firstpresvanorder by niusheng

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									Welcome

Paul Haran
Principal,
UCD College of Business & Law
Introduction

Tom Begley
Dean,
UCD Schools of Business
Keynote Speaker

Prof Robert Van Order
Professor of Finance,
University of Michigan
 PROPERTY VALUES,
SUB PRIME MARKETS
AND SECURITIZATION:
THE U.S. MARKET AND
 IMPLICATIONS FOR
      IRELAND
                TOPICS
• Overview: Property Values in U.S. and Ireland

• What are Subprime loans?

• Role of Securitization and structuring.

• How has the market changed?

• Effects on Mortgage Markets and implications.
                   Overview
•   Rapid house price growth has been a part of life for about a
    decade in most of Europe and North America. E.g., the
    U.S.. has had rapid growth; Ireland more so.

•   Ireland has also had a production boom. Production has
    been around 15% of the economy.

•   There is evidence of decline now. Is this the bursting of a
    ―bubble‖? Maybe, but not like the tech bubble in late 90s.

•   It has long been known that declining property values play
    a big role in mortgage default. There has been a very large
    increase in troubled (delinquent plus in foreclosure)
    subprime loans in the U.S., much more so than for prime
    loans.
                 Overview
• The market in which these are traded-via
  securitization- has more or less collapsed, and there
  have been ―spillovers‖ into seemingly unrelated
  markets.

• There is pressure for policy change. However, the
  details of the problem are not clear, and precipitous
  policy changes are not a good idea

• Ireland has a small sub prime market, but very big
  price increases. It is poised for a decline. But like the
  U.S. not a tech boom like bubble.
 Ireland had a “Regime
Change” in the mid 1990s
     Prices of Used Houses: Ireland and Dublin


  600,000
  500,000                                                                                    Ireland
  400,000                                                                                    Dublin
  300,000
  200,000
  100,000
       0
            1978Q1
                     1981Q1
                              1984Q1
                                       1987Q1
                                                1990Q1
                                                         1993Q1
                                                                  1996Q1
                                                                           1999Q1
                                                                                    2002Q1
                                                                                             2005Q1
 The U.S. has had strong
growth, but not like Ireland
           House Prices: Ireland and U.S. 1978-2007

  25

  20

  15                                              U.S.
  10                                              Ireland

   5

   0
       1    13   25 37   49 61   73 85 97 109
                          Time
WHAT IS A BUBBLE?
 5000
                       NASDAQ
 4500                  S&P 500
                       National HPI
 4000

 3500

 3000

 2500

 2000

 1500

 1000

 500

   0
        1981
               1984
                      1986
                             1988
                                    1990
                                           1993
                                                  1995
                                                         1997
                                                                1999
                                                                       2002
                                                                              2004
                                                                                     2006
       Subprime Loans
• Borrowers with bad credit history

• Used to be defined by lender (Money Store)

• Now by ―FICO‖ score and related credit
  history

• Quantifying credit history was a big deal in
  securitizing high risk loans because of
  agency problems
Subprime Used To Be About 10%
  Of The Market, But It’s Share
   Increased a Lot After 2003.
Should we be surprised in a market expanding
      that fast that quality deteriorated?
                     Market shares

    70
    60                               FHA/VA
    50
    40                               Conform ing
    30
    20                               Subprim e+Alt-
    10                               A
     0
         1   2       3       4   5
                 2001-2005
    Subprime and FHA Delinquency
      Rates vs Those on Prime.
           Until recently subprime didn’t look all that bad.
     Loans 90 days or more delinquent or in foreclosure (percent of number)
9
                   – Recession
8
                                                                                        Subprime
7

6                                                                           FHA
5

4
                                                                     VA
3

2
            Prime Conventional
1

0
    1998




                1999




                           2000




                                       2001




                                                  2002




                                                              2003




                                                                          2004




                                                                                     2005




                                                                                                2006Q1
    Source: Mortgage Bankers Association and Loanperformance.com (through first quarter 2006)
What Determines Credit Risk?
• Here are some results from Freddie Mac data. The
  loans are not really subprime but some have low
  credit scores.

• Credit history matters, so does equity.

• The problem of layering.

• Everyone knew this stuff was risky, but it was riskier
  than previously thought. (Getting caught with your
  parameters down?). E.g., a small but significant share
  of the 2007 originations didn’t make the first payment.
  Relative Default Probabilities
 Recent history is movement to
   the Northeast of the Chart
               LTV <70     LTV 71-80         LTV 81-90           LTV 91-95


FICO <620
                    0.96               4.8               11.04        19.68

FICO 620-679
                    0.46               2.3                5.29         9.43

FICO 680-720
                     0.2                 1                 2.3          4.1

FICO >720
                    0.08               0.4                0.92         1.64
HOUSE PRICES AND DEFAULT:
                             Equity Matters. So Does Diversification
                                                Default Probability vs. House-Price Appreciation
                                    State/Origination Year and National/Origination Year Cohorts (1985-1995)
                                       80% Loan-to-Value, 30-Year Fixed-Rate Home-Purchase Mortgage

                            25%
                                                                                           Individual States                National
 Cumulative Defau lt Rate




                                                   AK 1986
                            20%



                            15%
                                     CA 1990
                                                       AZ 1985
                            10%

                                         CA 1989
                                                                     NV 1985
                            5%

                                       HI 1994                                        DC 1995

                            0%

                             -30%     -10%               10%         30%        50%             70%            90%   110%         130%
                                                             5-Year Cumulative House-Price Appreciation
 What’s Going on Now?
• Prices are Falling—Though by how much is less
  clear

• Otherwise the economy is growing ok and the
  unemployment rate is relatively low.

• So from the macro side it’s the price decline that
  seems to be the problem.

• But that probably doesn’t explain the sudden
  divergence between prime and subprime.
          Securitization:
        Is it the Problem?
•   Securitization involves selling pools and shares of pools
    loans into the bond market

•   Not new-Mainstay of the market for around 30 years

•   Nor is division of labor between servicer and investor—e.g.,
    Ginnie Mae

•   Ginnie Mae and FHA (substitute for subprime

•   Fannie Mae, Freddie Mac and Ginnie Mae provide credit
    guarantees.

•   The non agency market is different.
     THE ECONOMICS OF
      SECURITIZATION
•   Securitization involves packaging and selling pools of
    loans in order to gain access to securities (bond) markets
    (e.g., rather than deposit markets). Mortgages, Car loans,
    David Bowie.

•   The major contribution of securitization is that it opens the
    mortgage (or other) market to bond markets and long term
    lending.

•   This is in contrast with traditional depositories (banks),
    which tend to be forced into short term funding and do not
    usually have an elastic source of funds.
     THE ECONOMICS OF
      SECURITIZATION
•   But there is cost. Bond market investors are at an
    informational disadvantage relative to those selling them
    the bonds: asymmetric information.

•   The key is understanding and managing the tradeoff
    between the greater efficiency of funding in capital
    markets and the asymmetric information. The balance
    does not always fall on the side of securitization. Bank
    funding (via deposits or bonds) may be the way to go.

•   Even if securitization is the way to go, it may need
    significant ―structuring‖ to work.
       STRUCTURING
    (AKA slicing and dicing)
•   The idea is get access to the bond market—vs the deposit
    market—getting around banks.

•   But there are agency problems because investors aren’t
    sure of what they’re getting: Both adverse selection and
    moral hazard.

•   For the ―Agencies‖ this is done via Agency guarantees and
    back up form their charters.

•   For others (e.g., commercial and nonconforming
    mortgages, like subprime) some enhancement is needed.

•   Typically this is done by structuring.
Senior/Subordinated Structures
• Senior/Sub structures are the most popular. They
  allow most of the credit risk to remain with originator
  and/or specialists and get intuitional investors
  interested in the senior part.

• The trick is prioritize the cash flows so that there is a
  queue and originators or specialists take the bulk of
  the credit risk’

• This means that a pool of B type securities can have
  most of it funded with AAA paper.

• That there were AAA pieces is consistent with the
  loans in the pool being junk bonds.
A TYPICAL STRUCTURE:
FOCUS ON SUBORDINATION

                                                           $1 Billion
Loan 1   Loan 2               Loan 3   Loan 4
                                                   …..     Total Loans




                    Trust




                   $850m
                  AAA Rated
                                         $1 Billion
                                         Subprime
                                         Structured Deal

              $100m, A Rated,
                  $50m, NR,


                                                                         24
A Commercial Deal (Courtesy: Davidson, Sanders etc)
      Bonds for GMAC 1997-C1 Deal



              Initial Cert.                    Rating      Percent of               Initial Pass- Weighted
               Balance or                     (Moody's/   Initial Pool             Through Rate Average Life   Payment
Class        Notional Amt.       Spread         Fitch)      Balance Sub-ordination      (approx.)   (yrs)      Window
 Bonds:
 A-1             $261, 582,000       48        Ass/AAA      15.4%        28.5%         6.830%       4.00         1 - 75
 A-2             $227, 661,000       62        Aaa/AAA      13.4%        28.5%         6.853%       7.50        75-108
 A-3              $724,100,000       65        Aaa/AAA      42.7%        28.5%         6.869%       9.71       108-119
  B                $67,879,000       70       Aa2/AA+        4.0%        24.5%         6.918%       9.94       119-120
  C                $50,909,000       75         A1/AA        3.0%        21.5%         6.898%       9.96       120-120
  D                $50,909,000       85         A2/A+        3.0%        18.5%         6.997%       10.01      120-125
  E                $93,334,000      100       Baa2/BBB       5.5%        13.0%         7.085%       11.45      125-158
  F                $25,454,000      118       Baa3/BBB-      1.5%        11.5%         7.222%       13.53      158-170
 G                 $84,849,000                  BB/BB        5.0%        6.5%          7.414%       14.93      170-195
 H                 $59,394,000                    B          3.5%        3.0%          6.600%       17.99      195-235
  J                $16,969,000                    B-         1.0%        2.0%          6.600%       19.78      235-242
 K                 $33,944,278                 Unrated       2.0%        0.0%          6.600%       22.0       242-358
  X             $1,696,984,278 Notional Amt    Aaa/AAA       N/A          N/A          1.629%        N/A         1-358

   Total        $1,696,984,278
Securities
     Quality Deterioration
•   Why Did The Defaults Increase?

•   Recent paper by Yuliya Demyanyk (FRB St. Louis) and
    Otto Van Hemert (NYU) suggests very mixed reasons

•   It looks like it was not Adjustable rates or low
    documentation especially.

•   High LTV loans

•   A prime candidate is that agency costs went up—(Lying
    and cheating by loan originators). Loan originators working
    at the margine of what is allowed in the contract.

•   Appraisals probably got worse.

•   Who is holding the bag? Representations and warranties.
Effects: Trading Drying Up-
Spillover into Unrelated Markets




                           <>
            So What?
We don’t know much about the contributions
 of the things the media seem sure are evil

• Rate adjustments?

• Predatory Lending?

• Documentation?

• Government pushing banks into risky
  areas?
          Some Bad Ideas.
  Remember the Subprime market is very private and very
        competitive- Exit is easy and the only thing
lenders/investors have is pricing and equity in the property.


 • Forced restructuring.

 • Making lenders/investors responsible for
   borrowers risk-taking

 • Restricting terms like prepayment
   penalties.
             IRELAND
• Bubble Candidate, but not like tech
  stocks

• Subprime market is small

• Looking forward: Securitization isn’t all
  bad and has been manageable.
               IRELAND
• It’s not easy expanding loan markets to
  riskier borrowers. You can’t expect to do it
  without mistakes and lots of defaults.

• How far are you willing to let consenting
  adults go?

• How do you know if consent is informed?

• Watch speed of market growth and loan to
  value ratios.

								
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