Overview of Pay-as-You-Go Credit Default Swaps

2005 ISDA Regional Member conference

September 28,2005

Chip Goodrich
Managing Director and Senior Counsel
Deutsche Bank AG

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Pay-as-You-Go Credit Default Swaps: Brief History

= Why did credit default m a p technology expand into the asset-backed securities
market?

- Sfandardilation of CDS M corporate names o p e d the d m for funher innovaon

- ABS market has grown signAcanUy in the past five years (in 2004, over t8W billion in ABS
#*sued)
- Parlitlcipants want the abilrm not available In cash ma*& to shwt the ma*eVspecAc credits
01hedge positions
- Market participantswant exposure lo assets that are dimcvn to swrce in the cash make1
- Proliferation of ABS CDO's (over 145 billion in C D h issued in ZM14 were ABSIRMBS-related
collaleral managers needed lo source ABS risk quickly

Why did CDS referencing ABS abandon the traditional CDS framework and
adopt the pay-as-you-go approach?

- Credit Event definitions do not adequately address the structural nuances or the paymern
mechanics of ABS
- Cash or physical settlement problematic due to me illquidity and mall hamhe sires of many
ABS
- Pa as yougo pmess deals (MVI these i s m s and hacks the performance d the underlying
~eYire&eObligation

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 Pay-as-You-Go Credit Default Swaps: Payment Diagram

Pay-as-You-Go Credit Default Swaps: Payments

Floating Payments
- Interest Shortfall:
- &curs #Vie anual amwnt of interest paid Is less thanthe expected interest
- Expected interest determined using Vle mupon of the Reference Obligation *but
taking into consideratim any available funds cap or deferral of interest

.
- Interest Shornall Payment Amount may be subject to Interest Shornall Cap
Fixed Cap - shornall capped at Fixed Rate
-
- Writedown:
-
m Variable Cap rhomall capped at sum of benchmark rate and fixed rate

Writedown or applied loss reduces the principalbalance of the Reference Obligation

c# implied Writedown exisls
- Implied Writedown m u 6 Ilosses occw but Reference OMigation delays witedom
- Principal Shortfall:
- k w s if the final principal payment made pusuant to the Reference Obligaflon is
less lhan the expected principal payment

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 Pay-as-You-Go Credit Default Swaps: Payment

A d d i t i o n a l F i x e d Payment Reimbursements
- H actual interest payment by Reference Obligation exceeds expected payment add6tional
payment to Protection Seller
- H winen down amounts are paM or reversed, addiimal payment to Protection Seller
- !Ipayment made toward unpaid pincipal. addiimnal payment to Protection Seller

m Physical Settlement
- R o t d o n Buyer has option to derrver the Reference OMigatian at any time &er a Credn
Event f a me Reference Price
- K Protembn Buyer delivers less than the notional amoum of Uw wade, that partion of the
vade will physically senle and trade will continue with a r e d d notional amount
- Credit Events include Writedown. Failurel o Pay Principal. Diswessed Ratings Dawngrade
(downgradeto Caa2. CCC n CCC or below) and Maturity Extension

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