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Chicago Bar Association
The Mortgage Crisis – Chapter 11 IssuesNovember 13, 2007
Paul Possinger, PartnerWinston & Strawn [email protected](312) 558-3717
Neil Luria, Managing DirectorNavigant Consulting, [email protected](216) 321-5606
3
What Caused the Subprime Crisis?
Foreclosures / Delinquencies
Originators Warehouse Lenders Investors
Decline in Housing Market Increase in Interest Rates
Subprime
Subprime Crisis Could Have Broader Effects
4
Mortgage Insurers and Home Building Products Stocks Have Been Impacted in the Recent Past
Note: Data as of August 9th ' 2007Source: CapitalIQ
60.0
80.0
100.0
120.0
7/10/2007 7/13/2007 7/16/2007 7/19/2007 7/22/2007 7/25/2007 7/28/2007 7/31/2007 8/3/2007 8/6/2007 8/9/2007
American Standard Companies, Inc. (NYSE:ASD) - Common Stock Armstrong World Industries, Inc. (NYSE:AWI)
Lennox International Inc. (NYSE:LII) Owens Corning Sales, Inc. (NYSE:OC)
USG Corp. (NYSE:USG)
30.0
50.0
70.0
90.0
110.0
7/10/2007 7/13/2007 7/16/2007 7/19/2007 7/22/2007 7/25/2007 7/28/2007 7/31/2007 8/3/2007 8/6/2007 8/9/2007
ACA Capital Holdings, Inc. (NYSE:ACA) - Common Stock Assured Guaranty Ltd. (NYSE:AGO)
MGIC Investment Corp. (NYSE:MTG) Radian Group Inc. (NYSE:RDN)
Security Capital Assurance Ltd. (NYSE:SCA)
Relative Performance – Building Products Suppliers
Relative Performance – Mortgage Insurers
5
The Top 5 Subprime Originators for theYear 2006 are Having Difficult Times in 2007
Source: CapitaIQ, Company Press Release and Filings
GE plans to sell the WMC mortgage business
New Century Financial Corp. Filed for Bankruptcy
Well Fargo shuts its Brokered Subprime Mortgage Loan Unit
HSBC Finance's loan impairment charges as a % of op.income in Q2'07 was 15% as compared to 11.3% in Q2'06
Countrywide's 2007 second quarter earnings dropped byApproximately 30%
Top 5 Subprime Originators in 2006
0
20,000
40,000
60,000
80,000
Wells FargoHome Mortgage
HSBC Finance New CenturyFinancial
Countrywide WMC MortgageCorp
(in $
mm
)
6
Most of the Major Financial Institutions Have Been Impacted by the Subprime Crisis
Originators Warehouse Lenders Investors
7
Mortgage REITS Have Been Hit Hard by Subprime; Very Low Price to Book Ratios Imply Overvaluation of Assets on the Books
Source: Bloomberg
Note 1: Price as of August 9th ' 2007
Note 2: Trailing 12Months Value
Subprime Issuers
Issuer Stock Price 1Market
Capitalization 1 Revenue 2Operating Margin 2
Profit Margin 2 ROE P/E P/B
($)Wells Fargo & Co 34.16 114,245 50,718 25.95% 17.54% 20.03% 13.10x 2.43xWashington Mutual 36.76 31,298 26,532 18.69% 12.89% 12.88% 10.21x 1.33xCountrywide Financial Corp 28.66 15,696 21,561 15.71% 10.15% 12.88% 7.63x 1.09xIndyMac Bancorp Inc 20.58 1,462 2,801 14.63% 9.12% 8.92% 5.73x 0.71x
High 36.76 114,245 50,718 25.95% 17.54% 20.03% 13.10x 2.43xLow 20.58 1,462 2,801 14.63% 9.12% 8.92% 5.73x 0.71xMedian 31.41 23,497 24,046 17.20% 11.52% 12.88% 8.92x 1.21xMean 30.04 40,675 25,403 18.75% 12.43% 13.68% 9.17x 1.39x
($mm) (%) (x)
Mortgage REITS
Issuer Stock Price 1Market
Capitalization 1 Revenue 2Operating Margin 2
Profit Margin 2 ROE P/E P/B
($)Impac Mortgage Holdings Inc 1.78 135 1,247 (5.40%) (5.33%) (39.73 %) NA 0.19xLuminent Mortgage Capital Inc 0.85 48 525 15.45% 12.69% 12.73 % 0.73x 0.10xNovastar Financial 5.53 62 498 12.51% 13.32% 3.02 % NA 0.13xAnworth Mortgage Asset Corp 5.61 195 334 (4.65%) (4.71%) 2.63 % NA 0.46xHanover Capital Mortgage Hol 2.02 17 35 75.09% (10.77%) NA NA 0.35xRAIT Investment Trust 5.61 195 334 (4.65%) (4.71%) 2.63 % NA 0.46x
High 5.61 195 1,247 75.09% 13.32% 12.73 % 0.73x 0.46xLow 0.85 17 35 (5.40%) (10.77%) (39.73 %) 0.73x 0.10xMedian 3.78 99 416 3.93% (4.71%) 2.63 % 0.73x 0.27xMean 3.57 109 496 14.73% 0.08% (3.74 %) 0.73x 0.28x
($mm) (%) (x)
8
Subprime Crisis Could Impact the Rating Agencies and Could Result in Additional Regulations
Source: Wall Street Journal
Credit RatingAgency
Moody's, S&P and Fitch could become more cautiousS&P/ Moody's recently downgraded approx. $17Billion Subprime MBS
RegulatoryBody
Bills have been introduced to protect the homeowners
SpilloverTo CDOMarket
Lending has been tight in the corporate sector
ContinuingHousingTrouble
The trouble in housing market to continue and could affect the building material suppliers
9
Politicians Have Responded to the Subprime Crisis by Proposing New Bills; Fed Provided Additional Liquidity
Regulatory SupportMonetary Policy
Support from the Fed
Political Support
POLITICAL SPEAKHillary Clinton – Proposing a $1Billion Fund to protect
homeowners…..Speaking to CNBC, August 7th 2007Senator Dodd – Laid out Statement of Principles to
Protect homeowners
FED SPEAKDownside risk to economy has increased;
Inflation is still the worry…August 7th 2007Fed provided liquidity "to facilitate the orderly working of
financial markets"…August 10th 2007
10
Bills Proposed Across the Country are Striving to Protect the Homeowners
Bills Introduced
U.S. Senator Charles Schumer, Chairman of JEC and Housing Subcommittee: Borrower's Protection Act of 2007
$300mm in federal fundsLegislation to upgrade standards for mortgage
brokers and other non bank mortgage originators, with regards to making new loans to borrowers
Holds lenders responsible
Congressman Spencer Bachus, ranking member of House Financial Services Committee introduced Fair Mortgage Practices Act
Mortgage lenders to weigh borrowers ability$100mm in federal funds
States are working towards amending predatory lending acts
11
Legal Issues: Assets and Liabilities
AssetsMortgage Loans• Mortgage• Promissory Note• Loan File, including due diligence
Servicer Agreements
Owned Real Estate ("REO Property")
Misc• Litigation• Furniture/computers/equipment• Leases• Cash on hand
12
Legal Issues: Assets and Liabilities
Assets (cont.)Mortgage Loans: Generally governed by UCC• Notes are "instruments"• Loans are "general intangibles"• Perfection of liens:
• Financing statement• Possession of Loan File/Notes required
Servicer Agreements• Might not be pledged to warehouse lenders• May be valuable
13
Legal Issues: Assets and Liabilities
Assets (cont.)REO Property• Real estate foreclosed in lender's name• Not UCC collateral• Might not be subject to warehouse lender lien
Causes of Action• Many debtors have scheduled claims against
declining buyers
14
Legal Issues: Assets and Liabilities
LiabilitiesWarehouse Loans
Repurchase Claims
Employees
General Trade
15
Legal Issues: Assets and Liabilities
LiabilitiesWarehouse Loans• Secured by first priority liens on "warehoused" loans• May not have other collateral• Usually not secured by 2nd liens on other loans
Repurchase Claims• Buyers have right to put non-complying loans back• Obligation is not secured• Gross price vs. net actual/estimated loss
16
Legal Issues: Insolvency and Bankruptcy
Creditors' Rights (Pre-Bankruptcy)UCC ForeclosureUCC Strict Foreclosure• Partial or Full• Reservation of deficiency
Repurchase Agreements• Sell Loans• Commercially reasonableness standard
Servicing: Ensure No Interruption• Transition to new servicer• Ensure continuity with 3rd party servicers
17
Legal Issues: Insolvency and Bankruptcy
BankruptcyMortgage loans are property of the estate, unless: • Properly foreclosed prepetition
OR
• Debtor holds legal title only for servicing purposes (§541(d))• Repurchase Agreement vs. Warehousing Credit Agreement
Automatic Stay• Does not stay right of repo participant to terminate repurchase
agreement (§559)• But, excess proceeds of mortgage loan liquidation are property of estate
• Does not stay right of repo participant to setoff mutual debts between debtor and repo participant (i.e. liquidate repo "collateral") (§362(b)(7))
18
Legal Issues: Insolvency and Bankruptcy
Bankruptcy (cont.)Financing / Use of Cash Collateral363 Sales• Servicing Rights: Valuable, can generate bidding• Mortgage Loans, if property of the estate• REO Property
Thank you
Paul Possinger, PartnerWinston & Strawn [email protected](312) 558-3717
Neil Luria, Managing DirectorNavigant Consulting, [email protected](216) 321-5606