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Atlanta ACC May 2008 Meeting Presentation Impact of the “Subprime Crisis”:  The Forecast and the Search For Solutions

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)350-6398 dlampe@wcsr.com May 13, 2008. SUBPRIME CRISIS?. Just what do we mean?

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Atlanta ACC May 2008 Meeting Presentation Impact of the “Subprime Crisis”:  The Forecast and the Search For Solutions

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  1. Atlanta ACC May 2008 MeetingPresentationImpact of the “Subprime Crisis”:  The Forecast and the Search For Solutions Donald C. Lampe Womble Carlyle Sandridge & Rice, PLLC Charlotte, NC (704)350-6398 dlampe@wcsr.com May 13, 2008

  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? 2

  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 3

  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 4

  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) 5

  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 6

  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 7

  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 8

  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 9

  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 10

  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 11

  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 12

  13. WHERE ARE WE NOW? • 2nd 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 13

  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) 14

  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 15

  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 16

  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 17

  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 18

  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 19

  20. FEDERAL LEGISLATION 2008 - 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 20

  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 21

  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 22

  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? 23

  24. QUESTIONS? • Donald C. Lampe • Womble Carlyle Sandridge & Rice, PLLC • Charlotte, NC • (704)350-6398 • dlampe@wcsr.com 24

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