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Structured Products and Related Credit Derivatives: A Comprehensive Guide for Investors by BRIAN P. LANCASTER, FRANK J. FABOZZI, GLENN M. SCHULTZ

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CHAPTER 3

Residential Asset-Backed Securities

Glenn M. Schultz, CFA

Senior Analyst

Wachovia Capital Markets, LLC

This chapter provides a guide to the residential asset-backed securities (RABS) sector, including collateral performance and modeling; the evaluation of alternative structures; and an introduction to the related credit derivative markets.

From its inception in the early 1990s, the home equity loan (HEL) market has experienced a dramatic evolution from a market representing predominantly second lien loans to prime borrowers to first lien loans to credit impaired borrowers, including a wide variety of loan types, for example, fixed rate, hybrid adjustable rate and interest-only loans. As lending practices evolved and investor acceptance of the product grew, the structures used to securitize loans in this sector also evolved. The earliest securitizations employed financial guarantees from third-party wrap providers. By the mid-1990s, the structures evolved to employ senior/subordinate tranching of credit risk, seller-paid mortgage insurance or deep mortgage insurance (MI) and net interest margin (NIM) transactions to monetize the front-end residual.

Recently, the advent of both single-name credit default swaps (CDS) and the ABX.HE credit index have increased notional trading volume and allowed investors to express directional opinions (long or short) regarding issuer origination and servicing practices, relative vintage performance and capital structure arbitrage.

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