Tranche ABX and Basis
Risk in Subprime RMBS
Structured Portfolios
Kevin Kendra
February 20, 2007

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 www.derivativefitch.com
3

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 www.derivativefitch.com
4

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 www.derivativefitch.com
5

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% www.derivativefitch.com
7

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 www.derivativefitch.com
8

Subprime RMBS 101
Sample Subprime RMBS Structure
Individual Mortgages
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 M39 M40
M41 M42 M43 M44 M45 M46 M47 M48 M49 M50
M51 M52 M53 M54 M55 M56 M57 M58 M59 M60
M61 M62 M63 M64 M65 M66 M67 M68 M69 M70
M71 M72 M73 M74 M75 M76 M77 M78 . . .
M
2000
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 . . .
M
1000
Mortgage
Pools
2/28
Hybrid ARM
Mortgage
Pool
Fixed Rate
Mortgage www.derivativefitch.com
REMIC
Trust
Special
Purpose
Vehicle
(RMBS
Trust)
RMBS
Bonds
‘AAA’
RMBS
‘AA’
RMBS
‘A’
RMBS
‘BBB’
RMBS
‘BBB-’
RMBS
Residual
9

Subprime RMBS 101
Sample Subprime RMBS Payments
Monthly Mortgage
Payments
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 M39 M40
M41 M42 M43 M44 M45 M46 M47 M48 M49 M50
M51 M52 M53 M54 M55 M56 M57 M58 M59 M60
M61 M62 M63 M64 M65 M66 M67 M68 M69 M70
M71 M72 M73 M74 M75 M76 M77 M78 . . .
M
2000
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 . . .
M
1000
$
$
REMIC
Trust
Servicer
$ I
$ P
Accounts
Interest
Scheduled
Principal
&
Prepayments
$ I
$ P
Interest
Payments
‘AAA’
L + % or Net WAC
‘AA’
L + % or Net WAC
‘A’
L + % or Net WAC
‘BBB’
L + % or Net WAC
‘BBB-’
L + % or Net WAC
Residual
Excess Interest
Principal
Payments
Scheduled
Principal
&
Prepayments
‘AAA’
‘AA’
‘A’
‘BBB’
‘BBB-’
Residual www.derivativefitch.com
10

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 www.derivativefitch.com
11

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.
www.derivativefitch.com
12

Sample Principal Waterfalls
Scenario 1: Sequential Principal Repayment
$ P
Accounts
Scheduled
Principal
&
Prepayments
Principal
Payments
Payments
Before Step Down
After Step Down
‘AAA’
Scenario 2: Performance Test Passes the Credit
Enhancement “Steps Down” by Paying Principal to Subordinated Notes
$ P
Accounts
Scheduled
Principal
&
Prepayments
Principal
Payments
Payments
Before Step Down
‘AAA’
‘AA’
‘A’
‘BBB’
‘BBB-’
Residual
‘AA’
‘A’
‘BBB’
‘BBB-’
After Step Down
Residual www.derivativefitch.com
13

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 www.derivativefitch.com
14

Sample RMBS Interest Waterfall
Step 1 – Interest
Paid Sequentially to Bonds, Capped at AFC
Step 2
– Excess
Interest to
Cover Collateral
Losses
$ I
Accounts
Interest
Payments
Principal
Payments
Scheduled
Principal
&
Prepayments
‘AAA’
L + % or Net WAC
‘AAA’
Interest
‘AA’
L + % or Net WAC
‘A’
L + % or Net WAC
‘BBB’
L + % or Net WAC
‘BBB-’
L + % or Net WAC
Residual
Excess Interest
‘AA’
‘A’
‘BBB’
‘BBB-’
Residual
Losses www.derivativefitch.com
Step 3 – Remaining
Excess Interest to
Pay AFC Shortfalls
Interest
Shortfalls
L + % - Net WAC
L + % - Net WAC
Step 4
– Remaining
Excess Interest to
Residual Holder
15

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.
16 www.derivativefitch.com

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 www.derivativefitch.com
18

Credit Default Swaps 101
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 www.derivativefitch.com
19

Credit Default Swaps 101
Sample Credit-Linked Note (CLN) using a CDS
Protection
Buyer
CDS Swap
Counterparty
CDS Premium
(bps)
Credit Default
Swap
Credit-Linked
Note Trust
Protection
Payments ($)
LIBOR
(L)
CLN
Proceeds
($)
Note Coupon
(L + bps)
CLN Proceeds
($)
Reference
Entity or
Obligation
Collateral or
Eligible
Investments
Protection
Seller
Protection
Seller www.derivativefitch.com
20

Credit Default Swaps 101
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
21 www.derivativefitch.com

Credit Default Swaps 101
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 www.derivativefitch.com
22

ISDA Pay-As-You-Go (PAUG) Template 101
> 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
23 www.derivativefitch.com

ISDA Pay-As-You-Go (PAUG) Template 101
Sample CLN using a PAUG CDS
Floating
Payments
Protection
Buyer
CDS Swap
Counterparty
CDS Premium
(bps)
Credit Default
Swap
Credit-Linked
Note Trust
Protection
Payments ($)
LIBOR
(L)
CLN
Proceeds
($)
Note Coupon
(L + bps)
CLN Proceeds
($)
Reference
Obligation
Collateral or
Eligible
Investments
Protection
Seller
Protection
Seller www.derivativefitch.com
24

ISDA Pay-As-You-Go (PAUG) Template 101
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 www.derivativefitch.com
25

ISDA Pay-As-You-Go (PAUG) Template 101
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 www.derivativefitch.com
26

ISDA Pay-As-You-Go (PAUG) Template 101
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
27 www.derivativefitch.com

Subprime RMBS AFC Risk
> 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 www.derivativefitch.com
28

Subprime RMBS AFC Risk
> Unrecovered AFC Interest Shortfalls can be prevalent by vintage
> Unrecovered AFC Interest Shortfalls can be present across all rating categories
Initial Rating
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
RMBS Bonds that Experience Unrecovered AFC Interest Shortfalls
2001
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
2002
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
2003
0.00%
0.00%
0.00%
0.00%
0.00%
0.93%
6.56%
4.95%
7.17%
2.77%
0.00%
0.00%
2004
0.69%
4.81%
3.09%
6.67%
7.46%
4.56%
5.18%
10.12%
10.10%
16.13%
11.11%
2.62%
2005
0.50%
0.96%
2.24%
1.05%
3.46%
3.35%
6.71%
13.51%
19.34%
25.49%
23.00%
18.04% www.derivativefitch.com
2006
0.00%
0.00%
0.00%
0.00%
0.33%
0.77%
0.75%
2.96%
6.67%
18.17%
33.25%
35.38%
29

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
Initial Rating
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
Cumulative Unrecovered AFC Interest Shortfalls as % of Bond Balance
2001
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
2002
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
2003
0.00%
0.00%
0.00%
0.00%
0.00%
0.01%
0.07%
0.16%
0.18%
0.64%
0.00%
0.00%
2004
0.01%
0.04%
0.08%
0.06%
0.08%
0.05%
0.05%
0.08%
0.19%
0.22%
0.34%
0.11%
2005
0.03%
0.21%
0.22%
0.20%
0.27%
0.31%
0.06%
0.09%
0.07%
0.08%
0.13%
0.12%
2006
0.00%
0.00%
0.00%
0.00%
0.05%
0.04%
0.05%
0.04%
0.04%
0.05%
0.03%
0.03%
30 www.derivativefitch.com

Structured Finance CDOs 101
> Generic Types of SF CDOs
– Cash SF CDOs
–
Bespoke SF CDOs
–
Hybrid SF CDOs www.derivativefitch.com
32

Structured Finance CDOs 101
Sample Cash SF CDO Structure
CDO Portfolio
RMBS
Bond 1
RMBS
Bond 2
RMBS
Bond 3
RMBS
Bond 4
RMBS
Bond 5
RMBS
Bond 6
RMBS
Bond 7
RMBS
Bond 8
RMBS
Bond 9
RMBS
Bond 10
RMBS
Bond 11
RMBS
Bond 12
RMBS
Bond 13
RMBS
Bond 14
RMBS
Bond 15
RMBS
Bond 16
RMBS
Bond 17
RMBS
Bond 18
RMBS
Bond 19
RMBS
Bond 20
RMBS
Bond 21
RMBS
Bond 22
RMBS
Bond 23
RMBS
Bond 24
RMBS
Bond 25
RMBS
Bond 26
RMBS
Bond 27
RMBS
Bond 28
RMBS
Bond 29
RMBS
Bond 30
RMBS
Bond 31
RMBS RMBS RMBS
Bond 32 Bond 33 Bond 34
RMBS
Bond 35
RMBS
Bond 36
RMBS RMBS
Bond 37 Bond 38
CDO
Bond 1
CDO
Bond 2
CDO
Bond 3
. . .
CDO
Bond 4
RMBS
Bond 80
CDO
Bond 5
CDO
Bond 6
CDO
Bond 7
CDO
Bond 8
CDO
Bond 9
CDO
Bond 10
Bond Coupons
(L + bps)
Proceeds
($)
CDO
Trust
Special
Purpose
Vehicle
(CDO
Trust)
CDO
Bonds
Note Coupon
(L + bps)
Proceeds
($)
‘AAA’
CDO
‘AA’
CDO
‘A’
CDO
‘BBB’
CDO
Preferred Shares or Equity www.derivativefitch.com
33

Structured Finance CDOs 101
> 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 www.derivativefitch.com
34

Structured Finance CDOs 101
> 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 www.derivativefitch.com
35

Structured Finance CDOs 101
> 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 www.derivativefitch.com
36

Structured Finance CDOs 101
Sample Bespoke SF CDO Structure
Reference Portfolio
RMBS
Bond 1
RMBS
Bond 2
RMBS
Bond 3
RMBS
Bond 4
RMBS
Bond 5
RMBS
Bond 6
RMBS
Bond 7
RMBS
Bond 8
RMBS
Bond 9
RMBS
Bond 10
RMBS
Bond 11
RMBS
Bond 12
RMBS
Bond 13
RMBS
Bond 14
RMBS
Bond 15
RMBS
Bond 16
RMBS
Bond 17
RMBS
Bond 18
RMBS
Bond 19
RMBS
Bond 20
RMBS
Bond 21
RMBS
Bond 22
RMBS
Bond 23
RMBS
Bond 24
RMBS
Bond 25
RMBS
Bond 26
RMBS
Bond 27
RMBS
Bond 28
RMBS
Bond 29
RMBS
Bond 30
RMBS
Bond 31
RMBS RMBS RMBS
Bond 32 Bond 33 Bond 34
RMBS
Bond 35
RMBS
Bond 36
RMBS RMBS
Bond 37 Bond 38
. . .
RMBS
Bond 80
CDS Swap
Counterparty
CDO
Trust
CDS
Premium
Protection
Payments
Special
Purpose
Vehicle
(CDO
Trust)
LIBOR
(L)
Collateral or
Eligible
Investments
Proceeds
($)
Note
Coupon
(L + bps)
Proceeds
($) www.derivativefitch.com
CDO
Structure
Unfunded
Super-Senior
Revolver
‘AAA’
Note
First Loss
Unfunded
CDS
Unfunded
CDS
37

Structured Finance CDOs 101
> 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
38 www.derivativefitch.com

Structured Finance CDOs 101
> 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 www.derivativefitch.com
39

Structured Finance CDOs 101
Sample Hybrid SF CDO Structure
CDS Portfolio
RMBS
CDS 1
RMBS
CDS 2
RMBS
CDS 3
RMBS
CDS 4
RMBS
CDS 5
RMBS
CDS 6
RMBS
CDS 7
RMBS
CDS 8
RMBS
CDS 9
RMBS
CDS 10
RMBS
CDS 11
RMBS
CDS 12
RMBS
CDS 13
RMBS
CDS 14
RMBS
Bond 15
RMBS
CDS 16
RMBS
CDS 17
RMBS
CDS 18
CDO
CDS 1
CDO
CDS 2
CDO
CDS 3
. . .
CDO
CDS 4
RMBS
CDS 20
CDO
CDS 5
Bond Portfolio
RMBS
Bond 1
RMBS
Bond 2
RMBS
Bond 3
RMBS
Bond 4
RMBS
Bond 5
RMBS
Bond 6
RMBS
Bond 7
RMBS
Bond 8
RMBS
Bond 9
RMBS
Bond 10
RMBS
Bond 11
RMBS RMBS RMBS
Bond 12 Bond 13 Bond 14
RMBS
Bond 15
RMBS
Bond 16
CDO
Bond 1
RMBS RMBS
Bond 17 Bond 18
CDO
Bond 2
CDO
Bond 3
. . .
CDO
Bond 4
RMBS
Bond 20
CDO
Bond 5
CDS Premium
Protection
Payments
Bond Coupons
(L + bps)
Proceeds
($) www.derivativefitch.com
CDO
Trust
Special
Purpose
Vehicle
(CDO
Trust)
CDO
Structure
CDS Premium
Super-Senior
Protection
Payments
Note Coupon
(L + bps)
‘AAA’
CDO
‘AA’
CDO
‘A’
CDO
‘BBB’
CDO
Preferred Shares or Equity
Proceeds
($)
Unfunded
Super-Senior
Revolver
Unfunded
CDS
Funded
Notes
40

Structured Finance CDOs 101
> 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 www.derivativefitch.com
41

ABX.HE and TABX.HE Indices 101
RMBS
1
RMBS
2
RMBS
3
RMBS
4
RMBS
5
RMBS
6
RMBS
7
RMBS
8
RMBS
9
RMBS
10
RMBS
11
. . .
RMBS
20
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
‘AAA’
RMBS
. . .
‘AAA’
RMBS
ABX.HE.AAA
‘AA’
RMBS
‘AA’
RMBS
‘A’
RMBS
‘A’
RMBS
‘AA’
RMBS
‘AA’
RMBS
‘A’
RMBS
‘A’
RMBS
‘AA’
RMBS
‘AA’
RMBS
‘A’
RMBS
‘A’
RMBS
‘AA’
RMBS
‘AA’
RMBS
‘A’
RMBS
‘A’
RMBS
‘AA’
RMBS
‘A’
RMBS
‘AA’
RMBS
‘AA’
RMBS
‘A’
RMBS
‘A’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
‘BBB-’
RMBS
. . .
. . .
. . .
. . .
‘AA’
RMBS
‘A’
RMBS
‘BBB’
RMBS
‘BBB-’
RMBS
Residual Residual Residual Residual Residual Residual Residual Residual Residual Residual Residual
. . .
Residual
ABX.HE.AA
ABX.HE.A
ABX.HE.BBB
ABX.HE.BBBwww.derivativefitch.com
42

ABX.HE and TABX.HE Indices 101
> 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 www.derivativefitch.com
43

ABX.HE and TABX.HE Indices 101 www.derivativefitch.com
TABX.HE.BBB
Reference Obligations
‘BBB’
RMBS 1
‘BBB’
RMBS 2
‘BBB’
RMBS 3
‘BBB’
RMBS 4
‘BBB’
RMBS 5
‘BBB’
RMBS 6
‘BBB’
RMBS 7
‘BBB’
RMBS 8
.
.
.
‘BBB’
RMBS 20
ABX.HE.BBB
06-2 Portfolio
ABX.HE.BBB
07-1 Portfolio
‘BBB’
RMBS 1
‘BBB’
RMBS 2
‘BBB’
RMBS 3
‘BBB’
RMBS 4
‘BBB’
RMBS 5
‘BBB’
RMBS 6
‘BBB’
RMBS 7
‘BBB’
RMBS 8
.
.
.
‘BBB’
RMBS 20
TABX.HE.BBB
Tranches
35 – 100%
20
– 35%
12 – 20%
7 – 12%
3 – 7%
0
– 3%
44

ABX.HE and TABX.HE Indices 101
> 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 www.derivativefitch.com
45

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
47

www.derivativefitch.com
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