Charlotte ACC Lunch-N-Learn Roundtable P

Charlotte ACC Lunch-N-Learn RoundtablePresentsThe “Subprime Crisis” and Housing Slowdown:  2008 Forecast and the Search For Solutions : 

Charlotte ACC Lunch-N-Learn RoundtablePresentsThe “Subprime Crisis” and Housing Slowdown:  2008 Forecast and the Search For Solutions Donald C. Lampe Womble Carlyle Sandridge & Rice, PLLC Charlotte, NC (704)350-6398 dlampe@wcsr.com January 22, 2007

SUBPRIME CRISIS? : 

SUBPRIME CRISIS? Just what do we mean? How did it happen? Who are the players? What is unique about it? What is the state of play now? What will happen in the future?

WHAT IS THE SUBPRIME CRISIS? : 

WHAT IS THE SUBPRIME CRISIS? Shorthand for contraction in availability of residential mortgage credit, particularly for less-than-creditworthy borrowers Not just consumers, but business related to home mortgage credit, including homebuilders Revaluation of mortgage-related assets (incl. derivatives) by banks, investment banks, hedge funds, others

WHAT IS THE SUBPRIME CRISIS? - cont’d : 

WHAT IS THE SUBPRIME CRISIS? - cont’d Stricter underwriting practices, meaning fewer loans will be made to consumers, others As < credit for refinancing, consumers squeezed financially, not just on mortgage loans Centered on “subprime” market – performance on prime/conventional market still good by historic measures

Definition of Subprime? : 

Definition of Subprime? No true legal definition, more of term of art based on “channel” of lending Higher-cost credit made available to borrowers with impaired or “thin” credit or other unique circumstances Made possible by credit scoring, automation and secondary markets Traditionally came from finance companies and FHA (banks)

GROWTH IN SUBPRIME : 

GROWTH IN SUBPRIME Subprime loans 20% of market in 2006, up from 9% in 2003 Over $1 Trillion outstanding Facilitated by 2’ndary market – funded thru private label or non-agency securitizations (RMBS) GSE’s – Fannie, Freddie, FHLB’s - not primary drivers

SUBPRIME GROWTH:DISINTERMEDIATION : 

SUBPRIME GROWTH:DISINTERMEDIATION Secondary market “fed” by (mostly) non-bank originators Mortgage broker → wholesale lender → aggregator/investment bank → securitization trust → bondholders Wholesale lenders funded by warehouse lines of credit (inventory financing) Each step: legal recourse

THE “PIPELINE” : 

THE “PIPELINE” Became “clogged” in 2007 – began with rating agency downgrades in early 2007 Actually, running in reverse, w/ repurchase and repo demands back up the chain Many of wholesale originators either bankrupt or out of business Subprime loans (funding) much harder to get – private securitizations have ceased

CHARACTERISTICS OF SUBPRIME “BOOM” : 

CHARACTERISTICS OF SUBPRIME “BOOM” Post 9/11/01 low interest rates and product innovation Capital from Wall Street – “irrational exuberance” and financial engineering Underwriting standards relaxed as means of expanding market share “Risk layering” and failure of risk assessment

RISK LAYERING : 

RISK LAYERING At loan level, lower credit scores (subprime) combined with high LTV, no doc/low doc, ARM’s ARM products, such as 2/28’s and POA’s, broadly offered to subprime borrowers Loans made available for “dot com” type speculation by (small) investors Wall Street incapable of pricing to the risk

FINANCIAL ENGINEERING : 

FINANCIAL ENGINEERING Mortgage assets grew at incredible pace, and Wall Street found new ways to offer “piece of the action” to investors Investment banks captured fee income at many stages Derivatives and derivatives of derivatives Many of the “sophisticated” products based on same models

ASSUMPTIONS PRIOR TO “MELTDOWN” : 

ASSUMPTIONS PRIOR TO “MELTDOWN” Risk-based pricing of subprime loans and of financial instruments backed by loans Continued low-rate environment and home price appreciation continue to rise Borrowers would be able to refinance or sell their way out “Healthy economy” and continued demand worldwide for RMBS and related assets

WHERE ARE WE NOW? : 

WHERE ARE WE NOW? Early 2008, haven’t hit “bottom” yet Financial institutions still struggling with valuation of assets Full extent of potential losses not known, particularly counterparty risk in credit default swaps ($41 Trillion) “Worldwide liquidity crisis” keyed to realization that market overheated

WHERE ARE WE NOW? - cont’d : 

WHERE ARE WE NOW? - cont’d Downgrades continuing Defaults and foreclosures are climbing still Media “feeding frenzy” and the search for blame Reaching the “third phase” of any economic cycle, i.e. (1) Boom, (2) Bust, (3) Recrimination

WHERE ARE WE NOW? - cont’d : 

WHERE ARE WE NOW? - cont’d Home price appreciation has become depreciation in many markets Increasing inventory of unsold homes – the “pocket” phenomenon Non-bank originators continuing to shut down or be sold Congress has not done much (yet)

WHAT CAN WE EXPECT? : 

WHAT CAN WE EXPECT? Legislation – Federal & State Regulation – Federal Banking Agencies Market-Based Solutions – e.g., HOPENOW; private companies (Countrywide) The “numerator problem” driving policy decisions

FEDERAL LEGISLATION 2008 : 

FEDERAL LEGISLATION 2008 Comprehensive “reform” bills from US Congress– Frank bill; Dodd bill Regulation of underwriting, loan terms, loan originators – “won’t let this happen again” “Something for everyone,” esp. Frank bill Tax; bankruptcy “cramdown”; FHA reform

FEDERAL LEGISLATION 2008 - cont’d : 

FEDERAL LEGISLATION 2008 - cont’d “Jawboning” on loan modifications, foreclosures – Rep. Frank, others Expect more hearings on the Hill Economic stimulus package may contain mortgage-related relief Election year politics may make a difference – stay tuned

FEDERAL REGULATION : 

FEDERAL REGULATION OTS unfair and deceptive trade practices proposal Federal Reserve Board proposed amendments to Regulation Z Increased attention to “asset quality” in exams, particularly state banking regulators

STATE LEGISLATION : 

STATE LEGISLATION NC: enactment of 6 bills in 2007 – will see how that plays out – more remedies, more lawsuits, emphasis on loan servicing May still see “foreclosure reform” in NC Field wide open in SC, GA – likely see comprehensive bills in SC, foreclosure-related bills in GA Enormous amount of state activity in ‘08

MARKET-BASED SOLUTIONS : 

MARKET-BASED SOLUTIONS “Teaser freezer” implementation through HOPENOW Loan modification and workout programs being implemented by industry participants Emerging community-based assistance programs (banks may be expected to help) Will large employers become involved?

QUESTIONS? : 

QUESTIONS? Donald C. Lampe Womble Carlyle Sandridge & Rice, PLLC Charlotte, NC (704)350-6398 dlampe@wcsr.com