mortgage lenders network

Distress for Subprime Mortgage Lenders: Risks and Opportunities March 29, 2007 . Agenda Registration………………………………………………………………………………...8:00 AM Breakfast……………………………………………………………………………..8:00–8:30 AM Presentation: Distress for Subprime Lenders, Risks and Opportunities ……………...8:30 AM Q&A………………………………………………………………………………………...9:30 AM Speakers Stroock & Stroock & Lavan LLP Lewis Kruger – Financial Restructuring Moderator Allan N. Krinsman – Structured Finance Partner – Panelist Mark Speiser – Financial Restructuring – Panelist Christopher Donoho – Financial Restructuring – Panelist Capstone Advisory Group, LLC Edwin N. Ordway, Jr., Executive Director – Panelist Christopher J. Kearns, Executive Director - Panelist 2 Table of Contents How the Business Works………………………………………………………………....4 Marketplace Dynamics…………………………………………………………………...7 Business Model………………………………………………………………….……….24 Bankruptcy Implications………………………………………………………………..31 Investment Opportunities…………………………………………………………...…..38 What Happens Next?…………………………………………………………………….42 Stroock and Capstone Teams…………………………………………………………...44 Appendix Glossary………………………………………………………..…………………………48 3 How the Business Works 4 How the Business Works – The Players Originator - Subprime Lender – – – – – – Originates mortgage loans from consumers Acquires mortgage loans from mortgage brokers Services mortgages from customers Services/manages mortgages for securitized pools Sell mortgages for gain and liquidity Hold mortgages for interest rate spread Warehouse Lenders – – Large institutions/money center banks Generally good visibility into makeup of collateral pool Third Parties – – – Collateralized Debt Obligations (“CDOs”) and Special Purpose Entities (“SPEs”) as purchasers of underlying loans Source of liquidity for originators Provide liquidity to originator through non-recourse or limited recourse purchase or financing of tranches of mortgage loans 5 How the Business Works The Subprime Mortgage Lending Process Warehouse Lenders provide funding for subprime lender. Takes collateral in mortgages entered into by the Lender Lender Lender originates mortgage directly to homebuyer, or through broker network Homeowner Brokers Lender sells mortgage to Third Party High Risk Third Party1 Low Risk Third Party “securitizes” or packages the mortgage into securities (RMBS). The RMBS, in turn, are Third Party sells the securitized either packaged with other RMBS or bonds mortgages to institutional and retail offering different risk and yield profiles as bonds, investors CDOs or referenced by credit default swaps (CDS) 1 The Warehouse Lenders may also be a Third Party mortgage purchaser 6 Marketplace Dynamics 7 Marketplace Dynamics What drove growth? Housing Starts Up – – – – – – Provided opportunity and demand for mortgages – drove volume Enhanced ability for borrowers to refinance Loan size grew LTV generally would improve fairly quickly Made borrowing more attractive versus renting Refinancing activity skyrocketed Appreciation of residential real estate values Rate Decline Securitization market demand for mortgage products expanded Lender growth in both number and type of lenders, e.g. non-federally regulated lenders – Potential lack of effective oversight as market became dominated by entities outside of federal regulation. According to the Federal Reserve, over half of subprime mortgages generated in 2005 were by entities that fell under state, not federal, regulation Lender practices became more aggressive as illustrated on the following pages Ability to quickly complete borrower evaluation process through web based credit programs 8 – – Marketplace Dynamics Subprime lender practices became more aggressive in recent years. Key data points include: Loans as a percent of collateral value increased, as did percent of stated income loans 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1999 2000 Subprime ARM Loan Attributes 2001 2002 Comb LT V 2003 2004 2005 2006 Stated Income Source: CSFB Even though borrower credit quality improved on the adjustable rate loans, the use of second or piggyback mortgages increased, as mirrored in the high combined loan to value trend Results in narrower LTV when median home prices stagnate 630 620 610 600 590 580 570 ARM Average FICO Score / Percent of Loans with Piggyback Loans 616 597 603 608 622 622 590 590 35% 30% 25% 20% 15% 10% 5% 0% 1999 2000 2001 2002 Fico Score 2003 2004 2005 2006 Piggyback 1st Source: CSFB 9 Marketplace Dynamics The percent of ARM subprime loans to total subprime loans increased, as did the use of interest only loans 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1999 2000 2001 2002 2003 2004 2005 2006 Interest Only Source: CSFB Subprime ARM Loan Attributes ARM Share/Subprime Subprime lenders introduced increasingly exotic offerings in order to expand the number of people who could qualify for loans, such as: – – – – – – Piggyback loans 40 year amortization Interest Only Option pay No document / stated income Teaser rates 10 Marketplace Dynamics Result is strong growth in business 2000 - 2006 Residential Mortgage Debt Outstanding ($ in Millions) $12,000,000 $10,000,000 $8,000,000 $6,000,000 $4,000,000 $2,000,000 $0 1990 1992 1994 1996 1998 2000 2002 2004 2006 $16,000 $14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $- Residential Mortgage Debt in Perspective ($ in Billions) $15,194 $12,980 $10,921 $2,581 United States GDP Rest of G-8 GDP Dow 30 Gross Revenues 2006 U.S. Residential Mortgage Debt Source: Office of Federal Housing Enterprise Oversight Sources: Central Intelligence Agency, Edgarpro, OFHEO Subprime originations increased from approximately $100 billion in 2000 to over $800 billion in 2005 Approximately $600 billion or one fifth of mortgages originated in 2006 were subprime According to the Mortgage Bankers Association about 6% of homeowners are both nonprime and hold adjustable rate loans 11 Marketplace Dynamics What is driving problem? Housing Starts - Down reflecting changed mortgage environment Median home prices are stagnant – Mortgage LTV coverage does not grow as quickly over time Mortgage Bankers Association Finance Forecast Q1 Housing Measures ('000) Housing Starts Single-Family Two or more Home Sales Total Existing Homes New Homes Median Price of Existing Homes ($ '000) Median Price of New Homes ($ '000) Source: Mortgage Bankers Association 2006 Q2 Q3 Q4 Q1 2007 Q2 Q3 Q4 Q1 2008 Q2 Q3 Q4 2006 2007 2008 1,802 1,485 1,586 1,465 1,175 1,274 337 310 313 6,478 6,084 6,156 1,060 962 972 221.9 219.4 224.3 245.3 242 246.3 2,123 1,873 1,714 1,562 1,747 1,530 1,401 1,235 376 343 313 327 6,863 1,111 217.6 244.8 6,627 6,287 6,263 1,100 1,007 1,040 226.7 225 219.3 246.1 236.2 243.9 1,460 1,461 1,496 1,523 1,155 1,152 1,188 1,207 305 310 309 316 6,260 6,013 6,031 6,032 958 953 964 973 215.5 221.4 218.4 222.3 239.4 241.4 238.8 248.4 1,552 1,578 1,602 1,613 1,241 1,265 1,289 1,300 312 313 313 313 6,086 6,149 6,187 6,202 966 970 974 979 219.6 223.3 229.3 225.1 242.5 245.9 248.5 248.5 12 Marketplace Dynamics Appreciation of residential real estate -Flat/Down since 2005/06 in key markets – Restricts borrower ability to refinance or, potentially, avoid loss on sale Year Over Year Price Appreciation 40 35 30 25 20 15 10 5 0 Percent 20 04 20 00 20 01 20 02 20 03 20 05 California Florida New York Illinois S o urc e : Offic e o f F e de ra l Ho us ing Ente rpris e Ove rs ight 13 20 06 Arizona Marketplace Dynamics Rates-Flat – Reduces refinance incentive Mortgage Bankers Association Finance Forecast Q1 Interest Rates % 30-Year Fixed Rate Mortgage 10-Year Treasury Yield 1-Year Treasury ARM 1-Year Treasury Yield 30-Year/1-Year Treasury Spread Source: Mortgage Bankers Association 2006 Q2 Q3 6.6 5.1 5.7 5 1.6 6.6 4.9 5.6 5.1 1.5 Q4 6.2 4.6 5.5 5 1.2 Q1 6.2 4.7 5.6 5.1 1.1 2007 Q2 Q3 6.4 4.8 5.6 5.1 1.3 6.5 4.9 5.7 5.2 1.3 Q4 6.6 5.0 5.8 5.2 1.4 Q1 6.6 5.0 5.8 5.2 1.4 2008 Q2 Q3 6.6 5.0 5.8 5.2 1.4 6.6 5.0 5.8 5.2 1.4 Q4 6.6 5.0 5.8 5.2 1.4 2006 2007 2008 6.4 4.8 5.5 4.9 1.5 6.4 4.8 5.7 5.2 1.2 6.6 5.0 5.8 5.2 1.4 6.2 4.6 5.3 4.6 1.6 – – – Little change in interest rate spreads is projected through 2008 As shown on the following page, rate resets are accelerating which, along with flat rates, results in borrower distress as monthly payments balloon The spread between 30-year fixed rate mortgages and the Federal Funds rate has declined significantly from 450 bp in 2004 to 140 bp in 20061 1. National Association of Homebuilders 14 Marketplace Dynamics Warehouse Loans are often priced on 1 month LIBOR Higher short term interest rates have eaten into the interest rate spread 8 7 6 5 4 3 2 1 - Key Industry Interest Rates (Percent) Sources: British Bankers Association/U.S. Federal Reserve ar 02 Ju n '0 Se 2 p '0 2 D ec '02 M ar '0 3 Ju n '0 Se 3 p '0 D 3 ec '0 M 3 ar '0 4 Ju n '0 4 Se p '0 D 4 ec '0 M 4 ar '0 5 Ju n '0 Se 5 p '0 D 5 ec '0 M 5 ar '0 6 Ju n '0 Se 6 p '0 D 6 ec '0 Fe 6 b '0 7 M 30 Year Mortgage 1 Month LIBOR Spread 15 Marketplace Dynamics – Rate resets are accelerating Cumulative Dollar Volume of Securitized Loans Backing Outstanding MBS/ABS by Year of Next Interest Rate Reset ($ in billions) $1,400 $1,200 $1,000 $800 $600 $400 $200 $2006 Source: Fannie Mae $1,167 $993 $844 $683 $407 $1,224 $1,257 $1,280 $1,299 $1,364 $1,377 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 – This segment represents roughly 60% ($5 trillion) of the estimated $8.5 trillion singlefamily first-lien mortgage debt currently outstanding 16 Marketplace Dynamics – The Gulf Coast and Midwest are experiencing the highest rates of delinquent payments for subprime loans Source: Mortgage Bankers Association 17 Marketplace Dynamics – – Recent data suggests the subprime lending fallout is bleeding into former safe-haven coastal areas Coastal markets could prove to be the “last shoe to drop” in the current subprime downturn Metro Areas With the Highest Growth of Subprime Loans 60+ Days Delinquent 25% 20% 19.3% 15% 14.1% 10% 12.2% 13.2% 9.5% 5% 3.4% 0% Sacramento, CA 2.4% Merced, CA 3.4% Modesto, CA Brockton, MA 3.5% Stockton-Lodi, New Bedford, CA MA Dec '05 Dec '06 FitchburgLeominster, MA 7.6% 7.8% 7.5% 2.6% Yuba City, CA Lowell, MA-NH 12.7% 17.0% 16.7% 16.3% 11.4% Source: Wall Street Journal 18 Marketplace Dynamics Defaults-Up – 6 5 4 3 2 1 Q1 02 Q3 06 Q3 02 Q1 03 Q3 03 Q1 04 Q3 04 Q1 05 Q3 05 Q1 06 Delinquencies are rising All Loan Delinquencies (Percent) 16 14 12 10 8 6 4 2 Q3 05 Q1 02 Q3 03 Q1 03 Q1 05 Q3 02 Q1 04 Q3 04 Q3 06 Q1 06 Subprime Loan Delinquencies (Percent) T otal Past Due 30 Days 60 days 90 Days or More T otal Past Due 30 Days 60 days 90 Days or More Source: Mortgage Bankers Association (MBA) – – – – – Delinquency rates had been in a downtrend into 2005 2005 marked a low-point in delinquencies Trends reversed in the latter part of 2005 and have been on an uptrend since. Fannie Mae estimates that 20%, or approximately $600 billion of mortgages originated during 2006, were subprime compared to 5%, or $120 billion in 2001 Delinquencies in subprime loans are more pronounced Still not clear how far the underwriters went 19 Marketplace Dynamics Early Payment Defaults (“EPD”) -Up – – Effect of aggressive underwriting Foreclosure rates are rising Foreclosure Rate All Loans (Percent) Foreclosure Rate Subprime Loans (Percent) 3.0 2.5 2.0 1.5 1.0 0.5 Q1 02 Q3 02 14 12 10 8 6 4 2 - Q3 05 Q3 04 Q3 03 Q3 02 Q1 03 Q3 03 Q1 04 Q3 04 Q1 05 Q3 05 Q1 06 Inventory at end of quarter Started during quarter Seriously Delinquent Q3 06 Q1 02 Inventory at end of quarter Q1 03 Q1 04 Started during quarter Q1 05 Seriously Delinquent Source: Mortgage Bankers Association – A significant amount of recent defaults have not yet gone through foreclosure, ultimate dollar loss not known 20 Q3 06 Q1 06 Marketplace Dynamics Implications of Market Conditions: Lower Volume – – – Overall decline in homebuilding since early 2006 Stricter lending standards, reduced liquidity to borrowers Fewer “qualified” buyers Liquidity Squeezed – – – Warehouse lenders demanding stricter lending criteria Increase cost of funds Securitization market seeing more risk, requires higher return, or, worst case, not willing to participate at all Excess Capacity in Market – – Originations and servicing infrastructures were built for much higher volumes Result is rising cost per loan and potential need to be even more aggressive in lending practices – Creates added regulatory risk Putback Exposure to Lenders – – EPDs causing liquidity concerns as companies buy back loans without a highly liquid secondary market to sell them into Capital structure of certain originators may prove to be inadequate to fund the buybacks 21 Marketplace Dynamics Leading Residential Originators In the first half of 2006. Dollars in millions Published October 24, 2006 Rank Company/Location Production $220,027 206,590 104,645 91,738 84,120 80,811 40,306 40,037 37,027 36,326 30,431 28,538 28,104 26,882 25,600 23,291 21,307 21,269 18,887 18,840 18,078 17,657 16,643 15,963 15,578 Year earlier $211,807 163,874 120,464 85,387 66,585 73,301 25,745 25,801 45,388 40,346 26,054 22,497 18,036 19,855 20,504 24,657 30,363 22,505 25,838 25,791 15,523 22,443 20,188 16,672 23,270 Change 3.90% 26.1 -13.1 7.4 26.3 10.2 56.6 55.2 -18.4 -10 16.8 26.9 55.8 35.4 24.9 -5.5 -29.8 -5.5 -26.9 -27 16.5 -21.3 -17.6 -4.3 -33.1 Market share 13.43% 12.61 6.39 5.6 5.14 4.93 2.46 2.44 2.26 2.22 1.86 1.74 1.72 1.64 1.56 1.42 1.3 1.3 1.15 1.15 1.1 1.08 1.02 0.97 0.95 Change -0.2% 2.1 -1.3 0.1 0.9 0.2 0.8 0.8 -0.7 -0.4 0.2 0.3 0.6 0.4 0.2 -0.2 -0.6 -0.1 -0.5 -0.5 0.1 -0.4 -0.3 -0.1 -0.5 1 Countrywide Financial Corp. Calabasas, Calif. 2 Wells Fargo Home Mortgage San Francisco 3 Washington Mutual Seattle 4 Chase Home Finance Iselin, N.J. 5 CitiMortgage Inc. O’Fallon, Mo. 6 Bank of America Charlotte 7 GMAC-RFC Minneapolis 8 IndyMac Bancorp Inc. Pasadena, Calif. 9 GMAC Residential Holdings Horsham, Pa. 10 EMC Mortgage Lewisville, Tex. 11 Wachovia Charlotte 12 HSBC Finance Prospect Heights, Ill. 13 American Home Mtg. Investment Melville, N.Y. 14 SunTrust Mortgage Inc. Richmond 15 New Century Financial Corp. Irvine, Calif. 16 Golden West Financial Corp./World Oakland, Calif. 17 National City Mortgage Miamisburg, Ohio 18 PHH Mortgage Mount Laurel, N.J. 19 ABN Amro Mortgage Ann Arbor, Mich. 20 Aurora Loan Services Inc. Aurora, Colo. 21 Fremont Investment and Loan Santa Monica, Calif. 22 GreenPoint Mortgage Funding Novato, Calif. 23 First Horizon Home Loans Irving, Tex. 24 Option One Mortgage Corp. Irvine, Calif. 25 Ameriquest Mortgage Corp. Orange, Calif. 22 Marketplace Dynamics Leading Residential Originators In the first half of 2006. Dollars in millions Published October 24, 2006 Rank Company/Location Production 14,784 14,100 14,081 13,529 12,400 12,250 11,291 10,602 8,961 8,276 7,666 7,480 7,327 7,025 6,772 6,765 6,115 5,554 5,458 5,398 5,200 5,050 5,020 4,909 4,806 $1,479,514 $1,610,226 Year earlier 10,729 12,244 11,720 7,426 7,334 11,136 7,860 10,197 14,117 9,126 6,460 7,200 7,030 6,284 7,775 6,402 7,244 3,892 3,288 6,233 7,000 5,200 4,800 1,478 4,514 $1,379,582 $1,520,103 Change 37.8 15.2 20.1 82.2 69.1 10 43.7 4 -36.5 -9.3 18.7 3.9 4.2 11.8 -12.9 5.7 -15.6 42.7 66 -13.4 -25.7 -2.9 4.6 232.1 6.5 7.20% 5.90% Market share 0.9 0.86 0.86 0.83 0.76 0.75 0.69 0.65 0.55 0.51 0.47 0.46 0.45 0.43 0.41 0.41 0.37 0.34 0.33 0.33 0.32 0.31 0.31 0.3 0.29 86.82% 93.89% Change 0.2 0.1 0.1 0.3 0.3 0 0.2 NM -0.4 -0.1 0.1 NM NM NM -0.1 0 -0.1 0.1 0.1 -0.1 -0.1 NM NM 0.2 NM 1.70% 0.50% 26 MortgageIT New York 27 WMC Mortgage Corp. Woodland Hills, Calif. 28 First Magnus Financial Corp. Tucson 29 Homecomings Financial Minneapolis 30 CitiFinancial Baltimore 31 First Franklin Financial San Jose 32 Taylor, Bean, and Whitaker Ocala, Fla. 33 U.S. Bank Home Mortgage Bloomington, Minn. 34 Flagstar Bank FSB Troy, Mich. 35 BB&T Financial Corp. Wilson, N.C. 36 Accredited Home Lenders San Diego 37 CTX Mortgage Dallas 38 Quicken Loans Inc. Livonia, Mich. 39 BNC Mortgage Inc. Irvine, Calif. 40 Credit Suisse New York 41 American Mortgage Network San Diego 42 HSBC Mortgage Corp. USA Depew, N.Y. 43 NovaStar Mortgage Inc. Kansas City, Mo. 44 Ownit Mortgage Woodland Hills, Calif. 45 NetBank Columbia, S.C. 46 Merrill Lynch Credit Corp. Jacksonville, Fla. 47 Provident Funding Associates Burlingame, Calif. 48 Aegis Mortgage Corp. Houston 49 Mortgage Lenders Network, USA Middletown, Conn. 50 Fifth Third Mortgage Cincinnati Top 50 total: Total submitted: Source: American Banker 23 Business Model 24 Business Model Subprime lenders are principally organized as either: A. REIT – 90% pass through of all REIT taxable income – Risk in that ability to retain cash from operations is severely curtailed – Attracts income investors – Public or non-public B. Non-REIT corporate entity – No restrictions on cash retention – Public or non-public 25 Business Model Material sources of income for subprime lenders include: – – – – – Sale of whole loans Residual interests IO strips Loan servicing Interest spread on held mortgages Material expenses of subprime lenders include: – – – Cost to originate loans Interest Cost of servicing Subprime lenders mainly choose non-bond debt and equity with which to capitalize operations – – Borrow at short-term rates, lend at long-term rates and sell the loan in the secondary market in or about 30 - 90 days from origin Off-balance sheet securitization of originated or purchased loans The following pages provide an illustration of the above points using New Century’s published (before restatement) financial statements 26 Business Model Example – New Century as reported 9/30/06 (before restatements) NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets September 30, 2006 and December 31, 2005 (Dollars in millions) September 30, 2006 (Unaudited) ASSETS Cash and cash equivalents Restricted cash Mortgage loans held for sale at lower of cost or market Mortgage loans held for investment, net of allowance of $191.6 and $198.1, respectively Residual interests in securitizations - held-for-trading Mortgage servicing assets Real estate owned, net of allowance of $56.3 and $18.2, respectively Accrued interest receivable Income taxes, net Office property and equipment, net Goodwill Prepaid expenses and other assets Total assets LIABILITIES AND STOCKHOLDERS' EQUITY Credit facilities on mortgage loans held for sale Financing on mortgage loans held for investment, net Accounts payable and accrued liabilities Junior subordinated notes Convertible senior notes, net Notes payable Total liabilities Total stockholders' equity Total liabilities and stockholders' equity $ $ 408.9 572.8 8,945.1 14,031.0 223.7 59.9 84.0 109.6 80.6 87.7 95.8 360.7 $ 25,059.8 8,487.9 13,858.9 574.3 51.5 22.8 22,995.4 2,064.3 25,059.8 $ $ December 31, 2005 $ 503.7 726.7 7,825.2 16,143.9 234.9 69.3 37.6 101.9 80.8 86.9 93.0 243.1 26,147.1 7,439.7 16,045.5 508.2 4.9 39.1 24,037.4 2,109.7 26,147.1 Loans held to be securitized Securitization residuals - Sale of mortgage loans to securitization vehicle moves the loans off-balance sheet - Present value of forecasted income from retained interests in the loans (residuals) booked as an asset Present value of future servicing cash flows - Values the servicing contract $ $ Owned real estate, typically from foreclosed collateral Loans held on-balance sheet - Financed with recourse 27 Business Model NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements Of Earnings (Dollars in millions) (Unaudited) Reported a 3.23% financing spread on OnBalance Sheet assets in 2005 as compared to 2.66% financing spread on mortgages held for sale, overall net interest spread in 2005 was 2.75% Nine Months Ended September 30, 2006 2005 Interest income Interest expense Net interest income Provision for losses on mortgage loans held for investment $141.5 million gain on securitization of $6.4 billion in loans in 2005, apx. 2.21% return $481.1 milllion gain on sale of $35.4 billion of loans in 2005, apx 1.36% return Net interest income after provision for losses Other operating income: Gain on sale of mortgage loans Servicing income Other income (loss) Total other operating income Operating expenses: Personnel General and administrative Advertising and promotion Professional services Total operating expenses Earnings before income taxes Income tax expense Net earnings Dividends paid on preferred stock Net earnings Common Share Declared Dividend $ $ 1,478.3 $ (1,019.6) 458.7 (80.9) 377.8 497.7 47.4 18.8 564.0 356.2 170.1 41.2 33.6 601.1 340.7 64.8 275.9 8.3 267.6 $ 1,246.6 (671.5) 575.0 (105.7) 469.4 409.8 23.6 12.3 445.6 378.3 133.9 66.2 29.1 607.4 307.5 7.6 299.9 2.9 297.1 $ $ $ Fiscal Year 2005 1,759.6 (988.1) 771.4 (140.2) 631.2 622.6 38.5 22.4 683.5 551.8 193.1 83.7 42.8 871.3 443.4 26.8 416.5 5.4 411.1 364.5 For third parties New Century generally receives 0.5% of outstanding principal on serviced loans plus other fees 28 Business Model NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Dollars in millions) (Unaudited) Nine Months Ended September 30, 2005 2006 Cash flows from operating activities: Net earnings Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization of office property and equipment Amortization of deferred costs related to mortgage loans held for investment Amortization related to mortgage servicing rights and other Other items, net Stock-based compensation Cash flows received from residual interests in securitizations Accretion of Net Interest Receivables, or "NIR" NIR gains Servicing gains Fair value adjustment of residual interests in securitizations Provision for losses on mortgage loans held for investment Provision for repurchase losses Increase in real estate owned, net Mortgage loans originated or acquired for sale Mortgage loan sales, net Principal payments on mortgage loans held for sale Increase in credit facilities on mortgage loans held for sale Tax benefit (change) related to non-qualified stock options Net change in other assets and liabilities Net cash provided by operating activities $ 275.9 22.7 65.0 15.0 16.7 2.1 (19.0) (30.0) 28.1 80.9 5.3 (46.4) (42,077.5) 40,630.4 446.8 1,048.2 (5.0) (249.2) 209.9 $ 299.9 16.0 65.1 8.6 5.7 15.0 (11.9) (34.8) (60.9) 7.6 105.7 4.3 (16.6) (30,215.3) 25,453.5 209.1 4,513.9 77.4 442.3 Fiscal Year 2005 $ 416.5 23.0 110.2 17.5 (17.0) (95.1) 10.0 140.2 17.5 (45,917.9) 41,757.0 275.6 3,735.4 17.6 58.9 549.5 29 Business Model NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Dollars in millions) (Unaudited) Nine Months Ended September 30, 2006 2005 (3,376.6) (10,273.6) 5,371.0 4,984.7 29.5 8.5 (23.5) (46.8) 9.8 (80.6) 2,010.1 (5,407.8) Fiscal Year 2005 (10,273.6) 7,122.1 24.9 (60.5) (80.6) (3,267.8) Cash flows from investing activities: Mortgage loans originated or acquired for investment, net Principal payments on mortgage loans held for investment Sale of mortgage servicing rights Purchase of office property and equipment Acquisition of net assets Net cash provided by (used in) investing activities Cash flows from financing activities: Proceeds from issuance of financing on mortgage loans held for investment, net Repayments of financing on mortgage loans held for investment (Increase) decrease in restricted cash Proceeds from issuance of junior subordinated notes Net proceeds from issuance of common stock Net proceeds from issuance of preferred stock Increase (decrease) in notes payable, net Payment of dividends on common stock Payment of dividends on preferred stock Excess tax benefits from stock-based compensation Purchase of common stock Net cash provided by (used in) financing activities Net decrease in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of period 3,280.9 (5,488.0) 153.9 51.5 14.7 55.6 (16.3) (294.2) (7.7) 5.0 (70.3) (2,314.9) (94.9) 503.7 408.9 9,792.2 (4,688.0) (317.3) 25.4 108.7 7.7 (259.1) (2.9) (14.0) 4,652.7 (312.8) 842.9 530.1 9,790.8 (6,875.8) (272.7) 26.5 108.7 1.5 (352.5) (5.4) (41.9) 2,379.2 (339.1) 842.9 503.7 $ $ $ 30 Bankruptcy Implications 31 Bankruptcy Implications Significant Industry Events Date Apr-05 Jun-05 Jul-05 Aug-05 Apr-06 Federal Reserve begins raising rates National Association of Realtors (NAR) announced record existing home sales Higher home inventories raise pricing fears USA Capital April 13, 2006 Bankruptcy Ameriquest Capital closed retail branch network NAR data signals slowing home sales Jun-06 Sep-06 Subprime delinquencies begin to accelerate NAR data shows drop in existing home sales prices On September 5, Merrill Lynch acquired the non-conforming lender First Franklin from National City Corp. On September 5, HF Financial Corp bought the mortgage servicing rights from Great Western Bancorp. Nov-06 Dec-06 Sebring Capital Partners December Bankruptcy Ownit Mortgage Solutions December 28 Bankruptcy Jan-07 Popular, Inc. announced January, it would shutter its wholesale subprime lending unit On January 9, GMAC ResCAP announced a 1,000 job reduction due to difficulties in their subprime unit On November 24, Bradford and Bingley PLC bought a mortgage loan portfolio from General Motors for $1.3 billion. On December 1, Fortress Investment Group acquired the Champion Origination Platform of KeyCorp Event Brasota Mortgage April 4th Bankruptcy Merger & Acquisition 32 Bankruptcy Implications Significant Industry Events (Continued) Date Feb-07 Event Mortgage Lender's Network USA, Inc. February 5 Bankruptcy Merger & Acquisition HSBC announced on February 7, it would take a $10.5 billion charge for bad debts due to its mortgage portfolio ResMAE Mortgage February 12 Bankruptcy ResMAE acquired by Citadel Investment Group on February 13 for $180 million On February 15, Franklin Credit Management acquired the wholesale mortgage origination business of New York Mortgage Trust Fieldstone acquired by C-BASS on February 16 Mar-07 Bank Regulators announced on March 2, an initiative to clean-up subprime lending standards Fremont General ends residential subprime operations March 2 New Century stops making loans on March 9 On March 9, New Century announced lenders would cease additional financing On March 15, ACC Capital announced workforce reductions and plans to consolidate its wholesale business, Argent Mortgage. The move follows similar reductions in its retail branch network which was closed in May, 2006 On March 15, Accredited Home Lenders announced it would sell substantially all of its $2.7 billion in loans funded out of its warehouse and repurchase credit facilities at an estimated 5% discount to par On March 19, Connecticut Senator Christopher Dodd calls a hearings on subprime lender industry On March 20, Accredited Home Loans receives $200 million loan from Farallon New Century announced March 20 that Fannie Mae would no longer buy its loans People's Choice Home Loan March 20 Bankruptcy SEC announced on March 20 a probe of subprime lenders H&R Block cuts funding to Option One on March 21 On March 21, Fremont General announced it had sold $4 billion in subprime loans at $0.96/$1.00 Sources: Bloomberg, Wall Street Journal, CBS MarketWatch, ML-Implode.com, Forbes, Company Documents 33 Bankruptcy Implications What events precipitate a filing? Regulatory constraints on ability to lend – – – Cease and Desist orders, on a state-by-state basis More stringent lending criteria Fannie Mae restricting loan purchases Liquidity Squeeze – – – Warehouse Lenders stop lending or tighten lending criteria Secondary market no longer willing to purchase mortgages or securities at a profitable price Demand for buyback of loans under Repurchase Financing Agreements Loans sold to third parties provide a key source of liquidity for the subprime lender A crisis of confidence ensues – Perceived higher risk lower selling prices for the loans Warehouse Lenders react with higher rates, more stringent borrowing base, or, in many cases, by cutting off funds Unable to sell or originate new loans, weak or overexposed subprime lenders are caught in a viscious downdraft 34 Bankruptcy Implications What to expect from a Bankruptcy: Implications of Repo bankruptcy rules 2005 Bankruptcy Code Amendments – Definition of Repurchase Agreement expanded to include: “an agreement, including related terms, which provides for the transfer of one or more...mortgage related securities...mortgage loans, interests in mortgage related securities or mortgage loans...against the transfer of funds by the transferee of such...securities, mortgage loans, or interests, with a simultaneous agreement by such transferee to transfer to the transferor thereof [such assets]...at a date certain not later than 1 year after such transfer or on demand, against the transfer of funds” “any security agreement or arrangement or other credit enhancement related to any [repurchase agreement], including any guarantee or reimbursement obligation by or to a repo participant or financial participant…” – “Repo Participant” means an entity that at any time before the filing of the petition, has an outstanding repurchase agreement with the debtor 35 Bankruptcy Implications Repo Safe Harbor Provisions: – Contractual right to liquidate, terminate or accelerate a repurchase agreement upon a bankruptcy filing cannot be stayed, avoided or otherwise limited by any provision of the Bankruptcy Code or by any order of a court or administrative agency in any proceeding under the Bankruptcy Code (section 559) exception where the debtor is a stockbroker or securities clearing agency upon liquidation, excess of market price over the sum of the stated repurchase price and all expenses in connection therewith received on liquidation shall be deemed property of the estate subject to available rights of setoff – Exception to automatic stay of the exercise by a repo participant of any contractual right under any security agreement or arrangement or other credit enhancement forming a part of or related to any repurchase agreement, or any contractual right to offset or net out any termination value, payment amount or other transfer obligation (section 362(b)(7) as amended by the Financial Netting Improvements Act of 2006) Court or an administrative agency may not stay the exercise or rights not subject to stay under section 362(b)(7) (section 362(o)) – Exception to Trustee's Avoidance Powers: trustee may not exercise avoidance powers to avoid a transfer, made by or to (or for the benefit of) a repo participant, except under section 548(a)(1)(A) (section 546(f) as amended by the Financial Netting Improvements Act of 2006) Net effect of these amendments is to remove debtor-borrower's unilateral right to seek to sell its assets subject to a repurchase agreement upon a bankruptcy filing – 36 Bankruptcy Implications DIP Issues – – DIP often cannot be justified/obtained without an M&A process in place DIP Lenders may seek to credit bid on a sale M&A/Liquidation – Portfolio Assets – Going concern segment of business Need for Expediency Little value proposition opportunity for distressed investors once a subprime lender seeks bankruptcy protection 37 Investment Opportunities 38 Investment Opportunities Limited Trading Opportunities – – – – – Well capitalized and experienced players already in the market, such as Morgan Stanley, Merrill Lynch, Lehman Brothers, etc. Industry is consolidating Strategic players are likely buyers/winners Need loan-level data to appropriately assess asset quality Warehouse Lenders and well capitalized and established industry players have best visibility into asset base Common/Preferred – Assess individual companies for possible short/long strategies. Variables to consider include: – Credit quality / EPD trend – Wholesale versus retail business model – Portion of mortgage assets that are no document / stated income – Geographic dispersion of loan portfolio – Capital structure – Bonds Bond financing not typical for industry (exceptions include Countrywide, Fremont and IndyMac) 39 Limited Data Assets/Instruments – Investment Opportunities Assets/Instruments (continued) – Loan Purchases Need to have servicing capabilities prior to purchasing loans – Servicing includes payment collection, account maintenance, escrow account maintenance, payment of taxes and insurance premiums and loan loss mitigation – Fees typically levied on amounts collected and late fees and charges. Fee structures change when dealing with delinquent loans – Major servicers include Countrywide Financial, Chase Home Finance, Option One Mortgage Corp. and CitiFinancial among others – – Warehouse Lending Certain larger funds appear to be entering the market Residuals Very hard to value now given state of the subprime industry Value dependent on pool performance Need to read securitization documents as the devil is in the details to clearly understand payment “waterfall” 40 Investment Opportunities Assets/Instruments (continued) – Platform Originating and servicing Long term market participant play – ABX Index ABX.HE – a synthetic index measuring pricing on various domestic home equity asset-backed securities – Useful in gauging performance/pricing on U.S. residential mortgage debt Short/long – – Servicing Rights have value Securitizations Buying tranches Again, need to understand what the “waterfall” is and how it can change 41 What Happens Next? 42 What Happens Next? The market will continue to consolidate – Profit growth may be available as overcapacity declines Continued liquidity pullback by warehouse lenders, tightened lending criteria, etc. Spreads tighten, further squeeze lender profitability – Lenders focus on: Improved credit evaluation and risk assessment metrics/measures Cost of funds Cost to originate Potential for bleeding up the quality ladder as cycle continues – Similar underwriting methods such as high LTV, piggyback loans, interest only, negative amortizing loans, etc., were applied to Alt-A loans (loans one level above subprime in terms of credit quality) in part Large number of subprime ARM resets in the coming years continuing distress on the system – – Resets occur following predetermined introductory rate Rates adjust to prevailing market rates of interest often considerably higher than introductory rate Foreclosures further depress real estate values creating downward cyclical pressure as collateral values drop Possible spillover to other sectors or industries Further regulation? Washington’s new scratching post 43 Stroock Team 44 Stroock Team Lewis Kruger Allan N. Krinsman Christopher R. Donoho Mark A. Speiser (212) 806-5430 (212) 806-5746 (212) 806-6209 (212) 806-5437 lkruger@stroock.com akrinsman@stroock.com cdonoho@stroock.com mspeiser@stroock.com 45 Capstone Advisory Group Team 46 Capstone Advisory Group Team Chris Kearns Ed Ordway Jay Borow (212) 782-1404 (201) 587-7114 (212) 782-1411 ckearns@CapstoneAG.com eordway@CapstoneAG.com jborow@CapstoneAG.com 47 Appendix: Glossary of Terms and Acronyms 48 Glossary of Terms and Acronyms Term Adjustable Rate Mortgage Acronym ARM Definition/Use Adjustable Rate Mortgages have interest rates which are tied to an underlying index such as the Prime Rate or London Interbank Offering Rate. In times of falling rates, mortgage payments will contract, and in periods of rising interest rates, Mortgage payments will increase. Exploding ARMs have artificially low initial rates with periodic resets following an initial period. Average selling price reflects the average price paid for units during the underlying period. A loan which monthly installments do not cover the total loan balance. The homeowner must make a large payment at the end of the designated period. Collateralized Debt Obligations are bonds backed by the assets or collateral of an underlying borrower. They are comprised of various classes of debt along the risk spectrum and sold to the investing public. Early Payment Default is the homeowner's failure to make the required mortgage payment under the underlying loan terms. For securitized loans, EDP can enable a buyer to put back the loan to the Lender under certain recource provisions. Federal Home Loan Mortgage Corporation is a GSE tasked with providing liquidity to the mortgage debt market. The company provides liquidity to the mortgage market by purchasing and securitizing mortgage debt and issues it to the investing public. Much Like Freddie Mac, Federal National Mortgage Corporation is a GSE tasked with providing liquidity to the mortgage debt market.. The company provides liquidity to the mortgage market by purchasing and securitizing mortgage debt and issues it to the investing public. Government sponsored enterprises are institutions set up by the government to facilitate a certain goal. In the case of residential building, Fannie Mae and Freddie Mac are GSEs which facilitate financing for, and access to, money for homeownership. The House Price Index is a broad measure published by the Office of Federal Housing Enterprise Low-Documentation loans are loans where lenders require little proof of a potential client's assets and Loan to Value is the loan amount outstanding divided by the value of the home. In difficult times, homeowners with high LTV ratios, or little equity, do not have the equity to fall back on should making diffi l The London Interbank Offering Rate is a widely used benchmark for short term interest rates. Metropolitan Statistical Areas are census defined regions for reporting purposes. MSAs tend to encompass multiple counties. Mortgage Backed Securities are debt obligations backed by a pool of mortgages. Like CDOs, they are comprised of debt with varying degrees of risk. The Office of Federal Housing Enterprise Oversight is a government institution tasked with promoting housing and overseeing the security of Fannie Mae and Freddie Mac. It also publishes the Housing Price Index. Payment Shock is an unmanageable jump in a homeowners payment often occurring with arms and resetting loans. Predatory Lending is an umbrella term for unscrupulous lending practices such as unnecessary refinancings, excessive fees, and unnecessarily high interest rates. The seasonally adjusted annual rate is a means of reporting certain statistics by smoothing seasonal factors for better comparability. Steering is a sales practice where mortgage representatives guide potential mortgage clientele to higher rate products despite a client's likelihood of qualifying for a lower rate loan. Subprime Lending is lending to customers with lower credit scores or spotty credit histories. The home mortgage market is comprised of Prime, Alt-A, and subprime borrowers with credit quality from high to low, respectively. Average Selling Price Balloon Mortgage Collateralized Debt Obligation ASP NA CDO Early Payment Default EPD Federal Home Loan Mortgage Corporation Freddie Mac Federal National Mortgage Corporation Fannie Mae Government Sponsored Enterprise GSE House Price Index Low-Doc/No-Doc Loans Loan to Value Ratio London Interbank Offering Rate Metropolitan Statistical Area Mortgage Backed Securities Office of Federal Housing Enterprise Oversight HPI NA LTV LIBOR MSA(s) MBS OFHEO Payment Shock Predatory Lending Seasonally Adjusted Annual Rate Steering Subprime Lending NA NA SAAR NA NA 49