Attachment A

Explanation of Securitization

Introduction

Securitization is notorious for its mind numbing complexity and inscrutability. One reason for this is that
up till now, securitization has been an insider’s game. This needs to change. The avalanche of
foreclosures requires members of the bar who defend clients against foreclosure to scrutinize
securitization because it presents a field ripe with affirmative defenses.

The purpose of this essay is to provide an explanation of securitization. This explanation should be used
as an attachment or exhibit to motions and pleadings to assist the court to understand the mechanics of
securitization. The legal arguments made are counterintuitive. Unless the mechanics of securitization
are understood, the arguments will not make sense. Securitization takes a commonplace, mundane
transaction and makes very strange things happen. The legal arguments provided state that the plaintiff
has no right to enforce foreclosure, the payments alleged to have been in default have, in fact, been
paid to the party to whom such payments were due and that rules and restrictions have been imposed
upon the debtor extrinsic to the note and mortgage as executed by the mortgagor and mortgagee
rendering the note and mortgage unenforceable. The explanation, including its charts, demonstrates
how securitization is a failed attempt to use a note and mortgage for purposes for which neither was
ever intended.

Securitization creates a hybrid, an amalgamation. It is like John Madden’s “terducken” at Thanksgiving.

Instead of a turkey, Madden enjoys a strange amalgamation which combines a turkey, with a duck and a
chicken- hence, terducken. Terduken is not a turkey, duck or chicken and does not even exist as a bird.
Securitization consists of a four way amalgamation. It is partly a refinancing with a pledge of assets, a
sale of assets, an issuance and sale of registered securities which can be traded publicly and the
establishment of a trust managed by third party managers. Enacted law and case law apply to each
component of securitization. However, specific enabling legislation to authorize the organization of a
securitization and harmonize the operation of its diverse components does not exist.

Why would anyone issue securities collateralized by mortgages using the structure of a securitization?

1. Immediately liquidate an illiquid asset such as a 30 year mortgage.

2. Maximize the amount obtained from a transfer of the mortgages and immediately realize the
profits now.
3. Use the liquid funds to make new loans and again and again earn immediately realized profits as
well as the fees and charges associated with making loans and again liquidate the loan as soon
as practicable.
4. To maximize earnings, transfer the assets so that the assets cannot be reached by creditors of
the transferor institution or by the trustee in the event of bankruptcy. By being “bankruptcy-
remote” the value to investors of the illiquid assets is increased and investors are willing to pay
more.

1
 5. Control management of the illiquid asset in the hands of the transferee by appointing managers
who earn service fees and may be affiliated with the transferor.
6. Enable the transferor to support the transferred asset by taking a portion of the first losses
experienced, if any, from default, entering into agreements to redeem or replace mortgages in
default and commit to providing capital contributions if needed to support the financial
condition of the transferee.
7. Carry the reserves and contingent liability for the support provided in paragraph 6 off the
balance sheet of the transferor thereby escaping any reserve requirements imposed upon
contingent liabilities carried on the books.
8. Avoid the effect of double taxation of first the trust to which the assets have allegedly been
transferred and second the investor receiving income.
9. Insulate the transferor from liability to the investors.
10. Leverage. Create a mortgage backed certificate that can be pledged as an asset which can be
resecuritized and repledged to create a financial pyramid.
11. Create a new financial vehicle so mind numbingly complicated that almost no one understands
what is going on.

The genius of capitalism and private ordering created a financial structure known as a securitization to
accomplish these goals. As long as profits continued to be made, all participants profited from the new
financial arrangement and bliss reigned supreme. Then the other shoe dropped.

There is a mortgage default crisis underway in the United States and a credit crisis caused by toxic assets
in the secondary mortgage market. Goldman Sachs estimates that, starting at the end of the last quarter
of 2008 through 2014, 13 million foreclosures will be started.5 The Center for Responsible Lending,
based on industry data, predicts 2.4 million foreclosures in 2009, and a total of 9 million foreclosures
between 2009 and 2012.6 At the end of the first quarter of 2009, more than 2 million houses were in
foreclosure. Mortgage Bankers Association, Nat’l Delinquency Survey Q109 at 4 (2009) (reporting that
3.85% of 44,979,733, or 1.7 million, mortgages serviced were in foreclosure). Roughly half of these were
serviced by national banks or federal thrifts. See Office of the Comptroller of the Currency & Office of
Thrift Supervision, OCC and OTS Mortgage Metrics Report: Disclosure of National Bank and Federal Thrift
Mortgage Loan Data, First Quarter 2009, at 8 (June 2009), available at
http://files.ots.treas.gov/482047.pdf (reporting that 884,389 foreclosures were in process by national
banks and federal thrifts at the end of the first quarter of 2009). The estimate of more than 2 million
homes in foreclosure is achieved by extrapolating from the MBA numbers. The MBA survey only covers
approximately 80% of the mortgage market. Thus, (44979733*3.85%)/0.8=2.16 million. Over twelve
percent of all mortgages had payments past due or were in foreclosure and over seven percent were
seriously delinquent—either in foreclosure or more than three months delinquent. Mortgage Bankers’
Association, Nat’l Delinquency Survey Q109 at 4 (2009). Goldman Sachs Global ECS Research, Home
Prices and Credit Losses: Projections and Policy Options (Jan. 13, 2009), at 16; see also Rod Dubitsky,
Larry Yang, Stevan Stevanovic & Thomas Suehr, Credit Suisse Fixed Income Research, Foreclosure
Update: Over 8 Million Foreclosures Expected 1 (Dec. 4, 2008) (predicting 9 million foreclosures for the
period 2009-2012). 6 Center for Responsible Lending, Soaring Spillover 1 (May 2009), available at

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http://www.responsiblelending.org/mortgage-lending/research-analysis/soaring-spillover-3-09.pdf. 7
Mortgage Bankers’ Association, Nat’l Delinquency Survey Q109 at 4 (2009) (reporting that 3.85% of
44,979,733, or1.7 million, mortgages serviced were in foreclosure). Roughly half of these were serviced
by national banks or federal thrifts. See Office of the Comptroller of the Currency & Office of Thrift
Supervision, OCC and OTS Mortgage Metrics Report: Disclosure of National Bank and Federal Thrift
Mortgage Loan Data, First Quarter 2009, at 8 (June 2009), available at
http://files.ots.treas.gov/482047.pdf (reporting that 884,389 foreclosures were in process by national
banks and federal thrifts at the end of the first quarter of 2009). The estimate of more than 2 million
homes in foreclosure is achieved by extrapolating from the MBA numbers. The MBA survey only covers
approximately 80% of the mortgage market. Thus, (44979733*3.85%)/0.8=2.16 million. 8 Mortgage
Bankers’ Ass’n, Nat’l Delinquency Survey Q109 at 4 (2009). Realtytrac recently reported that an
additional 300,000 homes go into foreclosure every month. Realtytrac, 1.9 Million Foreclosure Filings
Reported On More Than 1.5 Million U.S. Properties in First Half of 2009, available at
http://www.realtytrac.com/ContentManagement/PressRelease.aspx?channelid=9&ItemID=680

These spiraling foreclosures weaken the entire economy and devastate the communities in which they
are concentrated. See, e.g., Ben S. Bernanke, Chairman, Bd. of Governors, Fed. Reserve Sys., Address at
the Federal Reserve System Conference on Housing and Mortgage Markets (Dec. 4, 2008), available
athttp://www.federalreserve.gov/newsevents/speech/bernanke20081204a.htm#f12; Ira J. Goldstein,
The Reinvestment Fund, Lost Values: A Study of Predatory Lending in Philadelphia, at 62/-/63 (2007),
available at www.trfund.com/resource/downloads/policypubs/Lost_Values.pdf (discussing disastrous
community impact left behind by failed subprime lenders). Neighbors lose equity; See John P. Harding,
Eric Rosenblatt, & Yao Vincent, The Contagion Effect of Foreclosed Properties (July 15,2008), available at
http://ssrn.com/abstract=1160354 ; Letter, Senator Dodd to Senator Reid (Jan. 22, 2008) (describing
cycle of disinvestment, crime, falling property values and property tax collections resulting from
foreclosures), available at http://dodd.senate.gov/multimedia/2008/012308_ReidLetter.pdf; Staff of the
J. Economic. Comm., 110th Cong., 1st Sess., The Subprime Lending Crisis: The Economic Impact on
Wealth, Property Values and Tax Revenues, and How We Got Here (2007), available at
http://jec.senate.gov/index.cfm?FuseAction=Reports.Reports&ContentRecord_id=c6627bb2-7e9c-9af9-
7ac7- 32b94d398d27&Region_id=&Issue_id= (projecting foreclosed home owners will lose $71 billion
due to foreclosure crisis, neighbors will lose $32 billion, and state and local governments will lose $917
million in property tax revenue); Dan Immergluck & Geoff Smith, The External Costs of Foreclosure: The
Impact of Single-Family Mortgage Foreclosures on Property Values, 17 Housing Pol’y Debate 57, 69, 75
(2006) (“for each additional conventional foreclosure within an eighth of a mile of a house, property
value is expected to decrease by 1.136 percent”; estimating total impact in Chicago to be between $598
million and $1.39 billion); William C. Apgar, Mark Duda, & Rochelle Nawrocki Gorey, The Municipal Cost
of Foreclosures: A Chicago Case Study (Hous. Fin. Policy Research Paper 2005), at 1, available at
www.995hope.org/content/pdf/Apgar_Duda_Study_Full_Version.pdf; John P. Harding, Eric Rosenblatt,
& Yao Vincent, The Contagion Effect of Foreclosed Properties (July 15, 2008), available at
http://ssrn.com/abstract=1160354 ; Letter, Senator Dodd to Senator Reid (Jan. 22, 2008) (describing
cycle of disinvestment, crime, falling property values and property tax collections resulting from
foreclosures), available at http://dodd.senate.gov/multimedia/2008/012308_ReidLetter.pdf.crime

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increases; See, e.g., J.W. Elphinstone, After Foreclosure, Crime Moves In, Boston Globe, Nov. 18, 2007
(describing Atlanta neighborhood now plagued by house fires, prostitution, vandalism and burglaries);
Dan Immergluck & Geoff Smith, The Impact of Single-Family Mortgage Foreclosures on Neighborhood
Crime, 21 Housing Stud. 851 (2006), available at www.prism.gatech.edu/~di17/housingstudies.doc
(calculating that for every 1% increase in the foreclosure rate in a census tract there is a corresponding
2% increase in the violent crime rate). tax revenue shrinks. See, e.g., ., Staff of the J. Economic Comm.,
110th Cong., 1st Sess., The Subprime Lending Crisis: The Economic Impact on Wealth, Property Values
and Tax Revenues, and How We Got Here (2007), available at

http://jec.senate.gov/index.cfm?FuseAction=Reports.Reports&ContentRecord_id=c6627bb2-7e9c-9af9-
7ac7-32b94d398d27&Region_id=&Issue_id= (projecting foreclosed home owners will lose $71 billion
due to foreclosure crisis, neighbors will lose $32 billion, and state and local governments will lose $917
million in property tax revenue); William C. Apgar, Mark Duda, & Rochelle Nawrocki Gorey, The
Municipal Cost of Foreclosures: A Chicago Case Study (Hous. Fin. Policy Research Paper), 2005, at 1,
available at www.995hope.org/content/pdf/Apgar_Duda_Study_Full_Version.pdf. Communities of color
remain at the epicenter of the crisis; targeted for subprime, abusive lending, they now suffer doubly
from extraordinarily high rates of foreclosure and the assorted ills that come with foreclosure.” Written
Testimony of Alys Cohen, National Consumer Law Center also on behalf of National Association of
Consumer Advocates and National Association of Consumer Bankruptcy Attorneys before the United
States Senate Subcommittee on Administrative Oversight and the Courts of the Committee on the
Judiciary. July 23, 2009.

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 What is a Securitization?

In a mortgage securitization, securities are issued which are collateralized by and receive payments from
mortgages collected in a collateralized mortgage pool. The collateralized mortgage pool is treated as a
trust. This trust is organized as a special purpose vehicle (“SPV”) and a qualified special purpose entity
(“QSPE”) which receives special tax treatment. The SPV is organized by the securitizer so that the assets
of the SPV are shielded from the creditors of the securitizer and the parties who manage the trust. This
shielding is described as making the assets “bankruptcy remote”.

To avoid double taxation of the trust and the certificate holders and obtain a single event tax treatment
from the Internal revenue Service, mortgages are held in Real Estate Mortgage Investment Conduits
(“REMICS”). To qualify for the single taxable event, all interest in the mortgage are supposed to be
transferred forward to the certificate holders. In fact, such a transfer never occurs. Emphasis supplied.
The legal basis of REMICs was established by the Tax Reform Act of 1986 (100 Stat. 2085, 26 U.S.C.A. §§
47, 1042), which eliminated double taxation from these securities. The principal advantage of forming a
REMIC for the sale of mortgage-backed securities is that REMIC’s are treated as pass-through vehicles
for tax purposes helping avoid double-taxation. For instance, in most mortgage-backed securitizations,
the owner of a pool of mortgage loans (the Sponsor or Master Servicer usually) sells and transfers such
loans to a QSPE, usually a trust, that is designed specifically to qualify as a REMIC, and, simultaneously,
the QSPE issues securities that are backed by cash flows generated from the transferred assets to
investors in order to pay for the loans along with a certain return. If the special purpose entity or the
assets transferred qualify as a REMIC, then any income of the QSPE is “passed through” and taxable to
the holders of the REMIC Regular Interests and Residual Interests.

Accordingly the trustee, the QSPE and the other parties servicing the trust have no legal or equitable
interest in the securitized mortgages. The plaintiff’s complaint alleges that plaintiff is the holder of the
note for purposes of standing to bring an action of foreclosure. This is a legal impossibility and,
accordingly, a false assertion. Plaintiff was instrumental in the issuance and sale of the certificate to
certificate holders. This means the plaintiff knew that it was not any longer the holder of the note.

The QSPE is a weak repository not engaged in active management of the assets. For this purpose, a
servicing agent is appointed. Moreover, all legal and equitable interest in the mortgages are required by
REMIC to be passed through to the certificate holders. Compliance with REMIC and insulating the trust
assets from creditors of third parties who create or service the trust leads to unilateral restructuring of
the terms and conditions of the original note and mortgage.

A typical mortgage pool consists of anywhere from 2000-5000 loans. This is millions of dollars in cash
flow payments each month from a Servicer (receiving payments from borrowers) to a REMIC (QSPE)
with the cash flow “passing through” the Trust (REMIC) without taxation to the investors. Only the
investors have to pay taxes on the payments of mortgage interest received. The taxes a trust would have
to pay on $30, 50 or 100 million dollars per year if this “pass through” taxation benefit didn’t exist would
be substantial and lower the value of certificates to investors. Worse, what would be the case if a Trust

5
that was organized in February 2005 were found to have violated the REMIC guidelines outlined in the
Internal Revenue Code? At $4 million per month in cash flow, there would arise around $190 Million in
now, TAXABLE income.

If a Trust - or a Servicer or Trustee acting on behalf of the Trust - were found to have violated these very
strict REMIC guidelines to qualify as a REMIC, the taxable status of the REMIC can be revoked; the
equivalent of financial Armageddon for the trust and its investors.

A REMIC can be structured as an entity (i.e., partnership, corporation, or trust) or simply as a segregated
pool of assets, so long as the entity or pool meets certain requirements regarding the composition of
assets and the nature of the investors’ interests. No tax is imposed at the REMIC level. To qualify as a
REMIC, all of the interests in the REMIC must consist of one or more classes of “regular interests” and a
single class of “residual interests.” Regular interests can be issued in the form of debt, stock, partnership
interests, or trust certificates, or any other form of securities, but must provide the holder the
unconditional right to receive a specified principal amount and interest payments. REMIC regular
interests are treated as debt for Federal tax purposes. A residual interest in a REMIC, which is any REMIC
interest other than a regular interest, is, on the other hand, taxable as an equity interest.

In order for the Trust to qualify as a REMIC, all steps in the “contribution” and transfer process (of the
notes) must be true and complete sales between the parties and be accomplished within the three
month time limit from the Startup Day. Therefore, every transfer of the Note(s) must be a true purchase
and sale, and, consequently the Note must be endorsed from one entity to another. Any mortgage
note/asset identified for inclusion in a Trust seeking a REMIC status MUST be deposited into the Trust
within the three month time period calculated from the official Startup Day of the REMIC. Section 860 of
the Internal Revenue Code. 

Securitization effectively severs financial responsibility for losses from the authority to incur or avoid
losses. With securitization the mortgage is converted so the party making the decision to foreclose does
not bear the loss resulting from foreclosure but avoids the liability which could result if a class of
certificate holders claimed wrongful injury resulting from a modification made to achieve an alternate
dispute resolution.

Securitization also makes the mortgage and note unalienable. Once certificates have been issued, the
note cannot be transferred, sold or conveyed. It might appear the inability to alienate the note has no
adverse consequences for the debtor. Recent history disproves this conclusion. Several legislative and
executive efforts to pursue alternate dispute resolution and provide financial relief to distressed
homeowners have been thwarted by the inability of the United States Government to buy securitized
mortgages without purchasing most of the certificates issued. An SPV cannot sell a mortgage to the
United States which is owned by different classes of certificate holders. The certificate holders likewise
cannot sell the mortgages. All they have are the securities hold each of which can be publicly traded.

The certificate holders are in no sense holders of the note and have no legal or beneficial interest in the
note. The certificate holders do not each hold undivided fractional interests in a note which added
together total 100%. The certificate holders also are not the assignees of one or more specific

6
installment payments made pursuant to the note. For the certificate holder, there is no note. A
certificate holder does not look to a specific note for repayment for the investment made. Instead, the
certificate holder holds a security similar to a bond with specific defined payments. The issuer of trust
certificates is selling segments of cash flow.

Every mortgage or deed of trust financing uses two basic documents: the mortgage and the mortgage
note. The terms “mortgage” and “mortgage note” for this discussion include a deed of trust and deed of
trust note. Let the mortgage and note together be referred to as the transaction (hereafter
“Transaction”). Every securitization has a structure. In this sense, a securitization is architectural. It is
useful to create charts to diagram securitizations. Such a chart identifies the parties and their
relationship to the securitization. The parties to a securitization and their relationship including the
duties and obligations one party owes to another party is referred to on Wall Street as “the deal”
( hereafter “Deal”). The Deal is created and defined by what functions as a declaration of trust and is
known as “the master servicing and pooling agreement” (hereafter “Pooling Agreement).

Securitization began as a simple paradigm for converting illiquid, long term debt into liquid, tradable
short term debt. Here is a chart that shows a net asset trust to convert long term mortgage debt into
short term, publicly traded securities. One of the simplest examples would be a Net Asset Trust. The
transferor purchases a portfolio of mortgages and sells them to a trust. The trust purchases the
mortgages. The trustee holds the mortgages and becomes the holder of legal title. The trust then issues
bond debenture like certificates to investors. The bond issues different classes of certificates called
tranches. The certificate entitles the certificate purchaser to certain stated, repeated segments of cash
flow paid by the trust. The certificate holders do not hold fractional, undivided interest in the
mortgages. Instead each tranche is entitled to an identified, segmented pool of money payable in an
order of priority. A senior tranche will get paid before a junior tranche. A junior rate provides a higher
promised rate of return because it has a higher risk than a senior tranche. Another tranche exists which
only pays interest but does not pay out principal. The type and variety of tranche created is limited only
by the limits of financial ingenuity. Tranches have been created which pay only a portion of principal
repaid on the mortgages but no interest. The concept is brilliant. It successfully transforms what had
previously been thought of as an illiquid, long term debt into a short term, liquid, publicly traded
instrument. It cashes out the lender allowing the lender to make new loans while realizing an immediate
profit on the loans sold.

Chart 1

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The Investors buy the mortgages from the Transferor by paying cash to the Trustee who pays the
Transferor. The Investors purchase securities (certificates) which are collateralized by the mortgages
held in trust in the Collateral Pool. Legal title to the mortgages is in the Trustee and beneficial title is in
the investors. In the case of defending the debtor, little time need be spent considering the wide variety
of flora and fauna created as certificates and all the different types of tranches. Suffice it to say that the
trust purchased mortgages and sold certificates. Another way to explain this is the trust bought beef
cattle and wound up selling hamburger. This then raises a nice question fit for a law school examination
or law journal article: Are the certificate purchasers really beneficial holders of the note or are they
merely purchasers of a contract right to payment from the trust. In other word, is the trustee limited to
being the holder of legal title or does the trustee also holds the beneficial title. For purposes of
defending the defendant, this issue becomes a nice academic exercise but is not germane to defending
the debtor. The reason is that under either case, the Trustee has standing to foreclose. The good news is
that securitizations likely to hold a debtor’s mortgage are not asset trusts.

Wall Street decided the Asset Trust Paradigm needed to be improved. If the Deal could be made safer
for and more lucrative to the investor, the investor would pay more for the investment. This was
accomplished by adding objectives 2-11 of the following list already referred to above:

1. Immediately liquidate an illiquid asset such as a 30 year mortgage.

2. Avoid the effect of double taxation of first the trust to which the assets have allegedly been
transferred and second the investor receiving income by creating a single taxable event.
3. Maximize the amount obtained from a transfer of the mortgages and immediately realize the
profits now.

8
 4. Use the liquid funds to make new loans and again and again earn immediately realized profits as
well as the fees and charges associated with making loans and again liquidate the loan as soon
as practicable.
5. To maximize earnings, transfer the assets so that the assets cannot be reached by creditors of
the transferor institution or by the trustee in the event of bankruptcy. By being “bankruptcy-
remote” the value to investors of the illiquid assets is increased and investors are willing to pay
more.
6. Control management of the illiquid asset in the hands of the transferee by appointing managers
who earn service fees and may be affiliated with the transferor but are not recognized as agents
of the transferor.
7. Enable the transferor to support the transferred asset by taking a portion of the first losses
experienced, if any, from default, entering into agreements to redeem or replace mortgages in
default and commit to providing capital contributions if needed to support the financial
condition of the transferee.
8. Carry the reserves and contingent liability for the support provided in paragraph 7 off the
balance sheet of the transferor thereby escaping any reserve requirements imposed upon
contingent liabilities carried on the books.
9. Insulate the transferor from liability to the investors.
10. Create a mortgage backed certificate that can be pledged as an asset which can be resecuritized
and repledged to create a leveraged, financial pyramid.
11. Create a new financial vehicle so mind numbingly complicated that almost no one understands
what is going on so that the public sector will minimize regulatory intrusion upon the Deal.

The net asset trust structure does not provide the additional 11 benefits of securitization listed above.
For instance, the income received by the Collateral Pool from the mortgage debtors is taxed and the
interest paid to each investor is again taxed.

To achieve the goals listed above, it became necessary to structure the Deal to create a pass through
trust and replace the net asset trust. The Deal starts off on straight forward easily charted path.

9
 Chart 2

The Transaction takes place between the debtor (mortgagor) and the creditor here called the
“Originator” who is the mortgagee. The Transaction consists of the mortgage note and the mortgage.
The Originator becomes the note holder. The Originator sells the Transaction to the Warehouser. The
Warehouser becomes the note holder. The Warehouser buys the mortgage and buys other mortgages
to assemble a portfolio of mortgages. The portfolio is then sold to the Transferor who is the initiating
party of the securitization. The Transferor becomes the note holder. A portfolio for securitization
typically will contain from 2,000-5,000 mortgages. The chart shows the path of the mortgages and
identifies the Note Holder at each stage.

The Transferor creates the securitization. There are many different structures for securitization but their
impact on the debtor is the same. Here is a typical securitization:

10
 Chart3

Securitization creates a hybrid, an amalgamation. It is like John Madden’s “terducken” at Thanksgiving.

Instead of a turkey, Madden enjoys a strange amalgamation which combines a turkey, with a duck and a
chicken- hence, terducken. Terduken is not a turkey, duck or chicken and does not even exist as a bird.
Securitization consists of a four way amalgamation like Terduken. It is partly a refinancing with a pledge
of assets, a sale of assets, an issuance and sale of registered securities which can be traded publicly and
the establishment of a trust managed by third party managers. Enacted law and case law apply to each
component of securitization. However, specific enabling legislation to authorize the pass through

11
structure of a trust holding a mortgage portfolio does not exist. Many unresolved legal issues could be
addressed if the Uniform Commercial Code Commissioners added a chapter for securitization.

This structure is called the “Deal”. The Deal is created through a complex instrument that, among other
things, serves as a declaration of trust”, identifies the parties who manage the Deal and describes their
duties, responsibilities, liabilities and obligations, defines the different classes of investment securities
and is called the Master Pooling and Servicing Agreement. This document is filed with the Securities and
Exchange Commission and is a public record. This document is the bible for the Deal and the most
important source for discovery. It provides the who, how, where and when of the Deal.

At the last map, the mortgage portfolio was left in the hands of the Transferor who was the note holder.
The Transferor transfers the mortgages to the Underwriter, the party in the yellow box. In addition, the
Transferor may arrange for credit enhancements to be transferred for the benefit and protection of
investors. Such enhancements may include liquid assets, other securities and performing mortgages in
excess of the mortgage portfolio being sold. The Transferor also usually obligates itself to redeem and
replace any mortgage in default. The Underwriter creates the securities and arranges to place the
securities with investors who are in the red box called tranches. The Underwriter transfers the mortgage
portfolio and securities to the Issuer. The Issuer is organized as a Special Purpose Vehicle, a passive
conduit to the investors. The Issuer issues the securities to the investors and collects payment. The
payments are transferred trough the Underwriter backs to the Transferor.

The mortgage portfolio is conveyed from the Issuer to the collateral pool which is organized as a
Qualifying Special Purpose Entity (“QSPE”). What makes the entity “qualified” is strict adherence to a set
of rules. Among other things, these rules make the QSPE a passive entity which has no legal or equitable
title to the mortgages in the mortgage portfolio and restrict modification of the mortgages in the
portfolio. As a result the QSPE is not taxed on the earnings paid to it by the mortgage debtors. These
earnings flow through the QSPE to the investors. Only the investors are taxed. The QSPE transfers the
mortgage portfolio to the Custodian who acts as a bailee of the assets. The Custodian is a mere
depository for safekeeping of the mortgages. The investors invest in different classes of securities. Each
class is called a tranche. Each tranche is ranked by order of preference in receipt of payment and the
segment of cash flow to be received and resembles a bond. The basic stratification by order of priority of
payment from highest to lowest has three major divisions Senior Notes, Mezzanine Notes and Unrated
Equity.

The Deal establishes a management structure to supervise the investment. The specific parties for a
Deal are indentified in the master Pooling and Servicing Agreement which states their duties and
obligation, compensation and liability. Typically the managers include a Master Servicer, a Trustee, a Sub
servicer and a Custodian. The day to day operations of the Collateral Pool is administered by the
Trustee. The Trustee does very little since the trust must remain passive. The Trustee does not have a
legal or equitable interest in any mortgage in the portfolio because the Trust is a mere passive conduit.
The Master Servicer is in overall charge of the Deal and supervises the other managing parties. The Sub
servicer is responsible for dealing with the Mortgage Debtors, collecting monthly payments, keeping
accounts and financial records and paying the monthly proceeds to the Trustee for distribution to the

12
investors by order of tranche. The Sub servicer may also be responsible for foreclosure in the event a
mortgage is in default or some Deals call for the appointment of a special sub servicer to carry out
foreclosure. Usually the Sub servicer is obligated to make monthly advances to the investors for each
mortgage in default. In addition, the Sub servicer may also have undertaken to redeem of replace any
mortgage in default.

Finally, there is a Counterparty to make sure that investors get paid on time. The Counterparty is like an
insurer or guarantor on steroids. The Counterparty is the repository of all kinds of financial
arrangements to insurer payment of the investors. Such financial arrangements include derivatives,
credit default swaps and other hedge arrangements. The term “counterparty” is frequently associated
with “counterparty risk” which refers to the risk that the counterparty will become financially unable to
make the “claims” to the investors if there are a substantial number of mortgage defaults. The Counter
Party may guarantee the obligation of the Transferor or Servicer to redeem or replace mortgages in
default and the obligation of the Sub servicer to make monthly payments for mortgages in default.

13