Subprime Lending Crisis Matthew Long, Program Co-Chair Bates White, LLC 1300 Eye St NW Suite 600 Washington, DC 20005 202-747-1127 Rapid growth of sub-prime mortgage originations
$700
$600
$500 37% CAGR $400 Billions $300
$200
$100
$0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: Inside Mortgage Finance: The 2007 Mortgage Market Statistical Annual – Volume I
2 Top ten subprime B&C mortgage originators in 2006
Originator Volume (millions) Market share
HSBC Finance,IL $52,800 8.8%
New Century Financial, CA $51,600 8.6%
Countrywide Financial, CA $40,596 6.8%
CitiMortgage, NY $38,040 6.3%
WMC Mortgage, CA $33,157 5.5%
Fremont Investment & Loan, CA $32,300 5.4%
Ameriquest Mortgage, CA $29,500 4.9%
Option One Mortgage, CA $28,792 4.8%
Wells Fargo Home Mortgage, IA $27,869 4.6%
First Franklin Financial Corp, CA $27,666 4.6%
Source: Inside Mortgage Finance: The 2007 Mortgage Market Statistical Annual – Volume I
3 Examples of alternative subprime mortgage loan products
• Adjustable rate mortgages (ARMs) – 2/28’s and 3/27’s Initial “teaser” interest rate resets after 24 or 36 months • Interest-only (IO) ARMs No initial principal payments Payment rises to much higher level once principle amortization begins • Option ARMs Buyer selects payment amount Lowest payment option often results in negative amortization • Stated income mortgages Borrower represents income / no documentation necessary • Low doc mortgages
4 Share of subprime adjustable rate mortgages (ARMs)
100%
90%
80%
70%
60%
50%
40% Share of Share total originations 30%
20% Fixed Rate Mortgages 10% Adjustable Rate Mortages
0% 1H 2006 2H 2006 1H 2007
Source: Mortgage Bankers Association
5 Growth of non-traditional mortgage products – interest only; option ARM; & other alternative mortgage products
35%
Alternative mortgages
30%
25%
20%
15% Share of Share total originations
10%
5%
0% 2004 2005 2006
Source: Inside Mortgage Finance: The 2007 Mortgage Market Statistical Annual – Volume I
6 Growth of reduced documentation mortgages
100%
Full Documentation Mortgages 90% Reduced Documentation Mortgages 80%
70%
60%
50%
40%
30%
20%
10%
0% Q12000 Q22000 Q32000 Q42000 Q12001 Q22001 Q32001 Q42001 Q12002 Q22002 Q32002 Q42002 Q12003 Q22003 Q32003 Q42003 Q12004 Q22004 Q32004 Q42004 Q12005 Q22005 Q32005 Q42005 Q12006 Q22006 Q32006 Q42006 Q12007 Q22007 Q32007
Source: First American CoreLogic
7 Index of national home prices
250
200
150
100 Case-Shiller Home Price Home Case-Shiller Index
50
S&P/Case-Shiller Home Price Index
0 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jan-00 Apr-00 Jan-01 Apr-01 Jan-02 Apr-02 Jan-03 Apr-03 Jan-04 Apr-04 Jan-05 Apr-05 Jan-06 Apr-06 Jan-07 Apr-07 Oct-00 Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Oct-06 Oct-07
Source: Standards & Poor
8 Mortgage delinquencies by industry segments
25%
Alt A mortgages
Subprime Mortgages 20% Conforming Prime Mortgages
15%
10% % of mortgages 60+ days delinquent
5%
0% Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07
Source: First American CoreLogic
9 Mortgage delinquencies compared to home prices
25% 250 Alt A mortgages
Subprime Mortgages
20% Conforming Prime Mortgages 200 S&P/Case-Shiller Home Price Index
15% 150
10% 100 Case-Shiller Home PriceHome Case-Shiller Index % of mortgages 60+ days delinquent
5% 50
0% 0 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07
Source: First American CoreLogic, Standards & Poor
10 Vintage analysis – Subprime mortgage delinquencies by year of origination
35%
30%
25%
20%
15%
10% % of 60+ mortgages days delinquent
2007 2006 2005 5% 2004 2003 2002
0% 0 month 5 10 15 20 25 30 35 40 45 50 55 60 65 70 months months months months months months months months months months months months months months
Source: First American CoreLogic
11 Vintage Analysis – Fixed and ARM subprime mortgage delinquencies by year of origination
45%
40%
35%
30%
25%
20%
15% % of 60+ mortgages days delinquent 10%
Fixed 2007 Fixed 2006 Fixed 2002 5% ARM 2007 ARM 2006 ARM 2002
0% 0 month 5 10 15 20 25 30 35 40 45 50 55 60 65 70 months months months months months months months months months months months months months months
Source: First American CoreLogic
12 Examples of common lax underwriting / fraud
• Occupancy misrepresentation • Suspicious credit bureau items / FICO inflation • Incorrectly calculated debt-income ratios • "Stated" income not reasonable • First time buyers with questionable credit/income • Inflated appraisals
Source: Fitch Ratings
13 Subprime mortgage compared to other subprime lending
Marketing Underwriting Financing
Indirect: Rule-based Correspondent Mortgage MBS CDO’s Brokers Decisioning Bank
Custom Indirect: Credit Fixed-term Auto Dealers Scoring ABS Models
Custom Direct Credit Revolving Card Mail Scoring ABS Models
Credit risk largely transferred Credit risk largely retained
14 Comparison of subprime ABS credit enhancements
Illustrative subprime Illustrative subprime auto finance securitization 1 mortgage finance securitization 2
Financial guaranty Retained by issuer Fee = 0.20% Subordination 20.0% Sold to investor Over-collateralization 5.50%
Reserve account: Over-collateralization & 1.50% retained subordination: 2.50%
Excess cash flow: Excess interest: ~3.0% - 4.0% ~3.0% - 4.0%
1 – Americredit 2006-R-M ABS securitization; Bates White estimate of excess cash flow 2 – Ameriquest Mortgage Securities 2006-R1; Freddie Mac estimate of excess interest
15 Overview of mortgage collateralized debt obligation (CDO) structure
BBB Bond 1
Senior Notes BBB Bond 2 Aggregate Principle & BBB Bond 3 principle & interest due interest Special On notes BBB Bond 4 Purpose 2nd Loss Vehicle Mezzanine Note BBB Bond 5 (SPV)
1st Loss Bond N-1 Portfolio Portfolio Junior Note losses losses Bond N
Source: Moodys, Wall Street Journal
16 Subprime mortgage related write-downs of loans, MBS & CDOs
Company Write-off Company Write-off
Citigroup $ 24.1B RBS 3.5
Merrill Lynch 22.5 Washington Mutual 3.3
UBS AG 18.7 Swiss Re 3.2
Morgan Stanley 17.2 Lehman Brothers 3.1
Crédit Agricole 11.1 LBBW 3.1
HSBC 10.3 JP Morgan Chase 3.0
Bank of America 9.4 Goldman Sachs 3.0
CIBC 4.8 Freddie Mac 2.9
Deutsche Bank 3.7 Credit Suisse 2.8
Barclays Capital 3.6 Sixteen Others 22.2
Bear Stearns 3.5 Total $179.0B
Source: http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
17 Subprime Lending Crisis Matthew Long, Program Co-Chair Bates White, LLC 1300 Eye St NW Suite 600 Washington, DC 20005 202-747-1127 About Bates White
19 A history of growth and diversification
• Founded in July 1999 by Drs. Charles Bates, Hal White, Eric Gaier, David DeRamus, and Matthew Raiff • Grown to more than 150 professionals with backgrounds in economics, statistics, finance, strategy, and accounting • Specializes in complex, data-intensive matters that require innovative problem solving • Practice areas include Antitrust Consumer finance Labor and employment Corporate finance Energy Environmental and product liability International arbitration
20 Our approach
• Develop long-term partnerships with clients • Work with clients to assess case strengths and weaknesses early in the case • Emphasize a culture focused on collaboration • Involve senior partners in all aspects of engagements • Provide deep empirical analysis using advanced economic, financial, and econometric theory to produce clear, precise, and thorough results • Distill and communicate information clearly and precisely • Invest in solutions
21 Bates White has a track record of consistently exceeding our clients’ expectations
• “Bates White consistently demonstrates a unique ability to distill and communicate information [and] consistently provides clear, precise, and thorough results that enable DuPont to resolve matters quickly and effectively.” -Thomas Sager, V.P. and Assistant General Counsel, DuPont
• “The depth of talent, knowledge, and expertise at all levels of Bates White is extremely impressive. When the stakes are high and the matters complex, we can count on everyone at Bates White to deliver the answers we need.” -Kent Gardiner, Partner, Crowell & Moring LLP
• "We have worked with Bates White on many different antitrust matters over the past five years. The firm always brings the A team. The direct involvement of senior partners means we can always count on getting more advanced economic analysis than our adversaries." -Kenneth L. Adams, Partner, Dickstein Shapiro
22 Bates White has extensive mortgage and subprime finance experience
• Fair lending Consulting analysis to prominent prime and subprime mortgage lender • Pricing disparities, business justification, alternative analysis, channel issues • Analyzed yield spread premium, points and fees on a broker-by-broker basis Pricing disparity analysis to $5B prime mortgage lender • Public policy Retained by deep-pocketed lobbying group to evaluate subprime mortgage borrower bailout legislation proposals • Market structure Retained in by Cerberus to evaluate market concentration and related anti- trust issues for potential acquisitions: • GMAC / Option One / New Century
23 Bates White has extensive mortgage and subprime finance experience (cont.)
• Subprime credit scoring & risk-based pricing Engaged as consulting experts in litigation by leading credit scoring provider Multiple engagements structuring risk-based pricing systems for subprime consumer finance companies Constructed underwriting and risk-base pricing structure for major subprime auto finance company Developed risk-base pricing structure and yield model for deep subprime auto finance company In NFHA v. Prudential provided expert report for plaintiffs on disparate impact of insurance scoring and alternative analysis • Secondary mortgage market Bates White experts have consulted with and worked for Freddie Mac in analyzing characteristics of purchased mortgages
24 Subprime Lending Crisis Matthew Long, Program Co-Chair Bates White, LLC 1300 Eye St NW Suite 600 Washington, DC 20005 202-747-1127
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