Subprime Lending
Crisis Conference
Banking Regulation, Oversight and
Enforcement
Kevin F. Barnard
White & Case LLP
March 18, 2008
Banking Regulation, Oversight and Enforcement

Introduction

Regulatory Guidance on Subprime Mortgage Lending

Likely Focus of Potential Future Regulatory Enforcement
Actions

Recommended Practices and Strategies

Summing Up
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
2
Banking Regulation, Oversight and Enforcement
Regulatory Guidance on Subprime Mortgage
Lending

Interagency Guidance on Subprime Mortgage
Lending (1999)
 Expanded Guidance on Subprime Mortgage
Lending (2001)
 Interagency Guidance on Nontraditional Mortgage
Risks (2006)

KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
3
Banking Regulation, Oversight and Enforcement

Interagency Statement on Subprime Mortgage
Lending (2007)


Statement on Subprime Mortgage Lending of the
CSBS, AARMR, NACCA (2007)
Statement on Subprime Mortgage Lending of
Various States (2007)
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
4
Banking Regulation, Oversight and Enforcement
Back to the Future . . . ?
Nine years ago this month –
“ . . . recent turmoil in the equity and asset-backed
securities market has caused some non-bank
subprime specialists to exit the market, thus
creating increased opportunities . . ..”
BUT . . .
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
5
Banking Regulation, Oversight and Enforcement
“If the risks associated with this activity are not
properly controlled, the agencies consider subprime
lending a high risk activity that is unsafe and
unsound.” (emphasis added)
Interagency Guidance on Subprime Mortgage
Lending (March 1, 1999)
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
6
Banking Regulation, Oversight and Enforcement
Essential Elements Board of Directors and
Management Should Consider



Capitalization
Risk Management Program

Critical risk issues:
 attracting/retaining qualified personnel
 technology investments
 after-the-fact assessment of underwriting performance
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
7
Banking Regulation, Oversight and Enforcement
specific lending policy for subprime including:
 pricing and profitability analysis covering all associated
costs including servicing, expected chargeoffs and
capital
 collateral evaluation and appraisal standards
 correspondent/broker approval process
 purchase considerations
 high upfront fees financed into the loan (may be an
incentive for high volume/low quality by originator)
 special care on loans from outside lender’s area
(specific risk for fraud or misrepresentation)

KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
8
Banking Regulation, Oversight and Enforcement
stringent loan administration procedures
 securitization and sale
 carries inherent risks, including interim credit risk
and liquidity risk
 loss of investor appetite – unsold pools forced into
deep discount sales
 should have contingency plan: back-up
purchasers/servicers; alternate funding sources;
capital raising measures
 complexity of valuation decisions

KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
9
Banking Regulation, Oversight and Enforcement

Likely Focus of Potential Future Regulatory
Enforcement Actions
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
10
Banking Regulation, Oversight and Enforcement
Report of the Senior Supervisors Group to the
Financial Stability Forum (March 6, 2008)



Assess which risk management policies worked well and
which did not
“Strategic decision” by some firms to retain large
exposures to super-senior tranches of collateralized debt
obligations
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
11
Banking Regulation, Oversight and Enforcement


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Exposures “far exceeded the firm’s understanding of the
risks inherent in such instruments, and failed to take
appropriate steps to control or mitigate such risks.”
(emphasis added)
Major losses taken on these holdings with substantial
implications for earnings performance and capital
positions
Risk management and pricing for off-balance sheet
obligations were seriously deficient
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
12
Banking Regulation, Oversight and Enforcement
“. . . some firms failed to price properly the risk that
exposures to certain off-balance sheet vehicles
might need to be funded on the balance sheet
precisely when it became difficult or expensive to
raise such funds externally. “
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
13
Banking Regulation, Oversight and Enforcement


The better positioned firms had comprehensive, firm-wide
risk management capability focused on quantitative and
qualitative information gathering and analysis
also exhibited a disciplined approach in how complex or
potentially illiquid positions were valued. Adaptive (not
static) risk measurement processes that could rapidly
alter underlying assumptions
An agenda is emerging to strengthen supervisory
oversight in critical areas.
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
14
Banking Regulation, Oversight and Enforcement
Recommended Practices and Strategies





Risk Management
Underwriting Standards and Loan Terms
Control Systems
Consumer Disclosure/Consumer Protection
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
15
Banking Regulation, Oversight and Enforcement

Summing Up
KEVIN F. BARNARD
BANKING REGULATION, OVERSIGHT AND ENFORCEMENT
WHITE & CASE LLP
March 18, 2008
16