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
Billions
$400
$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%
Share of total originations
70%
60%
50%
40%
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%
Share of total originations
25%
20%
15%
10%
5%
0%
2004
2005
2006
Source: Inside Mortgage Finance: The 2007 Mortgage Market Statistical Annual – Volume I
6
Q32007
Q22007
Q12007
Q42006
Q32006
Q22006
Q12006
Q42005
Q32005
Q22005
Q12005
Q42004
Q32004
Q22004
Q12004
Q42003
Q32003
Q22003
Q12003
Q42002
Q32002
Q22002
Q12002
Q42001
Q32001
Q22001
Q12001
Q42000
Q32000
Q22000
Q12000
Growth of reduced documentation mortgages
100%
90%
Full Documentation Mortgages
Reduced Documentation Mortgages
80%
70%
60%
50%
40%
30%
20%
10%
0%
Source: First American CoreLogic
7
Oct-07
Jul-07
Apr-07
Jan-07
Oct-06
Jul-06
Apr-06
Jan-06
Oct-05
Jul-05
Apr-05
Jan-05
Oct-04
Jul-04
Apr-04
Jan-04
Oct-03
Jul-03
Apr-03
Jan-03
Oct-02
Jul-02
Apr-02
Jan-02
Oct-01
Jul-01
Apr-01
Jan-01
Oct-00
Jul-00
Apr-00
Jan-00
Case-Shiller Home Price Index
Index of national home prices
250
200
150
100
50
S&P/Case-Shiller Home Price Index
0
Source: Standards & Poor
8
Mortgage delinquencies by industry segments
25%
Alt A mortgages
Subprime Mortgages
20%
% of mortgages 60+ days delinquent
Conforming Prime Mortgages
15%
10%
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
Conforming Prime Mortgages
200
S&P/Case-Shiller Home Price Index
15%
150
10%
100
5%
50
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
0
Case-Shiller Home Price Index
% of mortgages 60+ days delinquent
20%
Source: First American CoreLogic, Standards & Poor
10
Vintage analysis – Subprime mortgage delinquencies by year of
origination
35%
% of mortgages 60+ days delinquent
30%
25%
20%
15%
10%
5%
0%
0 month
5
months
10
months
15
months
20
months
25
months
30
months
35
months
40
months
45
months
50
months
2007
2006
2005
2004
2003
2002
55
months
60
months
65
months
70
months
Source: First American CoreLogic
11
Vintage Analysis – Fixed and ARM subprime mortgage delinquencies
by year of origination
45%
40%
% of mortgages 60+ days delinquent
35%
30%
25%
20%
15%
10%
5%
0%
0 month
5
months
10
months
15
months
20
months
25
months
30
months
35
months
40
months
Fixed 2007
Fixed 2006
Fixed 2002
ARM 2007
ARM 2006
ARM 2002
45
months
50
months
55
months
60
months
65
months
70
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
Mortgage
Auto
Card
Underwriting
Financing
Indirect:
Brokers
Rule-based
Decisioning
Correspondent
Bank
Indirect:
Dealers
Custom
Credit
Scoring
Models
Fixed-term
ABS
Direct
Mail
Custom
Credit
Scoring
Models
Revolving
ABS
MBS
CDO’s
Risk largely transferred
Risk largely retained
14
Comparison of subprime ABS credit enhancements
Illustrative subprime
auto finance securitization1
Illustrative subprime
mortgage finance securitization2
Financial guaranty
Fee = 0.20%
Retained by issuer
Subordination
20.0%
Sold to investor
Over-collateralization
5.50%
Reserve account:
1.50%
Over-collateralization &
retained subordination:
2.50%
Excess cash flow:
~3.0% - 4.0%
Excess interest:
~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
BBB Bond 3
Aggregate
principle &
interest
BBB Bond 4
BBB Bond 5
Bond N-1
Portfolio
losses
Special
Purpose
Vehicle
(SPV)
Principle &
interest due
On notes
2nd Loss
Mezzanine Note
Portfolio
losses
1st Loss
Junior Note
Bond N
Source: Moodys, Wall Street Journal
16
Subprime mortgage related write-downs of loans, MBS & CDOs
Company
Citigroup
Write-off
$ 24.1B
Company
Write-off
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
Bear Stearns
3.5
Total
22.2
$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 antitrust 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