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Womble Carlyle Sandridge & Rice, PLLC Atlanta ACC May 2008 Meeting Presentation Impact of the “Subprime Crisis”: The Forecast and the Search For Solutions.

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Presentation on theme: "Womble Carlyle Sandridge & Rice, PLLC Atlanta ACC May 2008 Meeting Presentation Impact of the “Subprime Crisis”: The Forecast and the Search For Solutions."— Presentation transcript:

1 Womble Carlyle Sandridge & Rice, PLLC Atlanta ACC May 2008 Meeting Presentation Impact of the “Subprime Crisis”: The Forecast and the Search For Solutions Donald C. Lampe Womble Carlyle Sandridge & Rice, PLLC Charlotte, NC (704) May 13, 2008

2 Womble Carlyle Sandridge & Rice, PLLC 2 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?

3 Womble Carlyle Sandridge & Rice, PLLC 3 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

4 Womble Carlyle Sandridge & Rice, PLLC 4 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

5 Womble Carlyle Sandridge & Rice, PLLC 5 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)

6 Womble Carlyle Sandridge & Rice, PLLC 6 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

7 Womble Carlyle Sandridge & Rice, PLLC 7 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

8 Womble Carlyle Sandridge & Rice, PLLC 8 THE “PIPELINE” Became “clogged” in 2007 – began with rating agency downgrades in early 2007 Actually, began running in reverse, w/ repurchase and repo demands back up the chain Many wholesale originators either bankrupt or out of business Subprime loans (funding) much harder to get – private securitizations have ceased

9 Womble Carlyle Sandridge & Rice, PLLC 9 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

10 Womble Carlyle Sandridge & Rice, PLLC 10 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

11 Womble Carlyle Sandridge & Rice, PLLC 11 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

12 Womble Carlyle Sandridge & Rice, PLLC 12 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

13 Womble Carlyle Sandridge & Rice, PLLC 13 WHERE ARE WE NOW? 2 nd quarter 2008, may not have hit “bottom” yet – foreclosures continuing to rise, home prices stagnant Financial institutions still struggling with valuation of assets and capital 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

14 Womble Carlyle Sandridge & Rice, PLLC 14 WHERE ARE WE NOW? - cont’d Defaults and foreclosures are climbing still Home price appreciation has become depreciation in many markets Increasing inventory of unsold homes, and major home-builders excess inventory Congress has not done much (yet)

15 Womble Carlyle Sandridge & Rice, PLLC 15 WHERE ARE WE NOW? - cont’d Presidential candidates all have ideas Media “feeding frenzy” and the search for blame Reaching the “third phase” of any economic cycle, i.e. (1) Boom, (2) Bust, (3) Recrimination

16 Womble Carlyle Sandridge & Rice, PLLC 16 ILLIQUIDITY EVERYWHERE Muni bonds and auction rate securities – impact of bond insurer downgrades Leveraged corporate transactions in decline RMBS market for subprime almost dead Commercial real estate being “watched” Int’l investors shaken up

17 Womble Carlyle Sandridge & Rice, PLLC 17 U.S. GOVERNMENT ACTIONS US Treasury support of ASF & Lifeline programs Fed’s lowering rates, to unblock liquidity – more home loan refis, e.g. Bear Stearns buyout and federal government “guaranty” US Treasury comprehensive market restructure proposal

18 Womble Carlyle Sandridge & Rice, PLLC 18 WHAT ELSE CAN WE EXPECT? Legislation – Federal & State Regulation – Federal Banking Agencies Market-Based Solutions – e.g., HOPENOW; private companies (loan servicers) The “numerator problem” driving policy decisions

19 Womble Carlyle Sandridge & Rice, PLLC 19 FEDERAL LEGISLATION 2008 Economic stimulus package contained mortgage-related relief Comprehensive 2007 “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

20 Womble Carlyle Sandridge & Rice, PLLC 20 FEDERAL LEGISLATION cont’d “Piecemeal” approach in recent Senate bill Government funds to buy or guaranty loans – e.g. FHA expansion Expect more hearings on the Hill Election year politics may make a difference – stay tuned

21 Womble Carlyle Sandridge & Rice, PLLC 21 FEDERAL REGULATION OTS unfair and deceptive trade practices proposal Federal Reserve Board proposed amendments to Regulation Z Comprehensive RESPA reform proposal from HUD Increased attention to “asset quality” in exams, particularly state banking regulators

22 Womble Carlyle Sandridge & Rice, PLLC 22 STATE LEGISLATION Limited steps from GA legislature in 2008 – foreclosure bill Field wide open in SC – likely see comprehensive bills moving in SC Enormous amount of state activity in ’08, following on heels of comprehensive bills in 2007

23 Womble Carlyle Sandridge & Rice, PLLC 23 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?

24 Womble Carlyle Sandridge & Rice, PLLC 24 QUESTIONS? Donald C. Lampe Womble Carlyle Sandridge & Rice, PLLC Charlotte, NC (704)


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