1234 Moderator:Michael Belfatti, ACE Financial Solutions Panelists:Patrick McCormick, American Re Scott Orr, American Re

Introduction Part 1 General overview of credit enhancement Part 2 Credit enhancement illustration

General Overview of Credit Enhancement What is credit enhancement? What forms exist? What is enhanced? What needs does it satisfy?

What is credit enhancement? Credibility  Capacity for belief Enhancement  To increase or improve in value, quality, desirability, or attractiveness

What forms exist? Financial Guaranty Credit Derivative Excess Spread Subordination Over-Collateralization Cash Reserves Enhancement  To increase or improve in value, quality, desirability, or attractiveness

Financial Guaranty Guaranty Insurance Company  Obligor unable to make payment  Guarantee  Timely Interest  Ultimate Principal

Credit Derivative Receives Premium Pays Par Amount of Defaulted Security Receives Recoveries Pays Premium Receives Par Amount of Defaulted Security A B

Excess Spread Interest Cash Flow LIBOR bps Interest Cash Flow LIBOR bps CollateralSecurity >

Subordination Layers Lowest layer absorbs first losses Senior Debt Subordinated Debt Equity

Over-Collateralization Notional Value Notional Value CollateralSecurity >

Cash Reserves Extra collateral held as cash Credit enhancement and Liquidity

What is enhanced? Municipal and international bonds Asset backed securities

Municipal and International Bonds Local, state, government agencies General obligations Limited recourse obligations International similar

General Obligation Example City of Los Angeles seeks funds Chooses to issue bond Repayment based on taxing powers and assets Financial Guarantor guarantees timely interest and ultimate principal if Las Vegas defaults on bond payment

Asset-Backed Securities Backed by pool of assets Asset cash flows cover bond interest and principal

Asset-Backed Securities - Examples Mortgage-backed securities Credit card receivables Auto loan receivables

What needs does it satisfy? Cost Marketability Liquidity New and complex asset classes Reduce need for credit analysis

Lender Financed the asset Owns the asset Low or unrated corporate entity Services the loan on the asset Mortgage Backed Securitization Illustration

Lender Pool of $100MM of residential mortgage loans to “tarnished” credit borrowers - Single family, owner occupancy - 13% Wtd. average coupon - 75% Wtd. average loan to value - Geographically diversified Originates Mortgage Backed Securitization Illustration

Lender $100MM mortgage loan pool Originates Trust - “New” owner of assets - Bankruptcy proof - Special purpose vehicle Sold to Trust Mortgage Backed Securitization Illustration

Trust $98MM Bonds - AAA rated (“BBB” shadow rating) - Monthly payments of principal and Interest - Payments directly related to payments on underlying mortgages - 8% coupon rate Mortgage Backed Securitization Illustration Lender $100MM mortgage loan pool Originates Sold to Trust Issue Securities

Trust $98MM Bonds Mortgage Backed Securitization Illustration Lender $100MM mortgage loan pool Originates Sold to Trust Issue Securities Investors - Pension fund - Insurance Companies - Receipt of monthly P & I Sell

Investors Mortgage Backed Securitization Illustration Trust $98MM Bonds Lender $100MM mortgage loan pool Originates Sold to Trust Issue Securities Financial Guaranty Insurance Policy - From one of five “AAA” providers - Guarantees timely payment of interest and ultimate payment of principal - Unconditional and irrevocable Insure

Competing Execution Trust Senior / Subordinate Structure $100MM Bonds $90mm ‘AAA’ 8% coupon $8mm ‘BBB’ 9% coupon $2mm UR 15% Coupon 8.3% wtd. average

Credit Enhancement ( Loss Coverage Protection) Borrower Equity Overcollateralization –$100MM Mortgages vs. $98mm Bonds Excess Spread 13.00% Weighted average mortgage rate -.75% Fees % Weighted average bond rate = 3.95% Excess Spread

Critical Players in Bond Insurance Securitization Market Originator/Lender Investment Banker Rating Agency Bond Insurer Reinsurer

Investment Banker Middleman Bring sellers & buyers of assets together Bring sellers & buyers of risk together Work for asset originator (Lender) Take little to no risk Receives fees from originator

Rating Agency Independent party assessing risk on investors behalf Originator pays fee Works with all parties Investor demand and Credit Enhancement levels are key Underwrite all facets of securitization process

Bond Insurer Primary relationship with lender Frequent Interaction with Investment Banker Rating agency involvement Ultimate risk taker Receives premium from originator Thorough and in-depth underwriting approach

Reinsurer Bond insurer are sole risk partners “Risk Share” arrangement Receive share of fee from bond insurer Perform “higher level” underwriting review Employees have extensive industry knowledge

Banker or Issuer will relay opportunity Opportunity will undergo comprehensive analytical process –Finance Company/Lender –Asset Pool –Structure Ongoing monitoring of transactions Bond Insurer Underwriting Process

Receive primary insurer underwriting material/output Confirm/refute bond insurers underwriting approach/results Solicit rating agency input Reinsurance Underwriting Process

Critical Players in Bond Insurance Securitization Market Originator/Lender Investment Banker Rating Agency Bond Insurer Reinsurer