Subprime Lending Crisis: New Regulations and Enforcement Efforts, Business and Litigation Strategies First Day Overview

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Subprime Lending CrisisNew Regulations and
Enforcement Efforts, Business and Litigation
StrategiesFirst Day Overview

• Veronica E. Rendon,
• Co-Chair
• Arnold Porter LLP
• 399 Park Avenue
• New York, NY 10022
• 212.715.1165
• veronica.rendon_at_aporter.com

March 18-19, 2008
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What Happened and Why Are We Here?
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Why the Market was Ripe for Growth

• Issuance of non agency MBS grew from 157
  billion in 2000 to 1.2 trillion in 2006
• Overall issuance of subprime non-agency MBS grew
  from 96 billion in 2001 to 483 billion in 2006
• Created surging demand for mortgage paper and
  increased competition
• Originations and MBS market share have more than
  doubled over the last few years

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Subprime Originations and MBS Market Share
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Why There Is A BIG Problem

• The Fed raised interest rates 17 times since 2004
• Home prices have fallen dramatically
• Delinquency and default rates are high
• Refinancing is difficult
• Foreclosures
• Warehouse lenders cut financing
• Securitization ratings keep falling
• Negative cycle feeds loss of value
• Has created more than a subprime issue really a
  credit crisis

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Why There Is A BIG Problem

• 50 percent of ARM originations over past four
  years have been subprime
• 80 percent of 2005 subprime originations were
  ARMs, most were 2/28 hybrids
• Nearly 2 million subprime ARMs will reset by the
  end of 2008, with monthly payment increases of 30
  percent or more
• Underwritten differently than before
• No doc/low doc
• Debt-to-income ratios based on teaser rates
• Increasing loan-to-value ratios
• Prepayment penalties

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The Subprime Meltdown

• The turbulence originated in concerns about
  subprime mortgages, but the resulting global
  financial losses have far exceeded even the most
  pessimistic estimates of the credit losses on
  these loans.
• Ben Bernanke, Chairman of the Federal Reserve,
  September 20, 2007

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Imploded Lenders

• Many lenders have already gone into bankruptcy
  or are near bankruptcy

• Alliance Bancorp
• Choice Capital Funding
• Premier Mortgage Funding
• Stone Creek Funding
• FlexPoint Funding
• Starpointe Mortgage
• Freestand Financial
• Wells Fargo Correspondent Alternative
• Altivus Financial
• ACT Mortgage
• Aegis Mortgage Corp.
• Ownit Mortgage Solutions
• Quality Home Loans

• New Century Financial Corporation
• Fremont General Corp.
• Ameriquest Mortgage
• Southstar Funding
• Oak Street Mortgage, LLC
• ResMAE Mortgage Corp.
• Peoples Choice Financial Corp.
• American Home Mortgage Investment
• LoriMac,Inc.
• First Magnus Financial
• Silver State Mortgage
• Sunset Direct Lending

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Guaranty Insurers Are Struggling

• Significant Subprime Exposure
• FGIC
• MBIA
• Ambac
• Radian
• Their own ratings are at risk
• Causing a lot of discomfort
• Worsening market conditions

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Plaintiffs Perspective
The implosion of an asset price bubble
always leads to the discovery of fraud and
swindles. - Charles P. Kindleberger, Economist
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Lawsuits, Lawsuits, Lawsuits

• Federal securities litigation filings increased
  in 2007
• NERA study 38 subprime securities class actions
• Concentrated in the Southern District of New York
• Shareholders claiming public companies made
  materially false and misleading public statements
  overstating performance and understating risk
• Press releases
• Audited financial statements
• Offering documents
• Targets lenders and brokers, builders, credit
  insurers and rating agencies

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Lawsuits, Lawsuits, Lawsuits

• Also a significant amount of borrower class
  actions
• Alleging fraud in the borrowing process
• Navigant Consulting study Federal subprime
  lawsuits are outpacing SL litigation
• According to Nielsen "This appears to be just
  the beginning. We are already observing a
  steady acceleration of continuing litigation
  activity into 2008. The explosion of cases in
  2007 suggests a daunting forecast of what is
  still to come."

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The Industry At War With Itself?
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Potential Legal Allegations

• Claims of fraud in the underwriting and
  origination process and permeation downstream
• Claims of misvaluation of assets
• Were modeling assumptions too aggressive?
• Claims of breach of securitization documents
• e.g., Reps and Warranties
• Claims of inadequate servicing
• Claims of inaccuracies in delinquency and default
  reporting
• Claims of omissions or materially misrepresented
  audited financial statements and disclosure
  documents

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Potential Defenses

• No industry-wide fraud
• At most, sporadic instances occurring at
  borrower/broker level
• Very difficult to value a new asset class
• Easy to use 20/20 hindsight to point fingers
• Assumptions in models were correct when made
• Will adjust as empirical performance data is
  collected
• Reps and warranties were complied with
• Servicing complied with industry standards
• Performance data and risk disclosures were
  accurate
• Sophisticated parties capable of extensive due
  diligence

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Really talking about foreseeability
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Monetary Policy

• The Fed was encouraging lenders to develop and
  market alternative adjustable rate products, just
  as it was embarking on a long series of hikes in
  short term rates.
• In my view, these actions set the conditions for
  the perfect storm that is sweeping over millions
  of American homeowners today.

• Christopher J. Dodd (D -Ct), Chairman, U.S.
  Senate Committee on Banking, Housing and Consumer
  Affairs

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• WE WELCOME YOUR
• QUESTIONS AND COMMENTS!