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Certain nuances of non-Agency RMBS are unique to the sector. We discuss these below.

Discount/Premium loans in non-Agency deals and creation of

WAC IOs and WAC POs

The dispersion of mortgage rates on loans within a given securitized pool relative to the fixed-rate security issued with a specified coupon results in non-Agency RMBS loans being split into two buckets: discount and premium. For example, due to this dispersion, the underlying group of mortgage loans could have loans bearing either a higher or lower rate relative to the desired pass-through coupon rate of 5.5% on a security (see Table 21). In order to create a security bearing a 5.5% pass-through rate, a portion of the coupon needs to be stripped off the loans bearing a premium rate relative to this pass-through rate. The collective interest-only strip created is referred to as the WAC (weighted average coupon) IO. On the flip side, for those loans bearing a discount rate relative to this pass-through rate, the coupon needs to be grossed up by stripping off a portion of the principal balance necessary to achieve the target coupon rate. The portion of these non-interest-bearing, principal-only cash flows is referred to as the WAC (weighted average coupon) PO. There is an active secondary market in both WAC IO and PO issues which are generally priced to Agency Trust IO and PO issues.

Table 21 Premium/discount loans in non-Agency deals

Pass-Through

Loan WAC IO/PO Security

Premium Loan 5.75% Rate WAC IO of 25bp 5.5% Security Discount Loan 5.25% Rate WAC PO of 4.54% of principal balance 5.5% Security

(1 - 5.25%/5.50%)*

* WAC PO percent of principal amount is calculated as 1 – (loan rate / target coupon). Source: Credit Suisse First Boston (US Mortgage Strategy)

Optional Redemptions

All non-Agency deals are subject to a call feature (referred to as an optional

redemption/termination) held by an entity, often the issuer or servicer on the deal, which can exercise a call on the deal. Investors in the deal are effectively short this call option. The primary criteria to exercise the call requires that the collateral factor, defined as the ratio of the current balance to the original balance, be lower than a threshold amount (in most cases, 10%, but for some issuers this may be set at 5%). Once the current reported factor drops below this threshold, the holder of the option can exercise the call. The exercise price of the call is often set to par. Hence, the call option is likely to be exercised only if the collateral market value is sufficiently above par to provide an economic return, after transaction costs, to the holder. Given an exercise price of par, the coupon rate and default performance of the underlying pool of mortgages are the

Exposure to this call feature varies across a deal structure. Last cash flow securities are more exposed to the call feature as these classes become current paying, i.e., receiving principal, around the same time the collateral factor drops below the threshold amount, making the call feature on the deal eligible for exercise. In contrast, shorter, front-end cash flows are less exposed to this call feature as they are likely to have paid off well before a deal is eligible to be called.

The issuer, servicer, or residual holder may hold the call rights. Financial Accounting Standards (FAS) 140 has limited the ability of the issuer to hold the call rights. In some cases, the servicer may own the call rights, but the economic benefits are directed to the residual holder. We guide readers to our Mortgage Market Insights publication, Optional Redemptions: Soon to be Exercised on Your Portfolio, March 14, 2003 for further details on the structure, differences among issuers and efficiency of exercise of this call feature.

Compensating Interest

Investors in non-Agency RMBS may be exposed to interest shortfalls. This is not the case for holders of Agency RMBS, wherein investors are guaranteed a full calendar month’s (30/360) worth of interest dollars.

Interest shortfalls arise from borrower prepayment in full. In this case, the borrower pays interest only for the period from the due date to the date of the prepayment. But, interest on the security is due for the full month (30 days).

The extent of the interest shortfall can be either 15 or 30 days depending on the

definition of the prepayment period. A mid-month prepayment period (only prepayments occurring during the latter 15 days of the month are passed through to investors on the following month's distribution date) reduces the maximum value of interest shortfall. Prepayment period definitions vary from issuer to issuer.

Investors in non-Agency RMBS are protected from prepayment shortfalls, to some degree, by compensating interest features. Compensating interest policies vary from issuer to issuer and the amount of protection is typically limited to a certain predefined amount. These limits can vary from a specified amount of 12.5 or 25bp to a certain amount of the servicing fee (SF) or master servicing fee (MSF) plus ancillary income (see Table 22).

As such, investors generally favor securities with higher amounts of compensating interest, especially in periods of heavy refinancing activity, and securities with mid- month prepayment periods. We guide readers to our Mortgage Market Insights publication, (Un)Compensated Interest: Revisiting Interest Shortfall Issues in Non- Agency MBS, 14 July, 2003.

Table 22 Compensating interest policies vary across issuers Issuer Bloomberg Shelf Name 2005 2004 2003 2002 2001 2000 1999 Residential Funding Corp RFMSI 12.5 12.5 12.5 12.5 12.5 12.5 12.5

Chase Mortgage Finance

Corp CHASE 12.5 12.5 12.5 12.5 12.5 12.5 12.5

Countrywide CWHL 12.5 12.5 12.5 12.5 12.5 12.5 12.5 Citicorp Mortgage CMSI 12.5 12.5 12.5 12.5 12.5 12.5 12.5 Bank of America

Mortgage Securities BOAMS 25 25 25 25 25 25 25

MASTR Asset

Securitization Trust MASTR SF* SF* SF* SF* SF* SF* SF*

Washington Mutual WAMU ** ** ** ** ** ** **

CSFB Mortgage

Securities Corp CSFB *** *** *** *** *** *** ***

Wells Fargo Mortgage

Backed Securities Trust WFMBS 20**** 20**** 20**** 20**** 20**** 20**** 20****

SF = Servicing Fee

* On loans serviced by WAMU, compensating interest is equal to the sum of the master servicing fee plus reinvestment income from prepayments in full on the 15th day of the preceding distribution month through the 14th day of the month of distribution plus interest payments received from full prepayments during the period from the 1st day through the 14th day of the month of distribution. ** For loans serviced by Washington Mutual Mortgage Securities Corp see WAMU under MASTR shelf, 25bp for loans serviced by Washington Mutual Bank, FA. In late 2004, WAMU changed the terms of coverage to cap it at the lesser of master servicing compensation and 12.5bp.

*** For deals issued from 2001-2003, the three major servicers and their respective compensating interest limits are Chase Manhattan Mortgage Corp (25bp), Fairbanks Capital (25bp), and Washington Mutual Mortgage Securities Corp (4bp plus reinvestment income from prepayments in full from the 15th day of the preceding distribution month through the 14th day of the month of distribution plus interest payments received from full prepayments during the period from the 1st day through the 14th day of the month of distribution). Prior to 2001, the policy varies by issuer and servicer. For more recent CSFB deals, the two major servicers are Select Portfolio Servicing and Wells Fargo Bank with the majority of coverage on deals of up to 25bp.

**** The lesser of 20bp or the available Master Servicing compensation as defined in the prospectus. Source: Credit Suisse First Boston (US Mortgage Strategy)

V. Prepayment Profiles of Prime Jumbo Fixed-