Subprime Mortgage Distress Effect on CDOs

Subprime Mortgage Distress Effect on CDOs

Kevin KendraManaging DirectorDerivative FitchU.S. Structured Credit

Glenn CostelloManaging DirectorFitch RatingsCo-Head, U.S. RMBS

Introduction and Agenda

> Recent headlines and quotes related to CDOs and the

U.S. subprime mortgage markets

> Selected Fitch Research related to Subprime RMBS

and CDOs

> Webcast Agenda

www.derivativefitch.com 3

U.S. subprime mortgage market media coverage has moved mainstream . . .

> Mortgage market news is now regularly on the front page of the Wall Street

Journal and New York Times

> Over 80 articles on subprime mortgages were filed with various news agencies

last week.

> A web site, “The Mortgage Lender Implode-O-Meter” tracks U.S. mortgage

lenders that have either shut down or are no longer operating independently

along with, “Mortgage Banking Bust News and Commentary.”

– 853,106 visitors to the site from January 1 to March 12, 2007

– Claims 36 lenders “imploded” by either bankruptcy filing, halting major

operations or last-ditch acquisition

– Claims another 10 lenders are “ailing”


Selected Fitch Subprime RMBS and CDO Research

15-Apr-05 “U.S. Subprime RMBS in CDOs,” co-authored by U.S. Structured Credit and RMBS groups

07-Sep-05 “Operational Risks Inherent in New RMBS Products,” by U.S. RMBS group

17-Jan-06 “2006 Global Structured Finance Outlook: Economic & Sector-by-Sector Analysis,” by Global Structured Finance

24-Jul-06 “U.S. Structured Finance CDO Performance: 2006 Update,” by U.S. Structured Credit group

21-Aug-06 “U.S. Subprime RMBS in CDOs (Update),” co-authored by U.S. Structured Credit and RMBS groups

04-Oct-06 “40, 45 and 50 Year Mortgages: Option ARMs, Hybrid ARMs and FRMs,” by U.S. RMBS group

13-Dec-06 “2007 Global Structured Finance Outlook: Economic & Sector-by-Sector Analysis,” by Global Structured Finance


Agenda

> Stress in the U.S. Mortgage and Capital Markets

– How does a mortgage loan get into a CDO?

– What is causing stress in the U.S. Mortgage Markets?

> Subprime RMBS Performance and Outlook

– What are the drivers of subprime RMBS performance?

– How does this impact originators, issuers and servicers?

– What are Fitch’s expectation for mortgage losses and RMBS impact?

– What is Fitch’s outlook for RMBS?

> Fitch-rated CDO Exposure to Subprime Mortgage Markets

– What CDOs may be affected by stress in the subprime mortgage markets?

– What is the potential impact on structured finance CDOs?

– CDO Surveillance – Process, People and Tools

Stress in the U.S. Mortgage and Capital Markets

> How does a mortgage loan get into a CDO?

> What is causing stress in the U.S. Mortgage Markets?


Subprime RMBS Structure

Interest

ScheduledPrincipal

&Prepayments

‘AAA’L + % or Net WAC

Accounts

‘AA’L + % or Net WAC

‘A’L + % or Net WAC

‘BBB’L + % or Net WAC

‘BBB-’L + % or Net WAC

ResidualExcess Interest

Servicer

REMICTrust

Monthly MortgagePayments

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 . . .

M1000

$

$

$ P

$ I

InterestPayments

PrincipalPayments

‘AAA’

‘AA’

‘A’

‘BBB’

‘BBB-’

Residual

$ I

$ P

ScheduledPrincipal

&Prepayments


Characteristics of Subprime Mortgages

> 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


Characteristics of Subprime RMBS

> 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


Structured Finance CDO Structure

‘AAA’CDO

‘AA’CDO

‘A’CDO

‘BBB’CDO

Preferred Sharesor Equity

CDOBonds

SpecialPurposeVehicle(CDOTrust)

CDOTrust

CDO Portfolio

CDOBond 1

CDOBond 3

CDOBond 4

CDOBond 5

CDOBond 2

RMBSBond 1

RMBSBond 3

RMBSBond 4

RMBSBond 5

RMBSBond 2

RMBSBond 6

RMBSBond 8

RMBSBond 9

RMBSBond 10

RMBSBond 7

RMBSBond 11

RMBSBond 13

RMBSBond 14

RMBSBond 15

RMBSBond 12

RMBSBond 16

RMBSBond 18

RMBSBond 19

RMBSBond 20

RMBSBond 17

RMBSBond 21

RMBSBond 23

RMBSBond 24

RMBSBond 25

RMBSBond 22

RMBSBond 26

RMBSBond 28

RMBSBond 29

RMBSBond 30

RMBSBond 27

RMBSBond 31

RMBSBond 33

RMBSBond 34

RMBSBond 35

RMBSBond 32

RMBSBond 36

RMBSBond 38

RMBSBond 80

RMBSBond 37 . . .

CDOBond 6

CDOBond 8

CDOBond 9

CDOBond 10

CDOBond 7

Note Coupon(L + bps)

Proceeds($)

Bond Coupons(L + bps)

Proceeds($)


Characteristics of Structured Finance CDOs

> 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


Characteristics of Structured Finance CDOs

> 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


U.S. Mortgage and Capital Market DiagramMortgage Origination Market

RMBS Market

CDO Market

Borrower

RMBS Investor/CDO Manager

RMBS Investor/CDO Manager

FinancialInstitution, REIT,Specialty Finance

Company

MortgageOriginator

FinancialInstitution

“Held for Sale”Assets

CompanyBalanceSheet

InvestmentAssets

FinancialInstitution, REIT,Specialty Finance

Company

MortgageOriginator


“Held for Sale”Assets

REMICTrust

RMBS

MortgagePayments

Proceeds($)


CDO WarehouseRMBS Conduit

AAA

BBBResidual

CDOTrust

CDO

AAA

BBBResidual


CDO Warehouse CDO Arranger

InstitutionalInvestors

CDO Investor


ABX.HE Structure

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS1

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS2

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS3

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS4

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS5

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS6

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS7

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS8

ABX.HE.AAA‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS9

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS10

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS20

‘AAA’RMBS

‘AA’RMBS

‘A’RMBS

‘BBB’RMBS

‘BBB-’RMBS

Residual

RMBS11

. . .

. . .

. . .

. . .

. . .

. . .

. . .

ABX.HE.AA

ABX.HE.A

ABX.HE.BBB

ABX.HE.BBB-


Characteristics of the ABX.HE Indices

> The ABX.HE indices are equally weighted indices of the 20 largest volume

subprime RMBS issuers.

> Three ABX.HE indices have been issued to date:

– ABX.HE.06-1 represents 20 subprime RMBS issued in 2H 2005



> Each index has 5 series representing different levels of risk

– AAA, AA, A, BBB and BBB-

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

otherwise opaque market

– Allows market participant to express market views

– Provides hedging mechanism for mortgage warehouse facilities


ABX.HE Prices

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

11/1/

06

11/8/

06

11/15

/06

11/22

/06

11/29

/06

12/6/

06

12/13

/06

12/20

/06

12/27

/061/3

/07

1/10/0

7

1/17/0

7

1/24/0

7

1/31/0

72/7

/07

2/14/0

7

2/21/0

7

2/28/0

7

ABX-HE-BBB 06-1 ABX-HE-BBB- 06-1 ABX-HE-BBB 06-2

ABX-HE-BBB- 06-2 ABX-HE-BBB 07-1 ABX-HE-BBB- 07-1

ABX.HE Prices(As of Mar 1, 2007)

Source: Markit Group Limited.


Stress in the Subprime Mortgage Markets

Home Price Appreciation (HPA) begins to dramatically slow nationally

2Q 2006 3Q 2006 4Q 2006 1Q 2007

HPA continues to slow

Early payment defaults (EPDs) begin to rise dramatically.

RMBS Conduits become more aggressive in putting loans back to originators for repurchase.

Lenders start to publicize improved underwriting guidelines

Small originators come under financial pressure as repurchase levels soar.

Reports of small originators closing doors.

Ownit Mortgage files for bankruptcy (Dec) citing withdrawn financing from Merrill Lynch.

Fremont under pressure from EPDs

ABX.HE indices start to show stress

Fremont announces it will stop originating second lien loans.

First-time home buyers blamed for EPDs

MLN ceases originations in Jan and files for bankruptcy in Feb.

New Century reveals accounting errors in Feb and in Mar announces it will not file quarterly financials and under criminal probe into stock trading and accounting irregularities.

NovaStar says they will have no taxable income for several years in Feb.

ABX.HE bottoms out with slight rebound

Cash HEL spreads widen

Subprime RMBS Performance and Outlook

> What are the drivers of subprime RMBS performance?

> How does this impact originators, issuers and

servicers?

> What is Fitch’s outlook for RMBS?


Subprime RMBS Collateral Performance Summary


Subprime and Alt-A Delinquencies RisingFitch-Rated Transactions

60+ Delinquency (Including Foreclsoure, REO and Bankruptcy)By Credit Sector

0%

2%

4%

6%

8%

10%

12%

14%

Subprime Alt-A Prime

Source: FitchRatings, LoanPerformance


2006 Vintage Delinquency Similar to 2000Fitch-Rated Transactions

Subprime 60+ Delinquency By Age (First 24 Months)

0%

5%

10%

15%

20%

25%

30%

2000 2001 2002 2003 2004 2005 2006



Early 2006 Vintage Loss Also Trending HighFitch-Rated Transactions

Subprime Cumulative Loss By Age

0%

1%

2%

3%

4%

5%

6%

1 7 13 19 25 31 37 43 49 55 61 67 73

2000 2001 2002 2003 2004 2005 2006



2006 Vintage Alt-A Also Showing StressFitch-Rated Transactions

Alt-A 60+ Delinquency By Age (First 24 Months)

0%

2%

4%

6%

8%

10%

2000 2001 2002 2003 2004 2005 2006



Fitch-Rated Alt-A Not Representative of Broader Performance

Alt-A 60+ Delinquency By Age

0%

1%

2%

3%

2005 Fitch 2005 Industry 2006 Fitch 2006 Industry



Subprime RMBS Collateral Performance Drivers


Piggyback 2nds and Low Doc Associated With Early Default

Collateral Attributes By Vintage

Vintage Avg.

Mtge Bal

FICO LTV CLTV Low/No

Doc

Purchase DTI Calif. WAC

Mortgages That Defaulted By Month 12 (90+ Days Delinquent)

2006 221,148 615 82% 89% 54% 56% 43% 31% 8.40

2005 180,730 604 82% 88% 48% 50% 42% 22% 7.78

2004 157,827 593 82% 85% 43% 40% 41% 19% 7.82

2003 146,219 589 82% 83% 41% 33% 41% 20% 8.44

Mortgages That Performed Through Month 12 (Never 90+ Days Delinquent)

2006 205,773 625 80% 85% 43% 42% 42% 27% 7.94

2005 194,163 627 81% 85% 40% 39% 41% 31% 7.13

2004 174,634 624 81% 83% 38% 34% 40% 34% 7.07

2003 155,236 620 80% 81% 34% 27% 40% 32% 7.59



ABX-HE Indices: 2006 Reference Pools Underperform 2005

60+ Delinquency By Age

0%

2%

4%

6%

8%

10%

12%

ABX 06-1 ABX 06-2 ABX 07-1



ABX-HE Indices: Loans with 2nd Liens Underperforming

No 2nd Lien 60+ Delinquency

0%

2%

4%

6%

8%

10%

12%

14%

16%

ABX 06-1 ABX 06-2 ABX 07-1

Has 2nd Lien 60+ Delinquency

0%

2%

4%

6%

8%

10%

12%

14%

16%

ABX 06-1 ABX 06-2 ABX 07-1



ABX-HE Indices: Limited-Documentation Underperforming

Full-Doc 60+ Delinquency

0%

2%

4%

6%

8%

10%

12%

ABX 06-1 ABX 06-2 ABX 07-1

Limited-Doc 60+ Delinquency

0%

2%

4%

6%

8%

10%

12%

ABX 06-1 ABX 06-2 ABX 07-1



Piggybacks 2nds and Lim Docs: ResiLogic Model Sensitive To Risk-Layering

Piggyback 2nd Full Doc FICO LTV 60+ DQ Relative DQ

No Yes 610 82 5.8% 100%

No No 630 80 7.6% 131%

Yes Yes 639 80 7.3% 125%

Yes No 671 80 9.3% 160%

2005 Vintage First-Lien 60+ Delinquency – Loans 12 Months Seasoned

Second Lien Doc FICO LTV/CLTV Expect. Loss Relative Loss

No Full 620 80 3.7% 100%

No Limited 620 80 4.5% 120%

No None 620 80 5.2% 140%

Yes Full 660 80/100 4.3% 116%

Yes Limited 660 80/100 5.2% 140%

Yes None 660 80/100 6.15% 165%

ResiLogic Single-Loan Results (2/28 ARM Single-Family, Purchase, Owner-Occ.)


Home Price Stress Driving Defaults Higher

Cumulative California HPA By Origination Qtr.

-2%

0%

2%

4%

6%

8%

10%

200503 200504 200601 200602 200603

6 months

12 months

18 months

Source: FitchRatings, OFHEO


Impact On Subprime Originators, Issuers and Servicers


Originator Crisis Caused By Repurchase Wave

> The sudden performance deterioration caused a spike in first payment defaults

(FPDs) and early payment defaults (EPDs)

> Loan buyers exercised their rights to put first payment defaults back to originators

> Large outlays for repurchase put substantial strain on smaller, poorly capitalized

companies

> Early payment defaults in warehouse lines caused lenders to tighten

> The need to change product mix further constrained lenders as they saw

volume/profitability fall

> High repurchase obligations and lack of financing drives marginal players into

bankruptcy (Ownit, ResMae, MLN, People’s Choice)

> Larger players also under severe stress (Fremont, New Century, Accredited)

> Discount loan pricing continues to weigh on originators

> Well-capitalized entities can weather the storm, and opportunistic buyers are active

www.derivativefitch.com 34Source: Fremont Investment & Loan




Issuers Continue To Struggle For Liquidity

> No demand for high concentrations of high risk products

> Pipeline leaves large volume of loans without a home

> Difficult to find clearing levels for subordinate bonds

> New deals beginning to appear with different collateral characteristics

> Investors on the sidelines waiting to see more evidence of better collateral


Distressed Companies Were Unrated or Low Rated Servicers

Originator Servicer? Current Servicer Rating Prior Servicer Rating

Ameriquest Yes RPS2+ RW Evolving RPS2+

Ownit (Bankrupt) No N/A N/A

ResMae (Bankrupt) No N/A N/A

MLN (Bankrupt) Yes Unrated Unrated

Fremont Yes RPS4 RW Negative RPS3+

New Century Yes RPS4 RW Negative RPS3+

Accredited Yes RPS3- RPS3+

People’s Choice (Bankrupt) No N/A N/A


Challenges To Servicers

> High risk products require intensive servicing

> Falling origination volumes will change ratio between

performing loans which are profitable to service and non-

performing loans which are less profitable

> Low home price inflation combined with ARM resets will require

loss mitigation proficiency

> Regulatory and legislative scrutiny may hamper effective

timeline management


Strengths Of Servicers

> Servicing is concentrated among capable, well-capitalized entities

> Industry has the capacity to absorb loans from distressed portfolios

Distribution Among Servicer Ratings By Current Balance (Fitch-Rated)

RPS1, 49%

RPS2, 37%

RPS3, 0%

RPS4, 7%

NR/NA, 7%



Subprime RMBS Outlook


Subprime ARM Resets Yet To Come…

First Reset Date as % Of Subprime Outstandings

0%5%

10%15%20%25%30%35%

2004 &Earlier

2005 2006 2007 2008 2009



2005-2006 Vintage Subprime Hybrid ARMs Face Upward Rate Adjustment Even if Rates Remain Flat

2-28 Hybrid ARM Initial Rate Adjustments by Year Originated

Vintage Initial Coupon Rate After Initial Reset*

2000 10.2 10.2

2001 9.4 9.4

2002 8.4 8.4

2003 7.5 9.8

2004 7.1 10.1

2005 7.3 10.3**

2006 8.4 11.4*** Lifetime Rate Floors typically prevent rates from adjusting down at the reset date and

initial adjustment caps typically limit the amount of the first adjustment to 300 bps.

**Projected assuming 6mL remains unchanged from today



Subprime Rating Activity Trends

Year Action Taken Downgrades Upgrades

2003 124 47

2004 156 88

2005 148 142

2006 331 259

Through 3/21/2007 80 94


Fitch Subprime RMBS Outlook

> 2006 will prove to be a poor vintage. Early defaults combined with on-going low

HPA and ARM reset risk will drive losses higher than recent vintages, and in

many instances higher than initial expectations.

> While the general trend is poor, much work is needed to refine forecasts of

long-term performance, and to differentiate among deals. Rating actions will be

taken promptly as the data warrants. Fitch does not foresee significant

investment grade defaults given current trends.

> There already is, and will continue to be, substantial performance differences

among originators, issuers, servicers, products and geographic areas.

> Origination volume will drop. Low HPA will reduce refinancing incentives.

Product changes will limit the “affordability purchase” borrowers. The final form

of regulatory guidance could greatly curtail subprime product offerings.

> Loan attributes are changing. Whether this results in true improvements in

credit quality remains to be seen.

Subprime Mortgage Markets and Fitch-rated CDOs

> What CDOs may be affected by stress in the subprime

mortgage markets?

> What is the potential impact on structured finance

CDOs?


Subprime RMBS Exposure in Structured Finance CDO

> Fitch rates over 200 structure finance CDOs with exposure to approximately

6,500 subprime RMBS bonds with a current notional balance in excess of $50

billion.

> Subprime RMBS exposures are diversified by:

– Vintage (originations between 2000 and 2006)

– Rating (current ratings between ‘CCC’ and ‘AAA’)


Average Structured Finance CDO Portfolio Composition by CDO Vintage

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2001 2002 2003 2004 2005 2006

RMBS ABS CMBS CDO Other


CDOpinions Article dated January 23rd, 2007

> In the ‘Collateral Talk’ section of our bi-weekly newsletter we address likely

scenarios facing structured finance CDOs in 2007

– Current delinquencies and defaults in 2006 subprime RMBS may be

severe enough that some mezzanine bonds will face negative rating

migration pressure in 2007

– 2003 vintage subprime RMBS is more likely to be downgraded as the

majority of these deals have passed their performance triggers and the

structures will release credit enhancement making them more vulnerable

to future stress.


Structured Finance CDO Exposure to Subprime RMBS

> Structured Credit Special Report exploring the effects of Subprime RMBS Performance on CDOs soon to be published - Co-authored between RMBS and Structured Credit

> Preliminary Analysis:

– RMBS downgrades in the second and third quarters of 2007 will likely be concentrated in the 2003 and 2004 vintages and in the ‘A’ and lower-rated portions of the subprime RMBS structures.

– Issuance from the second half of 2005 and 2006 are expected to under perform older vintages over time, with second lien securitizations coming under stress first.

– If a substantial number of 2005 and 2006 subprime RMBS is downgraded in 2007, then it is likely to trigger downgrades of subordinate classes in mezzanine SF CDOs in 4Q 2007 or 2008.

– The ratings of the most senior classes are likely to be unaffected.


Corporate CDOs Exposure to U.S. Subprime Mortgage Originators?

> Small corporate debt exposure to subprime mortgage originators

– Fitch rates 18 TruPS CDOs with exposure to residential mortgage REITs

or other residential mortgage lenders

> 11 REIT TruPS CDOs

> 7 Hybrid TruPS CDOs

– Total REIT exposure typically capped between 5-15%

> Structured Credit Special Report called, “Residential Mortgage Exposure in

CDOs of Trust Preferred Securities” to be published in March 2007

– Co-authored between REIT, Financial Institutions and Structured Credit

– Conclude that Fitch’s sensitivity analysis shows the TruPS CDO structures

allow the CDO to withstand 1-2 collateral defaults without negatively

impacting the CDO note ratings.

CDO Surveillance – Process, People and Tools

> How does Derivative Fitch monitor CDOs?

> What is Fitch doing to provide better clarity and

understanding to this topic?


Defining CDO Surveillance

> Our goal is to:

– Provide accurate and timely ratings on all Fitch-rated CDOs

– Maintain ratings across all parts of the CDO capital structure

– Work with Asset Managers in understanding portfolio strategy and risks

– Promote transparency by providing in-depth commentary on Fitch’s

analysis and market trends

> Our perspective is from:

– Investors looking to buy the bond on the secondary market


CDO Surveillance – Process, People and Tools

People

Process

Tools

• Proprietary surveillance database

• Data scrubbing and processing

• Automated e-mail notification

• Automated credit models

CDO

Surveillance

• Dedicated Staff

• Understanding of underlying assets

• Formal Analyst training program

• Surveillance process blends use of tools and technology, quantitative techniques and fundamental credit analysis to perform ongoing monitoring and rating action recommendations


CDO Surveillance Framework

Three Pillars of CDO Performance

> Performance of Underlying Assets

– Primary CDO performance driver is the performance of the underlying assets

– Successful CDO surveillance must be able to measure and monitor performance changes

> CDO Structural Features

– CDO structural features vary deal-by-deal

– Features may impact rating actions on specific CDO tranches

– Features may impact severity of rating actions on CDO tranches

> Asset Manager’s Decisions

– Asset Manager incentive or focus may change throughout the life of a CDO

– Successful CDO Surveillance must work with Asset Managers to:

> Understand manager’s view on asset selection

> Understand manager’s view of asset performance and trading strategy

> Assess manager’s ability to adjust to current market conditions


CDO Surveillance – Process

> Identifying Deals for Review

– Event-driven reviews

– CDO CreditWatch notifications

– One year since last review

– Support research or performance reports

> CDO Asset and Liability Modeling

– VECTOR Model simulates asset defaults

– Cash Flow Model stresses CDO liability structure

> Credit Committee

> Communicating Rating Action to the Public


CDO Surveillance – People

> Dedicated Surveillance Group

– 23 Global CDO Credit Analysts: 16 U.S. and 7 EU

– 7 Global Data and Operations Analysts: 7 U.S. and 2 EU

> Interaction with Other Fitch Ratings Groups

– CMBS, RMBS, ABS, Financial Institutions, Corporates, Insurance, REITs,

Homebuilders, Project Finance, Public Finance, etc.

> Interact with Quantitative Finance Research Analysts

– Fitch’s Default Vector Model

– Fitch’s Master Data Warehouse

– Market Implied Ratings

– CRS Model


CDO Surveillance – Tools

> CDO CreditWatch E-mail Notifications

– Portfolio credit migration

– Change in OC/IC compliance status

– Change in portfolio compliance status

– CDO tranche amortization

– Counterparty rating breaches

> CDO Daily Report

– Consolidated report with CDO CreditWatch notifications for “My Portfolio”

– Includes links to press releases for new:

> New Issue Ratings

> Rating Actions

> Presale, Criteria and Special Reports


CDO Surveillance and Research Initiatives

> Forthcoming Research on Subprime RMBS and CDOs

– Impact of Subprime RMBS in Structured Finance CDOs

– Residential Mortgage Exposure in CDOs of Trust Preferred Securities

– Rating Considerations for the Tranche ABX.HE (TABX.HE) Indices

> Other Initiatives

– Conferences and investor meetings

– RMBS and CDO group collaboration

> Joint credit committee representation

> RMBS cash flow repository

> Bi-weekly senior management meeting

www.derivativefitch.com

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Date post:	03-Feb-2016
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Subprime Mortgage Distress Effect on CDOs

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