Basis in Abx Tabx Bespoke SF Cdos

Tranche ABX and Basis
Risk in Subprime RMBS

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

What is “basis risk”?
Why is “basis risk” between these structures important
now?
What are structured subprime RMBS portfolios?
> Portfolio exposure to subprime Residential Mortgage-Backed Securities

(RMBS) can be obtained using various structures:
– Structured Finance Collateralized Debt Obligations (SF CDOs)
> Cash SF CDOs
> Bespoke SF CDOs
> Hybrid SF CDOs
– ABX.HE Indices
– Tranche ABX.HE (TABX) Indices
www.derivativefitch.com 2
What is “basis risk”?
> Basis risk describes the risk that offsetting investments in a hedging strategy
will not experience cash flow or price gains in the same manner.
> Basis risk has the potential to create an excess gain or loss and therefore is
not directional. The amount of basis risk in a hedging strategy describes the
how much risk is left behind due to imperfect correlation between the two
investments.
> Basis risk in subprime RMBS portfolios generally arises from:
– Performance differences in the underlying portfolio assets
– Structural differences in portfolio instruments
– Liquidity differences in the different secondary markets
– Timing of expected cash flows from the portfolio instruments
Why is “basis” between these structures important
now?
> Standard tranches of the ABX.HE Index commenced trading on Feb. 14, 2007
> Index tranches promise to provide:
– Liquidity
– Transparency
– Standardization
– Market Consensus
> Motivations for TABX participation:
– Hedging
– Relative Value Trading
– Benchmarking
– Leveraged Market Positions
Framework for Understanding Basis Risk in
Subprime RMBS Portfolios
> Subprime RMBS 101
> Credit Default Swaps on Subprime RMBS
– Credit Default Swaps 101
– ISDA Pay-As-You-Go Template 101
– Subprime RMBS AFC Risk
> Typical Subprime RMBS Portfolio Structures
– Structured Finance CDOs 101
– ABX.HE and TABX.HE Indices 101
> Basis Risk between TABX.HE and Other Structures
Subprime RMBS Overview
Subprime RMBS 101

Subprime RMBS 101
> Typical Subprime Borrower and Loan Characteristics

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

– Hybrid Adjustable-Rate Mortgages (ARMs)
> 2/28 Mortgage is fixed for the first two years and then switches to
adjustable rate for the remaining 28 years
> Other common Hybrid ARMs 3/27 and 5/25 terms
– Hybrid Interest Only (IO) ARMs
– 40-Year Hybrid ARMs
– Piggyback Second Liens
– Limited Documentation Loan Programs
Subprime RMBS 101
Sample Subprime RMBS Structure

Mortgage REMIC RMBS
Individual Mortgages
Pools Trust Bonds
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
2/28 ‘AAA’
M31 M32 M33 M34 M35 M36 M37 M38 M39 M40 RMBS
Hybrid ARM
M41 M42 M43 M44 M45 M46 M47 M48 M49 M50 Mortgage
Pool
M51 M52 M53 M54 M55 M56 M57 M58 M59 M60 Special
Purpose
M61 M62 M63 M64 M65 M66 M67 M68 M69 M70 Vehicle
(RMBS
M ‘AA’
M71 M72 M73 M74 M75 M76 M77 M78 . . . Trust)
2000 RMBS
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10 ‘A’
RMBS
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20 ‘BBB’
Fixed Rate RMBS
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30 Mortgage ‘BBB-’
M31 M32 M33 M34 M35 M36 M37 M38 . . . RMBS
M
Residual
1000
Subprime RMBS 101
$P
Sample Subprime RMBS Payments
$I
Monthly Mortgage REMIC Interest Principal
Accounts
Payments Trust Payments Payments
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10 Scheduled
Principal
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20 &
Prepayments
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 M39 M40
$ ‘AAA’
L + % or Net WAC
M41 M42 M43 M44 M45 M46 M47 M48 M49 M50 ‘AAA’
$I Interest
M51 M52 M53 M54 M55 M56 M57 M58 M59 M60
M61 M62 M63 M64 M65 M66 M67 M68 M69 M70 Servicer
M ‘AA’
M71 M72 M73 M74 M75 M76 M77 M78 . . . ‘AA’
2000 L + % or Net WAC
‘A’
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10 ‘A’
L + % or Net WAC
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20 ‘BBB’
$ L + % or Net WAC
‘BBB’
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
$P Scheduled ‘BBB-’
‘BBB-’
M31 M32 M33 M34 M35 M36 M37 M38 . . . Principal L + % or Net WAC
M & Residual
Prepayments Residual
1000 Excess Interest
Subprime RMBS 101
> Standard Structural Features of Subprime RMBS

– Subordination serves as credit enhancement to account for credit risk
– Interest rate instruments to hedge interest rate risk
– Performance test at three year mark
> If test fails then the priority of payments remains unchanged with the
senior notes receiving all principal proceeds
> If test passes then principal proceeds repays subordinated notes until
targeted subordination is met.
– Defaulted loans worked out by servicers
> Each Subprime RMBS will have somewhat unique performance profiles
Subprime RMBS 101
Principal Waterfalls
– Sequential pay
> All scheduled principal and prepayments go to repay the senior bond holders
first until paid-in-full, then to the next senior note holder, etc.
> Subprime RBMS are initially sequential pay for the first three years and will
remain sequential pay if the performance tests fail
– Credit Enhancement (CE) “Step Downs”, if performance tests pass
> If overcollateralization (OC) targets have been met, the CE is stepped down by
repaying subordinate bond holders.
> OC targets are set to double the original subordination, ie. If the original ‘AAA’
bond subordination is 7.5% then the target is 15%
> Test senior note target for compliance first and if passing then check the next
senior bond and so on.
> Over periods of rapid prepayments all bonds may be meeting the OC targets,
then principal prepayments become inverse sequential pay.
Sample Principal Waterfalls
Scenario 2: Performance Test Passes the Credit
Enhancement “Steps Down” by Paying Principal
Scenario 1: Sequential Principal Repayment to Subordinated Notes
$P
$P
Principal
Principal Accounts
Accounts Payments
Payments
Scheduled
Scheduled Principal
Principal Payments
Payments & Before Step Down
& Before Step Down Prepayments
Prepayments
After Step Down
‘AAA’
‘AAA’
‘AA’
‘AA’
‘A’
‘A’
‘BBB’
‘BBB’
‘BBB-’
‘BBB-’ After Step Down
Residual
Residual
Subprime RMBS 101
Interest Waterfalls
– Regular interest
> Paid sequentially to bonds, capped at weighted average mortgage
rate net of expenses (Net WAC) or available funds cap (AFC)
– Excess Interest
> Excess interest is the remaining interest proceeds in the interest
collection account after paying bondholders regular interest above
> First, excess interest is used to recover realized collateral losses
> Second, excess interest is used to recover any interest shortfalls
created where Net WAC is lower than the stated bond coupon
> Finally, the remaining excess interest goes to the residual bond holder
Sample RMBS Interest Waterfall
Step 1 – Interest Step 2 – Excess Step 3 – Remaining
Paid Sequentially Interest to Excess Interest to
to Bonds, Capped Cover Collateral Pay AFC Shortfalls
at AFC Losses
$I
Interest Principal Interest
Accounts Shortfalls
Payments Payments
Scheduled
Principal
&
Prepayments
‘AAA’
L + % or Net WAC
‘AAA’
Interest
‘AA’
‘AA’
L + % or Net WAC
‘A’
‘A’
L + % or Net WAC
‘BBB’
‘BBB’ L + % - Net WAC
L + % or Net WAC
‘BBB-’
‘BBB-’
L + % or Net WAC L + % - Net WAC
Residual Residual
Excess Interest Losses Step 4 – Remaining
Excess Interest to
Residual Holder
Subprime RMBS 101
AFC Interest Shortfall

– AFC Shortfall is the difference between the stated bond coupon and the
Net WAC
– AFC Shortfalls accrue over time and may be recoverable
– AFC Shortfalls manifest themselves in times of rising interest rates
> Typical subprime RMBS deals have 75% hybrid ARM mortgages
> RMBS bonds are generally floating rate bonds based on the London
InterBank Offering Rate (LIBOR)
> If short-term LIBOR interest rates rise during the 2- or 3-year fixed
rate period then the interest coupon from the mortgages is insufficient
to pay the RMBS bond holders LIBOR plus the stated spread
– AFC shortfalls may be unrecoverable if excess interest is eroded.
Credit Default Swaps on Subprime
RMBS
Credit Default Swaps (CDS) 101

ISDA Pay-As-You-Go (PAUG) Template 101
Subprime RMBS AFC Risk
Credit Default Swaps 101
Protection Seller
– Receives CDS premium payment and reimbursement payments in
exchange for providing protection payments if a credit event occurs.
– CDO note holders are protection sellers in a synthetic CDO.
Protection Buyer
– Pays CDS premium in exchange for protection payments if a credit event
occurs.
– CDS Swap Counterparty is the protection buyer in a synthetic CDO.
Calculation Agent
– Determines the amount of the protection payment upon a credit event per
the terms of the credit default swap
– Usually the Protection Buyer serves this role
Collateral or Eligible Investment

– Highly rated, highly liquid financial instruments purchased from the sales
proceeds of the initial CDO notes.
– Provides the index portion of the note coupon
– Provides protection payments or the return of principal to note holders
Reference Entity and Reference Obligation
– Reference entities are security issuers like a corporation or sovereign
– Reference obligations are securities with specific debt seniority levels
> Reference obligations in a corporate CDS is usually informational to
establish the seniority of debt to be valued if a credit event occurs
> Reference obligations in CDS of structured finance assets or
leveraged loans or in total return swap structures
Sample Credit-Linked Note (CLN) using a CDS
Protection Credit Default Protection

Buyer Swap Seller
CDS Premium Note Coupon
(bps) (L + bps)
CDS Swap Credit-Linked Protection

Counterparty Note Trust Seller
Protection CLN Proceeds
Payments ($) ($)
CLN
LIBOR Proceeds
(L) ($)
Reference Collateral or
Entity or Eligible
Obligation Investments
Credit Events
– Applicable credit events will vary by CDS
– Typical credit events may include:
> Bankruptcy
> Failure to Pay (FTP)
> Restructuring
> Repudiation/Moratorium, usually emerging markets and sovereigns only
> Obligation Acceleration, usually emerging markets sovereigns only
– Once a credit event has been called and settled then the credit default swap
is terminated
Settlement and Valuation Procedures

– Protection Buyer calls a credit event by sending notice to the Protection
Seller what credit event has occurred
– Settlement method is determined by the CDS contract
> Physical settlement means the Protection Buyer gives the Seller the
reference obligation, or equivalent, in return for cash par amount
> Cash settlement means the parties look to the market value of the
reference obligation to determine the net protection payment
– Fitch’s preferred valuation process includes:
> Dealer poll of at least 5 dealers, not including the Protection Buyer
> Polls typically held 30 to 60 days after credit event notification
> ISDA PAUG template is designed to replicate the cash flow profile of the cash
bond with a credit default swap (CDS) contract
> CDS contracts for corporate and sovereign issuers are insufficient to replicate
the payment profile of a structured finance bond
> ISDA PAUG template was introduced in the U.S. in XXXX 2005 for RMBS and
CMBS securities for CDO securities in June 2006
> Introduces the concept of “floating payments”
– Floating payments are paid by the Protection Seller in the event of an AFC
Interest Shortfall
– Floating payments may be reimbursed by the Protection Buyer if the AFC
Interest Shortfall is ultimately recovered
Sample CLN using a PAUG CDS
Floating
Payments
Protection Credit Default Protection

Buyer Swap Seller
CDS Premium Note Coupon
(bps) (L + bps)
CDS Swap Credit-Linked Protection

Counterparty Note Trust Seller
Protection CLN Proceeds
Payments ($) ($)
CLN
LIBOR Proceeds
(L) ($)
Reference Collateral or
Obligation Eligible
Investments
PAUG Credit Events

– Failure to Pay (FTP) Principal
– Writedown
– Distressed Rating Downgrade (‘CCC’ or below)
– FTP Interest for CDO reference obligations only
PAUG Floating Amount Events
– Interest Shortfalls
– Principal Shortfalls
– Writedown Amounts
> Protection Buyers typically have an option whether to call a credit event or a
floating amount event
PAUG Settlement
– The secondary market for structured finance securities is not liquid and
therefore valuation procedures are not applicable
– Floating payments are designed to replicate the actual loss amounts
– If a credit event occurs then the Protection Buyer has the option to
physically deliver all or part of the notional amount to the Seller
> If the entire notional is physically settled then the CDS is terminated
> If a portion of the notional is settled then the CDS continues on the
remaining amount
Interest Shortfalls
– RMBS reference obligations are called AFC shortfalls
– CMBS reference obligations are called WAC shortfalls
– CDO reference obligations are called PIK-ing shortfalls
Interest Shortfall Cap Options

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

– REMIC law limits a floating rate RMBS bond pass-through rate to the
lesser of:
> Bond spread plus some index (typically 1 month LIBOR), or
> Underlying mortgage collateral pool’s weighted average coupon, net
of expenses (Net WAC).
– AFC Risk varies by RMBS transaction based on:
> Actual prepayment speeds of underlying mortgages
> Effectiveness of interest rate hedges in the RMBS structure
> Short-term interest rate increases before Hybrid ARM mortgages
switch to floating interest rate payments
> Unrecovered AFC Interest Shortfalls can be prevalent by vintage

> Unrecovered AFC Interest Shortfalls can be present across all rating categories
RMBS Bonds that Experience Unrecovered AFC Interest Shortfalls

Initial Rating 2001 2002 2003 2004 2005 2006
AAA 0.00% 0.00% 0.00% 0.69% 0.50% 0.00%
AA+ 0.00% 0.00% 0.00% 4.81% 0.96% 0.00%
AA 0.00% 0.00% 0.00% 3.09% 2.24% 0.00%
AA- 0.00% 0.00% 0.00% 6.67% 1.05% 0.00%
A+ 0.00% 0.00% 0.00% 7.46% 3.46% 0.33%
A 0.00% 0.00% 0.93% 4.56% 3.35% 0.77%
A- 0.00% 0.00% 6.56% 5.18% 6.71% 0.75%
BBB+ 0.00% 0.00% 4.95% 10.12% 13.51% 2.96%
BBB 0.00% 0.00% 7.17% 10.10% 19.34% 6.67%
BBB- 0.00% 0.00% 2.77% 16.13% 25.49% 18.17%
BB+ 0.00% 0.00% 0.00% 11.11% 23.00% 33.25%
BB 0.00% 0.00% 0.00% 2.62% 18.04% 35.38%
Key Risks – AFC Risk
> Unrecovered AFC Interest Shortfall amounts have been small

> Difference in CDS premium required for No Cap protection may exceed the
actual unrecovered AFC interest shortfalls experience in the cash bond market
Cumulative Unrecovered AFC Interest Shortfalls as % of Bond Balance
Initial Rating 2001 2002 2003 2004 2005 2006
AAA 0.00% 0.00% 0.00% 0.01% 0.03% 0.00%
AA+ 0.00% 0.00% 0.00% 0.04% 0.21% 0.00%
AA 0.00% 0.00% 0.00% 0.08% 0.22% 0.00%
AA- 0.00% 0.00% 0.00% 0.06% 0.20% 0.00%
A+ 0.00% 0.00% 0.00% 0.08% 0.27% 0.05%
A 0.00% 0.00% 0.01% 0.05% 0.31% 0.04%
A- 0.00% 0.00% 0.07% 0.05% 0.06% 0.05%
BBB+ 0.00% 0.00% 0.16% 0.08% 0.09% 0.04%
BBB 0.00% 0.00% 0.18% 0.19% 0.07% 0.04%
BBB- 0.00% 0.00% 0.64% 0.22% 0.08% 0.05%
BB+ 0.00% 0.00% 0.00% 0.34% 0.13% 0.03%
BB 0.00% 0.00% 0.00% 0.11% 0.12% 0.03%
Subprime RMBS Portfolio
Structures
Structured Finance CDOs 101

ABX.HE and TABX.HE 101
> Generic Types of SF CDOs

– Cash SF CDOs
– Bespoke SF CDOs
– Hybrid SF CDOs
Sample Cash SF CDO Structure

CDO CDO
CDO Portfolio
Trust Bonds
RMBS RMBS RMBS RMBS RMBS
Bond 1 Bond 2 Bond 3 Bond 4 Bond 5
Note Coupon
RMBS RMBS RMBS RMBS RMBS (L + bps)
Bond 11 Bond 12 Bond 13 Bond 14 Bond 15 ‘AAA’
CDO
RMBS RMBS RMBS RMBS RMBS Bond Coupons
Bond 16 Bond 17 Bond 18 Bond 19 Bond 20 (L + bps) Proceeds
RMBS RMBS RMBS RMBS RMBS Special ($)
Bond 21 Bond 22 Bond 23 Bond 24 Bond 25 Purpose
Vehicle
RMBS RMBS RMBS RMBS RMBS Proceeds (CDO
Bond 26 Bond 27 Bond 28 Bond 29 Bond 30 ($) Trust) ‘AA’
RMBS RMBS RMBS RMBS RMBS CDO
‘A’
RMBS RMBS RMBS RMBS CDO
...
Bond 36 Bond 37 Bond 38 Bond 80
‘BBB’
CDO CDO CDO CDO CDO CDO
CDO CDO CDO CDO CDO Preferred Shares
Bond 6 Bond 7 Bond 8 Bond 9 Bond 10 or Equity
> Cash SF CDO Asset Portfolio Highlights

– Portfolios contain between 60 and 140 bonds
– Assets may be diversified by market sector, however recent vintage SF
CDOs have been concentrated in subprime RMBS
– Assets may be diversified by risk profile (intial ratings)
– Assets may be diversified by vintage
– Asset acquisition and selection
> Asset manager warehouses bonds prior to issuing CDO notes
> CDO notes typically issued when asset manager has accumulated
approximately 60-80% of the target portfolio
> Initial portfolio is typically fully ramped within 6 months of CDO note
issuance
> Managed vs Static Portfolios

– Static portfolios are typically fully ramped at closing and principal proceeds
are used to amortize the senior notes
– Managed portfolios are typically partially ramped at closing and principal
proceeds are typically reinvested for a finite period between 3 and 6 years
> If the portfolio experiences negative credit migration then discretionary
trading is limited to “maintain or improve” credit quality
> If the portfolio significantly under performs then the transactions may
shift to a static portfolio
> Cash SF CDO Note Highlights

– Credit enhancement comes from subordination and excess spread
– Interest is paid sequentially to note holders
– Overcollateralization (OC) and Interest Coverage (IC) performance tests
are checked prior to distributions to subordinate notes
– Excess interest may be used to:
> If tests are passing then distributed to Preferred Shares or Equity
> A portion may be used to repay mezzanine notes
> If tests are failing then distributions may be used to cure the tests
– Purchase new assets
– Pay down senior notes
Sample Bespoke SF CDO Structure

CDO CDO
Reference Portfolio
Trust Structure
RMBS RMBS RMBS RMBS RMBS Unfunded
Bond 11 Bond 12 Bond 13 Bond 14 Bond 15 CDS Super-Senior Unfunded
Premium Special Revolver CDS
CDS Swap Purpose
Counterparty Vehicle
RMBS RMBS RMBS RMBS RMBS (CDO
Protection
Bond 21 Bond 22 Bond 23 Bond 24 Bond 25 Trust) Note
Payments
RMBS RMBS RMBS RMBS RMBS Coupon
Bond 26 Bond 27 Bond 28 Bond 29 Bond 30 (L + bps)
‘AAA’
RMBS RMBS RMBS RMBS RMBS Note
Bond 31 Bond 32 Bond 33 Bond 34 Bond 35 Proceeds
($) Unfunded
RMBS RMBS RMBS RMBS
... First Loss
Bond 36 Bond 37 Bond 38 Bond 80 CDS
Proceeds
LIBOR
($)
(L)
Collateral or
Eligible
Investments
> Bespoke SF CDO Asset Portfolio Highlights

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

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

CDO CDO
CDS Portfolio
Trust Structure
CDS 1 CDS 2 CDS 3 CDS 4 CDS 5
CDS 6 CDS 7 CDS 8 CDS 9 CDS 10 CDS Premium CDS Premium
RMBS RMBS RMBS RMBS RMBS Unfunded
CDS 11 CDS 12 CDS 13 CDS 14 Bond 15 Super-Senior Unfunded
Revolver CDS
RMBS RMBS RMBS RMBS Protection Super-Senior
... Protection
CDS 16 CDS 17 CDS 18 CDS 20 Payments
Payments
CDO CDO CDO CDO CDO
CDS 1 CDS 2 CDS 3 CDS 4 CDS 5 Special
Purpose
Note Coupon
Bond Portfolio Vehicle
(L + bps)
(CDO ‘AAA’
Trust) CDO
Bond 1 Bond 2 Bond 3 Bond 4 Bond 5 ‘AA’
Bond Coupons CDO
(L + bps)
Bond 6 Bond 7 Bond 8 Bond 9 Bond 10 ‘A’
CDO Funded
RMBS RMBS RMBS RMBS RMBS Notes
Bond 11 Bond 12 Bond 13 Bond 14 Bond 15 ‘BBB’
Proceeds CDO
RMBS RMBS RMBS RMBS
... ($)
Bond 16 Bond 17 Bond 18 Bond 20
Preferred Shares
CDO CDO CDO CDO CDO or Equity
Bond 1 Bond 2 Bond 3 Bond 4 Bond 5 Proceeds
($)
> Hybrid SF CDO Asset Portfolio Highlights

– Portfolio assets may be in a cash or synthetic form
– Portfolios contain between 60 and 140 bonds or CDS
– Asset attributes similar to the cash SF CDO portfolios
– Portfolios are typically managed
> Asset managers can find relative value on the same asset between
cash and synthetic markets
> Asset managers can use the synthetic market to access collateral
from vintages that are not available in the secondary market
> Asset managers can use the synthetic market to get full exposure to
cash bonds where they received a partial allocation
ABX.HE and TABX.HE Indices 101
RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS ...
RMBS
1 2 3 4 5 6 7 8 9 10 11 20
‘AAA’ ‘AAA’ ‘AAA’ ‘AAA’ ‘AAA’ ‘AAA’ ‘AAA’ ‘AAA’ ‘AAA’ ‘AAA’ ‘AAA’ ... ‘AAA’
RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS ABX.HE.AAA
‘AA’ ‘AA’ ‘AA’ ‘AA’ ‘AA’ ‘AA’ ‘AA’ ‘AA’ ‘AA’ ‘AA’ ‘AA’ ‘AA’
RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS
... RMBS
ABX.HE.AA
‘A’ ‘A’ ‘A’ ‘A’ ‘A’ ‘A’ ‘A’ ‘A’ ‘A’ ‘A’ ‘A’ ‘A’ ABX.HE.A
RMBS
...
‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’ ‘BBB’
...
RMBS
ABX.HE.BBB
‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ‘BBB-’ ABX.HE.BBB-
RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS RMBS ... RMBS
Residual Residual Residual Residual Residual Residual Residual Residual Residual Residual Residual ... Residual
> ABX.HE Asset Portfolio Highlights

– Portfolios reference 20 bonds
– Assets are all subprime RMBS
– Assets are homogenous by risk profile (intial ratings)
– Assets are originated in a 6 month time frame
– Asset selection
> Aggregate a list of the largest volume subprime RMBS issuers
> Select two representative transactions from each issuer
> Index participants vote on transactions to be included in each index
TABX.HE.BBB TABX.HE.BBB
Reference Obligations Tranches
ABX.HE.BBB ABX.HE.BBB
06-2 Portfolio 07-1 Portfolio
‘BBB’ ‘BBB’
RMBS 1 RMBS 1
‘BBB’ ‘BBB’
RMBS 2 RMBS 2
‘BBB’ ‘BBB’
RMBS 3 RMBS 3
‘BBB’ ‘BBB’
35 – 100%
RMBS 4 RMBS 4
‘BBB’ ‘BBB’
RMBS 5 RMBS 5
‘BBB’ ‘BBB’
RMBS 6 RMBS 6
‘BBB’ ‘BBB’
RMBS 7 RMBS 7
‘BBB’ ‘BBB’
RMBS 8 20 – 35%
RMBS 8
. . 12 – 20%
. .
. . 7 – 12%
3 – 7%
‘BBB’ ‘BBB’
RMBS 20 RMBS 20 0 – 3%
> TABX.HE Asset Portfolio Highlights

– Portfolios reference 40 bonds from two ABX.HE indices
– Assets are all subprime RMBS
– Assets are homogenous by risk profile (intial ratings)
– Assets are originated in a one year time frame
Conclusions
ABX.HE and TABX.HE Conclusions
> The ABX.HE has proven to be effective in providing market transparency in an

otherwise opaque market
– Allows market participant to express market views
> The TABX.HE promises to provide similar benchmarking and relative value
views for the Bespoke SF CDO market
> TABX.HE will be less effective in benchmarking for cash and hybrid SF CDOs
– Portfolios have significantly different portfolio characteristics
– Portfolios are typically managed in SF CDOs
– TABX.HE is equally weighted by the largest issuers whereby SF CDOs
portfolios are typically selected by an asset manager
www.derivativefitch.com
New York
One State Street Plaza
New York, NY 10004
Tel. +1 212 908 0500
London
101 Finsbury Pavement
London EC2A 1RS
Tel. +44 (0) 20 7862 4000
Hong Kong
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89 Queensway, Hong Kong
Tel. +852 2263 9963

Basis in Abx Tabx Bespoke SF Cdos

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Tranche ABX and Basis

Risk in Subprime RMBS

What are structured subprime RMBS portfolios?

> Portfolio exposure to subprime Residential Mortgage-Backed Securities

Subprime RMBS 101

> Typical Subprime Borrower and Loan Characteristics

> Typical Subprime Loan Types

Sample Subprime RMBS Structure

> Standard Structural Features of Subprime RMBS

AFC Interest Shortfall

Credit Default Swaps (CDS) 101

Collateral or Eligible Investment

Sample Credit-Linked Note (CLN) using a CDS

Protection Credit Default Protection

CDS Swap Credit-Linked Protection

Settlement and Valuation Procedures

Sample CLN using a PAUG CDS

Protection Credit Default Protection

CDS Swap Credit-Linked Protection

PAUG Credit Events

Interest Shortfall Cap Options

> Available Funds Cap (AFC) Risk

> Unrecovered AFC Interest Shortfalls can be prevalent by vintage

RMBS Bonds that Experience Unrecovered AFC Interest Shortfalls

> Unrecovered AFC Interest Shortfall amounts have been small

Structured Finance CDOs 101

> Generic Types of SF CDOs

Sample Cash SF CDO Structure

> Cash SF CDO Asset Portfolio Highlights

> Managed vs Static Portfolios

> Cash SF CDO Note Highlights

Sample Bespoke SF CDO Structure

> Bespoke SF CDO Asset Portfolio Highlights

> Bespoke SF CDO Note Highlights

Sample Hybrid SF CDO Structure

> Hybrid SF CDO Asset Portfolio Highlights

> ABX.HE Asset Portfolio Highlights

> TABX.HE Asset Portfolio Highlights

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

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