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Donald C. Lampe
Womble Carlyle Sandridge & Rice, PLLC
Charlotte, NC
(704)350-6398
[email protected]
January 22, 2007

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 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?

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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

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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 ³subprime´ market ±
performance on prime/conventional market
still good by historic measures

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 Definition of Subprime?
‡ No true legal definition, more of term of art
based on ³channel´ of lending
‡ Higher-cost credit made available to
borrowers with impaired or ³thin´ credit or
other unique circumstances
‡ Made possible by credit scoring,
automation and secondary markets
‡ Traditionally came from finance companies
and FHA (banks)
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 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

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 SUBPRIME GROWTH:
DISINTERMEDIATION
‡ Secondary market ³fed´ by (mostly) non-
bank originators
‡ Mortgage broker ĺ wholesale lender ĺ
aggregator/investment bank ĺ
securitization trust ĺ bondholders
‡ Wholesale lenders funded by warehouse
lines of credit (inventory financing)
‡ Each step: legal recourse

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 THE ³PIPELINE´
‡ Became ³clogged´ 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

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 CHARACTERISTICS OF
SUBPRIME ³BOOM´
‡ Post 9/11/01 low interest rates and product
innovation
‡ Capital from Wall Street ± ³irrational
exuberance´ and financial engineering
‡ Underwriting standards relaxed as means
of expanding market share
‡ ³Risk layering´ and failure of risk
assessment

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 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 ³dot com´ type
speculation by (small) investors
‡ Wall Street incapable of pricing to the risk

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FINANCIAL ENGINEERING
‡ Mortgage assets grew at incredible pace,
and Wall Street found new ways to offer
³piece of the action´ to investors
‡ Investment banks captured fee income at
many stages
‡ Derivatives and derivatives of derivatives
‡ Many of the ³sophisticated´ products based
on same models

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 ASSUMPTIONS PRIOR TO
³MELTDOWN´
‡ 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
‡ ³Healthy economy´ and continued demand
worldwide for RMBS and related assets

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WHERE ARE WE NOW?
‡ Early 2008, haven¶t hit ³bottom´ 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)
‡ ³Worldwide liquidity crisis´ keyed to
realization that market overheated

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

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 WHERE ARE WE NOW?
- cont¶d
‡ Home price appreciation has become
depreciation in many markets
‡ Increasing inventory of unsold homes ± the
³pocket´ phenomenon
‡ Non-bank originators continuing to shut
down or be sold
‡ Congress has not done much (yet)

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 WHAT CAN WE EXPECT?
‡ Legislation ± Federal & State
‡ Regulation ± Federal Banking Agencies
‡ Market-Based Solutions ± e.g.,
HOPENOW; private companies
(Countrywide)
‡ The ³numerator problem´ driving policy
decisions

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FEDERAL LEGISLATION 2008
‡ Comprehensive ³reform´ bills from US
Congress± Frank bill; Dodd bill
‡ Regulation of underwriting, loan terms, loan
originators ± ³won¶t let this happen again´
‡ ³Something for everyone,´ esp. Frank bill
‡ Tax; bankruptcy ³cramdown´; FHA reform

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FEDERAL LEGISLATION 2008
- cont¶d
‡ ³Jawboning´ 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

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 FEDERAL REGULATION
‡ OTS unfair and deceptive trade practices
proposal
‡ Federal Reserve Board proposed
amendments to Regulation Z
‡ Increased attention to ³asset quality´ in
exams, particularly state banking regulators

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 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 ³foreclosure 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 µ08

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MARKET-BASED SOLUTIONS
‡ ³Teaser 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?

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 ù
#$%

‡ Donald C. Lampe
‡ Womble Carlyle Sandridge & Rice, PLLC
‡ Charlotte, NC
‡ (704)350-6398
‡ [email protected]

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