D E C E M B E R 2 0 0 6

M B S

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Analyst CertificationThe 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 memberof 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.

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. 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 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 warranted as to completeness or accuracy and are subject to change without notice. Transactions involving securities and financial instruments mentioned herein (including 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 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.

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Market Overview and Origination 1

Demand 12

Mortgage Cashflows and Intro to Prepayments 24

Valuation and OAS 33

Prepayments Analysis and Reports 44

TBA Market and Specified Pools 60

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Relative Value Trading 78

Case Studies 100

ARMs 111

1

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Agency MBS market composition and issuance

M B S

Securitized agency market compositionSecuritized agency market composition Annual fixed-rate net issuance ($ billions)Annual fixed-rate net issuance ($ billions)

30-year

($2.3

trillion)

68%

Other Fixed

($152.3

billion)

4%

Hybrid ARM

IO ($148.6

billion)

4%

1/1 ARM

($23.4

billion)

1%

Hybrid ARM

($226.5

billion)

6%

15-year

($617 billion)

17%

Source: JPMorgan, FNMA, FHLMC, GNMAAs of December 2006

Total = $__mm

217276

156

292211 231

-21

101

239

1998 1999 2000 2001 2002 2003 2004 2005 2006

Source: JPMorgan, FNMA, FHLMC, GNMAAs of December 2006

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Annual hybrid ARM net issuance ($ billions)Annual hybrid ARM net issuance ($ billions)

-31-13

10

-11

49

74 79

4829

1998 1999 2000 2001 2002 2003 2004 2005 2006Total = $3.4 trillion

Source: JPMorgan, FNMA, FHLMC, GNMAAs of December 2006

3

MBS in the U.S. fixed income market

M B S

Fixed income market compositionFixed income market compositionOverviewOverview

Largest US fixed income asset class

Many products to choose from within the MBS market

Agency fixed-rates and ARMs

Non-agency fixed-rates and ARMs (Jumbos, Alt-As)

Whole loans

CMOs and other structured MBS

Superior liquidity

The TBA market adds unique liquidity to MBS

MBS market often used to express duration and curve views (due to its liquidity and size)

Agency fixed-rate pass-throughs is 34% of the Lehman U.S. Aggregate Index (a benchmark of the U.S. investment grade debt).

Municipal

9%

Mortgage

Related

24%

Fed Agencies

10%

Money

Market

14%

Asset-

backed

8%

Corporate

19%

U.S.

Treasury

16%

Source: The Bond Market Association, as of September 2006

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Total = $25.9 trillion

4

The mortgage market has surged, thanks to a strong housing market and cash-out refis

M B S

5,133

5,614

6,317

7,120

8,079

8,6838,978

2000 2001 2002 2003 2004 2005 2006

1-4 Family Mortgage Debt Outstanding ($ billions)1-4 Family Mortgage Debt Outstanding ($ billions)

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Source: Bond Market Association, Federal Reserve Board

5

The MBS market links borrowers and investors

M B S

Agencies

Mortgage lenders

MBS Dealers

Borrowers MBS Investors

Mortgage Loans MBS Pass-through

Securitization

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The issuer of the pass-through obtains the mortgages either by purchasing or originating the loans

Loans with similar characteristics are pooled together; loans are securitized

The investor has undivided ownership interest (the investor is entitled to the pro-rata share of interest and principal payments of the underlying loans)

A “pass-through” is the basic MBS structure

It passes the monthly principal and interest payments, minus a servicing spread, from a pool of mortgages to investors

6

Origination: The Menu of Mortgages Has Expanded

M B S

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

– OtherBalloon mortgages (5-year / 7-year)Prepayment penalty mortgages

“Conforming” balance loans

“Non-conforming” loans (Private label, Non-agencies)

Jumbos and Alt-As

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Understanding Mortgage Collateral : Borrower Credit & Housing Leverage

M B S

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

Leverage (Debt to Income Ratios)

Reserves : Staying Power in the event of financial trouble

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Understanding Collateral cont…

M B S

Housing Leverage

Loan-to-Value Ratio— House Value / Mortgage Amount

— Higher LTV Less Equity Protection for the Mortgage Investor 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)

Property Type— Single Family Property (Most Secure)— Condos— Multi-Family

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Conforming loan limits rose by 16%, reaching $417,000 in 2006; limit unchanged for 2007

M B S

Conforming Limits ($’000)Conforming Limits ($’000)

150

200

250

300

350

400

450

1990 1992 1994 1996 1998 2000 2002 2004 2006

Source: FHFB, JPMorgan

Conforming loan limit for 2006

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Origination channels

M B S

$3.0 trillion origination volume in

2005

Retail (42%) - loan officer employed by mortgage banking company; mortgage loan is closed in the name of the lender

Broker (34%) – mortgage loan broker represents borrower to lending institution; mortgage loan is closed in the name of the lender

Correspondent (24%) – independent mortgage banking company; mortgage loan is closed in “ABC” Mortgages name and sold to mortgage banker

Internet – mortgage loan originated and funded by mortgage banking company through website

Top 5 mortgage banking companies account for over 48% of all new origination volume

1. Countrywide

2. Wells Fargo

3. Washington Mutual

4. Chase Home Finance

5. CitiMortgage

Source: National Mortgage News, as of Q1 2006

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M B S

Market Overview and Origination 1

Mortgage Cashflows and Intro to Prepayments

Demand 12

24

Valuation and OAS 33

Prepayments Analysis and Reports 44

TBA Market and Specified Pools 60

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Relative Value Trading 78

Case Studies 100

ARMs 111

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Major MBS investors

M B S

MBS Investor BreakdownMBS Investor BreakdownMBS Investors ($ billion)MBS Investors ($ billion)

% Chg Investor Type All MRSs Non-Agency All MRSs Non-Agency % of MRS since 2004Fannie Mae/Freddie Mac 1,260.90 $266.80 $1,190.00 $432.00 25% -6%FDIC Commercial Banks $876.40 $124.30 $897.10 $167.20 19% 2%Foreign Investors $330.00 $30.00 $550.00 $70.00 11% 67%Mutual Funds $445.00 N.A. $428.00 N.A. 9% -4%Personal Sector $225.00 N.A. $330.00 N.A. 7% 47%Life Insurance Cos $270.00 N.A. $350.00 N.A. 7% 30%All Thrifts $234.30 $53.60 $242.60 $73.40 5% 4%State/Local $147.00 N.A. $170.00 N.A. 4% 16%Public Pension Funds $149.00 N.A. $151.00 N.A. 3% 1%Private Pension Funds $120.00 $12.50 $130.00 $18.00 3% 8%FHLBanks $113.10 $71.00 $122.30 $75.30 3% 8%REITs $79.00 $70.00 $110.00 $100.00 2% 39%Property/Casualty Insurers $56.00 N.A. $70.00 N.A. 1% 25%MBS Dealer Inventory $41.00 $15.00 $60.00 $20.00 1% 46%Federal Credit Union $27.50 N.A. $23.70 N.A. 0% -14%Subtotal: 4,374$ 643$ 4,825$ 956$ All Other Investors* $46.70 $313.70 $635.80Total Outstanding $4,420.90 $1,004.40 $5,138.50 $1,591.70

YE 2005YE 2004

Source: Inside MBS & ABS

Total = $4.8 trillionSource: Inside MBS & ABS

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Foreign demand has dominated the mortgage market over the past several years

M B S

Source: US Treasury, Federal Reserve, FNMA, FHLMC, JPMorgan* Foreign purchase data: Dec ’06, GSE: Dec ’06, Bank: Dec ‘06

Net Purchases ($ billions, annual)Net Purchases ($ billions, annual)

-150

-100

-50

0

50

100

150

200

250

2001 2002 2003 2004 2005 2006

Foreign GSE Bank

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Trends in bank demand

M B S

Bank holdings are still growing, but at a slower pace.

Some signs that bank demand could slow:

MBS holdings as a percentage of deposits have increased

C&I loan growth has picked up

But, there are mitigating factors:

Deposit rates have remained sticky

Available-for-sale security losses

Mortgages remain one of the few sectors that offers the size and

liquidity that large banks need

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Large banks have been drawn to the mortgage market

M B S

Top 3 Bank Holdings as % of Total Banks’Top 3 Bank Holdings as % of Total Banks’

20%

22%

24%

26%

28%

30%

32%

34%

36%

38%

40%

Mar-01 Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06

Source: Federal Reserve, JPMorgan

Large banks have enjoyed the liquidity of the mortgage market for large trades,

and average trade size has increased significantly.

Diversification and movement away from credit risk have been themes, but could

shift if mortgages remain tight.

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Top 10 banks ranked by MBS portfolios as of 3Q 2006

M B S

Rank Bank Holding Company Total MBS Change % Chg Pass-through Change % Chg CMO Change % Chg1 BANK OF AMERICA CORPORATION 164,844,749 (43,372,911) -21% 159,488,610 (43,346,218) -21% 5,356,139 (26,693) 0%2 WACHOVIA CORPORATION 82,193,000 (12,713,000) -13% 71,024,000 (8,716,000) -11% 11,169,000 (3,997,000) -26%3 JPMORGAN CHASE & CO 70,680,000 12,379,000 21% 67,559,000 12,547,000 23% 3,121,000 (168,000) -5%4 CITIGROUP INC 66,653,000 52,609,000 375% 57,412,000 45,735,000 392% 9,241,000 6,874,000 290%5 WELLS FARGO & COMPANY 40,957,000 (18,682,000) -31% 35,725,000 (15,491,000) -30% 5,232,000 (3,191,000) -38%6 US BANCORP 34,214,000 43,000 0% 21,624,000 (121,000) -1% 12,590,000 164,000 1%7 CITIZENS FINANCIAL GROUP INC 31,435,489 325,511 1% 11,419,948 77,453 1% 20,015,541 248,058 1%8 STATE STREET CORPORATION 24,025,439 4,204,622 21% 6,227,724 1,956,872 46% 17,797,715 2,247,750 14%9 COMMERCE BANCORP INC 22,093,374 (318,998) -1% 3,434,901 (425,699) -11% 18,658,473 106,701 1%

10 ABN AMRO NORTH AMERICA HOLDING COMPANY 18,837,207 5,710,027 43% 17,654,559 5,746,389 48% 1,182,648 (36,362) -3%

Source: Federal Reserve, JPMorgan

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Bank MBS holdings continue to grow

M B S

MBS Holdings of Large Banks ($ billions)MBS Holdings of Large Banks ($ billions)

200

250

300

350

400

450

500

550

600

650

May-99 May-00 May-01 May-02 May-03 May-04 May-05 May-06

Source: Federal Reserve

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Security purchases and C&I loan growth has typically been inversely correlated

M B S

MBS and C&I Holdings (Annual changes since 2000)MBS and C&I Holdings (Annual changes since 2000)

R2 = 0.6155-15%

-10%

-5%

0%

5%

10%

15%

-5% 0% 5% 10% 15% 20% 25% 30% 35%

MBS Annual % Chg

C&

I An

nu

al %

Ch

g

Source: Federal Reserve, JPMorgan

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With many bank positions underwater, it is unlikely that there will be large selling

M B S

(100)

(50)

0

50

100

150

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Cha

nges

in s

ecur

ities

hol

ding

s ($

bn)

(20)

(15)

(10)

(5)

0

5

10

15

20

Unr

ealiz

ed g

ains

/loss

es ($

bn)

Quarterly Changes in Security Holdings

Unrealized Gains/Losses

Banks did not sell amid losses in 2000…… While most bank sales have occurred amid

gains

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The GSEs

M B S

•Fannie Mae

•Freddie Mac

•Ginnie Mae

•FHLBs – the MPF and MPP programs

•GNMA pools are backed by FHA/VA loans which are government insured.

These pools have an explicit U.S. government guarantee and a zero risk-

capital weighting.

•FNMA and FHLMC pools are backed by conventional conforming loans, have an

implicit U.S. government guarantee, and a 20% risk-capital weighting. Single-

family loan limit is $359,650 in 2005.DD

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Unique role of GSEs: issuer / investor

M B S

Mission is to facilitate secondary mortgage market in U.S. which provides

steady flow of low cost mortgage funds

Issue agency debt

Hold MBS, CMOs, and loans as well as ABS, CMBS, and mortgage-related spread

products

Large portfolios (FN + FH hold over $1.4 trillion loans and MBS) demand active

hedging via swap and swaption markets

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Agency portfolio growth has slowed

M B S

Retained Portfolio ($ billions)Retained Portfolio ($ billions)

300

400

500

600

700

800

900

1000

Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06

FNMA Portfolio FHLMC Portfolio

Source: FNMA, FHLMC, JPMorgan

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M B S

Market Overview and Origination 1

Demand 12

Valuation and OAS

Mortgage Cashflows and Intro to Prepayments 24

33

Prepayments Analysis and Reports 44

TBA Market and Specified Pools 60

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Relative Value Trading 78

Case Studies 100

ARMs 111

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MBS Terminology

M B S

Pools are comprised of mortgage loans with similar rates and terms

WAC – weighted average coupon of all loans in pool (vs Coupon)

WAM – weighted average maturity of loans in pool

WALA – weighted average loan age

Original face – original principal amount of pool

Current face – remaining principal balance of pool

Origination year – average origination year of loans in pool; age (WALA) is important in prepayment

assessment (“seasoning”)

CPR – Constant Prepayment Rate – annualized percentage of remaining principal prepaid

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Mortgage cash-flow characteristics

M B S

FHLMC FNMA14th 24th

August 1st September 1st October 1st30 days in arrears 14 to 24 days processing

44 to 54 day delay

Homeowner's August payment due (in arrears)

After processing, security holders receive shares of

August payment

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Mortgage cash-flow

M B S

Example: $500,000 purchase price; $400,000 loan amount; 6% mortgage rate; 30-year fixed-rate loan

Using “MP” function on BBG…

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Mortgage cash-flows: without prepayments

M B S

Interest

Principal

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Source: Bloomberg

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Mortgage cash-flows: with prepayments

M B S

Interest

Pre-paid Principal

Principal

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Source: Bloomberg

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Prepayments: source of MBS optionality

M B S

Borrowers have the right to prepay at any time without penalty – in effect “calling” their loans away from investors; prepayments may be partial or complete

Valuing this call option and the cash flow uncertainty it creates is the key to understanding MBS

Timing and rate of prepayments vary and produce non-level, less-predictable cash flows

Prepayment (Call) Risk vs extension risk

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Determinants of prepayments

M B S

Prepayments can be for economic / non-economic reasons

Interest rate incentive

Yield curve shape: refi down the curve

WALA: mobility increases over time

Seasonality: Summer months have the fastest speeds owing to school vacation

“Burnout”: Remaining borrowers in a pool may be credit constrained

Cash-out refinancing: Take built-up equity out of the home

Default: Shows as a prepayment in agency pools

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Prepayment standards

M B S

CPR – Constant Prepayment Rate – annualized percentage of remaining principal prepaid

PSA – prepayment vector expressed as a series of CPRs; begins at .2% in the first month, increases .2% per month, leveling out at 6.0% in month 30; prepayment assumptions for pricing stated as linear multiples of PSA schedule

0

2

4

6

8

10

12

14

0 10 20 30 40 50Age

CPR

(%)

200 PSA

100 PSA

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Market Overview and Origination 1

Demand 12

Mortgage Cashflows and Intro to Prepayments 24

Prepayments Analysis and Reports

Valuation and OAS 33

44

TBA Market and Specified Pools 60

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Case Studies 100

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Many Different Types of Spreads

M B S

Basic: static yield spread over a single point on the curve

“I” : spread to Treasury

“N” : spread to swaps

Intermediate: zero volatility yield curve spread

“Z” : spread to Treasury curve

“E” : spread to Libor/swap curveLibor ZSpread on JPMorgan’s analytic reports.

Advanced

OAS : option-adjusted spread

LIBOR OAS

Treasury OAS

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Yield analysis in the MBS market

M B S

Static Spread (Yield Spread): standard measure of incremental return over a single benchmark Treasury

Compares MBS to single point on the yield curve, usually to the interpolated point closest to the Weighted Average Life of the MBS

But MBS does not return principal in one lump sum but over many periods. A better assumption would include multiple data points on the yield curve. Z Spread takes this another step further.

Z Spread (Yield Curve Spread) : discounts each monthly MBS cashflow by the monthly forward rates derived from the current yield curve

More accurate for securities that return principal over many periods as opposed to bullets

Still a static measure since it assumes that interest rates and MBS cashflows remain constant

VA

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NA

ND

OA

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Evaluating pass-throughs: yield / average life

M B SVA

LU

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NA

ND

OA

S

Source: Bloomberg

36

Prepayments and OAS

M B S

Prepayment issues:

Reinvestment risk: When rates decline and speeds increase the investor has to reinvest an increased amount of principal at lower ratesWhen rates increase and speeds decline, the investor has less cashflow to reinvest at higher rates

Discount bonds: when rates decline, the benefit of earlier return of principal at par may mitigate reinvestment risk

Premium bonds: when rates increase, the benefit of a larger outstanding principal balance and longer average life means higher and more interest payments which may mitigate the reinvestment risk

OAS has been derived to account for the dispersion and uncertainty associated with this return of principal from MBS

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37

OAS Calculation

M B S

To incorporate prepayment volatility in the valuation of MBS, we can calculate a theoretical price for a given OAS1. Hundreds of hypothetical interest rate paths are simulated2. On each interest rate path the prepayment model is used to predict prepayment speeds and thus,

MBS cashflows3. For each path, the present value of the projected cashflows are calculated using a specified spread,

s, which is added to the forward rates4. Value of MBS = Average value of PV(s) over all simulated interest rate paths

= AVGPV(s) where s is OAS

To find OAS given market price:1. Start with an initial estimate for OAS2. Calculate AGVPV(s) and keep adjusting until AVGPV(s) = market price

Drawback of OAS:1. The spread earned by the investor depends on the actual path realized and can be drastically

different from the OAS2. Wide differences in OASs are produced by different firms models due to different term structures,

volatility assumptions and prepayment projections3. Doesn’t account for dollar roll financing4. Is a “black box” – difficult for investors to decompose OAS into its component parts.

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Pass-through risk measurement (duration)

M B S

Various measures of duration: % change in price for a 1% change in rates.

Modified duration is inappropriate for pass-throughs as it cannot accommodate varying cash flows.

OAD is found by calculating constant OAS prices for parallel curve shifts.

Empirical duration uses actual observations regressed against a Treasury benchmark. Directional/empiricals could be different against different parts of the yield curve.

None of these measures is perfect. We tend to use a combination of them all.

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Pass-through risk measurement (convexity)

M B S

Convexity: the rate at which the duration of a security changes as interest rates change.

– Positive convexity implies that for small, equal and opposite changes in interest rates, the increase in price if rates go down will be more than the decrease in price if rates rise.

– Negative convexity implies that the increase in price if rates go down will be smaller than the decrease in price if rates rise.

– Bullet Treasuries have positive convexity. Pass-throughs typically have negative convexity.

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Negative convexity of mortgages

M B S

80

85

90

95

100

105

-300 -225 -150 -75 0 75 150 225 300Bps

FN 6

Px

($)

FN 6 prices ($) vs shift in rates (bps)FN 6 prices ($) vs shift in rates (bps)

Source: JPMorgan

VA

LU

AT

IO

NA

ND

OA

S

41

Mortgages have embedded options – valuation needs to incorporate vol

M B S

Homeowners have the right to prepay at any time during the life of the mortgage

Consequently, an MBS investor is short many options to the homeowner:

Short LongShort 1m x 1y 1m x 10yLong 5m x 1y 5m x 10y

Underlying

Option

Term structure models are calibrated to the entire vol surface in swaptions

Higher vol should cause mortgages to cheapen

FN 30 Vega FN15 Vega

5.0 -0.21 4.5 -0.091

5.5 -0.26 5.0 -0.123

6.0 -0.27 5.5 -0.145

6.5 -0.23 6.0 -0.111

VA

LU

AT

IO

NA

ND

OA

S

Source: JPMorgan

42

Changes in mortgage market duration can impact the rates markets

M B S

The rate of extension of the mortgage market will slow in a sell-off

A sell-off could cause the curve to steepen

Change in 10-year equivalents for the mortgage market across the curve for a parallel +50 rate shock

Change in 10-year equivalents of the agency fixed rate market for various parallel shifts in rates

-800

-600

-400

-200

0

200

400

-100 -75 -50 -25 0 25 50 75 100

Rate change (bp)

Cha

nge

in 1

0-yr

equ

ivs

($bn

)

-50

0

50

100

150

200

2 5 10 30Tenor10

-year

Equ

iv ($

bn)

VA

LU

AT

IO

NA

ND

OA

S

43

M B S

Market Overview and Origination 1

Demand 12

Mortgage Cashflows and Intro to Prepayments 24

Valuation and OAS 33

TBA Market and Specified Pools

Prepayments Analysis and Reports 44

60

JP

MO

RG

AN

MB

SP

RI

ME

R

Relative Value Trading 78

Case Studies 100

ARMs 111

44

A closer look at turnover

M B S

Existing Home Sales (EHS)

Strong Lock-in

Seasonality and Calendar Effect

Cumulative Home Appreciation (CHPA)

Overall Shorter Baseline Ramp:

Interaction between EHS, CHPA, Lock-in and Aging Ramp successfully captures periods of apparent shorter and longer ramps

In effect lower CHPA lengthens the ramp

Lock-in also lengthens the apparent ramp

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

45

Home price appreciation and discount speeds have been highly correlated…

M B S

87% correlation between discount speeds and the housing strength now

… in the weaker housing environment of 2000, there was no correlation.

Discount Speeds by State (Last 12 mo.) versus HPI in 2005

4

5

6

7

8

9

10

11

12

13

14

0 5 10 15 20 25 30 35 40Home Price Appreciation,%

1-ye

ar C

PR, %

CA

AZ

NYTX

MDVA

MA

OH

MIPA

FLNJ

Discount Speeds by State vs. HPI in 2000

4

5

6

7

8

9

10

11

12

13

14

0 5 10 15 20 25 30 35 40

Home Price Appreciation, %

1-ye

ar C

PR, %

CA

NY

FL

AZ

MA

TX

VA

MD

WA

OH

PAMI

NJ

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

Notes: Deep discount: 75bps or more out of the money; balance weighted average 12-month CPR observed in the past year

46

Seasoning ramps under different HPA assumptions

M B S

0.00.10.20.30.40.50.60.70.80.91.0

1 11 21 31 41 51 61 71 81 91 101 111

WALA

Turn

over

Mul

tiplie

r

0pct hpa 1pct hpa 4pct hpa 8pct hpa

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

Source: JPMorgan

47

Turnover (cont’d)

M B S

Lock-in (disincentive to move)

Captures the relationship between turnover and refinancing “disincentive”

Strong Lock-in. However, home price appreciation can strongly mitigatelock-in

Lock-in (long WAM)

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

1 1.1 1.2 1.3 1.4 1.5 1.6

MtgRate/WAC

Mul

tiplie

r

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

48

Turnover (cont’d)

M B S

Seasonality: Patterns tend to be impacted by weather and school schedules

School schedules and weather conditions are the main reasons for seasonal behavior

There is also a separate “day count” adjustment to account for different collection days in each month

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

49

Economics of refinancing

M B S

• CATO (curve at origination) – borrowers who take out a 30-year mortgage in a steep curve

environment are likely to exhibit slow turnover

• SATO (spread at origination) – high mortgage rates relative to prevailing rates at origination

indicate credit impairment. These borrowers are less likely to refinance

• Loan size – with similar fixed costs for refinancing, borrowers with larger loan sizes are more

likely to refi

• Home price appreciation – higher HPA allows borrowers to “cash-out refi”, or may allow some

borrowers to “cure” and obtain a better mortgage rate with A lower LTV

• Mortgage banking capacity – in large refi waves mortgage bankers may become inundated

with supply, causing mortgage spreads to widen

RE

PO

RT

SA

NA

LY

SI

SA

ND

PR

EP

AY

ME

NT

S

50

The Refinancing Index

M B S

Seasonally-adjusted refinancing indexSeasonally-adjusted refinancing index

0

2,000

4,000

6,000

8,000

10,000

12,000

Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

Source: MBAA

51

Burnout

M B S

0

0.2

0.4

0.6

0.8

1

1.2

10 30 50 70 90 110

130

150

170

190

210

230

250

270

290

310

330

350

370

390

410

430

450

470

490

Cumulative Incentive (bps)

Bur

nout

Mul

tiplie

r

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

Source: JPMorgan

52

Primary differences between GNMA and conventional pools

M B S

Characteristic Conventional GNMA I GNMA II

Assumable No YesPass-through rate 25 to 250bps below loan rate 50bps below 50 to 150bps below loan rateGuarantee fee Negotiated (10 to 25bps) 6bps 6bpsServicing fee 25bps minimum 44bps 44bps minimumMortgage insurance LTVs worse than 80% Mandatory MandatoryExcess servicing Allowed Not allowed AllowedBuy-ups/-downs Allowed Not allowed 10% buy-down allowedDelay days 24 for FNMA, 14 for Golds 14 days 19 daysPrepayment reports Fifth business day Fifth business day Seventh business day

Revised GNMA II pooling guidelines came into effect July 1, 2003.

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

Source: JPMorgan, FNMA, FHLMC, GNMA

53

GNMA prepayments

M B S

Refinancing into conventionals

Servicer buy-out

Higher delinquencies

Rolling 90-days delinquent with only one missing payment;

changed in 2003 to 90-days delinquent

NA

LY

SI

SA

ND

RE

PO

RT

SP

RE

PA

YM

EN

TS

A

54

GNMA delinquencies

M B S

2

4

6

8

10

12

14

Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05

Tota

l Pas

t Due

(%)

Conventional (Prime) VA FHA

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

Source: JPMorgan, MBA

55

Prepayment reports: speeds by origination year

M B S

Source: JPMorgan

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

56

Prepayment reports: speeds by WALA

M B S

Source: JPMorgan

PR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

57

Prepayment reports: speeds by servicer

M B SPR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

Source: JPMorgan

58

Prepayment expectations

M B SPR

EP

AY

ME

NT

SA

NA

LY

SI

SA

ND

RE

PO

RT

S

Source: JPMorgan

59

M B S

Market Overview and Origination 1

Demand 12

Mortgage Cashflows and Intro to Prepayments 24

Valuation and OAS 33

Prepayments Analysis and Reports 44

Relative Value Trading

TBA Market and Specified Pools 60

78

JP

MO

RG

AN

MB

SP

RI

ME

R

Case Studies 100

ARMs 111

60

TBA pass-through market

M B S

TBA = “To Be Announced”. Essentially, a cheapest-to-deliver market (like a futures contract). Most liquid market.

As with other delayed delivery transactions, a seller agrees to issue a TBA security at a future date. However, in a TBA trade, the seller and the buyer do not identify the specific underlying mortgage pools, simply certain pre-specified terms

TBAs are identified by agency, term, coupon, settle month, and traded on a dollar-price basis

“Cheapest-to-deliver” gives the seller a delivery option that the buyer is short

Standardized delivery dates (see Bloomberg TDAT).

Settles once a month like a futures contract

Delivering pools: seller must provide pool information by 3 p.m. 2 business days prior to

settlement (48-hour day).

Variance: the amount by which the face value at delivery can vary from the amount

specified at the time of the trade, expressed as a percentage of the initial face value

requested. The Bond Market Association suggests 0% variance on all TBA tradesET

AN

DS

PE

CI

FI

ED

PO

OL

ST

BA

MA

RK

61

Bloomberg Generic TBA Tickers

M B STB

AM

AR

KE

TA

ND

SP

EC

IF

IE

DP

OO

LS

62

Dollar rolls

M B S

Dollar rolls are transactions where an institution sells mortgage

backed securities with a commitment to buy similar, but not identical,

mortgage backed securities on a future date at a lower price.

In the case of mortgage pass-throughs, “similar” securities refers to

securities with the same coupon, security type, and mortgage

collateral.

Dollar rolls offer an attractive means of borrowing at a low cost

primarily because they allow dealers to cover their short positions.

SP

EC

IF

IE

DP

Dollar rolls offer dealers a convenient way to obtain promised

mortgage securities, avoiding the higher costs of failing to deliver.

AR

KE

TA

ND

OO

LS

TB

AM

63

TBA transactions: evaluating dollar rolls

M B S

Drop

Coupon

Prepayments

Delivery optionality

Re-investment rateSP

EC

IF

IE

DP

OO

LS

TB

AM

AR

KE

TA

ND

64

TBA transactions: evaluating dollar rolls

M B STB

AM

AR

KE

TA

ND

SP

EC

IF

IE

DP

OO

LS

Source: Bloomberg

65

Price spreads influence coupon production

M B S

TBA 6.0% TBA 6.5%Mortgage note rate (a) 6.88 6.88Less agency guaranty fee (b) 0.15 0.15Retained servicing spread (c) 0.25 0.25Remaining note rate (a-b-c) 6.48 6.48Excess servicing (a-b-c-e) 0.48 0.00Buydown of Guaranty Fee (%) 0.00 0.03Cost to buydown guaranty fee (d) 0.00 0.12Desired MBS coupon (e) 6.00 6.50Market price of MBS (f) 98.05 100.13Adjustment to TBA price for low WAC (g) 0.00 0.03Price adjusted for cost of buydown (f+g-d) 98.05 100.04Value of excess servicing (h) 2.09 0.00Price adjusted for servicing value (f+g+h) 100.14 100.04

TB

AM

AR

KE

TA

ND

SP

EC

IF

IE

DP

OO

LS

Note: Prices are for illustration purposes only

Source: JPMorgan

66

The many dimensions of specified pools

M B S

WALA

FICO

Low WAC

Low loan balance (LLB)

Geographic

Prepayment penalty

Relocation

Originator

OO

LS

High LTVPT

BA

MA

RK

ET

AN

DS

PE

CI

FI

ED

67

What are specified pools?

M B S

DefinitionFixed-rate pass-throughs that do not trade in the TBA market.

TBA eligible specified poolsPass-throughs with attributes which make them more valuable than generics.Attributes

WALA (Age)WACLoan SizeGeographyCredit Score (FICO) / LTVOccupancy

TBA prices are the floorsQuoted at “pay-ups” to TBAs

Non-TBA eligible poolsCan trade at lower dollar prices than TBAs due to lack of deliverability.Strong structured demand can lead to prices that exceed TBA prices.

Example: relocation mortgages (faster turnover as discounts)

PO

OL

SI

FI

ED

TB

AM

AR

KE

TA

ND

SP

EC

68

Why Specified Pools ?

M B S

TBA delivery riskCheapest to deliver TBA pools have the worst prepayment convexity.

They are usually far worse than the generic cohort.

Improve ConvexityCall protection

Extension protection

Improve CarrySlower peak speeds on premiums & faster peak speeds on discounts translate to better net coupon return (carry): coupon income and gain/loss from return of principal at par.

New origination premiums: they provide better return during the first 6 to 12 months as it takes time for prepayments to reach their peaks.

PO

OL

ST

BA

MA

RK

ET

AN

DS

PE

CI

FI

ED

69

Extension Protection

M B S

SeasoningHigher up on the prepayment aging ramp

Closer to maturity date

Longer home tenure (the average home tenure in the U.S. is 7 years)

High accumulated home equity

Low Loan BalanceLess “lock-in” – i.e. less disincentive to move due to higher mortgage rates

Low Credit / High LTVBorrowers are typically first time home buyers with shorter horizon, leading to faster turnover

S

Credit curing

OO

L

Fast prepaying statesP

California speeds were 50% or more faster than the generic cohort

IF

IE

D

OthersC

Relocation MortgagesSP

E

Shorter amortization securities, e.g. 20-year, 25-year mortgagesND

TB

AM

AR

KE

TA

70

Call Protection

M B S

Seasoned PremiumsMore stable prepayment profile

“Burnout” leads to lower refinancing response— Borrowers are less reactive to similar levels of interest rate incentive

Low Loan BalanceLow loan sizes dampen borrowers’ incentive to refinance due to relatively high fixed cost versus lower monthly savings

GeographyDifferences in state-level prepayments are due to— Tax, such as New York’s mortgage recording taxS

— Home price appreciation - strong HPA affects the level of turnover and/or cash-out refinancing

Credit-constrained / Alt-ACredit constrained borrowers (low FICO and/or high LTV) should have lower refinancing options. However through credit curing they can prepay faster than comparable generics when they are fully seasoned.S

PE

CI

FI

ED

Prepay Penalty Pools

AN

D

Not TBA eligible, trade at a concession to TBA

TB

AM

AR

KE

TP

OO

L

71

A New Asset Class: Fixed Rate Initial Interest (“IO”) Pools

M B S

Definition

10/20 – a 30-year mortgage with 10-years of interest only payments. Amortizes from year 11 through 30.

15/15 – a 30-year mortgage with 15-years of interest only payments. Amortizes from year 16 through 30.

Issuance:

10-fold increase since the summer of 2005

Combined monthly issuance by Fannie Mae & Freddie Mac increased from under $100 million in the summer of 2005 to almost $3 billion in February 2006.

Over 90% of fixed rate IOs are 10/20s.

Eligible for Agency CMOs: strong bids from dealer desks.

Borrower characteristics

Credit profiles are similar to the regular amortizing pools (715 FICO, 74% LTV).

Average loan sizes comparable to regular amortizing pools.

All single family & predominantly owner occupied residences (> 95%).

Recent issues have > 70% share of refinancing loans.

Affordability product, most often used by younger and more mobile borrowers.

PO

OL

ST

BA

MA

RK

ET

AN

DS

PE

CI

FI

ED

72

Specified pools make up roughly 80% of the mortgage market

M B S

Spec pool market compositionSpec pool market composition

New TBA

20%

Seasoned

(>30 WALA)

49%

New

Specified

4%

Moderate

(13-30

WALA)

27%

Source: JPMorgan

TB

AM

AR

KE

TA

ND

SP

EC

IF

IE

DP

OO

LS

Total = $2.814 trillion

Data is as of May 2006

73

What are specified pools?

M B S

DefinitionPools that have more valuable loan level attributes than generic TBA delivery

TBA eligible specified poolsTBA prices are the floorsQuoted at “pay-ups” to TBAsAttributes

WALA (Age)WACLoan SizeGeographyCredit: low FICO and/or high LTVOccupancy: e.g. investment property, second homeLoan Purpose: refinancing, purchase

Non-TBA eligible poolsLiquidity premium: can trade at lower dollar prices than TBAs due to lack of deliverabilityStrong structured demand can lead to prices that exceed TBA prices

Example: relocation mortgages (faster turnover as discounts)

PO

OL

SI

FI

ED

TB

AM

AR

KE

TA

ND

SP

EC

74

Why Specified Pools ?

M B S

Avoid “cheapest to delivery” TBAsTBA pools are assumed to have the worst prepayment convexity

… they will consist of faster than average premiums and slower than average discounts

ConvexityCall protection

Extension protection

Carry and SpreadSpecified pools are often priced at a fraction of their fair value; they can provide more spread and/or carry than TBAs

New origination premiums: they provide better return during the first 6 to 12 months as it takes time for prepayments to reach their peaks

PO

OL

ST

BA

MA

RK

ET

AN

DS

PE

CI

FI

ED

75

New issue specified pools report

M B STB

AM

AR

KE

TA

ND

SP

EC

IF

IE

DP

OO

LS

Source: JPMorgan

76

Seasoned specified pools report

M B STB

AM

AR

KE

TA

ND

SP

EC

IF

IE

DP

OO

LS

Source: JPMorgan

77

M B S

Market Overview and Origination 1

Demand 12

Mortgage Cashflows and Intro to Prepayments 24

Valuation and OAS 33

Prepayments Analysis and Reports 44

TBA Market and Specified Pools 60

JP

MO

RG

AN

MB

SP

RI

ME

R

Case Studies

Relative Value Trading 78

100

ARMs 111

78

Relative value strategies and analysis

M B S

Trading StrategiesTrading Strategies Evaluation ApproachesEvaluation Approaches

Mortgage - Swap basis

Mortgage - Tsy basis

Coupon swap

15s / 30s

Ginnie / Fannie

TBA / Seasoned

Agency / Non-agency

Pass-through / ARM

CMO / Collateral

OAS

Spread

Hedge-Adj Carry

Regressions

Deliverable

Sponsorship

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

79

Where to find JPMorgan MBS data

M B S

Factor Where to find itSupply Net supply MRV charts, Dataquery

Gross supply MRV charts, Daily Packet, DataqueryDemand Banks Federal Reserve Website

JPM quarterly bank report

Agencies Fannie, Freddie website

Dealers Bloomberg (PDPPMORT <index>)

Non-US investors TIC dataPrepayments by WALA, servicer, etc. JPM Monthly Prepay Appendix

MorganMarkets.comOAS TBAs Current

Specifieds, strips, hybrids, etc Daily packetCoupon swap history Daily packetHedge adjusted carry Daily packet (soon)Volatility swaption premiums, bp vol Daily packet, DataqueryRegression Historical OAS by relative coupon JPM trading bloomberg

Coupon swaps, butterflies MBS AnalyzerMBS Index/performance Performance by coupon vs swaps and Treasuries Index Monitor

DataqueryDaily packet TBA Performance ReportDataquery

Other Analytics/historical data Daily packetMBS Analyzer

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

80

Mortgages have widened back to the widest levels since the beginning of the year – but are they fundamentally cheap?

M B S

30-year current coupon OAS (bps)

(30)

(20)

(10)

0

10

20

30

40

50

60

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

Source: JPMorgan

81

Declining long-dated vol has caused nominal spreads and OAS to diverge

M B S

OAS vs. CC ZV spread (bps)

(20)

(15)

(10)

(5)

0

Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06

50

60

70

80

OAS ZV spreadCurrent coupon OAS has been relatively stable, while nominal spreads have continued to tighten recently …

3YX10Y swaption premium (bps)… Declining long-dated vol has been the driver

Source: JPMorgan

375

385

395

405

415

425

435

445

455

465

475

Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06

3Yx1

0Y S

wap

tion

Pre

miu

m (

bps)

82

GR

EL

AT

IV

EV

AL

UE

TR

AD

IN

Mortgage / Swap basis

M B SRE

LA

TI

VE

VA

LU

ET

RA

DI

NG

83

30- and 15-year current coupon OAS

M B SRE

LA

TI

VE

VA

LU

ET

RA

DI

NG

84

JPMorgan MBS Index

M B S

The JPMorgan Mortgage Index (“the Index”) measures the performance of fixed-rate agency-backed mortgage pass-through securities

• Included:

– Thirty-year and 15-year fixed-rate pass-through securities issued by FNMA, FHLMC, and GNMA

• Excluded:

– ARMs

– Non-Agency (whole loan), Jumbo, and 10- or 20-year securities

– Balloons, GPMs, and TPMs

– FHLMC 75-day delay mortgages

– FNMA Mega, FHLMC Giant, and GNMA Platinum pools

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

85

JPMorgan MBS Index

M B S

Due to paydowns and new pool issuance which are reported monthly, the mortgage universe undergoes monthly transformations

JPMorgan re-balances the Index automatically to reflect the changing compositions of the mortgage market. Once a month, on the last business day of the month, all the pools represented in the Index are re-aggregated for use next month

At the end of each business day, JPMorgan trader marks are used to price all the constituent securities in the Index

Traders mark benchmark issues (TBAs) and specified pools

Algorithm is used to price securities that are not actively traded

ET

RA

DI

NG

RE

LA

TI

VE

VA

LU

86

Mortgage Index returns

M B SRE

LA

TI

VE

VA

LU

ET

RA

DI

NG

Source: Bloomberg

87

Index Composition

M B S

Index composition in June 2006, par weighted (%) and month/month changes in 10-year equivalents ($bn)Index composition in June 2006, par weighted (%) and month/month changes in 10-year equivalents ($bn)

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

Source: JPMorgan

88

Index Performance

M B S

Index duration and convexity profile, as of 5/31/06Index duration and convexity profile, as of 5/31/06

Index statistics, May 31st, 2006Index statistics, May 31st, 2006 Index statistics, May 31st, 2006Index statistics, May 31st, 2006

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

89

Index Performance

M B S

Index returns and excess returns by sector and coupon (bps), in May 2006Index returns and excess returns by sector and coupon (bps), in May 2006

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

90

MBS Fixed-Rate Daily Analytics

M B S

COB June 9, 2006

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

91

Hedge-adjusted carry

M B S

We introduce a hedge-adjusted carry methodology which provides a short-

term (1- to 2-month) measure of performance using rather

straightforward calculations

Option-adjusted spreads serve as a long-term spread measure and assume

vega hedging, among other risk measures

It serves as a good complement to OAS valuations, capturing the return

for taking duration and convexity risks

Essentially, hedge-adjusted carry gives us the net carry of holding a TBA

after hedging for duration and adjusting for convexity hedging costs

Higher carry could suggest overweighting certain coupons. However, this

valuation ignores other risks like vega and mortgage Libor spread

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

92

Hedge-adjusted carry components

M B S

The valuation incorporates factors such as the roll, hedge ratios, durations,

convexities. Specifically, the main components of the analysis are:

Swap Hedge Ratios (using partial durations).

Duration Hedged Carry

Total Negative Convexity

Convexity Hedging Cost

RE

LA

TI

VE

VA

LU

ET

RA

DI

NG

93

Hedge-adjusted carry components

M B S

We hedge three partial durations on the swap curve (2-yr, 5-yr and 10-yr) with the cost being the carry and rolldown on each of the swaps

To figure out the duration adjusted carry we simply calculate:

Duration Hedged Carry= TBA roll – ∑(cost of swap hedge)

Cost of swap hedge = hedge ratio * swap carry

In calculating total convexity cost, we incorporate swap convexity since we are long MBS and short swaps (which are positively convex)

Total Convexity = MBS convexity – swap convexity

We can estimate the convexity cost using short-dated swaption implied vols (1-month x 10-year swaptions)

TBA Passthroughs - 30 Year ConventionalsRoll

(32nds)Dur Hedged

CarrySec Price .. (32nds)FN 30 4.5 91-00 1.25 .. 0.1FN 30 5.0 93-29 1.87 .. 0.8FN 30 5.5 96-12 2.25 .. 1.2FN 30 6.0 98-25+ 3.00 .. 2.1FN 30 6.5 100-29 3.25 .. 2.6FN 30 7.0 102-14+ 2.00 .. 1.5

TBA Passthroughs - 30 Year ConventionalsRoll

(32nds)Dur Hedged

CarryCnv. Hedging

CostHedge Adj.

CarrySec Price .. (32nds) (32nds) (32nds)FN 30 4.5 91-00 1.25 .. 0.1 -0.7 -0.6FN 30 5.0 93-29 1.87 .. 0.8 -1.1 -0.4FN 30 5.5 96-12 2.25 .. 1.2 -1.6 -0.4FN 30 6.0 98-25+ 3.00 .. 2.1 -1.9 0.3FN 30 6.5 100-29 3.25 .. 2.6 -2.1 0.4FN 30 7.0 102-14+ 2.00 .. 1.5 -2.1 -0.6

( ) 3222122

21 ∗∧⎥

⎦

⎤⎢⎣

⎡∧∗⎟⎟

⎠

⎞⎜⎜⎝

⎛∗ days

daybpC

VA

LU

ET

RA

DI

NG

RE

LA

TI

VE

Source: JPMorgan (as of June 1, 2006)

94

Hedge Adjusted Carry Report

M B S

New York J.P. Morgan Securities Inc.Jun 05, 2006 MBS Research

(1-212) 834-3121MBS Research morganmarkets.jpmorgan.com

MBS Hedge Adjusted Carry

TBA Passthroughs - 30 Year Conventionals Settle Dates Spot = [Jun-13-2006], 1M = [Jul-13-2006], 2M = [Aug-14-2006]

TotalSec Price 1m 2m OAD OAS 2Y 5Y 10Y 1m 2m Cnvx 1m 2m 1m 2mFN 30 4.5 91-21 1.25 2.25 6.0 -5 0.21 0.32 0.49 0.3 0.6 -1.2 -0.8 -1.6 -0.4 -1.0FN 30 5.0 94-16+ 1.87 3.37 5.5 -6 0.28 0.33 0.42 1.0 1.8 -1.9 -1.2 -2.5 -0.2 -0.6FN 30 5.5 96-29+ 2.12 4.12 4.8 -7 0.37 0.32 0.34 1.3 2.7 -2.4 -1.6 -3.2 -0.3 -0.5FN 30 6.0 99-07+ 3.00 6.00 3.8 -9 0.49 0.25 0.23 2.4 4.9 -2.8 -1.8 -3.7 0.6 1.2FN 30 6.5 101-05+ 3.25 6.50 2.9 -1 0.51 0.20 0.15 2.7 5.7 -3.2 -2.0 -4.2 0.7 1.5FN 30 7.0 102-19 2.00 4.00 1.9 0 0.51 0.11 0.07 1.7 3.5 -2.9 -1.9 -3.9 -0.2 -0.4

TBA Passthroughs - GNMA I 30 Years Settle Dates Spot = [Jun-19-2006], 1M = [Jul-18-2006], 2M = [Aug-17-2006]

TotalSec Price 1m 2m OAD OAS 2Y 5Y 10Y 1m 2m Cnvx 1m 2m 1m 2mGN 30 4.5 92-29 2.00 4.00 5.4 -6 0.24 0.30 0.42 1.2 2.6 -1.2 -0.7 -1.5 0.5 1.1GN 30 5.0 95-26+ 2.00 4.00 5.2 -23 0.29 0.32 0.40 1.2 2.6 -1.8 -1.1 -2.3 0.1 0.3GN 30 5.5 97-31 2.50 5.00 4.8 -20 0.37 0.32 0.34 1.8 3.8 -2.4 -1.5 -3.1 0.3 0.7GN 30 6.0 100-06+ 2.50 5.00 3.7 -20 0.47 0.26 0.22 1.9 4.0 -2.9 -1.8 -3.7 0.2 0.3GN 30 6.5 102-03 3.00 6.00 2.3 -21 0.50 0.17 0.09 2.7 5.5 -2.7 -1.7 -3.5 1.0 2.0GN 30 7.0 103-14 0.00 0.00 1.4 -31 0.52 0.09 0.01 -0.2 -0.3 -2.3 -1.4 -3.0 -1.6 -3.2

TBA Passthroughs - 15 Year Conventionals Settle Dates Spot = [Jun-21-2006], 1M = [Jul-20-2006], 2M = [Aug-21-2006]

TotalSec Price 1m 2m OAD OAS 2Y 5Y 10Y 1m 2m Cnvx 1m 2m 1m 2mFN 15 4.0 93-00 0.50 1.00 4.3 -1 0.30 0.35 0.25 -0.1 -0.1 -1.0 -0.6 -1.3 -0.7 -1.3FN 15 4.5 95-06+ 0.75 1.25 4.3 -15 0.34 0.35 0.25 0.1 0.2 -1.3 -0.8 -1.7 -0.7 -1.5FN 15 5.0 97-01 1.75 3.75 4.0 -15 0.40 0.33 0.22 1.1 2.7 -1.7 -1.1 -2.2 0.1 0.5FN 15 5.5 98-28+ 2.00 4.00 3.4 -14 0.48 0.28 0.17 1.5 3.1 -2.1 -1.3 -2.8 0.2 0.4FN 15 6.0 100-26 3.50 6.50 3.0 -8 0.48 0.23 0.14 3.0 5.8 -2.1 -1.3 -2.7 1.7 3.0FN 15 6.5 101-28 2.00 4.00 2.2 5 0.51 0.18 0.06 1.7 3.5 -1.8 -1.1 -2.3 0.6 1.2

Rolldown and Carry of Swaps between settlesSwap 1m 2m Dur2Y 0.29 0.36 1.895Y 0.82 1.46 4.3810Y 1.25 2.32 7.68

Hedge Adj. Carry(32nds)

Roll(32nds) Hedge Ratio / Swap

Dur Hedged Carry(32nds)

Cnv. Hedging Cost(32nds)

Hedge Adj. Carry(32nds)

Roll(32nds) Hedge Ratio / Swap

Dur Hedged Carry(32nds)

Cnv. Hedging Cost(32nds)

Hedge Adj. Carry(32nds)

Roll(32nds) Hedge Ratio / Swap

Dur Hedged Carry(32nds)

Cnv. Hedging Cost(32nds)

RE

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95

Performance vs. swaps and Treasuries

M B SCOB June 9, 2006 96RE

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MBS Issuance Report

M B SRE

LA

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VA

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97

MBS coupon price spread

M B SRE

LA

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Source: JPMorgan

98

MBS butterfly price spread

M B SRE

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Source: JPMorgan

99

M B S

Market Overview and Origination 1

Demand 12

Mortgage Cashflows and Intro to Prepayments 24

Valuation and OAS 33

Prepayments Analysis and Reports 44

TBA Market and Specified Pools 60

JP

MO

RG

AN

MB

SP

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Relative Value Trading 78

ARMs

Case Studies 100

111

100

Case Study #1: FNMA 6.5s – The Deliverable

M B S

Aggregate 1-month speeds on TBA 6.5s (3-17 WALA) for different delivery size (based on Apr prepayments)

2030405060708090

100

0 1000 2000 3000 4000 5000 6000Balance, $mil

1mo

CPR,

%

Distribution of 1-mo speeds on 3-17 WALA FNMA 6.5s, (April 2006)

0

500

1000

1500

2000

2500

60+ 50-60 40-50 30-40 20-30 10-20 0-10CPR Range

Bala

nce,

$m

il

•There are still a lot of fast pools available in TBA 6.5s

Over $400mm TBA 6.5 pools prepaid above

60CPR

The relationship between delivery size and paydown cost is non-linear; smaller trades

are far more exposed to adverse selection

CA

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101

Case Study #1: FNMA 6.5s – Issuance and supply

M B S

•FN 6.5 supply should be robust

FN 6.5Issuance Projection ($bn)

Apr-06 3.8 May-06 5.1 Jun-06 6.7 Jul-06 8.9

FNMA 30-year relative coupon issuance Issuance by coupon as a % of total FNMA 30

year issuance

(10)%

0%

10%

20%

30%

40%

50%

% o

f FN

30

Issu

ance

(1.00) (0.50) 0.00 0.50 1.00 1.50 2.00Relative coupon

R2 = 0.8793R2 = 0.8045

(1,000)

2,000

5,000

8,000

11,000

14,000

17,000

(1.00) (0.50) 0.00 0.50 1.00 1.50 2.00

Relative Coupon

FN 3

0-yr

Issu

ance

($M

M)

Source: JPMorgan, FNMANote: Since September 2005

Source: JPMorgan, FNMANote: Monthly issuance of FN 5s through 6.5s plotted as relative

coupons vs CC, since September 2005

F N 6 .5Issu a n ce P r o je c tio n ( $ b n )

A p r - 0 6 3 .8 M a y - 0 6 5 .1 Ju n - 0 6 6 .7 Ju l- 0 6 8 .9

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Case Study #1: FNMA 6.5s – Fundamentals

M B S

(14)

(12)

(10)

(8)

(6)

(4)

(2)

00 4 8 12 16 20

40

50

60

70

80

90

100

110

OAS SATO

Short WALA 6.5s have tight OAS and low SATOOAS (left axis, bps) and SATO (right axis, bps) on FN 6.5s by WALA (in months)

•FNMA 6.5s: New

issue pools have

worse loan

characteristics than

more seasoned

pools

Source: JPMorgan, FNMA

FNMA 6.5s are fair fundamentallyLIBOR static spread of FNMA 6.5s by CPR, in bp

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CPR10 20 30 40 50

101—01 73 60 44 25 2

103

Case Study #2: DW 4.5s – Regressions

M B S

Rich / cheap of the Dwarf 5 / 4.5 swapThe Dwarf 5 / 4.5 is cheap historically

Residual of Dwarf 5 / 4.5 swap vs 15-year current coupon yield, in ticks

Jun06-8

-2-4-6

02468

10

Feb06 Apr06

Dwarf 5/4.5 swap (y-axis, in ticks) versus 15-year CC yield (x-axis, %)

60

50

45

65

70

5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9

55

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104

Case Study #2: DW 4.5s – Fundamentals

M B S

0

2

4

6

8

10

12

1 3 5 7 9 11 13 15 17 19 21 23WALA (mos)

1-m

o C

PR

(%)

02468101214161820

Cum

ulat

ive

Bala

nce

($ B

)1mo CPR

Cum bal

0

2

4

6

8

10

12

14

1 3 5 7 9 11 13 15 17 19 21 23WALA (mos)

1-m

o C

PR

(%)

0

5

10

15

20

25

30

35

Cum

ulat

ive

Bal

ance

($ B

)1-mo CPR

Cum Bal

Dwarf 5s are fundamentally cheaper than Dwarf 4.5s.LIBOR static spread on Dwarf 4.5s and 5s by CPR

Price 6 CPR 7 CPR 8 CPR 9 CPR 10 CPRDwarf 4.5s 95-08 -7 -3 1 6 10Dwarf 5s 96-31 6 9 11 14 17

LIBOR Static Spread (bp)

Outstanding balance and 1-month CPR

of Dwarf 4.5s by WALA

Outstanding balance and 1-month CPR

of Dwarf 5s by WALA

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Case Study #3 (Seasoned pricing): Lower the dollar price, higher the price spread between seasoned and new WALA pools

M B S

Payups by WALA vs. TBA Price

WALA

0

2

4

6

8

10

12

14

0 5 10 15 20 25 30 35

Pay

up, 3

2nd

$96 $97 $98

Pricing assumptions:1. 24-month aging ramp2. Peak speed of 9% CPR for $96 TBA3. Peak speed of 10% CPR for $97 TBA4. Peak speed of 11% CPR for $98 TBA

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Case Study #3 (Seasoned pricing): Peak speeds versus the length of the ramp

M B S

Payups by WALA vs. peak speed ($97 TBA, 24-mo ramp)The peak speed plays an

insignificant role when pricing seasoned pools

(Payup versus TBA assuming constant LIBOR static spread)

0.0

2.0

4.0

6.0

8.0

10.0

12.0

0 5 10 15 20 25 30 35WALA

Payu

p, 3

2nd

10CPR 11CPR9CPR

Payups by WALA vs. aging ramp ($97 TBA price)

02468

101214

0 5 10 15 20 25 30 35WALA

Payu

p, 3

2nd

34mo ramp 24mo ramp 14mo ramp

However, the length of seasoning ramp is crucial

A longer seasoning ramp leads to higher payups for seasoning

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Case Study #3: Aging ramp on moderate discount collateral

M B S

Moderate discounts have two peaks: 14 months and 24 months

The 24 months peak is driven by

Tax-advantaged capital gains treatment of two-year old primary residences

Cash-out refinancing has been front-loaded

Aging curve: moderate discount, -25 to -75bps incentive

0

4

8

12

16

1mo

CP

R, %

Age0 5 10 15 20 25 30 35 40

2000~20012005~2006

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Note: Average prepayment aging curves observed from 2000 to 2001 and from 2005 to March 2006

108

Case Study #3: Specified Pools WALA- Actual versus theoretical payup

M B S

Seasoned payups suggest that the market is priced to a 24 months ramp

Potential lengthening of the aging ramp should translate to higher payups for seasoned discounts

Relative value advantage in the’04 discounts versus the ’03s

FNMA 5: Actual vs. theoretical FNMA 5.5: Actual vs. theoretical

02468

1012141618

5 10 15 20 25 30 35WALA

Payu

p, 3

2nd

’05–’06 ramp (24-mo.) ’00–’01 ramp (34-mo.)

02468

10121416

0 5 10 15 20 25 30 35WALA

Payu

p, 3

2nd

24-mo. ramp 14-mo. ramp34-mo. ramp

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Note: As of: 5/3/2006; FNMA 5s are priced to 9% CPR terminal speed; FNMA 5.5s are priced to 10% CPR terminal speed

109

Case Study #4: Specified Pools LLB – Call/extension protection

M B S

The trend points to faster LLB discount speeds similar to 1999-2000Prepayment S-Curve differences (LLB (<$100k) minus generics ($>150k)), in 1999-2000, 2004, 2005 and since fall 2005: 1mo CPR vs. Rate Incentive,bps.

-3

-2

-1

0

1

2

-125 -100 -75 -50 -25

Incentive, bps

1moCPR1999~2000 20042005 2005 Oct~2006 Apr

Low loan balance discounts are priced at a small fraction of their combined call and extension value.

Payups and model valuations of MLB ($110k max) pools

TBA MarketCall

Protection 10% Faster Turnover 20% Faster TurnoverCoupon Price Payup Payup Ext. Protection Total Ext. Protection Total

FNCL 5 94-05 0.5 2 9 11 17 19FNCL 5.5 96-22+ 1.5 3 6 9 11 14FNCL 6 99-05 4 7 4 11 7 14

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110

M B S

Market Overview and Origination 1

Demand 12

Mortgage Cashflows and Intro to Prepayments 24

Valuation and OAS 33

Prepayments Analysis and Reports 44

TBA Market and Specified Pools 60

JP

MO

RG

AN

MB

SP

RI

ME

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Relative Value Trading 78

Case Studies 100

ARMs 111

111

M B SAR

MS

112

ARM share has remained close to half of total applications

M B S

ARM share of total applications by $ volume (%)ARM share of total applications by $ volume (%)

0

10

20

30

40

50

60

Jun-97 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06

ARM

Sha

re o

f Ap

ps b

y $

Volu

me

(%)

Source: MBA

AR

MS

113

Hybrids contributed to most of the growth of the non-agency market

M B S

Year-end outstandings ($ billions)Year-end outstandings ($ billions)

0

100

200

300

400

500

600

700

800

200620052004200320022001200019991998

Jumbo Fixed Jumbo ARM Alt-A Fixed Alt-A ARM

Source: JPMorgan, Loan Performance. 2006 data as of April.

AR

MS

114

Hybrid ARM Structure and Valuation

M B S

ExampleExampleStructureStructure

Typically 30-year terms

Fixed Rate Cash-Flows3, 5, 7,10 Year Fixed-Rate

Hybrid ARM TailsLibor/CMT Floaters

Resets subject to Caps (initial/periodic/life)

2/2/6

5/2/5

5/1 Hybrid ARM borrower with an initial coupon rate of 4.5% and a 5/2/5 cap structure pays 4.5% for 5 years

The highest the borrower’s rate can reset after the 5 year fixed rate period ends is (4.5%+5%), or 9.5%

The on-going periodic cap restricts the borrower from resetting up more than 2% at each yearly reset

The life cap also protects the borrower by ensuring that the coupon cannot reset above 9.5% for the life of the loan

AR

MS

115

Hybrid ARM Key Terminology

M B S

Rate caps (initial, periodic, and lifetime) offer protection from large interest rate movements by providing a cap and a floor, limiting the amount the resetting contract rate can increase or decrease on each adjustment date

The initial adjustment cap provides a cap and floor on the interest rate at the first adjustment date

Periodic adjustment caps restrict upward and downward movements at each subsequent reset date

Lifetime caps dictate the maximum interest rate of the mortgage loan at any given time

MTR (months to reset) is defined as the number of months until the Hybrid ARM resets off its specified Index. In other words, the number of months until the fixed rate portion of the bond ends

Once a Hybrid ARM loan reaches reset, the borrower’s new coupon is determined off a specified index

The most popular indices are LIBOR and CMT

The gross margin is the spread added to the Index that determines the mortgage holder’s new rate

The net margin is what is passed on to the investor. The net margin is the spread added to the Index that determines the coupon the investor receives. Typically, unless otherwise specified, LIBOR-indexed ARMs have approximately 175bps net margin, while CMT-indexed bonds have approximately 225bps margin

AR

MS

116

How are Non-Agency MBS Valued and Traded

M B S

Non Agency MBS do not trade ‘in the screens’ thus valuation and pricing levels reflect this uncertainty

Trading is Negotiated around structure, settlement and collateral composition

Relative Value and performance analytics help drive trading levels

Pricing Conventions

N-A Fixed Rates; Pass throughs relative to agency pass throughs

N-A ARMs : Swaps, Treasuries

Prepayment Analytics

OAS Methodology : Prepayment Modeling

Credit Analytics

Liquidity Premiums

AR

MS

117

M B SAR

MS

118