ABS/CMBS-CDS Credit Default Swaps Referencing Structured Products Louis Nees, Senior Managing Director Structured Product Derivatives

ABS-CDS : Volumes Public ABS Issuance Asset Type 2005 Issuance Percentage of Total Automobile$ % Credit Cards % HLTV % Home Equity % Lease % Manufactured Housing % Rate Reduction Bonds % Student Loans % Other % Total$707.3 Source: BMA 2005 ABS-CDS (PAUG) Estimated at $150Billion RMBS = 60% CMBS = 35% CDO = 3% Other = 2% AAA/Aaa = 18% AA/Aa2 = 0% Single A = 8% BBB+/Baa1 = 9% BBB/Baa2 = 27% BBB-/Baa3 = 35% Single & Double B = 3% Assume BBB stack of HEQ is 4%, then 2005 saw $18.4 billion of BBB HEQ 2005 saw ~$64 billion of BBB HEQ (150x60%x( )%) = 3.4x the market

ABS-CDS : Investor Type

Current Players and Uses Client TypeUsesProsConcerns Hedge Funds-Establish negative view on market -Capital structure trades -Relative value between originators -Establish positions quickly -only way to take a negative view -Liquidity when unwinding transaction Dealers-Hedge inventory -Express a view -First time able to actively hedge spread risk -Tend to be long newer origination while hedge seasons CDO Managers-Ramp up 100% synthetic deals -Fill buckets of hybrid deals -Establish position until cash bond can be found -Deals can be ramped up much more quickly -Whole asset class universe is potential investment, not just what is in dealer inventory ??

ABS-CDS : Basis Cash vs. Synthetic

ABX.HE (Launched January 19, 2006) Each Index will be created from qualifying deals of 20 of the largest sub-prime home equity ABS shelf programs from the six month period preceding the roll –Dealers will select one of the two largest deals from the 20 shelves Diversification obtained by: –Limiting the same loan originator to 4 deals –Limiting the same master servicer to 6 deals –If the algorithm process results in originator or master servicer over- concentration, the deal from the shelf program with the smallest issuance (i.e., lowest priority) will be excluded. The largest qualifying deal from the issuer with the lowest ranking will be chosen, as long as concentration limits are not breached

ABX.HE Reference obligations from deals issued within the six months prior to the launch/roll date –Minimum deal size of $500M –No more than four deals with the same originator –No more than six deals with the same master servicer –Each tranche must have a weighted average life between 4-6 years as of the issuance date (except the AAA tranche which must be greater than 5 years) –Must be rated by Moody’s and S&P; the lesser of all ratings will apply Five indices based upon the rating of reference obligations: AAA, AA, A, BBB, and BBB- –One bond from each deal will be referenced in each index (AAA will be comprised of the longest average life AAA tranche with an initial issuance size of at least $15M) –Reference obligations equally weighted by initial par amount as of roll date, subsequent weightings may change based on the prepayment and credit experience of the underlying transactions –Based on standard ISDA Pay-As-You-Go template –Index represents aggregate performance of the basket of credit default swaps

ABX.HE: Indicative Terms & Conditions Indices: Notional:Amortization mirrors that of the underlying bonds Fixed Rate:Established on roll date premium. Subsequent trades require upfront exchange of premium/discount Floating Rate Payments:Interest Shortfall, Writedown, Principal Shortfall Additional Fixed Payments:Interest Shortfall Reimbursement, Writedown Reimbursement, Principal Shortfall Reimbursement Quotations:Dealers will quote price and exchange upfront amounts based on the difference between that price and par Credit Events:Principal Shortfall and Writedown (2005 ISDA PAYG Template Definitions) Physical Settlement: Not Applicable

CMBX.NA (Launched March 7, 2006) Each Index will be created from qualifying deals of 25 of the largest CMBS issuances Qualification requirements: –Minimum deal size of USD 700 million –Be a debt or pass-through security referencing a pool of fixed rate securities –Have a factor of 1.0 –Be secured by obligations from at least 50 separate mortgages from at least 10 unaffiliated borrowers –No more than 40% of underlying obligations can be from the same state –No more than 60% of underlying obligations can be of the same property type –Ratings provided by at least two of the following: Moody’s, Fitch, and S&P; the lesser of all ratings will apply

CMBX.NA Five indices based upon the rating of the reference obligations: –AAA/Aaa, AA/Aa2, A/A2, BBB/Baa2, & BBB-/Baa3 –One bond from each deal will be referenced in each index AAA will be comprised of the most credit enhanced tranche with the longest average life with an initial issuance size of at least $100MM & a weighted average life between 8 & 12 years based on 0% CPY at issuance AAA must be a publicly issued security, whereas other rating classes can be publicly or privately issued –Reference obligations equally weighted by initial par amount as of roll date (4.0% each), subsequent weightings may change based on the prepayment and credit experience of the underlying transactions –Based on standard ISDA Pay-As-You-Go template –Index represents aggregate performance of the basket of credit default swaps –Each index will contain this same list of reference obligations until all reference obligations have been fully paid off or have matured

CMBX.NA: Indicative Terms & Conditions Indices: Notional:Amortization mirrors that of the underlying bonds Fixed Rate:Established 1-day prior to roll date. Payable monthly based on average balance Floating Rate Payments:Interest Shortfall, Writedown, Principal Shortfall Additional Fixed Payments:IInterest Shortfall Reimbursement, Writedown Reimbursement, Principal Shortfall Reimbursement Quotations:Dealers will quote a current market spread and exchange upfront amounts based on the difference between the current market spread and the Fixed Rate Credit Events:Principal Shortfall and Writedown (2005 ISDA PAYG Template Definitions) Physical Settlement: Not Applicable Accruals:Accrues 25 th to 25 th with no following convention Payments:Payments made on the 25 th of each month Day Count:Actual/360

ABX.HE & CMBX.NA Potential Trading Strategies Capital Structure Plays Vintage Plays A rated BBB rated BBB 1 st 2006 BBB 2 nd 2008

ABX.HE & CMBX.NA Potential Trading Strategies IO Plays Index Premium $ Investor Single Name swaps at 100 Investor shorts IO

ABX.HE & CMBX.NA Potential Trading Strategies Tranching of: –Single index % 25-35% 15-25% 5-15% 0-5% ABX.HE.BBB

ABX.HE & CMBX.NA Potential Trading Strategies –Combine Indices within asset type (i.e., equally weight all 5 ABX Indices) % 25-35% 15-25% 5-15% 0-5% ABX.HE.AAA ABX.HE.AA ABX.HE.A ABX.HE.BBB ABX.HE.BBB-

ABX.HE & CMBX.NA Potential Trading Strategies –Combine Indices across asset type (i.e., 50% ABX BBB/50% CMBX BBB) % 25-35% 15-25% 5-15% 0-5% ABX.HE.BBB CMBX.NA.BBB

The Year Ahead New Products Tranching of ABX/CMBX Tranching of CMBX Correlation/Bespoke trading Standard ISDA Document referencing Note-Structures (CDOs) –Utilization of CDOLibrary will be essential for this market to develop

The Year Ahead New Players Insurance Companies –First time have the ability to reduce exposure to assets on the books without actually selling them –Gain exposure to market segments in a size not available before –Not constrained by what is currently in dealer inventory, allowing grater leverage of credit expertise Asset Originators –Hedge pipeline/securitization execution risk More traditional money managers –Not constrained by what is currently in dealer inventory, allowing grater leverage of credit expertise