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Banking Regulation, Oversight and Enforcement

Subprime Lending Crisis Conference. Banking Regulation, Oversight and Enforcement. Kevin F. Barnard White & Case LLP March 18, 2008. Banking Regulation, Oversight and Enforcement. Introduction Regulatory Guidance on Subprime Mortgage Lending

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Banking Regulation, Oversight and Enforcement

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  1. Subprime Lending Crisis Conference Banking Regulation, Oversight and Enforcement Kevin F. Barnard White & Case LLP March 18, 2008

  2. Banking Regulation, Oversight and Enforcement • Introduction • Regulatory Guidance on Subprime Mortgage Lending • Likely Focus of Potential Future Regulatory Enforcement Actions • Recommended Practices and Strategies • Summing Up BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  3. Banking Regulation, Oversight and Enforcement • Regulatory Guidance on Subprime Mortgage Lending • Interagency Guidance on Subprime Mortgage Lending (1999) • Expanded Guidance on Subprime Mortgage Lending (2001) • Interagency Guidance on Nontraditional Mortgage Risks (2006) BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  4. Banking Regulation, Oversight and Enforcement • Interagency Statement on Subprime Mortgage Lending (2007) • Statement on Subprime Mortgage Lending of the CSBS, AARMR, NACCA (2007) • Statement on Subprime Mortgage Lending of Various States (2007) BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  5. Banking Regulation, Oversight and Enforcement Back to the Future . . . ? Nine years ago this month – “ . . . recent turmoil in the equity and asset-backed securities market has caused some non-bank subprime specialists to exit the market, thus creating increased opportunities . . ..” BUT . . . BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  6. Banking Regulation, Oversight and Enforcement “If the risks associated with this activity are not properly controlled, the agencies consider subprime lending a high risk activity that is unsafe and unsound.” (emphasis added) Interagency Guidance on Subprime Mortgage Lending (March 1, 1999) BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  7. Banking Regulation, Oversight and Enforcement • Essential Elements Board of Directors and Management Should Consider • Capitalization • Risk Management Program • Critical risk issues: • attracting/retaining qualified personnel • technology investments • after-the-fact assessment of underwriting performance BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  8. Banking Regulation, Oversight and Enforcement • specific lending policy for subprime including: • pricing and profitability analysis covering all associated costs including servicing, expected chargeoffs and capital • collateral evaluation and appraisal standards • correspondent/broker approval process • purchase considerations • high upfront fees financed into the loan (may be an incentive for high volume/low quality by originator) • special care on loans from outside lender’s area (specific risk for fraud or misrepresentation) BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  9. Banking Regulation, Oversight and Enforcement • stringent loan administration procedures • securitization and sale • carries inherent risks, including interim credit risk and liquidity risk • loss of investor appetite – unsold pools forced into deep discount sales • should have contingency plan: back-up purchasers/servicers; alternate funding sources; capital raising measures • complexity of valuation decisions BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  10. Banking Regulation, Oversight and Enforcement • Likely Focus of Potential Future Regulatory Enforcement Actions BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  11. Banking Regulation, Oversight and Enforcement • Report of the Senior Supervisors Group to the Financial Stability Forum (March 6, 2008) • Assess which risk management policies worked well and which did not • “Strategic decision” by some firms to retain large exposures to super-senior tranches of collateralized debt obligations BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  12. Banking Regulation, Oversight and Enforcement • Exposures “far exceeded the firm’s understanding of the risks inherent in such instruments, and failed to take appropriate steps to control or mitigate such risks.” (emphasis added) • Major losses taken on these holdings with substantial implications for earnings performance and capital positions • Risk management and pricing for off-balance sheet obligations were seriously deficient BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  13. Banking Regulation, Oversight and Enforcement “. . . some firms failed to price properly the risk that exposures to certain off-balance sheet vehicles might need to be funded on the balance sheet precisely when it became difficult or expensive to raise such funds externally. “ BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  14. Banking Regulation, Oversight and Enforcement • The better positioned firms had comprehensive, firm-wide risk management capability focused on quantitative and qualitative information gathering and analysis • also exhibited a disciplined approach in how complex or potentially illiquid positions were valued. Adaptive (not static) risk measurement processes that could rapidly alter underlying assumptions An agenda is emerging to strengthen supervisory oversight in critical areas. BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  15. Banking Regulation, Oversight and Enforcement • Recommended Practices and Strategies • Risk Management • Underwriting Standards and Loan Terms • Control Systems • Consumer Disclosure/Consumer Protection BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

  16. Banking Regulation, Oversight and Enforcement • Summing Up BANKING REGULATION, OVERSIGHT AND ENFORCEMENT

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