP. In aggregate,
these programs hold U.S. mortgage assets of around $80 billion.

Figure 2a. Size of ABCP Vehicles and Figure 2b. Estimated Size of ABCP Outstanding
Estimated Mortgage Holdings

Outstanding, U.S. Residential ∆ in

Type $ bn CP Issued Assets Type CP Issued CP Issued

Multi Seller Conduits 750 713 68 Multi Seller Conduits 664 -49
Single Seller Conduits 230 219 72 Single Seller Conduits 80 -139
Sec-arb Conduits 196 186 59 Sec-arb Conduits 140 -46
SIV 350 105 18 SIV 95 -10
CDOs with CP 45 45 45 CDOs with CP 45 0
Others 15 15 - Others 15 0
Total 1,586 1,282 261 Total 1,039 -243

Source: Lehman Brothers, Moody’s, S&P. As of August 13, 2007. The aggregate Source: Lehman Brothers, Moody’s. Includes multi-seller, single-seller,
residential exposures are estimates based on asset composition from rating agency sec-arb, SIVs, and other structures. Amounts outstanding are estimates.
reports.

October 23, 2007 19

Lehman Brothers | U.S. Securitized Products Research

Asset Composition of ABCP Vehicles

Exposure to various In aggregate, ABCP vehicles hold an estimated $250 billion in mortgage assets, both
sectors may vary by vehicle loans and securities. The asset composition can vary dramatically by vehicle and
and program program. As a result, the potential for forced asset sales can vary.

Figure 3a. Multi-Seller Conduit Asset Composition Figure 3b. Single-Seller Conduit Asset Composition

Trade Trade Other, 15%

Other, 25% Auto, 19%
Receivables Receivables
, 17% , 1%
Student
Loans, 2% Corporate
Auto Loans,
11% Loans, 7%
CBO/CLOs,
Securities,
4%
6%
Student
Loans, 4% Credit Card Credit Card
Receivables Rec, 14%
Mortgage , 10%
Loans, 9% Commercial Mortgages,
Securities, Loans, 9% 37%
11%

Source: Lehman Brothers, rating agency reports Source: Lehman Brothers, Moody’s

Figure 3c. Security Arb Conduit Asset Composition Figure 3d. SIV Asset Composition

Residential Other,
Other, 29% MBS, 21% 12.70%
Consumer
ABS, Financial
12.70% Assets,
41.00%

C&I Loans,
12%
CDO/CLO,
10.70%

CMBS, 12% RMBS RMBS

CBO &CLO, (U.S.),
(U.K.),
26% 5.70%
17.20%

Source: Lehman Brothers, rating agency reports Source: Lehman Brothers, Moody’s

October 23, 2007 20

 Lehman Brothers | U.S. Securitized Products Research

Holdings of Mortgage Assets Are Small

Despite strong growth in recent
years, ABCP mortgage assets
account for only a small share
of the overall mortgage market
We estimate that the ABCP market currently finances around $250 billion of mortgage
exposure. While ABCP conduits have seen tremendous growth in the past few years, this
growth has not been anomalous (Figure 4a). The mortgage market itself has grown
quickly over this period. Assuming that 20% of ABCP assets are in mortgages
historically, we estimate that the share of mortgages held in ABCP conduits as a
proportion of the overall market has remained at 2%-3% over the past 4-5 years (Figure
4b). In contrast, the mortgage holdings of domestic banks are almost 20 times as high,
accounting for close to 40% of the outstanding mortgage debt.
If the CP market stops providing liquidity for incremental mortgage financing, we do not
think this is a disaster scenario. In an environment of reduced mortgage originations, we
think the rest of the investing community will be able to pick up the slack. Specifically,
commercial banks could issue unsecured CP to fund the additional mortgage supply that
used to be funded through the ABCP market.

Figure 4a. Growth in Asset Backed CP ($ billion) Figure 4b. ABCPs Finance Only a Fraction of Market

$1,400 50% 4.0%

$1,200 46%
3.0%
$1,000
42%
$800 2.0%
38%
$600 1.0%
34%
$400
30% 0.0%
$200 Jan-98 Jul-99 Jan-01 Jul-02 Jan-04 Jul-05 Jan-07

$0 Bank Mortgage Holdings/Total Market

Jan-98 Mar-00 May-02 Jul-04 Oct-06 ABCP Mortgage Holdings/Total Market (RHS)

Source: Federal Reserve Source: Lehman Brothers, Federal Reserve. Assumes mortgage assets are
25% of the ABCP market, which is the approximate composition today.

October 23, 2007 21

 Lehman Brothers | U.S. Securitized Products Research

Protection in the Event of Distress

ABCP vehicles have a variety of
measures in place to mitigate
the risk that CP doesn’t roll
The overarching source of anxiety in the markets has been about what will happen if CP
does not roll. The market is concerned that there could be a forced sale of mortgage
assets from ABCP vehicles. The resulting supply in an already-illiquid market could lead
to very nasty technicals. To understand the risk from potential unwinds, we look at the
composition and structural features of ABCP vehicles.
Multi-seller conduits are not mark-to-market vehicles. In the event of a downgrade,
securities are purchased at par by the designated liquidity provider and go onto their
balance sheet. A liquidity put provider is typically a large, well-capitalized bank that
agrees to step in and either purchase or fund the assets in the case that CP is not rolled
over.
Single-seller conduits typically have an extendible feature. The CP can be extended past
the initial maturity date in case of an inability to roll over. The assets of the conduit need
to be auctioned if the CP is extended and no new financing is found before the end of the
extension period. CP holders are protected from this risk by the existence of a market
value swap provider. These entities make up for any shortfall in the proceeds from asset
sales.
SIVs are sensitive only to severe mark-to-market losses on the total portfolio, while sec-
arb conduits are not marked to market. In SIVs, the risk to the CP holders from adverse
moves in asset prices is mitigated by the existence of capital notes that are subordinated
to the interests of the CP investors. These vehicles typically need to unwind if a mark-to-
market impairment is greater than 50% of the capital notes. In most sec-arb conduits,
there is a liquidity put provider.

We believe that many assets
held by single-seller conduits
have either been sold or
gone onto sponsor balance
sheets in recent weeks
Recent Developments
As we have written in the past, we believe the biggest risks of asset sales in the ABCP
market are from single-seller conduits and SIVs. These are largely the risk from one-off
SIV transactions with more concentrated assets in the mortgage sector, where mark-to-
market losses could trigger unwinds. On the single-seller side, these represent potential
unwinds from sponsors with weak liquidity.
The amount of ABCP outstanding has declined dramatically in recent weeks. Single-
seller conduits have seen the largest decline in ABCP financing. We believe that most of
these assets have been sold or have gone onto sponsor balance sheets.

Figure 5. Summary of ABCP Conduit Protection Features

Multi-seller Conduits Single-seller Conduits Sec-arb Conduits SIVs

Est Mortgage Assets, $ bn 68 72 59 18

Mark-to-market?
Protection
By liquidity put provider if CP
Risk of Asset Sales?
Probability of Sales
Potential Asset Sales, $ bn
No No
Extendible feature, market
Liquidity put provider
value swap provider
If no new financing is found If no new financing is found
before end of extension
does not roll over
period
Certain vehicles may have
Unlikely higher risk due to limited
funding availability
- 20
No Yes, only severe losses
Liquidity put provider Liquidity provision
If MTM impairment is greater
before end of extension
than 50% of capital notes
period
Vehicles with composition
Unlikely skewed to mortgage/ABS
CDOs more sensitive
- 5

Source: Lehman Brothers. Mortgage assets estimated as of August 13, 2007.

October 23, 2007 22

Lehman Brothers | U.S. Securitized Products Research

Limited Concern of Fire Sale of Assets from Banks

While the exposure of U.S.
banks to ABCP conduits is low
in aggregate, they may have
little appetite for other assets
until stability returns
One of the big concerns about banks today is the potential for ABCP assets of conduits
for which they have written liquidity protections to end up on balance sheet. We found
that the total exposure of U.S. banks to ABCP conduits was around $350 billion in
assets. Also, the bulk of the exposure was in the hands of the largest commercial banks.
We concluded that there was a limited risk of any fire sale of assets, assuming that these
assets did end up on bank balance sheets (see A Closer Look at Liquidity Put Providers
in the ABCP Market).
The market has also gradually stabilized, as the spike in Libor has assuaged and the
decline of the ABCP market has abated. However, in an extreme scenario, it is
conceivable that banks could end up holding all the ABCP assets on which they have
written protection. If banks were preparing for such a scenario, their appetite for other
assets in the interim could be low (see MBS Weekly, September 14, 2007).

Figure 6. Protection in the Event of Distress Figure 7. Liquidity Provision Exposures of U.S. Banks
CP Protection Total CP
Extend CP/ Liquidity Written as % of # of Total Bank Liquidity/Credit
Type Mkt Val Swap Put Provider Provision Assets Banks Assets Provisions
Multi Seller - 713 -
Single-Seller 180* - - 1-2% 2 758 9
Security Arbitrage 20* 166 - 2-4% 2 1993 69
SIVs - - 88* 4-6% 5 3136 148
CDOs with CP - 45 - 6-12% 2 1449 90
Others - - - >12% 2 159 32
Total 200 924 88

Source: Lehman Brothers, Moody’s. The distribution of extendible CP Source: FFIEC Call Reports, FDIC. As of 1Q07.
protection across vehicles and the size of liquidity providers are estimates.

Figure 8. Historical Leverage Ratios— Figure 9. Potential Effect of ABCP Consolidation

Commercial Banks on Bank Balance Sheets

11% 12/98 12/01 12/04 Today

Total Risk-weighted Assets 4,218 5,074 6,292 8,107

10%
Tier-1 Capital 400 507 631 777

Tier-1 Capital Ratio

9%
1. Historical 9.5% 9.9% 10.0% 9.58%
8%
Tier 1 Capital/Risk Weighted A ssets All ABCP Comes
on Balance Sheet;
Equity Capital/Total A ssets 2. 9.50%
7% No Losses on
CP Assets
Potential Tier-1 Ratio if A BCP
A ssets Come on Balance Sheet
6% All ABCP Comes on
12/92 11/95 10/98 09/01 08/04 06/07 3. Balance Sheet; 5% 9.29%
Losses on Assets
Source: FDIC, Statistics on Depository Institutions. Includes only U.S. Source: FDIC, Statistics on Depository Institutions. Includes only U.S.
commercial banks. commercial banks. Today’s assets and equity are as of 2Q07 filings. Effect of
ABCP assumes a 20% risk weighting on ABCP assets consistent with the
assets’ being predominantly AAA in nature.

October 23, 2007 23

Analyst Certification
The views expressed in this report accurately reflect the personal views of Prasanth Subramanian and Olga Gorodetsky, the
primary analysts responsible for this report, about the subject securities or issuers referred to herein, and no part of such
analysts' compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed herein.

Important Disclosures
Lehman Brothers Inc. and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides
liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives
thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or
derivative instruments, which may pose a conflict with the interests of investing customers.
Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly
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The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the
quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the
profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability
of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst.
Lehman Brothers generally does and seeks to do investment banking and other business with the companies discussed in its
research reports. As a result, investors should be aware that the firm may have a conflict of interest.
To the extent that any historical pricing information was obtained from Lehman Brothers trading desks, the firm makes no
representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market
levels, prices or spreads, some or all of which may have changed since the publication of this document.
Lehman Brothers' global policy for managing conflicts of interest in connection with investment research is available at
www.lehman.com/researchconflictspolicy.
To obtain copies of fixed income research reports published by Lehman Brothers please contact Valerie Monchi
(vmonchi@lehman.com; 212-526-3173) or clients may go to https://live.lehman.com/.

Company-Specific Disclosures
Aurora Loan Services LLC and BNC Mortgage Inc, both subsidiaries of Lehman Brothers through Lehman Brothers Bancorp, are
primarily engaged in the business of originating residential mortgage loans in the U.S.

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