Mortgage-Backed and Asset-Backed Securities: High Credit Quality and Cash Flow Stability

1. Mortgage-Backed and Asset-Backed Securities: High Credit Quality and Cash Flow Stability Jim Womack, CFA Managing Director & Principal March 2011

2. Mortgage-Backed & Asset-Backed Securities Introduction: High Credit Quality and Cash Flow Stability • For Some, A Mortgage-Backed (MBS) or Asset-Backed Security (ABS) Carries a Negative Connotation. • For Many More, These Sectors Provided Ultra High Credit Quality and Cash Flow Stability Even In the Height of Market Turmoil in 2008 & 2009. • Today, Investors Are Seeking High Quality Alternatives To Low Yielding Treasury and Agency Debentures. • The Market For Many Types of MBS and ABS Is Deep, Transparent, Liquid and Offers Relatively High Yields. • Investment Officers Can Meaningfully Raise The Yield On Their Portfolios By Selectively Including These Assets In Their Arsenal of Eligible Investments…Without Sacrificing Credit Quality or Cash Flow Stability.

3. Asset-Backeds: How The Typical Auto Structure Works Two Types of Credit Support: Overcollateralization & Subordination Overcollateralization Lesser Amount of Bonds Backed by Loans Pool of Auto Loans Subordination Still Lesser Amount Of Senior (AAA Rated) Bonds Backed by Loans Lesser Amount of Bonds Backed by Loans

4. Asset-Backeds: How The Typical Auto Structure Works Subordination Protects The Senior Note Holders 5 Ways Class Rating Size Percent A1 A2-A A2-B A3 A4 AAA AAA AAA AAA AAA 93.0% 410,000,000 200,000,000 650,000,000 392,000,000 249,260,000 B A 60,200,000 5th Loss Protection 3.0% C BBB 40,135,000 4th Loss Protection 2.0% D BB 40,135,000 3th Loss Protection 2.0% Reserve Account 2nd Loss Protection 0.8% Reserve Account 1st Loss Protection 1.0% Total Subordination For Senior Note Holders 8.8% Overcollateralization at Origination 5.7% Total Credit Support to Senior Bondholders 14.5%

5. Class Rating Size Percent A1 A2-A A2-B A3 A4 AAA AAA AAA AAA AAA 93.0% 410,000,000 200,000,000 650,000,000 392,000,000 249,260,000 B A 60,200,000 3.0% C BBB 40,135,000 2.0% D BB 40,135,000 2.0% Reserve Account 0.8% Reserve Account 1.0% Total Subordination For Senior Notes 8.8% Overcollateralization at Origination 5.7% Total Credit Support to Senior Notes 14.5% Asset Backeds: How The Typical Auto Structure Works Historically, Even The Lowest Rated Bonds Have Been Well Protected Fitch Prime Auto ABS Cumulative Net Loss Index 1.4% 1.4% 1.2% 1.2% 1.0% 1.0% 0.8% 0.8% 0.6% 0.6% 0.4% 0.4% 0.2% 0.2% Source: Fitch Ratings 0.0% 0.0% 9/93 9/94 9/95 9/96 9/97 9/98 9/99 9/00 9/01 9/02 9/03 9/04 9/05 9/06 9/07 9/08 9/09 9/10

6. Asset-Backeds: Selected Bonds Through The CrisisIn Good Economic Times and Bad, Credit Support Increases Over Time Auto ABS as of December 2005 Original Credit Support Credit Support at 12-2005 Unemployment Rate Credit Support (%) Wachovia Auto 04A A4 Carmax Auto 03-2 A4 Americredit Auto 05-AX A3 Chase Auto 03-B A3 Wachovia Auto 05-B A4 WFS Auto 02-4 A4 WFS Auto 02-2 A4 Onyx Auto 04-C A3 Capital Auto 03-2 A4 Auto ABS as of December 2009 Original Credit Support Credit Support at 12-2009 Unemployment Rate Credit Support (%) Wachovia Auto 05-B A4 Household Auto 06-3 A3 Household Auto 07-1 A3 Honda Auto 07-1 A3 Harley Davidson 07-2 A4 Wachovia Auto 07-1 A3A USAA Auto 06-4 A3 Source: Servicer Reports

7. Asset-Backeds: What About Insured Bonds? Example: FGIC Takes Less Protection And a Fee to Guarantee Notes Class Rating Size Percent A1 A2 A3-A A3-B A4 AAA AAA AAA AAA AAA 349,000,000 334,000,000 294,500,000 294,500,000 478,000,000 100% Reserve Account Loss Protection For Insurance Provider 1.5% Overcollateralization at Origination 7.3% Total Credit Support to FGIC Insurance Co. 9.2% 9.2% PLUS An Insurance Policy by AAA Rated FGIC Total Credit Support to Senior Bondholders

8. Asset-Backeds: Even Wrapped Issues Performed WellMany Insured Bonds Were Initially Downgraded, Then Upgraded CREDIT RATINGS CHANGES Reference Issue: COAFT 2006-C A4,

9. Asset-Backeds: More Yield Than Lower Rated CorporatesComparing Yield of AAA Auto ABS vs. A Rated Corporate Bonds Merrill Lynch AAA Rated Auto ABS & Similar Maturity A Rated Corporates Yield in Percent Source: Merrill Lynch and Bloomberg Data as of December 31, 2010 Since Inception (ex 2008 & 2009) Since Inception 4.75% 4.69% AAA Rated Auto ABS Average Yield: ABS +0.14% ABS +0.28% A Rated Corproate Average Yield: 4.61% 4.41%

10. Asset-Backeds: Auto-Loan ABS Was In The Press Too! Because It Performed Like It Was Supposed To “Most Senior GMAC prime auto ABS ratings able to withstand “depression” unemployment scenario.” - Moody’s Investor Service, 5-12-09 “Rebound in used vehicle prices benefits auto ABS transactions.” “Moody’s has placed fifteen tranchesfrom eight loan securitizations sponsored by Ford Motor Company in 2006 and 2007 on review for possible upgrade. The build up of credit enhancement more than offsets modest increases in lifetime cumulative losses observed in the underlying collateral pools.” - Moody’s Investor Service, 8-21-09 “Auto-loan Backing is Popular; Investors Like These Tried and Tested Securities” - Headline, Wall Street Journal, 9-16-2009 - Fitch Ratings, 10-15-09 “Due to available credit enhancement and structural protections, ratings for prime senior tranches of ABS auto loan transactions have remained stable year-to-date.” - Fitch Ratings, 10-26-09

11. Mortgage-Backed SecuritiesTraditional GSE Guaranteed Mortgage-Backed Securities Key Features and Characteristics of MBS: • Bonds Receive Principal and Interest Monthly, Because Borrowers Make Monthly Mortgage Payments • Borrowers Can Repay Their Loans Without Penalty and at Any Time • People Prepay Their Mortgages For a Variety of Reasons They Refinance, Get Transferred, Death, Divorce, Buy Bigger/Smaller Home, Etc. • The Speed at Which They Prepay Their Loan is Measured by PSA & CPR PSA = Prepayment Speed Assumption, CPR = Constant Prepayment Rate 100 PSA or 100% of the PSA model rate, calls for prepayments to start slowly and build to a 6% constant prepayment rate (CPR) after 24 months. However: If mortgage rates declined, the prepayment rate could jump to 200+ PSA and reach a 12%+ constant prepayment rate after 24 months (because homeowners are refinancing).

12. Mortgage-Backed SecuritiesNon-Callable Bonds Have Positive Convexity Price Positive Convexity +1.1% -0.9% Yield -1% +1%

13. Mortgage-Backed SecuritiesBecause The Home Owner Can Prepay At Any Time, Mortgage-Backed Securities, Like Other Callable Bonds, Have Negative Convexity Price Negative Convexity +0.8% -1.2% Yield -1% +1%

14. Mortgage-Backed SecuritiesTraditional Mortgage Pass-Through & Cash Flow Profile Homeowner Bank Trustees Guaranteed Timely Principal & Interest Government Sponsored Entity (Ginnie Mae, Fannie Mae, Freddie Mac) Investors receive pro-rata share of interest, principal, and principal prepayments. Investors have uncertainty about when they get principal back. Investors

15. Mortgage-Backed SecuritiesTraditional 30-Year Mortgage Lending Key Features and Characteristics of 30-Year Loans & MBS: • 30-Year Loans Spread Payments Out to Reduce Monthly Payment • Nearly All of The Payment In The Early Years Is Interest • The Interest Rate Level Impacts The Monthly Payment For the Borrower on a 30-Year Loan More Than on a 15-Year or 10-Year Loan (A Key Reason Why People Don’t Refinance Their Cars) So 30-Year Borrowers Are Typically Very Rate Sensitive • Borrowers Can Repay Their Loans Without Penalty and at Any Time • Bondholders Receive An Attractive Yield Above Treasuries, Agency Issued Debentures and Other Types of Securities Because Borrowers Can Repay Their Loans Without Penalty and at Any Time • Agency MBS are Backed by The Homeowner, by The Agency, • and by The Implied Guarantee Of The Government.

16. Mortgage-Backeds: More Yield Than Corporates…But Why? Comparing Yield of MBS vs. A Rated Corporate Bonds 30-Year Mortgage-Passthroughs & Similar Maturity A Rated Corporates Yield in Percent Source: Merrill Lynch and Bloomberg Data as of December 31, 2010 Since Inception (ex 2008 & 2009) Since Inception 6.23% 6.40% 30 Year MBS Pass-through Average Yield: MBS +0.71% MBS +0.74% A Rated Corproate Average Yield: 5.52% 5.66%

17. Mortgage-Backed SecuritiesTraditional 30-Year Mortgage Pass-Through & Cash Flow Profile Mortgage Rates Near Current Rates Mortgage Rates UNCHANGED Mortgage Rates HIGHER Mortgage Rates LOWER NO REFINANCE LESSTrading Up LESSRenovation LESSDownsizing Get Transferred Death, Divorce, Etc. REFINANCE MORE Trading Up MORERenovation MOREDownsizing Get Transferred Death, Divorce, Etc. Trading Up Major Renovation Downsizing Get Transferred Death, Divorce, Etc. OR OR 6% CPR Per Year 12%CPR Per Year 25% CPR Per Year 2 Year Bond 8 Year Bond 5 Year Bond 3 Year Contraction 3 Year Extension

18. Mortgage-Backed SecuritiesTraditional 10-Year Mortgage Lending Key Features and Characteristics of 10-Year Loans & MBS: • 10-Year Loans Are Made To People Who Want To Pay Debt Back Fast • Most of the Payment Is Principal, So The Interest Rate Has Less of an Impact on The Monthly Payment So 10-Year Borrowers Are NOT Typically Rate Sensitive • The Shorter The Loan, The Less Variability The Cash Flows At a Given Prepayment Speed • Borrowers Can Repay Their Loans Without Penalty and at Any Time • They Have The Same Credit Backing as Bonds Backed by 30-Year Loans • 10-Year Pass-throughs Receive An Attractive Yield Above Treasuries, Agency Issued Debentures and Other Types of Securities, • But Less Than a 30-Year Passthrough

19. Mortgage-Backeds: Outsized Yield Premiums For MBS NowComparing Yield of MBS vs. A Rated Corporate Bonds 10-Year Mortgage-Passthroughs & Similar Maturity A Rated Corporates Yield in Percent Source: RW Baird Research and Bloomberg Data as of January 31, 2011 Since Inception (ex 2008 & 2009) Since Inception 4.05% 3.92% AAA Rated Auto ABS Average Yield: MBS +0.14% MBS +0.19% A Rated Corproate Average Yield: 4.91% 3.73%

20. Mortgage-Backed SecuritiesTraditional 10-Year Mortgage Pass-Through & Cash Flow Profile Mortgage Rates Near Current Rates Mortgage Rates UNCHANGED Mortgage Rates MUCH HIGHER Mortgage Rates MUCH LOWER NO REFINANCE LESSTrading Up LESSRenovation LESSDownsizing Get Transferred Death, Divorce, Etc. REFINANCE MORE Trading Up MORERenovation MOREDownsizing Get Transferred Death, Divorce, Etc. Trading Up Major Renovation Downsizing Get Transferred Death, Divorce, Etc. OR OR 7% CPR Per Year 12%CPR Per Year 25% CPR Per Year 2.9 Year Bond 4.0 Year Bond 3.4 Year Bond 0.5 Year Contraction 0.6 Year Extension

21. Mortgage-Backed SecuritiesCollateralized Mortgage Obligations (CMOs) & Cash Flow Profile Homeowner Bank Trustees Guaranteed Timely Principal & Interest Government Sponsored Entity (Ginnie Mae, Fannie Mae, Freddie Mac) Classes Increase Cash Flow Certainty Investor certainty is increased. Investors in short-term, intermediate-term and long-term securities can now participate in the mortgage-backed securities market. $ $ $ $ $ $ $ $ $ Class 2 Class 1 Class 3

22. Mortgage-Backed SecuritiesThe Two Main Types of Collateralized Mortgage Obligations (CMOs) Sequntial Class CMO: • Cash Flow Stability Improved vs. Pass-Through Since Tranches Get Paid Back In Sequential Order. • Collateral Subject to Big Prepayment Swings Can Still Cause Some Cash Flow Variability (e.g., A Sequential Backed By New 30 Year Loans). • A Sequential Backed By More Stable Collateral Can Greatly Improve Cash Flow Stability (e.g., A Sequential Backed By Seasoned 15 Year Loans). Pre-Planned Ammortization Class (PAC) CMO: • Can Be The Most Stable Form of Mortgage-Backed Security. • Cash Flow Structured to Follow Pre-Planned Schedule Subject to Prepayment Speeds Remaining Within Stated Parameters (e.g., Cash Flows Unchanged Assuming PSA Between 100 and 350). • The Key is to Analyze “Stressed” Prepayment Assumptions to Ensure The Bond Will Act Like You Expect

23. Mortgage-Backed SecuritiesAnalyzing The PAC CMO Structure • The PAC Can Have Stability Because Other Support Bonds Make It So. • If Prepayments Are Greater Than Expected, The Support Classes Will Take The Additional Prepayments So The PAC Doesn’t Have To. • If Prepayments Are Less Than Expected, The Support Classes Will Forego Principal So The PAC Gets The Desired Amount. $ $ $ $ $ $ $ $ $ Support Class 1 Support Class 2 PAC CMO • Investors Typically Run “Stress Tests” To Ensure The Support Classes Are Adequate To Provide The Required Stability For The PAC Class.

24. Consistent Payment History Well Within Wide PAC Bands 1 Year Bond at +83 bps Over Treasuries Mortgage-Backed SecuritiesThe Well Structured PAC CMO Structure • A Well Structured PAC CMO Often Provides Greater Yield and Cash Flow Stability Than Traditional Agency Callable Debentures • Yields On Well Structured PAC CMOs Are Comparable to A-Rated Corporates.

25. Mortgage-Backed & Asset-Backed Securities Summary: High Yield and High Quality Are Not Mutually Exclusive • Investors Are Looking For High Quality Alternatives To Low Yielding Government Debentures • The Mortgage-Backed and Asset-Backed Sectors Can Offer Attractive Investments That Can Add Significant Yield and Total Return Over Time. • Premiums Comparable to or Higher Than Many ‘A’ Rated Corporate Bonds. • Bonds Backed By Traditional Fixed Rate Mortgages and Auto Loans, As An Example, Have A Proven Track Record of Maintaining The Highest Credit Quality Even In The Deepest Economic Downturns. • Credit Quality Is Primarily Achieved By Loan Diversification, Over- Collateralization, Subordination and/or Agency Guarantees. • Cash Flow Stability Is Achieved Primarily By Collateral Type and Security Structure • When High Credit Quality and Cash Flow Stability Are Properly Combined, Event Risk Can Be All But Eliminated

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