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New York Investing Meetup: The Catalyst for the Financial Crisis: Mortgages, CDOs

New York Investing Meetup: The Catalyst for the Financial Crisis: Mortgages, CDOs. April 7, 2009 Thomas J. Adams Paykin Mahon Rooney & Krieg, LLP. Thomas Adams Bio Background on MBS/CDO Market How Mortgage Loans Became Bonds The Market Turmoil What Went Wrong? What’s Happening Now?

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New York Investing Meetup: The Catalyst for the Financial Crisis: Mortgages, CDOs

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  1. New York Investing Meetup:The Catalyst for the Financial Crisis: Mortgages, CDOs April 7, 2009 Thomas J. Adams Paykin Mahon Rooney & Krieg, LLP

  2. Thomas Adams Bio Background on MBS/CDO Market How Mortgage Loans Became Bonds The Market Turmoil What Went Wrong? What’s Happening Now? What’s Next? Discussion Overview Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  3. PAYKIN MAHON ROONEY & KRIEG, LLP – January 2009 to present ADAMS ADVISORY SERVICES– May 2008 to present FINANCIAL GUARANTY INSURANCE CORPORATION - 2003-2008 Senior Managing Director AMBAC ASSURANCE CORPORATION - 1996-2003 Managing Director MOODY’S INVESTORS SERVICE - 1992-1996 Senior Credit Officer THACHER PROFFITT & WOOD - 1989-1992 FORDHAM UNIVERSITY SCHOOL OF LAW -J.D. 1989 COLGATE UNIVERSITY - B.A. 1986 Thomas J. Adams Bio Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  4. MBS Market Agency MBS Sub-Prime Mortgages Jumbo Mortgages Other Non-Conforming MBS HELOCs, Scratch & Dent, Alt A, Option ARM Mortgage Loan Originators Portfolio lenders Secondary market lenders Investment bank “distributors” Retail vs. wholesale CDO Market Collateralized Loan Obligations Collateralized Debt Obligations ABS CDOs Mezzanine CDOs High Grade CDOs CDO-squared Hybrid CDOs Parties to CDO Transaction Debt originators CDO managers Super-senior investors Equity investors Background on MBS/CDO Market Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  5. Sample MBS and CDO Structures Source: Fitch Investors Service Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  6. Origination Origination based on lender underwriting standards and borrower demand Feedback loop - underwriting standards adjusted based on secondary market demand Loan pool submitted to rating agency for credit enhancement assessment Securitization Loan pools assessed and credit enhanced Loan pool tranched, or sliced, into classes of bonds based on increasing payment seniority for payment Typical bonds issued with floating rates, LIBOR index Additional features for amortization and coupons Equity tranche “retained” How Mortgage Loans Became Bonds Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  7. MBS, ABS and CDO Issuance Volume Source: Citigroup Global Capital Markets Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  8. The Roots of the Market Turmoil • Liquidity Issues Emerge in Early 2007 • New Century Financial bankruptcy • Bear Stearns hedge funds • Collateral Performance Decouples from Model Projections • Rating Agency “sudden” downgrades in summer of 2007 • Mark to Market and Portfolio Write-downs • Fall 2007 • Lending Curtailment and Credit Crunch • Fall 2007 • Continued Decline of Home Values • Further pressure on portfolio valuations in 2008 (and 2009?) • Uncertainty on Loss Projections • Liquidity fails to return, broader economy infected Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  9. Pricing Issues Emerge in ABS Market Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  10. What Went Wrong? • Agency arbitrage • Market participants developed tools to arbitrage the rating agency models - agencies were willing participants • Artificial demand • Decline of cash investors - new investment vehicles drove demand for MBS and CDO bonds (SIVs, ABCP, etc.) • Poor transparency • Historically, limited secondary market obscured price discovery • Credit default swap innovation • CDS and ABX introduced two way trading - introduction of “shorting” • Insufficient data and model flaws • Limited data for home price declines - impact of declining home values on borrower default patterns • Bad loss estimates • Loss estimates and enhancement calculations based on statistical analysis of historical data Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  11. Historical ABX Pricing (06-1) Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  12. What’s Happening Now? • Securitization market shut down • Loss of credibility - rating agencies, models • Fear of future losses • Counterparty fears • Limited credit available • Government: lender of last, and first, resort • TALF, PPIP, Legacy securities, legacy loans • FHA, Fannie Mae, Freddie Mac • Finding the scapegoat • AIG, Fannie Mae, Freddie Mac, Rating Agencies? • Looking for a bottom • “Stopping” home price declines, fine tuning mark to market, unlocking liquidity and other myths Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

  13. What’s Next? • The passage of time… • Prices must come down - homes, bonds, etc. • Government props provide limited benefit • Insolvent is insolvent • A new future • Humpty dumpty won’t fit back together again • Adjusting to a new reality • More risk retained, less risk taken • Less liquidity not all bad • Finally a new RTC? • New regulations and restrictions Thomas J. Adams - Paykin Mahon Rooney & Krieg, LLP

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