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Moderator: Michael Belfatti, ACE Financial Solutions

Panelists: Patrick McCormick, American Re

Scott Orr, American Re

Introduction

Part 1General overview of credit enhancement

Part 2Credit 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 GuarantyCredit DerivativeExcess SpreadSubordinationOver-CollateralizationCash 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 + 300 bps

Interest Cash Flow

LIBOR + 100 bps

Collateral Security

>>

Subordination

LayersLowest layer absorbs first

losses

Senior Debt

Subordinated Debt

Equity

Over-Collateralization

NotionalValue

NotionalValue

Collateral Security

>>

Cash Reserves

Extra collateral held as cashCredit enhancement and Liquidity

What is enhanced?

Municipal and international bondsAsset backed securities

Municipal and International Bonds

Local, state, government agenciesGeneral obligationsLimited recourse obligationsInternational similar

General Obligation Example

City of Los Angeles seeks fundsChooses to issue bondRepayment based on taxing powers

and assetsFinancial Guarantor guarantees

timely interest and ultimate principal if Las Vegas defaults on bond payment

Asset-Backed Securities

Backed by pool of assetsAsset cash flows cover bond interest

and principal

Asset-Backed Securities - Examples

Mortgage-backed securitiesCredit card receivablesAuto loan receivables

What needs does it satisfy?

CostMarketabilityLiquidityNew and complex asset classesReduce 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

- 8.30% Weighted average bond rate

= 3.95% Excess Spread

Critical Players in Bond Insurance Securitization Market

Originator/LenderInvestment BankerRating AgencyBond InsurerReinsurer

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 feeWorks with all partiesInvestor demand and Credit Enhancement

levels are keyUnderwrite all facets of securitization

process

Bond Insurer

Primary relationship with lenderFrequent Interaction with Investment

BankerRating agency involvementUltimate risk takerReceives premium from originatorThorough and in-depth underwriting

approach

Reinsurer

Bond insurer are sole risk partners“Risk Share” arrangementReceive share of fee from bond insurer

Perform “higher level” underwriting review

Employees have extensive industry knowledge

Banker or Issuer will relay opportunityOpportunity 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/LenderInvestment BankerRating AgencyBond InsurerReinsurer