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F E B R U A R Y 2 5 , 2 0 0 9
T H E D E C L I N E A N D F A L L O F T H E S E C U R I T I Z A T I O N M A R K E T S
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Kedran Garrison PanageasFixed Income Strategy: CDOs / Interest Rate Derivativeskedran g panageas@jpmchase com
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(212) 270-0137
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This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including such client’s subsidiaries, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither thisonly and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be disclosed or used for any other purpose without the prior written consent of JPMorgan.
The information in this presentation is based upon any management forecasts supplied to us and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. JPMorgan’s opinions and estimates constitute JPMorgan’s judgment and should be regarded as indicative, preliminary and for illustrative purposes only. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us In addition our analyses are not and do not purport to be appraisals of the assets stock or business of the Company or any
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otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or anyother entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction. Unless expressly contemplated hereby, the information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects.
Notwithstanding anything herein to the contrary, the Company and each of its employees, representatives or other agents may disclose to any and all ith t li it ti f ki d th U S f d l d t t i t t t t d th U S f d l d t t i t t t f th
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persons, without limitation of any kind, the U.S. federal and state income tax treatment and the U.S. federal and state income tax structure of the transactions contemplated hereby and all materials of any kind (including opinions or other tax analyses) that are provided to the Company relating to such tax treatment and tax structure insofar as such treatment and/or structure relates to a U.S. federal or state income tax strategy provided to the Company by JPMorgan.
JPMorgan’s policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its T
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research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors.
JPMorgan is a marketing name for investment banking businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by a combination of J.P. Morgan Securities Inc., J.P. Morgan plc, J.P. Morgan Securities Ltd. and the appropriately licensed subsidiaries of JPMorgan Chase & Co. in Asia-Pacific, and lending, derivatives and other commercial banking activities are performed by JPMorgan Chase Bank, N.A. JPMorgan deal team members may be employees of any of the foregoing D
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g p y g , g y p y y g gentities.
This presentation does not constitute a commitment by any JPMorgan entity to underwrite, subscribe for or place any securities or to extend or arrange credit or to provide any other services.
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OverviewOverview
The global ‘liquidity glut’ sought out yield and ‘Fed’ the housing bubbleThe global liquidity glut sought out yield and Fed the housing bubble.
Risk-based capital requirements and off-balance sheet accounting led to an explosion of securitization.
CDO ff d di ifi ti d dit t hi b t k d i i l
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CDOs offered diversification and credit tranching but repackaged increasingly levered securities; correlation was massively underestimated.
Subprime and CDO losses triggered a system-wide de-leveraging process; securitization (the unregulated banking system) is in peril FinancialI
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securitization (the unregulated banking system) is in peril. Financial disclosure, accounting and regulatory capital rules will be revised.
A broad-based recapitalization of banks, guarantors, and conduits is required (halfway completed) Earlier negative returns and the spectre ofT
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(halfway completed). Earlier negative returns and the spectre of nationalization discourages private investment.
Spillover into markets such as Alt-A, HELOCs, credit cards, auto loans, student loans and commercial mortgages. Corporate lending is down as well. D
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[ C L I E N T N A M E ] 1TH
ED
AgendaAgenda
C dit E i 2
Drivers of Securitization
Credit Expansion 2
9
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The role of CDOs
Subprime: the first domino 14
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The credit crunch is not contained
e ole o C Os
30
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Appendix 42
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[ C L I E N T N A M E ] 2TH
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Household leverage increased massively over time
Debt outstanding as percent of nominal GDP
Household leverage increased massively over time
98
7680
100Government Household Non-Financial Business
5260
40
0
20
ON
Source: Federal Reserve. As of 2008 Q2.
52Q1 55Q1 58Q1 61Q1 64Q1 67Q1 70Q1 73Q1 76Q1 79Q1 82Q1 85Q1 88Q1 91Q1 94Q1 97Q1 00Q1 03Q1 06Q1
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fed by the global liquidity glut…fed by the global liquidity glut
Trade balance and foreign purchases of agencies. Foreign net purchases of agencies and the US trade balance. 3-month avg.
F i P h f A i T d B l
30
35
es (
$bn)
-70
-60
Foreign Purchase of Agencies Trade Balance
NAFTA implemented
(Jan 1994)
China joined WTO
(Dec 2001)
20
25
of A
genc
y Se
curi
ti
-50
-40
nce
($bn
)
10
15
eign
Net
Pur
chas
e
-30
-20
Trad
e Ba
lan
0
5
Fore
-10
0ON
Source: JPMorgan, US Census, TIC
0
Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
0
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The “virtuous credit cycle” kept spreads tight for a long timetime
Credit spreads and household to government debt gap
6000
7000
600
700
800Household minus Government Debt ($ bn, left) AAA Credit Card Spread to Treasuries (bp, right)
4000
5000
400
500
600
3000
4000
200
300
400
1000
2000
0
100
ON
Source: J.P. Morgan, Federal Reserve
Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08
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Securitization drove US credit expansion
Supply ($ Billions)
Securitization drove US credit expansion
Agency MBS Non Agency MBS CMBS ABS CDOs
500
71
210
391
3072,800
3,000
3,200
3,400Agency MBS Non Agency MBS CMBS ABS CDOs
345
78
230402
500
702
874888 529
64126
210 307
1 800
2,000
2,200
2,400
2,600
217
264
404646
67867
52
93
169203
330
702
67
65
203940
773 1213752
1,000
1,200
1,400
1,600
1,800
422
1020
1362
957 913 8561082 1112
1024727267
0
200
400
600
800
ON
* Non-Agency MBS through Nov. 2008Sources: J.P. Morgan, SIFMA
0
2000 2001 2002 2003 2004 2005 2006 2007 2008
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Securitization example: Pooled credit tranched riskSecuritization example: Pooled credit, tranched risk
Cash transactions involve outright purchase (true sale) of assets and funded issuance of notes
A t d i th k t (d l h ) f b l h t f i i tAssets sourced in the market (dealer warehouses) or from balance sheet of originator
Repayment of the ABS is derived from cash flow generated by the underlying assets
Broad theme for structured credit: expanding markets, increasing liquidity, distributing risk
Hedge Counterparties
Class A Notes
Asset
Class B Notes
AssetPortfolio SPV
Class C Notes
ON
Trustee & Custodian
Equity/First Loss
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How do ABS issued get AAA Ratings?How do ABS issued get AAA Ratings?
Trust Structure Credit Enhancement
Bankruptcy Remote Vehicle
Insulates Investor from
Internal
Excess Spread
Subordination
AAA Rating
Issuer Reserve Fund
Spread Account
Overcollateralization
Payout Events /Performance Triggers
Protects investors from
External
AAA-rated Monoline Insurer
Mortgage Insurance adverse credit developments
g g(Lender Paid)
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AgendaAgenda
C dit E i 2
Drivers of Securitization
Credit Expansion 2
9
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The role of CDOs
Subprime: the first domino 14
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The credit crunch is not contained
e ole o C Os
30
TH
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Appendix 42
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[ C L I E N T N A M E ] 9TH
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Basel 1 promoted securitization through regulatory arbitragearbitrage
Balance Sheet Post-SecuritizationBalance Sheet Post Securitization
Assets $100 Mortgages $98.50 Notes
Risk weight x 50%x 0% (No capital against sold
tranches)
Capital charge x 8% x 8%$98.5 Notes
Capital charge x 8% x 8%
Capital requirement $ 4.00 $ 0.00
Assets - $1.5 Equity tranche
Capital charge - x 100%
(Sold)
$1 5 Equity (Retained)Capital requirement - $ 1.50
Total Capital requirement $ 4.00 $ 1.50
$1.5 Equity (Retained)
N
Capital requirement = flat 8% capital charge * risk-weighted assets (RWA)
Risk weight categories overly broad, capital charge not aligned to underlying economic risk
Basel 1
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Rating agency capital requirement less than regulatory capital charge leads to capital arbitrage via securitization
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Basel II lowered risk weights for highly rated assets, encouraging banks to invest in ABS and increasing the role of rating agencies
700%
Risk weights under Basel II Standardized Approach (%)
For IRB banks, increased reliance on external ratings to determine capital charge (risk weights by rating)
of rating agencies
Resid
650%
600%
700%Senior tranches Basel I
Rating Corporates Securitization
Resid Mortgages (Prime)*
AAA-AA 20 20 35
Single-A 50 50 35
425%400%
500%BBB 100 100 35
BB 100 350 35 Single-B 150 ** 35 Below 150 ** 35
NR 100 ** 35
250%
200%
300%
Source: BIS, June 2004. *Ratings not applicable. *Deduction/Supervisory formula.
NR 100 35
Basel I 100 100 50
N
100%
60%
35%20%12%10%8%7%
0%
100%
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AAA AA A+ A A- BBB+ BBB BBB- BB+ BB BB-
Source: BIS, June 2004.
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As allowable leverage increased, AAA spreads narrowed (and non-bank investors were priced out)
Lower capital requirement => much higher leverage on AAA ABS/CDO => very attractive Return on Equity
out)
140%
160%
180% 7% risk weight (IRB banks)
20% risk weight (Standardized Banks)
100% risk weight (Basel 1)
80%
100%
120%
n Ti
er 1
Cap
ital
AAA CLO, 2004
40%
60%
80%
Retu
rn o
n
N
0%
20%
0.15% 0.20% 0.25% 0.30% 0.35% 0.40% 0.45% 0.50% 0.55% 0.60% 0.65% 0.70% 0.75% 0.80%
AAA CLO, 2006
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Source: JPMorgan. Returns assume bank capital structure of 90% senior debt, 4% Tier II capital, and 6% Tier I capital. Cost of funding: 12.5 bp spread to Libor on senior debt and 20bp spread to Libor on Tier II capital (average from June 2005-June 2007).
AAA CLO Spread over Libor
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CP markets offered non-term financing at cheap rates, aided by regulatory treatment of liquidity facilities (0% risk weighting)
CP outstanding ($ billions)
risk weighting)
1,800
2,000
2,200Asset-Backed Commercial Paper
Commercial Paper
1,200
1,400
1,600
600
800
1,000
N
0
200
400
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Jan-91 Apr-92 Jul-93 Oct-94 Jan-96 Apr-97 Jul-98 Oct-99 Jan-01 Apr-02 Jul-03 Oct-04 Jan-06 Apr-07 Jul-08
Sources: Federal Reserve
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AgendaAgenda
C dit E i 2
Drivers of Securitization
Credit Expansion 2
9
MA
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The role of CDOs
Subprime: the first domino 14
19IT
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The credit crunch is not contained
e ole o C Os
30
TH
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Appendix 42
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[ C L I E N T N A M E ] 14TH
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ABS product types
Global ABS issuance by collateral type ($bn)
ABS product types
250
300 Student LoansOther
Non US RMBSManufactured Housing
Home Eq (subprime)E i
150
200
Equipment
Credit CardsAutos
100
150
NO
0
50
FI
RS
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OM
I
Source: JPMorgan, MCM, Bloomberg, CreditFlux, IFR, Moody’s, S&P, Fitch
Jan-00 Oct-00 Jul-01 Apr-02 Jan-03 Oct-03 Jul-04 Apr-05 Jan-06 Oct-06 Jul-07 Apr-08
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[ C L I E N T N A M E ] 15SU
BP
R
Types of Home Equity LoansTypes of Home Equity Loans
2nd Lien 1st Lien
Types of Mortgage Loans
Borrower
2nd Lien 1st Lien
2nd Lien/ High LTV
Home Equity Line of Credit
Subprime B&C Alt-B Alt-A
PrimeJumboA
Prime Near Prime
Prime Credit Impaired
Near Prime Prime Documentation
Prime
Lien
LTV
Property Type 2nd 2nd 1st
1st 1st 1st
2nd: 90% HLTV: 115%
90%-100% 80%-85% 80%-85% 75% 70%
WAC
FICO
HLTV: 115%
2nd: 8%-10%HLTV: 12%
6% 7%-8%
6.5%-7.5% 6.5% 6.25%
690-715 715 600-625 650-700 715 725
NO
Originators CountrywideCSFB (HEMT)
GMAC RFC (RFMS2)
CountrywideGreenPoint RFC (RFMS2)
Wachovia
Ameriquest Countrywide Option One
RFC
Ameriquest Impac
RFC (RAMP)
CountrywideIndyMac
RFC (RALI)
Chase CountrywideWells Fargo
WaMu
FI
RS
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OM
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Asset BackedHome Equity
MortgageBacked
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BP
R
Fuel for the fire: declining credit standards, increased reliance on refi and a burst of the real estate bubble
36%
Increases in 2nd’s and low documentationSubprime and Alt-A delinquencies on the rise (60+ del as % current balance)
reliance on refi, and a burst of the real estate bubble
28%
32%
36%Subprime Alt-A Prime Jumbo
30%
40%
16%
20%
24%
Dec 200610%
20%
8%
12%
16%
-10%
0%
NO
0%
4%
Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan-
-20%2000 2001 2002 2003 2004 2005 2006 2007
Silent 2nds % Stated Doc %FI
RS
TD
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93 94 95 96 98 99 00 01 03 04 05 06 08Silent 2nds % Stated Doc %National 12m HPA (Dec)
Source: JPMorgan, National Mortgage News, FARES, LoanPerfromance. Source: JPMorgan, Loan Performance.
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Basecase collateral loss estimates were around 4-5%Basecase collateral loss estimates were around 4-5%
Typical HEL ABS Structure HEL ABS ARM cumulative losses by loan age (months)
7%
8%
9% 2000 2001 2002 2003
2004 2005 2006 2007
AAA: 21-100%
5%
6%
7%
AA: 12-21%
3%
4%
5%
NO
Single-A: 7-12%
BBB+ : 6-7% BBB: 5-6%
BBB- : 4-5% 1%
2%
FI
RS
TD
OM
I
First-Loss: 0-2%
Source: JPMorgan
BB+: 3-4%BB- : 2-3% 0%
1 9 17 25 33 41 49 57 65 73 81 89 97 105
Source: JPMorgan,Intex, Deal documents.IM
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BP
R
AgendaAgenda
C dit E i 2
Drivers of Securitization
Credit Expansion 2
9
MA
RK
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S
The role of CDOs
Subprime: the first domino 14
19IT
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The credit crunch is not contained
e ole o C Os
30
TH
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EC
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Appendix 42
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[ C L I E N T N A M E ] 19TH
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What is a CDO?
Basic Accounting
What is a CDO?
A CDO is a tranched investment fund
CDO Balance Sheet
A CDO is a tranched investment fund
Comparable to a finance companyBorrows money (liabilities)Invests in collateral (assets)Has residual value (equity)
Equity represents an ownership stake and first loss position
Typically managed by a seasoned assetAssets
Liabilities
CDO Typically managed by a seasoned asset manager with a strong track record in the respective asset class
Repayment of liabilities relies on the performance of the underlying collateral
CDO collateral
pool
Senior & Mezz Debt
p y g
Credit enhancement and tranching created different rating levels, allowing involvement of a wide investor base
Equity investors look for monetization ofCDO Equity
OS
Equity investors look for monetization of illiquidity premia and ratings arbitrage
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Indicative CDO timeline
Event
Indicative CDO timeline
5-7 weeks
7-10 weeks
8-14 weeks
Structuring
Draft Documents
Warehouse Assets 8-14 weeks
4-8 weeks
3-5 weeks
Warehouse Assets
Equity Marketing
Debt Marketing
Pricing
Closing and Funding
3-6 monthsRamp-up Period
Non-Call Period 3-5 years
OS
5-7 yearsReinvestment Period
Note: The information presented above is indicative and subject to change. The timeline of an actual CDO may vary significantly from the information set forth above.
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The CDO market boom (and bust) cycle
Global issuance by collateral type ($bn)
The CDO market boom (and bust) cycle
600
700
800HY Loans IG* / HY Debt Mezzanine ABS, CRE High Grade ABS Other, CDO^2, EM
400
500
600
200
300
400
0
100
OS
Source: JPMorgan, MCM, Bloomberg, CreditFlux, IFR, Moody’s, S&P, Fitch.*Excludes unfunded IG corporate exposure
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
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ABS CDOs hold other Asset-Backed Securities
Mezz ABS collateral by sector (x-axis: vintage)
ABS CDOs hold other Asset-Backed Securities
Mezz ABS collateral by rating (x-axis: vintage)
20%
40%
60%
80%
100%
20%
40%
60%
80%
100%
0%
20%
2003 2004 2005 2006 2007
AAA AA A BBB <=BB
0%
20%
2003 2004 2005 2006 2007
HEL RMBS CDO CMBS Other ABS
High Grade ABS collateral by rating (x-axis: vintage)
60%
80%
100%
High Grade ABS collateral by sector (x-axis: vintage)
60%
80%
100%
0%
20%
40%
2003 2004 2005 2006 2007
0%
20%
40%
60%
2003 2004 2005 2006 2007
OS
Source: Intex, JPMorgan
HEL RMBS CDO CMBS Other AAA AA A BBB <=BB
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Higher rated assets allow higher leverageHigher rated assets allow higher leverage
Typical Mezzanine ABS CDO Structure Typical High Grade ABS CDO Structure
Sr. AAA: 38 100%38-100%
(Unfunded)Sr. AAA: 17-100%
(Term funded or CP)
Jr. AAA: 23-38%
AA: 15-23%AA: 15-23%
A: 10-15%
BBB: 5-10%
Jr. AAA: 7-17%
AA: 3.5-7%
OS
BB/Equity: 0-5%
BBB: 5 10%
BB/Equity: 0-1%
A: 2-3.5%
BBB: 1-2%
Source: JPMorgan
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Securitization can be “synthetic”Securitization can be synthetic
Illustrative synthetic ABS CDO structure
Credit Default Swap Portfolio
P i P t ti
Issuing Trust
Trustee
Asset Manager
Contingent Collateral Account:
Designated Aaa/AAA
Premium Protection
Cash
Security
Senior AAA
Notes (unfunded)
Junior AAA Notes
Subordinate
Notes
Preferred
Shares
Asset ManagerSecurity Cash
Aaa/AAAABS assetsPremium Protection
Notes (unfunded) (funded) (funded) (funded)
Collateral amortization and interest payments
OS
Source: JPMorgan
Collateral losses and contingent payments
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[ C L I E N T N A M E ] 25TH
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Synthetics facilitated the growth of ABS CDOs beyond the cash market
% of US Mezz ABS CDO issuance in synthetic formatTotal Mezz ABS CDO volume* vs US BBB/BB HEL ABS issuance ($ billions)
cash market
80%
90%
100%
Cash Synthetic
50
60HEL issuance HEL issuance inside CDOs
60%
70%
80%
30
40
30%
40%
50%
20
30
0%
10%
20%
0
10
OS
2001 2002 2003 2004 2005 2006 2007
Source: JPMorgan, MCM, Bloomberg, CreditFlux, IFR, Moody’s, S&P, Fitch. Source: JPMorgan, MCM, Bloomberg, CreditFlux, IFR, Moody’s, S&P, Fitch. *ABS CDO volume scaled by typical HEL share of portfolio.
2000 2001 2002 2003 2004 2005 2006 2007
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Who bought CDOs?
Estimated Supersenior ABS CDO investors by type Estimated Jr. AAA to BBB ABS CDO investors by type
Who bought CDOs?
Hedge funds
/ managers
20 0%
Bank
12.5%
Conduits &
SIVs
1%
Hedge funds
/ managers
Insurance
10%
Bank
5%
20.0%10%
Dealer
CDOs
55.0%
Insurance
7.5%Negative
Basis
24%
Dealer
50%
5.0%
OS
Source: JPMorgan Source: JPMorgan
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ABX and TABX: new benchmarks for ABS and CDOs
Each TABX series composed of 40 underlying reference obligations (06-2 = 20 of ABX 06-2 and 20 of ABX 06-1)
ABX and TABX: new benchmarks for ABS and CDOs
Reference Obligations ABX Ref Obs Standardized
TranchesMortgage Portfolio
AA
AAA
25-40%
40-100%BBB- 1
BBB- 3
BBB- 2
Subprime Mortgages A
BBB
BBB
15-25%
10-15%
5 10%
BBB- 4
BBB- 5
BBBBBB-
Residual 0-5%
5-10%BBB- …
BBB- 40
OS
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Liquid synthetic benchmarks helped to re-price risk quickly
ABX 06-2 index prices
quickly
TABX BBB- 06-2/06-1 index prices
80
90
100AAA AA A BBB
80
90
100 10-15 (BBB/BB)
15-25 (A)
25-40 (AA)
40-100 (AAA)
50
60
70
50
60
70
30
40
50
30
40
50
0
10
20
0
10
20
OS
Source: JPMorgan, Markit
2/15/07 8/2/07 1/17/08 6/19/08 10/30/08
Source: JPMorgan, Markit
2/16/07 7/20/07 12/27/07 5/29/08 10/30/08
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AgendaAgenda
C dit E i 2
Drivers of Securitization
Credit Expansion 2
9
MA
RK
ET
S
The role of CDOs
Subprime: the first domino 14
19IT
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The credit crunch is not contained
e ole o C Os
30
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Appendix 42
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Turmoil in the short-term markets implies balance sheet squeeze even liquidation
ABCP outstandings ($bn) Bank borrowing costs (%)
squeeze, even liquidation
5.5
6
6.5
1,000
1,200 Other Asset-backed
4
4.5
5
600
800
ED
3
3.5
4
400
600
TC
ON
TA
IN
E
2
2.5
Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-080
200
0 8 1 0 1 0 1 1 0 1 0 1 0 9NC
HI
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1M Libor 1M EuriborABCP 30 Day Fed Funds1/
30
2/28
3/3
4/3 0
5/3
6/30
7/3
8/3
9/30
10/3
11/3
0
12/3 1/30
2/29
Source: Federal Reserve Board Source: JPMorgan
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Off-balance sheet assets weren’t far enough off balance sheetsheet
15 largest global liquidity providers (as of 2007 Q1)
I $
Estimated putable HG ABS CDO ABCP exposure (as of 08/2007)
Put provider O di ($ )Issuer $mnABN AMRO Bank N.V. 103,075Citibank, N.A. 90,798Bank of America Corp. 84,637JPMorgan Chase Bank N.A 73,342Morgan Stanley 64 764
Put provider Outstandings ($mn)
Citi $18,968 Barclays $18,805 Soc Gen $5,855 West LB $5,777 BOA $4,600 Morgan Stanley 64,764
Wachovia Bank N.A. 51,282Barclays Bank PLC 49,866Deutsche Bank AG 42,594Bank of Scotland 42,121Rabobank Nederland 41 669
$ , Credit Suisse $4,022 Calyon $4,020 Goldman Sachs $3,865
Bear Stearns $3,600 Wachovia $2,293
ED
Rabobank Nederland 41,669Societe Generale 38,450Lloyds TSB Bank PLC 32,583Royal Bank of Scotland PLC 32,269WestLB AG 30,390Fortis Bank 29,201
UBS $1,672 JPMorgan $880
Rabobank $880 AIG $737 Merrill $624 Morgan Stanley $174T
CO
NT
AI
NE
Source: Standard & Poors.
,Total 807,041
Morgan Stanley $174
Total $76,771 Source: JPMorgan, Moody’s, S&P, Fitch, Bloomberg, MCM.
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Into the vortex: declining asset prices pull equity prices ever downwardsever downwards
ABX.07-1 AAA versus BKX* index prices
100
120
90
100
BKX (left) ABX.07-1 AAA (right)
80
60
70
80
ED
60
40
50
60
TC
ON
TA
IN
E
20
40
20
30
40
NC
HI
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Source: J.P. Morgan, Markit, Bloomberg. *KBW bank stock index.
20
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09
20
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Structured Finance writedowns necessitate capital infusions across the bank and guarantor community
Financial writedowns and credit losses - $1.1tn and counting ($bn)
infusions across the bank and guarantor community
Share of losses taken worldwide by investor type
250
300Americas Europe Asia
GSEs
10%
Insurers
15%
150
200Banks/
Brokers
75%
ED
100
150
400
500 Worldwide
Financial capital raised - $1tn so far ($bn)
TC
ON
TA
IN
E
0
50
0
100
200
300
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Source: Bloomberg. Does not include trading losses.
4Q08 3Q08 2Q08 1Q08 4Q07 3Q07 Prior 1Q09 4Q08 3Q08 2Q08 1Q08 4Q07 3Q07
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A decent chunk of banks’ capital holes have been plugged, but $750 1000b i$750-1000bn remains
Estimates of financial sector potential losses as of October 2008 (in billions of US dollars)
Breakdown of Losses
Out-
standing
Estimated Losses on Loan & Mark-to-
market Losses on Securities Banks Insurance
Pensions/ Savings
GSEs & Government
Other (Hedge
Funds, etc.)
Unsecuritized Loans
Subprime 300 90 Alt-A 600 100 Prime 3,800 100 Commercial real estate 2,400 60 Consumer loans 1,400 40 Corporate loans 3 700 75E
D
Corporate loans 3,700 75 Leveraged loans 170 20
Total for loans 12,370 485 215-280 20-40 20-40 60-100 80-100
Securities ABS 1,100 300 ABS CDOs 400 300
TC
ON
TA
IN
E
Prime MBS 3,800 150 CMBS 940 300 Consumer ABS 650 25 High-grade corporate 3,000 50 High-yield corporate 600 50 CLOs 350 50N
CH
IS
NO
T
Source: J.P. Morgan
CLOs 350 50 Total for securities 10,840 1225 615-690 170-200 175-220 70-160 125-270
Total for loans & securities 23,210 1,710 800-1,000 190-235 160-290 125-250 200-360
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The credit crunch remains in full swing
Net percentage of domestic respondents tightening lending standards
The credit crunch remains in full swing
70
80
90
100 Resi Mortgage Loans Credit Cards CRE Loans
40
50
60
ED
0
10
20
30
TC
ON
TA
IN
E
-30
-20
-10
0
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Source: Federal Reserve Board (Senior Loan Officer Survey)
Sep-90 Mar-92 Sep-93 Mar-95 Sep-96 Mar-98 Sep-99 Mar-01 Sep-02 Mar-04 Sep-05 Mar-07 Sep-08
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Danger of overshooting on the way down
1987 t 1997
S&P/Case-Shiller home price index (composite-10)
Danger of overshooting on the way down
No. of borrowers (owner occupied, first lien mortgage) by CLTV
Current CLTV
1.5
1.6 1987 to 1997
2003 to Oct 2008
Projected
Current CLTV
<80% 80-90% 90-100% >100% Borrowers
underwater Alt-A 931,310 478,112 521,972 1,357,584 41% Subprime 1,438,821 715,026 738,104 1,476,263 34% Jumbo 1,069,345 307,495 247,956 383,490 19% A 20 00 000 6 900 000 2 00 000 200 000 %
1.3
1.4 Currently down 25%
from 6/06 peak
10/89 – 12/97: 8 years
Agency 20,100,000 6,900,000 2,100,000 1,200,000 4%Total 23,539,476 8,400,633 3,608,033 4,417,338 11%
State HPA distribution (peak to current HPA, market share)ED
Source: J.P. Morgan, LoanPerformance
1.2 10/89 to 2/94: down
8% peak to trough
10/89 12/97: 8 years
and 2 months
State HPA distribution (peak to current HPA, market share)
-35%-30%-25%-20%-15%
HPA
1: -32% HPA, 32% share
2: -23%, 11%
3: -14%, 10%4: -10%, 12% 0.
1%,
5%0.
02%,
4%
TC
ON
TA
IN
E
1.0
1.1-10% over 12
months
87 88 89 90 91 92 93 94 95 96 97
-10%-5%0%
0% 20% 40% 60% 80% 100%
Subprime Market Share
,5: -5%, 26%
6: -
07:
-0
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Source: J.P. Morgan, S&P/Case-Shiller
87 88 89 90 91 92 93 94 95 96 97 03 04 05 06 07 08 09 10 11 12 13
Group 1: CA, NV, AZ; Group 2: FL; Group 3: RI, MI, MA, NH, HI, OH, MN; Group 4: NY, MD, NJ; Group 5: WY, IL, VA, PA, WA, LA, DC, CT, ME, GA, WI, OR, AL, ND, CO, NE, VT, TN, AK, AR, NC, KY, DE, OK, WV, ID, UT; Group 6: TX; Group 7: NM, SC, IA, IN, KS, MO, MS, MT, SD. As of June 2008Source: J.P.Morgan, LoanPerformance
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Inventory overhang remains; buyers’ marketInventory overhang remains; buyers market
Inventory (mn units)NAR Housing Affordability Index (as of 3Q08)
3Q08 Actual 3Q09 Projected
3.5
4.0
0 5
0.55
0.6Existing (left) New (right)
Excess supply
Excess labor
300
350California
Ohio
Florida
US
3Q08 Actual 3Q09 Projected
92 137
218 323
121 180
151 224
2 5
3.0
0 4
0.45
0.5
200
250
ED
2.0
2.5
0.3
0.35
0.4
100
150
TC
ON
TA
IN
E
1.0
1.5
0.2
0.25
0
50
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1/89 1/92 1/95 1/98 1/01 1/04 1/07
Source: JPMorgan, NAR, Moody’s Economy.com
Mar-79 Mar-84 Mar-89 Mar-94 Mar-99 Mar-04 Mar-09
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Bank funding pressure receding after government supportBank funding pressure receding after government support
TED spread (3-month LIBOR minus 3-month TBills, bp)
500 LIBOR minus Tbills (3-month) Average
400
450
500 LIBOR minus Tbills (3 month) Average
300
350
ED
200
250
150TC
ON
TA
IN
E
50
100
150 150
94
NC
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OT
Source: J.P. Morgan, Bloomberg
50
7/31/07 9/30/07 11/30/07 1/31/08 3/31/08 5/31/08 7/31/08 9/30/08 11/30/08 1/31/09
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Foreclosures will get much worse: 2010 explosion in liquidationsForeclosures will get much worse: 2010 explosion in liquidations
Cumulative liquidations (number of loans)Foreclosure inventory (number of loans)
1 500 000
2,000,000Agency
Prime Jumbo
Alt-A
Subprime
6 000 000
7,000,000
8,000,000Agency
Prime Jumbo
Alt-A
Subprime
1 000 000
1,500,000
4 000 000
5,000,000
6,000,000
ED
500,000
1,000,000
2,000,000
3,000,000
4,000,000
TC
ON
TA
IN
E
0
,
0
1,000,000
2,000,000
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Source: J.P. Morgan, LoanPerformance
Nov-08 May-09 Nov-09 May-10 Nov-10 Nov-08 May-09 Nov-09 May-10 Nov-10
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High-yield loan default rate expected to rise to 10% in 2009, base
High-yield Loan Default Rate (%)
case, according to JPMorgan High Yield Strategy; risk is to upside
2009 Estimate, 10% 10%
12%
2009 Estimate, 8%12/31/2000, 8.2%
6%
8%
ED
3.75% as of Dec 31
4.35% as of Dec 314%
6%
TC
ON
TA
IN
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0%
2%
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Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 2009
Estimate
By Dollar Amount By Issuer Count
Source: S&P LCD, JPMorgan
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AgendaAgenda
C dit E i 2
Drivers of Securitization
Credit Expansion 2
9
MA
RK
ET
S
The role of CDOs
Subprime: the first domino 14
19IT
IZ
AT
IO
N
The credit crunch is not contained
e ole o C Os
30
TH
ES
EC
UR
Appendix 42
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[ C L I E N T N A M E ] 42TH
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Single-Name CDS basics
Single name credit default swaps
Single-Name CDS basics
Reference
Entity
Risk (Notional)
Protection
Seller
Protection
Buyer
Premium
Contingent payment upon a
Credit Event
• Buy CDS• Buy protection• “Short risk”
• Sell CDS• Sell protection• “Long risk”
• Pay periodic payments • Receive periodic payments
Source: JPMS.
Credit risk profile of shorting bond Credit risk profile of owning bond
DI
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PE
N
Synthetic Corporate SecuritizationSynthetic Corporate Securitization
Super Senior /
CDS 1
CDS 2 Single name
dit t tiBasket credit
t ti
Asset 1
Asset2
Super Senior / AAA Tranche
SPV Reference portfolio
(Static or
CDS3
…..
Periodic premium
credit protection protection
Periodic premium
Asset 3
…..
Reference Entities
AA/A Tranche
(Managed)CDS
98
CDS 99
Asset 98
Asset 99
BBB/BB Tranche
First loss
CDS 100
Asset 100
DI
X
[ C L I E N T N A M E ] 44AP
PE
N
“Pay-as-you-go” credit default swaps specifically designed for ABS securitiesdesigned for ABS securities
Reference Obligation is cusip-specific: performance varies by trust, rating level
Trade notional amortizes with the underlyingTrade notional amortizes with the underlying
After credit events protection buyer has the option to physically settle the contractOption avoids risk of short squeeze – limited universe of deliverable obligationsAvoids reliance on cash valuation in less liquid markets
Otherwise, pay-as-you-go settlement: contingent payments as writedowns and interest shortfalls occur
Term extends to final maturity of the underlying
Pay as you go (PAYG) with physical settle option
Premium
Protection
SellerProtection
BuyerWriteups, Interest Reimbursements
Writedowns, Interest Shortfalls
Buyer
Par
Physical Bond
Source: JPMorgan.DI
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[ C L I E N T N A M E ] 45AP
PE
N
CDO ti b i
Most CDO tranches are rated by at least two, perhaps three, of Moody’s, Standard & Poor’s,
CDO rating basics
Sample tranche loss distribution
6%
7%
and Fitch
Rating agencies examine portfolio characteristics, structural parameters, legal documentation, and the CDO manager’s track
5%
6%record and operational experience
Rating process is to
model the portfolio
generate default distributions
3%
4%
Equity
Mezzanine 10%—20% Super Senior: from 30% up
generate default distributions
run cashflow scenarios based off default assumptions and other factors (interest rates, default timing, etc.)
quantify tranche risk
1%
2%
Equity 0%—10%
quantify tranche risk
All three agencies have moved to a Monte-Carlo approach - assets are modeled with individual
default probabilities
0 503% 6%0%
1%
0% 10% 20% 30% 40% 50% 60%
recovery rates (possibly stochastic)
asset correlation factors to — industry / ABS sector— wider market
i i (ABS/CMBS) (CDO)
DI
X
[ C L I E N T N A M E ]
— originator (ABS/CMBS) or manager (CDO)
46AP
PE
N
Intex is predominant cashflow modeling toolIntex is predominant cashflow modeling toolD
IX
[ C L I E N T N A M E ] 47AP
PE
N
Typical debt scenario analysis
200
Typical debt scenario analysis
10% recovery rate (Trust Preferred CDO)
100
150
200AAA, No call
Single-A, No call
50
100
ount
Mar
gin
-50
0
0 0.4 0.8 1.2 1.6 2 2.4 2.8 3.2 3.6 4 4.4 4.8 5.2 5.6 6 6.4 6.8 7.2 7.6 8
Tran
che
Disc
o
-150
-100
-200 Annual Default Rate1
DI
X
[ C L I E N T N A M E ] 48AP
PE
N