Overview of the Mortgage-Backed Securities Markets

Presented By
Randy Appleyard
Director, Mortgage Finance
Citigroup Global Markets

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 Agenda

Market Overview

Agency and Non-Agency Market Sector

Analyzing MBS

Role of Mortgage Finance at Citigroup Global Markets

Questions

2
Market Overview

3
 Mortgage-Backed Securities Market

Constitutes the largest sector of the bond market with more than $5.3 trillion
outstanding

Core holding of almost all U.S. institutional fixed-income investors

Wall Street dealers trade hundreds of billions of dollars of mortgage backed securities
every day

Largest market segment consists of securities backed by residential mortgage loans

However, the complexity and variety of these securities means that very few people in the
financial industry have a detailed understanding of their characteristics

4
 Relative Size of US Debt Sectors

(Dollars in Trillions)
All Mortgage Debt $9.465
Single Family Mortgage Debt 7.282

Mortgage-Backed Securities(1) 5.357

Corporate 4.569
U.S. Treasury(2) 3.755
Fed Agencies 2.725
Money Market(3) 2.648
Asset-Backed(4) 1.771
Source Bond Market Association
(1) Includes GNMA, FNMA and FHLNC MBS and CMOs and non-agency MBS/CMOs
(2) Interest bearing marketable public debt
(3) Includes commercial paper, bankers acceptance and large time deposits
(4) Includes public and private placements

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 What are Mortgage-Backed Securities (MBS)?

Definition: Securities entitled to the cash flow from a specific pool of mortgage loans.

Characteristics

Payment received on the assets and paid on the securities are made monthly

Payments include interest and principal (scheduled and unscheduled)

Cash flows are channeled to investors in two ways:

Passed through to investors (a pass-through security)

or
Allocated according to specific rules (structured securities such as collateralized
mortgage obligations)

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 Factors Influencing the Development of MBS Market

Mortgage Loans Economic Drivers

Unique characteristics of each loan Financial institutions desire to sell
fixed-rate, long-term assets
Relatively illiquid
Growing market share of mortgage
Unrated
bankers with little interest and limited
High geographic and economic capability to hold mortgage loans
concentrations in portfolios
Supply/Demand imbalance for mortgage
Cumbersome and expensive to loans
sell/buy whole loans

Securitization is a means of turning illiquid assets into liquid securities, creating an

efficient tool for balance sheet management

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 Origination of the MBS Market

In 1970 the Government National Mortgage Association

(Ginnie Mae) guaranteed the first mortgage-pass through
security

Fannie Mae and Freddie Mac closely followed Ginnie

Mae with their own issuance of pass-through MBS

The non-agency market developed several years

later, primarily as funding tool for mortgage bankers

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 Benefits of Mortgage Securitization

Attracts new capital to the market, improves overall liquidity and keeps rates low

Stabilizes the U.S. housing finance system by shifting interest rate and credit risk
from banks and thrifts to broader investors that are often better able to diversify
and hedge

Made homeownership available to more buyers 69.2% of Americans own their

homes

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 Benefits of Investing in MBS

Higher Returns: Significantly higher yields (+100bps) over Treasuries and comparable-
quality corporate bonds

Credit Quality: Ginnie Mae MBS are backed by the full faith and credit of the US
government, Fannie Mae and Freddie Mac which have close ties to the US Government are
perceived as minimal risk investments and private MBS typically are rated AAA

Variety of Investment Profiles: Sector provides the widest range of investment

characteristics, including durations, coupons, indices, and prepayment sensitivities

Liquidity: The outstanding MBS supply, trading volume and involvement of major
dealers provides an active and liquid market for most MBS

Analytic Tools: Sophisticated analytical models for evaluating MBS provide an in-depth
understanding of the mortgage cash flows and characteristics

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Agency and Non-Agency Market Sectors

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 Two Primary Sectors of the MBS Market

Agency Market Non-Agency Market

Underlying loans conform to Agency Underlying loans typically DO NOT
guidelines conform to Agency guidelines
Securities guaranteed by the issuer No guarantee, bonds independently
credit enhanced.
Securities carry triple-A ratings based
upon U.S. government guaranty (Ginnie Covers complete spectrum of
Mae) or implied support (Fannie Mae borrowing demographics and credit
and Freddie Mac) characteristics
Largest and most liquid part of the Highly rated bonds, with most of the
MBS market structure rated triple A
Large and diverse sector of the market

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Agency Sector

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 Agency Market

Ginnie Mae Fannie Mae Freddie Mac

Types of Mortgages FHA/VA Conventional (Some Conventional (Some
FHA/VA) FHA/VA)
Guarantee Timely payment of Timely payment of Timely payment of
interest and principal interest and principal interest and principal
Guarantor U.S. Government Fannie Mae Freddie Mac
Currently Outstanding (in $457.3 $1,879.0 $1,189.7
Billions)

Main Collateral Types 30 Yr Fixed Ginnie I 30 Year Fixed 30 Year Fixed

Ginnie II 15 Year Fixed 15 Year Fixed
15 Yr Fixed Ginnie I Balloons Balloons
Ginnie II ARMs ARMs
ARMs Multifamily Multifamily
Projects

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 Agency Market

Agency Issuance and Outstandings

1400 2000
1800
1200
1600

Outstanding Volume
1000 1400
New Issuance

1200
800
1000
600
800

400 600
400
200
200
0 0
1980 1983 1986 1989 1992 1995 1998 2001 2004

Ginnie Mae Fannie Mae Freddie Mac

Ginnie Mae Outstanding Fannie Mae Outstanding Freddie Mac OUtstanding

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 Agency Trading
To-Be-Announced (TBA) Pools
Most common agency trade
Buyer and seller decide on trade parameters, but exact pools are unknown to the
buyer until two days before settlement
TBA market facilitates liquidity in pass-through trading, as most individual pools
are small

Specified Pools
Buyers know exactly which pools they are buying and its relevant characteristics
Specified pools typically trade at a premium to TBAs due to the certainty

Pass-Through Vintages
Investors specify a particular loan origination year. Buyer may specify 2003 30-
year Fannie 5s.
Extra certainty of prepayment characteristics results in pools trading at a premium
to TBAs

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 Agency TBA Pricing

9/28 19:44 GMT [ TELERATE - US MBS ] 09/28 15:44 7105

30-YEAR FIXED RATE MBS INDICATIONS ]
GN 6.0 |OCT 103.23-25 -.01| FN 6.0 |OCT 103.17-19 -.01 |GOLD| OCT 103.13-15 -.01|
|NOV 103.14-16 -.01| |NOV 103.03-05 -.01 |6.0 |NOV 103.03-05 -.01|
|DEC 103.04-06 -.01| |DEC 102.22-24 -.01| |DEC 102.23-25 -.01|
|JAN 102.26-28 -.01| |JAN 102.09-11 -.01| |JAN 102.11-13 -.01|
OCT GNMA OCT FNMA OCT PC GOLD TREASURY (BID)
4.5 97.15-17 -.04 4.5 96.28-30 -.04 4.5 96.27-29 -.04 5Y 100.15 +.01
5 99.29-31 -.03 5 99.14-16 -.03 5 99.16-18 -.03 10Y 101.30+ -.03+
5.5 101.31-01 -.03 5.5 101.20-22 -.03 5.5 101.22-24 -.03 30Y 108.19+ -.13
6 103.23-25 -.01 6 103.17-19 -.01 6 103.13-15 -.01 DJIA
6.5 105.13-15 -.02 6.5 104.30-00 -.02 6.5 104.30-00 -.02 10084.25 + 95.71
7 106.18-20 -.01 7 106.00-02 -.01 7 106.01-03 -.01 CURRENCIES
7.5 107.20-22 + 7.5 107.02-04 + 7.5 107.10-12 + JPY 111.36-41
8 109.04-06 + 8 108.04-06 + 8 108.04-06 + EUR 1.2314-19
8.5 109.20-22 + 8.5 108.12-14 + 8.5 108.12-14 + GBP 1.8121-25
9 108.27-29 + [FED FUNDS BID 1 11/16 ASK 1 3/4 LAST 1 3/4 ]
9.5 109.07-09 + |[<NEW> TELERATE DATA ON BLACKBERRY PG 11

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Non-Agency Sector

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 Non-Agency Market

Securities backed by mortgage loans that do not conform to agency guidelines.

Loan balance in excess of agency limitations (currently $333,700)
Loan documentation that does not meet agency requirements
Non-prime credit borrowers

A large and diverse market sector covering the complete spectrum of borrower
demographics, credit characteristics, loan types and loan sizes

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 Non-Agency Residential Mortgages
Credit Prime/A Credit Alternative A Sub-Prime
Description High credit quality borrowers High credit quality borrowers Borrowers with lower credit
generally with loan amounts with loan documentation that quality that do not meet
in excess of agency limits does not conform to agency agency credit standards
(currently $333,700) requirement i.e. no-income
verification
Characteristics Low interest rate Interest rates generally 25- Higher interest rates
Avg loan balance $600k 50 bps higher than Prime commensurate with risk
High California and NE Avg loan balance $250k Avg loan balance $150k
concentrations Limited loan documentation Limited loan documentation
Affluent borrowers Good credit Poor credit
Very efficient refinancers High debt load Heavy debt load
when rates drop High California
concentrations
Some second liens
Current Interest Rate (30yr 6.0% 6.35% 7.5%
Fixed)
Major Issuers Countrywide GMAC Residential Ameriquest
Wells Fargo Funding New Century
Washington Mutual Impac Mortgage Option One

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 Non-Agency Market

Since non-agency MBS have no Agency guarantees that assure investors they will
receive timely payment of interest and principal, regardless of delinquency or default
rates on the underlying loans, credit enhancement is needed to protect investors from
borrower delinquencies.

P&I Payments AAA

Mortgage Loans
AA
A
BBB
BB
B
Unrated

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 Asset-Backed Pass-Through Certificates
Series 2004-WCW2
Park Place Securities, Inc

August 9, 2004

Approxim ate WAL (3), (4) Principal Pm t Interest Expected

Size ($) (yrs) Paym ent Delay Accrual Ratings
Discount
Call / M at Window (3), (4) (days) Basis Margin S&P / M / F Initial Credit
Class Type (1), (2) Call / M at Enhancem ent (%)
Offered Certificates
A-2 250,000,000 FLT / PT 2.51/2.72 1-95/1-214 0 Act/360 38 AAA / Aaa / AAA 23.75
A-3 100,000,000 FLT / SEQ 1.00/1.00 1-24/1-24 0 Act/360 17 AAA / Aaa / AAA 23.75
A-4 39,300,000 FLT / SEQ 2.70/2.70 24- 49/24-49 0 Act/360 34 AAA / Aaa / AAA 23.75
A-5 36,427,000 FLT / SEQ 6.46/7.48 49- 95/49-214 0 Act/360 53 AAA / Aaa / AAA 23.75
A-6 94,960,000 FLT / SEQ 0.70/0.70 1-15/1-15 0 Act/360 15 AAA / Aaa / AAA 23.75
A-7 145,204,000 FLT / SEQ 3.70/4.05 15- 95/15-214 0 Act/360 43 AAA / Aaa / AAA 23.75
M-1 147,000,000 FLT / MEZ 5.39/5.98 42- 95/42-187 0 Act/360 62 AA+ / Aa1 / AA+ 18.85
M-2 120,000,000 FLT / MEZ 5.34/5.91 40- 95/40-177 0 Act/360 65 AA / Aa2 / AA 14.85
M-3 54,000,000 FLT / MEZ 5.32/5.87 40- 95/40-167 0 Act/360 70 AA- / Aa3 / AA- 13.05
M-4 52,500,000 FLT / MEZ 5.30/5.83 39- 95/39-162 0 Act/360 118 A+/A1/A+ 11.3
M-5 51,000,000 FLT / MEZ 5.30/5.81 38- 95/38-156 0 Act/360 125 A / A2 / A 9.6
M-6 37,500,000 FLT / MEZ 5.28/5.77 38- 95/38-150 0 Act/360 145 A- / A3 / A- 8.35
M-7 36,000,000 FLT / MEZ 5.28/5.74 38- 95/38-144 0 Act/360 195 BBB+ / Baa1/ BBB+ 7.15
M-8 33,000,000 FLT / MEZ 5.28/5.70 38- 95/38-138 0 Act/360 205 BBB / Baa2 / BBB 6.05
M-9 39,000,000 FLT / MEZ 5.27/5.63 37- 95/37-131 0 Act/360 410 BBB-/ Baa3 / BBB- 4.75
Certificates
A-1(5) 1,621,609,000 FLT / PT Not Offered AAA / Aaa / AAA
M 10 36,000,000 FLT / MEZ Not Offered BB+/ Ba1 / BB+
CE N/A Not Offered NR N/A
P N/A Not Offered NR N/A
R N/A Not Offered NR N/A

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Analyzing MBS

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 Prepayments

Prepayments have a dramatic impact on the performance and valuations of MBS

Why do prepayments occur:

Home Sales Generally leads to the payoff of the sellers mortgage

Refinancings Borrower pays off old mortgage with proceeds from new loan,
generally to take advantage of lower rates

Defaults Prepayments caused by foreclosure and subsequent liquidation of the

mortgage

Curtailments and Full Payoffs Borrowers make extra payments or pay additional
principal, up to the full amount of the mortgage, to speed up payoff of the loan

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 Impact of Prepayments

7% Cash Flows with no Prepayments 7% cash Flow at Prepayment Rate of 100% PSA

$9,000.00 $16,000.00
C a s h F lo w p e r $ 1 0 0 ,0 0 0

C a s h F lo w p e r $ 1 0 0 ,0 0 0
$8,000.00 $14,000.00
$7,000.00 $12,000.00
$6,000.00
$10,000.00
$5,000.00 Principal Principal
$8,000.00
$4,000.00 Interest Interest
$3,000.00 $6,000.00
$2,000.00 $4,000.00
$1,000.00 $2,000.00
$- $-
1
4
7

1
4
7
10
13
16
19
22
25
28

10
13
16
19
22
25
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 Impact of Prepayments

Effect of Prepayments On Average Life Mortgage Market Extension Risk

25.00 4.5
4
20.00
A v g L ife in Ye a rs

3.5
3

Duration
15.00 2.5
2
10.00
1.5
5.00 1
0.5
0.00 0
0.0% 13.5% 27.0% 40.5% 54.0% 3.2 3.45 3.7 3.95 4.2 4.45 4.7 4.95 5.2 5.45 5.7

Prepayment Speed (CPR) Rate of 10-Year Treasury

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 Extension Risk

Yield
Purchase Bond at +55 to yield curve

+55 bps

Term
5 Yr

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 Extension Risk

Yield
Upward shift in yield curve as rates increase

Term
5 Yr

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 Extension Risk

Yield
Prepayments slow and life of bond extends

Less cash flow than

originally anticipated, can
not reinvest at higher
rates

Term
5 Yr 7 yr
Extension

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 Shortening Risk

Yield
Purchase Bond at +55 to yield curve

+55 bps

Term
5 Yr

30
 Shortening Risk

Yield
Downward shift in yield curve as rates decrease

Term
5 Yr

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 Shortening Risk

Yield
Prepayments increase and life of bond shortens

More cash flow than

originally anticipated
which must be reinvest at
lower rates

Term
3 yr 5 Yr
Shortens

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 Impact of Prepayments on MBS Pricing

Negative Convexity of Pricing

109
107
FN Oct (10/1/04)

105
103
101
99
97
95
4.5 5 5.5 6 6.5 7 7.5 8 8.5
Coupon

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 Factors Influencing Prepayments and Defaults
Factor Turnover Rate-Driven Other* Defaults
Collateral and Borrower Related

Larger Loan Sizes

Higher Credit Score, Lower Debt
More Second Liens
Higher LTV
Macro Economics
Lower Rates
Healthier Economy
Higher Home Prices
* Refinancings on lower credits that are insensitive to rate moves, driven by debt consolidation and credit improvement

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Role of Mortgage Finance Group at CGM

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 Mortgage Finance Organizational Structure

Citigroup Global
Corporate and Investment Bank

Global Fixed Income

Global Securitized Markets

ABS MBS CMBS Conduits

Syndicate Trading Trading Multi Seller CP Facilities

Trading Mortgage Finance CMBS Finance Proprietary Trading
ABS Finance Mortgage Analytics

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 Mortgage Finance Department

Product specialist
Touch all aspects of the organization when mortgage expertise is required (M&A assignments,
valuations, balance sheet restructuring)

Account coverage
Cover accounts from Washington Mutual and Countrywide to small mortgage originators

Represent products and services offered by Citigroup

Securitization, whole loan trades, financing

Transaction origination
Generate new business

Transaction execution
Responsible for all aspects of transaction execution

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 Mortgage Finance Products

Mortgage-Backed Securities
Agency MBSs
Non-Agency Jumbo MBSs

Mortgage Related Asset-Backed Securities

Home Equity ABS
Timeshare Transactions
Small Balance Commercial

Whole Loan Mortgage Transactions

Financing / Warehouse Lines

Internal Securitizations

Credit Default Swaps

Synthetic Securitizations

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 Transaction Execution

Issuer
Issuer

Pricing and
Client Relationship
Market Color
Overall Execution
Responsibility

Attorneys
Attorneys Capital
Capital Markets
Markets
Mortgage
Mortgage Sales
Accountants
Accountants Syndicate
Syndicate
Finance
Finance Assist in Investors
Investors
Trustees
Trustees Coordinate Trading
Trading
Distribution
Transaction Research
Rating
Rating Agencies
Agencies Effort Research
Process

Analyzes Data and

Structures Transactions

Mortgage
Mortgage
Analytics
Analytics

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 My Contact Information

Randy Appleyard
Director
Citigroup Global Markets Inc
390 Greenwich Street
New York, NY 10013
212-723-6394
Email: [email protected]

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