7 Deadly Frictions in Subprime Mortgage Securitization Adam Ashcraft, Til Schuermann FRBNY Research Q-Group, October 2008 Filename
Bank Write Downs billions; through September 25, 2008 55.1 Citi 52.2 Merrill 44.2 UBS 27.4 HSBC 22.7 Wachovia 21.2 BofA 15.7 Morgan Stanley 15.1 IKB 14.8 WaMu 14.3 JPMC 13.8 Lehman Total: $523 bn Deutsche Bank 10.6 (and counting…) 6.7 SocGen Total Capital Raise: $381bn 6.1 Mizuho Goldman 4.9 3.2 Bear Stearns* $- $10 $20 $30 $40 $50 $60 1 Source: Bloomberg Filename
I. Example deal from New Century � GSAMP 2006-NC2 2nd largest subprime lender New Century Financial Moody’s, S&P 2004-2006 Originator Credit Rating Agencies Mezz tranches Initial Servicer Filed for Ocwen downgraded bankruptcy April Servicer severely in Goldman Sachs 2007 Wells Fargo historical rating Arranger Master Servicer Swap Counterparty action by Securities Moodys in July Administrator GSAMP Trust 2006- 3949 subprime 2007 Deutche Bank NC2 loans Trustee Bankruptcy-remote trust Issuing entity $881 million principal originated 2006:Q2 2 Filename
GSAMP 2006-NC2 original and current credit ratings SP Moodys Original Current Original Current AAA AAA Aaa Aaa AAA AAA Aaa Aaa AAA AAA Aaa Aa1 AAA AAA Aaa Aa2 AAA AAA Aaa A1 AA+ AA Aa1 Baa3 AA BB Aa2 B2 AA- B Aa3 B3 A+ CCC A1 Caa1 A CCC A2 Caa2 A- CCC A3 Caa3 BBB+ CCC Baa1 Ca BBB CCC Baa2 C BBB- CC Baa3 C BB+ CC Ba1 C BB CC Ba2 C 3 Filename
GSAMP 2006-NC2: mortgage pool at origination � 98.7% of the mortgage loans are first-lien. � 43.3% are purchase loans � 90.7% owner-occupied � 73.4% single-family homes � 38.0% and 10.5% CA and Fl, respectively � Mean FICO of 626, 31.4% below 600, 6.7% above 660. � Mean CLTV of 80.34%, 62.1% of 80% or lower, 28.6% between 80% and 90%, and 9.3% between 90% and 100%. � Average DTI is 41.78%. 4 Filename
GSAMP 2006-NC2 mortgage pool at origination Loan Type Gross Rate Margin Initial Cap Periodic Cap Lifetime Cap Floor IO Period Notional ($m) % Total FIXED 8.18 X X X X X X $ 79.12 8.98% FIXED 40-year Balloon 7.58 X X X X X X $ 24.80 2.81% 2/28 ARM 8.64 6.22 1.49 1.49 15.62 8.62 X $ 221.09 25.08% 2/28 ARM 40-year Balloon 8.31 6.24 1.5 1.5 15.31 8.31 X $ 452.15 51.29% 2/28 ARM IO 7.75 6.13 1.5 1.5 14.75 7.75 60 $ 101.18 11.48% 3/27 ARM 7.48 6.06 1.5 1.5 14.48 7.48 X $ 1.71 0.19% 3/27 ARM 40-year Balloon 7.61 6.11 1.5 1.5 14.61 7.61 X $ 1.46 0.17% Total 8.29 X X X X X X $ 881.50 100.00% 5 Filename
Overview of mortgage pool performance to date .4 1 .9 .3 Serious Delinquency Pool Factor .8 .2 .1 .7 .6 0 5 10 15 20 25 Weigthed Average Loan Age... Serious Delinquency Pool Factor 6 Filename
Pool performance by original CLTV 1 .5 .9 .4 .8 .3 .7 .2 .6 .1 .5 0 5 10 15 20 25 Weighted Average Loan Age... Serious Delinq, CLTV<90 Serious Delinq, 90<=CLTV<100 Serious Delinq, CLTV = 100 Pool Factor, CLTV<90 Pool Factor, 90<=CLTV<100 Pool Factor, CLTV = 100 7 Filename
Pool performance by documentation level .5 1 .4 .9 .3 .8 .2 .7 .1 .6 0 5 10 15 20 25 Weighted Average Loan Age... Serious Delinquency, Full Doc Serious Delinquency, Low Doc Pool Factor, Full Doc Pool Factor, Low Doc 8 Filename
Tranching for GSAMP Trust 2006-NC2 Tranche description Credit Ratings Coupon Rate Class Notional Width Sub S&P Moody’s -1 -2 A-1 $239,618,000 27.18% 72.82% AAA Aaa 0.15% 0.30% A-2A $214,090,000 24.29% 48.53% AAA Aaa 0.07% 0.14% A-2B $102,864,000 11.67% 36.86% AAA Aaa 0.09% 0.18% A-2C $99,900,000 11.33% 25.53% AAA Aaa 0.15% 0.30% A-2D $42,998,000 4.88% 20.65% AAA Aaa 0.24% 0.48% M-1 $35,700,000 4.05% 16.60% AA+ Aa1 0.30% 0.45% M-2 $28,649,000 3.25% 13.35% AA Aa2 0.31% 0.47% M-3 $16,748,000 1.90% 11.45% AA- Aa3 0.32% 0.48% M-4 $14,986,000 1.70% 9.75% A+ A1 0.35% 0.53% M-5 $14,545,000 1.65% 8.10% A A2 0.37% 0.56% M-6 $13,663,000 1.55% 6.55% A- A3 0.46% 0.69% M-7 $12,341,000 1.40% 5.15% BBB+ Baa1 0.90% 1.35% M-8 $11,019,000 1.25% 3.90% BBB Baa2 1.00% 1.50% M-9 $7,052,000 0.80% 3.10% BBB- Baa3 2.05% 3.08% B-1 $6,170,000 0.70% 2.40% BB+ Ba1 2.50% 3.75% B-2 $8,815,000 1.00% 1.40% BB Ba2 2.50% 3.75% X $12,340,995 1.40% 0.00% NR NR N/A N/A 9 Filename
7 Frictions in Subprime Mortgage Credit Securitization MORTGAGOR WAREHOUSE ORIGINATOR LENDER CREDIT RATING ARRANGER AGENCY SERVICER ASSET MANAGER INVESTOR 10 Source: Ashcraft and Schuermann (2007): “Understanding the Securitization of Subprime Mortgage Credit” Filename
7 Frictions in Subprime Mortgage Credit Securitization 1. Predatory lending : Subprime borrowers can be financially unsophisticated – either MORTGAGOR unaware of all options available or unable to make the best choice between options. WAREHOUSE ORIGINATOR LENDER CREDIT RATING ARRANGER AGENCY SERVICER ASSET MANAGER INVESTOR 11 Source: Ashcraft and Schuermann (2007): “Understanding the Securitization of Subprime Mortgage Credit” Filename
1. Originator & borrower: predatory lending � Welfare-reducing provision of credit – Results in “too much” lending � Borrowers, especially subprime, can be financially unsophisticated MORTGAGOR – Some borrowers don't know best price – Some borrowers can't make the right ORIGINATOR choice (overconfidence) – % of subprime mortgage with strong optionality*: 2000 (2007): 0.1% (36.8%) � Resolution: State, local, federal laws and the rating agencies; warranties and representations of originator *: include interest only ARMs and 30-year ARMs on a 40-year amortization schedule 12 Filename
Evidence from Academic Literature Ernst, Bocian, and Li (2008): "Steered Wrong: Brokers, Borrowers, and Subprime Loans“ � Study 1.7 million mortgages produced between 2004 to 2006 � Use matched sample methods, comparing brokered and retail originations � Note between 63 and 81 percent were brokered in 2006 � Conclude that brokered loans cost more (130 bps), and that the effect larger for subprime 13 Filename
Final Thoughts on Predatory Lending (1) � Problems are larger than predation: –Subprime loan performance remains horrific and is not improving despite massive rate cuts (which offset hybrid ARM resets) � High-cost credit is not all bad: –Morgan (2006): "Defining and Detecting Predatory Lending" 14 Filename
7 Frictions in Subprime Mortgage Credit Securitization 1. Predatory lending : Subprime borrowers can be financially unsophisticated – either MORTGAGOR unaware of all options available or unable to make the best choice between options. WAREHOUSE ORIGINATOR LENDER 2. Mortgage fraud: The originator, who sells a pool of mortgages to the arranger, has an information advantage CREDIT RATING ARRANGER over the arranger AGENCY regarding quality of the borrower. An originator, collaborating with the SERVICER borrower, may misrepresent the information on the ASSET application. MANAGER INVESTOR 15 Source: Ashcraft and Schuermann (2007): “Understanding the Securitization of Subprime Mortgage Credit” Filename
2. Originator & arranger: predatory borrowing & lending � Originator has an informational advantage over the arranger with regard to the quality of the borrower – Predatory borrowing (and lending) � Originator and borrower collaborate to ORIGINATOR overstate income, misrepresent occupancy, hide other details – % of full-doc subprime mortgage in 2000 ARRANGER (2006): 73.4 (57.7) � Fast HPA increase returns to speculation, criminal activity, reduces the cost of fraud to lenders � Resolution: due diligence of arranger, representation & warranties of originator, capital and other business lines of originator 16 Filename
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Evidence from Academic Literature � Ben-David (2008): "Manipulation of Collateral Values by Borrowers and Intermediaries“ – Documents that highly leveraged borrowers more likely to buy a property which signals willingness of seller to give cash back, and are more likely to pay full listing price or more; also these buyers pay more for houses and are more likely to default, but pay the same interest rate � Seru et al. (2008): "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans?" – The authors document that securitized loans with FICO scores above 620 default more frequently than securitized loans with scores just below 620, but only for low documentation loans 18 Filename
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