Post on 13-Jan-2016
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Womble Carlyle Sandridge & Rice, PLLC
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Charlotte ACC Lunch-N-Learn RoundtablePresents
The “Subprime Crisis” and Housing Slowdown:
2008 Forecast and the Search For Solutions
Donald C. LampeWomble Carlyle Sandridge & Rice, PLLC
Charlotte, NC(704)350-6398
dlampe@wcsr.comJanuary 22, 2007
Womble Carlyle Sandridge & Rice, PLLC
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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?
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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 “subprime” market – performance on prime/conventional market still good by historic measures
Womble Carlyle Sandridge & Rice, PLLC
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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)
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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 “dot com” type speculation by (small) investors
• Wall Street incapable of pricing to the risk
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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 “pocket” phenomenon
• Non-bank originators continuing to shut down or be sold
• Congress has not done much (yet)
Womble Carlyle Sandridge & Rice, PLLC
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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 “numerator problem” driving policy decisions
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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
Womble Carlyle Sandridge & Rice, PLLC
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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 “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
Womble Carlyle Sandridge & Rice, PLLC
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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?
Womble Carlyle Sandridge & Rice, PLLC
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QUESTIONS?
• Donald C. Lampe• Womble Carlyle Sandridge & Rice, PLLC• Charlotte, NC• (704)350-6398• dlampe@wcsr.com