Conduits: Their Structure and Risk

Conduits: Their Structure and Risk

Primary Functions of a Conduit Loan Originators (may or may not retain the servicing) Mortgage Bankers Mortgage Brokers Buy Side - set purchase guidelines - set underwriting guidelines - fund commitments - buy loans - manage loans while in portfolio awaiting dispositon Sell Side: Securitization requires many players and commitments - investment banker underwrites and structures the securities - trustee holds the securitized assets - master servicer oversees servicing - servicers, sub-servicers, and/or special servicers service the loans - certificate custodian - certificate registrar and paying agent - third-party credit support (pool insurance, etc. ) - extensive legal support in all areas - control credit and cash-flow risk of ongoing commitments - investor relations supports securities in aftermarket Securities brokers and dealers sell the securities, then support trading in the aftermarket Security 1 to market Security 2 to market Secondary market for securities Banks Buy loans Sell as securities Thrifts Portion of collateral cashflow returns as part of profit Security 3 to market Non-Originators Secondary Market Sell Side: Whole-loan sale requires few players or commitments - flip loans back to the secondary market Security 4? May be sold or held by a conduit in many ways Sell as whole loans Secondary market for whole loans

Other 24% Investment Banks 17% Source: The Mortgage Market Statistical Annual for 1999. Banks/Thrifts 15% Private Conduits 44% Other 54% Banks/Thrifts 13% Investment Banks 27% Other 22% Banks/Thrifts 23% Finance/Credit-Card Companies 48% Private Conduits 6% Private Conduits 7%

Carry = Interest Inc. Interest Exp. Hedge Cost (1) Spread (%) 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Commercial Mortgage Spread to High-Quality Commercial Paper Commercial Mortgage Spread to Low-Quality Commercial Paper 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 1997 1998 1999 Note: The spread between the commercial mortgage and commercial paper rates is calculated as the difference between the Levy commercial mortgage rate and either the high- or low-quality commercial paper rate, net of twenty basis points servicing fee. The Levy commercial mortgage rate is reported monthly by Barron s. Commercial paper rates are reported by Bloomberg Financial Markets. All yields are computed on a bond yield basis.

Value of Securitization = Value of Class A + Value of Class B +... + Value of Excess Interest + Value of Excess Servicing + Value of the Residual (or Seller s Interest) Class Cost of Assets Underwriting/Sale Expenses (2) Last $100 Principal 7.70% Coupon --.20% Servicing Fee = 7.50% Net Coupon for Security Holders $75 Class A Senior Bond Rated AAA Interest on AAA-Rated A Bond = 6.40% (Sold at Par) Loss Priority First $8 Class B Bond Rated AA $5 Class C Bond Rated A $5 Class D Bond Rated BBB $4 Class E Bond Rated BB $3 Class F Subordinated Bond Not Rated Interest on AA-Rated B Bond = 6.65% (Sold at Par) Interest on A-Rated C Bond = 7.00% (Sold at Par) Interest on BBB-Rated D Bond = 8.00% (Sold at Par) Interest on BB-Rated E Bond = 11.00% (Sold at Par) Interest on Unrated F Bond = 6.00% (Sold at Discount) Excess Interest (IO Strip) = 0.80%* (Retained by Conduit or Other Use) Residual or R Class (Retained by Conduit) *Excess interest = net coupon (7.50%) less the combined interest expense of the bonds, ((0.75*6.40)+(0.08*6.65)+(0.05*7.00)+(0.05*8.00)+(0.04*11.00)+(0.03*6.0)).

Conduit Stock Value Index 14 12 10 8 6 4 2 0 S&P 500 Index of Conduit Equity Value - SFAS 125 - Rising delinquencies raise asset-quality and prepayment issues - Cityscape problems begin - Cityscape problems deepen - High prepayments reduce the value of IO strips - Widespread financial problems raise credit spreads and hedge risk - Conduits generally confront less-favorable market conditions 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 1993 1994 1995 1996 1997 1998 1999 S&P 500 Note: The index of conduit equity, set with January 1993 = 1, is calculated by summing the value of public equity of 7 public conduits listed in the top 25 conduits by The Mortgage Market Statistical Annual for 1998: Firstplus Financial Group, Advanta Corp., Aames Financial Corporation, AMRESCO, Cityscape Financial Corporation, IMC Mortgage, and Southern Pacific. Two other public conduits in this listing, Greentree Financial Corp. and the Money Store, Inc., were omitted from the index because they were purchased by other institutions in 1998 before the decline in the stock market in July 1998. 2,000 1,600 1,200 800 400 0

Spread (%) 3.5 3.0 2.5 2.0 1.5 1.0 0.5 BBB Spread AAA Spread Levy Commercial Mortgage Spread 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 1997 1998 1999 Note: AAA and BBB spreads are calculated relative to ten-year Treasury rates by Morgan Stanley for conduit commercial mortgage securities, as reported by Bloomberg Financial Markets. The Levy commercial mortgage rate is spread to tenyear Treasury rates, net of twenty basis points servicing fee. 8 9