The document discusses structured subprime RMBS portfolios and basis risk between different structures. It defines basis risk as imperfect correlation between hedging investments that can create excess gains or losses. Basis risk in subprime RMBS arises from differences in underlying assets, structures, liquidity, and cash flow timing. Recently, standardized ABX.HE index tranches were introduced to provide liquidity, transparency and benchmarking for hedging, relative value trades, and leveraged positions in subprime RMBS.

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

2. Introduction What are structured subprime RMBS portfolios? What is “basis risk”? Why is “basis risk” between these structures important now?

7. Subprime RMBS Overview Subprime RMBS 101

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

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

18. Credit Default Swaps on Subprime RMBS Credit Default Swaps (CDS) 101 ISDA Pay-As-You-Go (PAUG) Template 101 Subprime RMBS AFC Risk

32. Subprime RMBS Portfolio Structures Structured Finance CDOs 101 ABX.HE and TABX.HE 101

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

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

47. Conclusions

49. 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 Suite 3902, Tower Two, Lippo Centre 89 Queensway, Hong Kong Tel. +852 2263 9963