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JUNE 2006 JPMORGAN MBS PRIMER NTIAL E CONFID ND A PRIVATE Y L T STRIC MBS Analyst Certification The strategist(s) denoted by an asterisk (“*”) certify that: (1) all of the views expressed herein accurately reflect his or her personal views about any and all of the subject instruments or issuers; and (2) no part of his or her compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by him or her in this material, except that his or her compensation may be based on the performance of the views expressed. This research contains the views, opinions and recommendations of research strategists with JPMorgan US Fixed Income Strategy. Research strategists routinely consult with JPMSI trading desk personnel in formulating views, opinions and recommendations in preparing this research. Trading desks may trade or may have traded as principal on the basis of the research strategist(s) views and report(s). Therefore, this research may not be independent from the proprietary interests of JPMSI trading desks which may conflict with your interests. In addition, research strategists receive compensation based, in part, on the quality of their analysis, firm revenues, trading revenues, and competitive factors. Copyright 2006 J.P. Morgan Chase & Co. All rights reserved. JPMorgan is the marketing name for J.P. Morgan Chase & Co. and its subsidiaries and affiliates worldwide. J.P. Morgan Securities Inc. is a member of NYSE and SIPC. JPMorgan Chase Bank is a member of FDIC. J.P. Morgan Futures Inc. is a member of the NFA. J.P. Morgan Securities Ltd. and J.P. Morgan plc are authorised by the FSA and members of the LSE. J.P. Morgan Europe Limited is authorised by the FSA. J.P. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. J.P. Morgan Securities (Asia Pacific) Limited is registered as an investment advisers with the Securities & Futures Commission in Hong Kong and itsCE numbers is AAJ321 Jardine Fleming Singapore Securities Pte Ltd is a member of Singapore Exchange Securities Trading Limited and is regulated by the Monetary Authority of Singapore (“MAS”). J.P. Morgan Securities Asia Private Limited is regulated by the MAS and the Financial Supervisory Agency in Japan. J.P.Morgan Australia Limited (ABN 52 002 888 011) is a licensed securities dealer. R This material is provided for information only and is not intended as a recommendation or an offer or solicitation for the purchase or sale of any security or financial instrument. E JPMorgan and its affiliates may have positions (long or short), effect transactions or make markets in securities or financial instruments mentioned herein (or options with respect thereto), or provide advice or loans to, or participate in the underwriting or restructuring of the obligations of, issuers mentioned herein. The information contained herein RIM is as of the date and time referenced above and JPMorgan does not undertake any obligation to update such information. All market prices, data and other information are not P warranted as to completeness or accuracy and are subject to change without notice. Transactions involving securities and financial instruments mentioned herein (including S futures and options) may not be appropriate for all investors. Clients should contact their salespersons at, and execute transactions through, a JPMorgan entity qualified in their B M home jurisdiction unless governing law permits otherwise J.P. Morgan Securities Inc. is a member of NASD, NYSE and SIPC In the UK and other EEA countries, this material is not available for distribution to persons regarded as private customers (or equivalent) in their home jurisdiction. AN G R O M JP MBS Market Overview and Origination 1 Demand 11 Mortgage Cashflows and Intro to Prepayments 23 Valuation and OAS 32 Prepayments Analysis and Reports 46 TBA Market and Specified Pools 62 Relative Value Trading 74 R E Case Studies 99 RIM P S ARMs 110 B M AN G CMOs 116 R O M JP MBS Index 163 MBS 1 Agency MBS market composition and issuance Securitized agency market composition Annual fixed-rate net issuance ($ billions) Hybrid ARM 1/1 ARM Hybrid ARM 292 IO ($107.1 ($29.4 276 ($229.5 217 211 231 billion) billion) billion) 156 3% 1% 109 93 7% Other Fixed ($157.2 -17 billion) 1998 1999 2000 2001 2002 2003 2004 2005 2006 5% Total = $__mm Source: JPMorgan, FNMA, FHLMC, GNMA 15-year Annual hybrid ARM net issuance ($ billions) ($650 billion) Annual hybrid ARM net issuance ($ billions) TION 19% 30-year 79 ($2.2 74 GINA 49 52 I trillion) R 65% O 10 13 D N A -13 -11 -31 W E I 1998 1999 2000 2001 2002 2003 2004 2005 2006 V Total = $3.4 trillion Source: JPMorgan, FNMA, FHLMC, GNMA Source: JPMorgan, FNMA, FHLMC, GNMA OVER RKET A M MBS 2 MBS in the U.S. fixed income market Fixed income market composition Overview Fixed income market composition Largest US fixed income asset class Many products to choose from within the MBS Asset- market backed Municipal 8% 9% Agency fixed-rates and ARMs Money Non-agency fixed-rates and ARMs (Jumbos, Alt- Market U.S. As) 14% Treasury 17% Whole loans CMOs and other structured MBS Fed Agencies Superior liquidity 10% TION The TBA market adds unique liquidity to MBS MBS market often used to express duration and GINA I Mortgage R curve views (due to its liquidity and size) O Corporate Related D Agency fixed-rate pass-throughs is 34% of the 19% 23% N A Lehman U.S. Aggregate Index (a benchmark of the W U.S. investment grade debt). E I V Total = $25.9 trillion Source: The Bond Market Association, as of March 2006 OVER RKET A M MBS 3 The mortgage market has surged, thanks to a strong housing market and cash-out refis 1-4 Family Mortgage Debt Outstanding ($ billions) 1-4 Family Mortgage Debt Outstanding ($ billions) 8,978 8,683 8,079 7,120 6,317 5,614 5,133 TION GINA I R O D N A W E I 2000 2001 2002 2003 2004 2005 2006 V Source: Bond Market Association, Federal Reserve Board OVER RKET A M MBS 4 The MBS market links borrowers and investors Agencies Mortgage Loans MBS Pass-through Securitization Mortgage MBS Dealers lenders TION Borrowers MBS Investors GINA I R O The issuer of the pass-through obtains the mortgages either by purchasing or originating the loans D N Loans with similar characteristics are pooled together; loans are securitized A W The investor has undivided ownership interest (the investor is entitled to the pro-rata share of interest and E I principal payments of the underlying loans) V A “pass-through” is the basic MBS structure OVER It passes the monthly principal and interest payments, minus a servicing spread, from a pool of mortgages to investors RKET A M MBS 5 Origination: The Menu of Mortgages Has Expanded Origination: production of new loans in primary market Products – Fixed-rate mortgages (30-year / 20-year / 15-year) – Adjustable rate mortgages (Hybrid ARMs: 3/1, 5/1, 7/1, 10/1) – Interest-Only – MTAs; Option ARMs – Other TION Balloon mortgages (5-year / 7-year) Prepayment penalty mortgages GINA I R “Conforming” balance loans O D N A “Non-conforming” loans (Private label, Non-agencies) W E I V Jumbos and Alt-As OVER RKET A M MBS 6 Understanding Mortgage Collateral : Borrower Credit & Housing Leverage Borrower Credit and Information FICO Score – Historical Credit Use and Management — Avg FICO Score for Jumbo Mortgages : ~730 — Avg FICO Score for Alt-A Mortgages : ~700 — Avg FICO Score for Subprime Mortgages : ~600 — Non-Linear Relationship Between FICO and Propensity to Default Documentation — Full vs. Limited/Reduced/No Doc TION Leverage (Debt to Income Ratios) Reserves : Staying Power in the event of financial trouble GINA I R O D N A W E I V OVER RKET A M MBS 7 Understanding Collateral cont… Housing Leverage Loan-to-Value Ratio — House Value / Mortgage Amount — Higher LTV Æ Less Equity Protection for the Mortgage Investor Æ Higher Risk Occupancy — Owner Occupied – Borrower Lives in the Property (Most Secure) — Second Home – Borrower has personal ties to the property — Investor – Business Decision on Economic Situation (Least Secure) TION Property Type GINA — Single Family Property (Most Secure) I R O — Condos D — Multi-Family N A W E I V OVER RKET A M MBS 8 Conforming loan limits rose by 16%, reaching $417,000 in 2006 Conforming Limits ($’000) 450 Conforming loan 400 limit for 2006 350 300 TION 250 GINA I R 200 O D N A 150 W E I 1990 1992 1994 1996 1998 2000 2002 2004 2006 V Source: FHFB, JPMorgan OVER RKET A M MBS 9 Origination channels $3.0 trillion origination volume in 2005 Top 5 mortgage banking companies account for over 48% of all new Retail (42%) - loan officer employed by origination volume mortgage banking company; mortgage loan is closed in the name of the lender 1. Countrywide Broker (34%) – mortgage loan broker 2. Wells Fargo represents borrower to lending institution; 3. Washington Mutual mortgage loan is closed in the name of the 4. Chase Home Finance lender TION 5. CitiMortgage Correspondent (24%) – independent Source: National Mortgage News, as of Q1 2006 GINA I mortgage banking company; mortgage loan R O is closed in “ABC” Mortgages name and D N sold to mortgage banker A W Internet – mortgage loan originated and E I V funded by mortgage banking company through website OVER RKET A M MBS 10 Market Overview and Origination 1 Demand 11 Mortgage Cashflows and Intro to Prepayments 23 Valuation and OAS 32 Prepayments Analysis and Reports 46 TBA Market and Specified Pools 62 Relative Value Trading 74 Case Studies 99 R E ARMs 110 RIM P S B M CMOs 116 AN G R MBS Index 163 O M JP MBS 11 Major MBS investors MBS Investor Breakdown MBS Investor Breakdown MBS Investors ($ billion) YE 2004 Mid-2005 % Chg Dealer Personal Investor Type All MSRs Non-Agency All MSRs Non-Agency % of MSRs since 2004 REITs Inventory Sector Fannie Mae/Freddie Mac $ 1, 261 $ 2 67 $ 1,192 $ 3 63 26% -5% 2% 1% 6% FDIC Commercial Banks $ 8 76 $ 1 24 $ 9 13 $ 1 58 20% 4% Life Insurance Cos.
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