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Subprime Lending Crisis 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 Source: First American CoreLogic American First Source: 100% Growth of Growthreduced documentation of mortgages 10% 20% 30% 40% 50% 60% 70% 80% 90% 0% Q12000 Q22000 Q32000 Q42000 Q12001 Q22001 Q32001 Q42001 Q12002 Q22002 Q32002 Q42002 Q12003 Q22003 Q32003 Q42003 Q12004 Q22004 Q32004 Q42004 Q12005 Q22005 Reduced Documentation Mortgages Documentation Reduced Full Mortgages Documentation Q32005 Q42005 Q12006 Q22006 Q32006 Q42006 Q12007 Q22007 Q32007 7 Source: Standards & Poor & Standards Source: Index of national home prices Case-Shiller Home Price Index 100 150 200 250 50 0 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 S&P/Case-Shiller PriceHome Index Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 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 25.
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