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New York Investing Meetup: The Catalyst for the Financial Crisis: Mortgages, CDOs April 7, 2009 Thomas J. Adams Paykin Mahon Rooney & Krieg, LLP April.

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Presentation on theme: "New York Investing Meetup: The Catalyst for the Financial Crisis: Mortgages, CDOs April 7, 2009 Thomas J. Adams Paykin Mahon Rooney & Krieg, LLP April."— Presentation transcript:

1 New York Investing Meetup: The Catalyst for the Financial Crisis: Mortgages, CDOs April 7, 2009 Thomas J. Adams Paykin Mahon Rooney & Krieg, LLP April 7, 2009 Thomas J. Adams Paykin Mahon Rooney & Krieg, LLP

2 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP2 Discussion Overview Thomas Adams Bio Background on MBS/CDO Market How Mortgage Loans Became Bonds The Market Turmoil What Went Wrong? Whats Happening Now? Whats Next? Thomas Adams Bio Background on MBS/CDO Market How Mortgage Loans Became Bonds The Market Turmoil What Went Wrong? Whats Happening Now? Whats Next?

3 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP3 Thomas J. Adams Bio PAYKIN MAHON ROONEY & KRIEG, LLP – January 2009 to present ADAMS ADVISORY SERVICES – May 2008 to present FINANCIAL GUARANTY INSURANCE CORPORATION Senior Managing Director AMBAC ASSURANCE CORPORATION Managing Director MOODYS INVESTORS SERVICE Senior Credit Officer THACHER PROFFITT & WOOD FORDHAM UNIVERSITY SCHOOL OF LAW - J.D COLGATE UNIVERSITY - B.A PAYKIN MAHON ROONEY & KRIEG, LLP – January 2009 to present ADAMS ADVISORY SERVICES – May 2008 to present FINANCIAL GUARANTY INSURANCE CORPORATION Senior Managing Director AMBAC ASSURANCE CORPORATION Managing Director MOODYS INVESTORS SERVICE Senior Credit Officer THACHER PROFFITT & WOOD FORDHAM UNIVERSITY SCHOOL OF LAW - J.D COLGATE UNIVERSITY - B.A. 1986

4 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP4 Background on MBS/CDO Market MBS Market Agency MBS Sub-Prime Mortgages Jumbo Mortgages Other Non-Conforming MBS HELOCs, Scratch & Dent, Alt A, Option ARM Mortgage Loan Originators Portfolio lenders Secondary market lenders Investment bank distributors Retail vs. wholesale MBS Market Agency MBS Sub-Prime Mortgages Jumbo Mortgages Other Non-Conforming MBS HELOCs, Scratch & Dent, Alt A, Option ARM Mortgage Loan Originators Portfolio lenders Secondary market lenders Investment bank distributors Retail vs. wholesale CDO Market Collateralized Loan Obligations Collateralized Debt Obligations ABS CDOs Mezzanine CDOs High Grade CDOs CDO-squared Hybrid CDOs Parties to CDO Transaction Debt originators CDO managers Super-senior investors Equity investors

5 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP5 Sample MBS and CDO Structures Source: Fitch Investors Service

6 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP6 How Mortgage Loans Became Bonds Origination Origination based on lender underwriting standards and borrower demand Feedback loop - underwriting standards adjusted based on secondary market demand Loan pool submitted to rating agency for credit enhancement assessment Origination Origination based on lender underwriting standards and borrower demand Feedback loop - underwriting standards adjusted based on secondary market demand Loan pool submitted to rating agency for credit enhancement assessment Securitization Loan pools assessed and credit enhanced Loan pool tranched, or sliced, into classes of bonds based on increasing payment seniority for payment Typical bonds issued with floating rates, LIBOR index Additional features for amortization and coupons Equity tranche retained

7 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP7 MBS, ABS and CDO Issuance Volume Source: Citigroup Global Capital Markets

8 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP8 The Roots of the Market Turmoil Liquidity Issues Emerge in Early 2007 New Century Financial bankruptcy Bear Stearns hedge funds Collateral Performance Decouples from Model Projections Rating Agency sudden downgrades in summer of 2007 Mark to Market and Portfolio Write-downs Fall 2007 Lending Curtailment and Credit Crunch Fall 2007 Continued Decline of Home Values Further pressure on portfolio valuations in 2008 (and 2009?) Uncertainty on Loss Projections Liquidity fails to return, broader economy infected Liquidity Issues Emerge in Early 2007 New Century Financial bankruptcy Bear Stearns hedge funds Collateral Performance Decouples from Model Projections Rating Agency sudden downgrades in summer of 2007 Mark to Market and Portfolio Write-downs Fall 2007 Lending Curtailment and Credit Crunch Fall 2007 Continued Decline of Home Values Further pressure on portfolio valuations in 2008 (and 2009?) Uncertainty on Loss Projections Liquidity fails to return, broader economy infected

9 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP9 Pricing Issues Emerge in ABS Market

10 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP10 What Went Wrong? Agency arbitrage Market participants developed tools to arbitrage the rating agency models - agencies were willing participants Artificial demand Decline of cash investors - new investment vehicles drove demand for MBS and CDO bonds (SIVs, ABCP, etc.) Poor transparency Historically, limited secondary market obscured price discovery Credit default swap innovation CDS and ABX introduced two way trading - introduction of shorting Insufficient data and model flaws Limited data for home price declines - impact of declining home values on borrower default patterns Bad loss estimates Loss estimates and enhancement calculations based on statistical analysis of historical data Agency arbitrage Market participants developed tools to arbitrage the rating agency models - agencies were willing participants Artificial demand Decline of cash investors - new investment vehicles drove demand for MBS and CDO bonds (SIVs, ABCP, etc.) Poor transparency Historically, limited secondary market obscured price discovery Credit default swap innovation CDS and ABX introduced two way trading - introduction of shorting Insufficient data and model flaws Limited data for home price declines - impact of declining home values on borrower default patterns Bad loss estimates Loss estimates and enhancement calculations based on statistical analysis of historical data

11 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP11 Historical ABX Pricing (06-1)

12 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP12 Whats Happening Now? Securitization market shut down Loss of credibility - rating agencies, models Fear of future losses Counterparty fears Limited credit available Government: lender of last, and first, resort TALF, PPIP, Legacy securities, legacy loans FHA, Fannie Mae, Freddie Mac Finding the scapegoat AIG, Fannie Mae, Freddie Mac, Rating Agencies? Looking for a bottom Stopping home price declines, fine tuning mark to market, unlocking liquidity and other myths Securitization market shut down Loss of credibility - rating agencies, models Fear of future losses Counterparty fears Limited credit available Government: lender of last, and first, resort TALF, PPIP, Legacy securities, legacy loans FHA, Fannie Mae, Freddie Mac Finding the scapegoat AIG, Fannie Mae, Freddie Mac, Rating Agencies? Looking for a bottom Stopping home price declines, fine tuning mark to market, unlocking liquidity and other myths

13 Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP13 Whats Next? The passage of time… Prices must come down - homes, bonds, etc. Government props provide limited benefit Insolvent is insolvent A new future Humpty dumpty wont fit back together again Adjusting to a new reality More risk retained, less risk taken Less liquidity not all bad Finally a new RTC? New regulations and restrictions The passage of time… Prices must come down - homes, bonds, etc. Government props provide limited benefit Insolvent is insolvent A new future Humpty dumpty wont fit back together again Adjusting to a new reality More risk retained, less risk taken Less liquidity not all bad Finally a new RTC? New regulations and restrictions


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