An Overview Of The Housing/Credit Crisis And
     Why There Is More Pain To Come
            T2 Accredited Fund, LP
      ...
T2 Partners Management L.P. Is A
 Registered Investment Advisor
    145 E. 57th Street 10th Floor
        New York, NY 100...
For more information…



                        3
More Mortgage Meltdown Has Just Been Released
and Is the #1 Selling Investing Book in the Country




                    ...
The Next Value Investing Congress is
    October 19-20 in New York City
Register at www.valueinvestingcongress.com




   ...
Value Investor Insight and
SuperInvestor Insight




                             6
For the Second Half of the 20th Century,
 Housing Was a Stable Investment

                                               ...
…And Then Housing Prices Exploded


                                                300
                                  ...
From 2000-2006, the Borrowing Power of a
 Typical Home Purchaser Nearly Tripled

                       $400,000
         ...
Housing Became Unaffordable in Many
Areas

                                        80
                                    ...
Americans Have Borrowed Heavily Against Their Homes Such
That the Percentage of Equity in Their Homes Has Fallen
Below 50%...
There Was a Dramatic Decline in Mortgage
Lending Standards from 2001 through 2006
                                        ...
Among the Many Causes of The Great
Mortgage Bubble, Two Stand Out

  •   The companies making crazy loans didn’t care very...
As Long As Home Prices Rise Rapidly,
     Even Subprime Mortgages Perform Well –
     But If Home Prices Fall, Look Out Be...
Deregulation of the Financial Sector Led to a
Surge of Leverage, Profits and Compensation
                         Ratio o...
Over the Past 30 Years, We Have Become a
           Nation Gorged in Debt – To The Benefit of
           Financial Service...
There Was a Surge of Toxic Mortgages
Over the Past 10 Years

                                 $4,000
                     ...
Private Label Mortgages (Those Securitized by
Wall St.) Are 15% of All Mortgages, But Are 51%
of Seriously Delinquent Mort...
Percentage of Home Loans
                                                                                                 ...
All Types of Loans, Led by Subprime, Are
Seeing a Surge in Delinquencies

                               45%
             ...
The Decline in Lending Standards Led to a
 Surge in Subprime Mortgage Origination

                      $700             ...
The Wave of Resets from Subprime
        Loans Is Mostly Behind Us

                                            $35




  ...
Numerous Areas of the Mortgage Market Will
Suffer Significant Losses Going Forward


                        Prime Mortgag...
Two Waves of Losses Are Behind Us…
But Three Are Looming

 Losses Mostly Behind Us
 • Wave #1: Borrowers committing (or th...
Recent Signs of Stabilization Are Likely
the Mother of All Head Fakes

  •   Rather than representing a true bottom, recen...
There Is a Surge of Notices of Default and
Foreclosures Among the GSEs




                                          Prime...
Future Losses Will Be Driven By Three
Primary Factors

 1. The Economy
     •   Especially unemployment
 2. Interest rates...
24% of Homeowners With a Mortgage Owe
  More Than the Home Is Worth, Making
  Them Much More Likely to Default
      Among...
Certain Types of Loans Are Severely
Underwater

                               80%

                                      ...
Outlook for Housing Prices

 •   We think housing prices will reach fair value/trend line, down 40% from the peak based on...
Percent Noncurrent (60+ days)
                                                                         Q
                 ...
15 States With the Highest Prime
Mortgage Foreclosure Rates




SOURCE: New York Times, 5/24/09.
                         ...
Delinquencies of Prime and Alt-A
Mortgages Are Soaring




SOURCE: New York Times, 5/24/09.
                              ...
There Are $2.4 Trillion of Alt-A Mortgages
and Their Resets Are Mostly Ahead of Us




                                   ...
Percent Noncurrent (60+ days)
                                                     Ja
                                    ...
Alt-A Delinquencies By Vintage Show the
Collapse in Lending Standards in 2006 and 2007

                                  ...
Percent Noncurrent (60+ days)
                                                     Ja
                                    ...
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
16193713 T2 Partners Presentation On The Mortgage Crisis
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16193713 T2 Partners Presentation On The Mortgage Crisis

  1. 1. An Overview Of The Housing/Credit Crisis And Why There Is More Pain To Come T2 Accredited Fund, LP Tilson Offshore Fund, Ltd. T2 Qualified Fund, LP June 2, 2009
  2. 2. T2 Partners Management L.P. Is A Registered Investment Advisor 145 E. 57th Street 10th Floor New York, NY 10022 (212) 386-7160 Info@T2PartnersLLC.com www.T2PartnersLLC.com
  3. 3. For more information… 3
  4. 4. More Mortgage Meltdown Has Just Been Released and Is the #1 Selling Investing Book in the Country 4
  5. 5. The Next Value Investing Congress is October 19-20 in New York City Register at www.valueinvestingcongress.com 5
  6. 6. Value Investor Insight and SuperInvestor Insight 6
  7. 7. For the Second Half of the 20th Century, Housing Was a Stable Investment 300 Shiller Lawler 275 Real Home Price Index (1890=100) 250 225 200 175 Trend Line 150 125 100 0 4 8 2 6 0 4 8 2 6 0 4 8 5 5 5 6 6 7 7 7 8 8 9 9 9 19 19 19 19 19 19 19 19 19 19 19 19 19 Source: Robert J. Shiller, Irrational Exuberance, Princeton University Press 2000, Broadway Books 2001, 2nd edition, 2005, also Subprime Solution, 2008, as updated by the author at http://www.econ.yale.edu/~shiller/data.htm; Lawler Economic & Housing Consulting 7
  8. 8. …And Then Housing Prices Exploded 300 Shiller Lawler 275 Real Home Price Index (1890=100) 250 225 200 Housing Bubble 175 Trend Line 150 125 100 86 94 02 62 70 78 98 06 82 90 66 74 50 4 58 5 20 19 19 19 19 20 19 19 19 19 19 19 19 19 19 SOURCES: Robert J. Shiller, Irrational Exuberance: Second Edition, as updated by the author; Lawler Economic & Housing Consulting. 8
  9. 9. From 2000-2006, the Borrowing Power of a Typical Home Purchaser Nearly Tripled $400,000 Pre-Tax Income Borrowing Power $300,000 $200,000 9.2x in January 2006 $100,000 3.3x in January 2000 $0 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Factors contributing to the ability to borrow more and more were: 1. Slowly rising income 2. Lenders being willing to allow much higher debt-to-income ratios 3. Falling interest rates 4. Interest-only mortgages (vs. full amortizing) 5. No money down Source: Amherst Securities 9
  10. 10. Housing Became Unaffordable in Many Areas 80 Riverside, CA 70 Los Angeles, CA San Diego, CA 60 Housing Opportunity Index 50 40 30 20 10 0 96 97 98 99 00 1 05 06 07 02 04 0 20 20 20 19 20 20 19 20 19 19 20 3 3 3 1 3 1 1 1 1 1 1 Q Q Q Q Q Q Q Q Q Q Q SOURCES: NAHB/Wells Fargo Housing Opportunity Index, which measures percentage of households that could afford the average home with a standard mortgage 10
  11. 11. Americans Have Borrowed Heavily Against Their Homes Such That the Percentage of Equity in Their Homes Has Fallen Below 50% for the First Time on Record Since 1945 $12,000 90% 80% $10,000 70% Equity as a % of Home Value $8,000 60% Mortgage Debt (Bn) 1945 50% $6,000 Mortgage Debt: $18.6 billion Equity: $97.5 billion 2008 40% Mortgage Debt: $10.5 trillion Equity: $8.5 trillion $4,000 30% 20% $2,000 10% $0 0% 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 SOURCE: Federal Reserve Flow of Fund Accounts of the United States 11
  12. 12. There Was a Dramatic Decline in Mortgage Lending Standards from 2001 through 2006 Combined Loan to Value 100% Financing 86 18% 84 17% • In 2005, 29% of 84 83 16% new mortgages 82 81 81 14% 14% were interest only 80 12% — or less, in the Combined Loan to Value (%) Percent of Originations 78 10% 9% case of Option 76 76 8% 8% ARMs — vs. 1% 74 74 74 6% in 2001 72 4% 3% • In 1989, the 70 2% 1% average down 1% 68 2001 2002 2003 2004 2005 2006 2007 0% payment for first- 2001 2002 2003 2004 2005 2006 2007 time home buyers Limited Documentation 100% Financing & Limited Doc was 10%; by 70% 12% 2007, it was 2% 65% 63% 11% 60% • The sale of new 10% 56% homes costing 49% 50% 45% 8% 8% $750,000 or more quadrupled from Percent of Originations Percent of Originations 40% 39% 33% 6% 5% 2002 to 2006. 30% 4% The construction 4% 20% of inexpensive 2% 1% homes costing 10% 0% $125,000 or less 0% 0% 2001 2002 2003 2004 2005 2006 2007 0% 2001 2002 2003 2004 2005 2006 2007 fell by two-thirds SOURCES: Amherst Securities, LoanPerformance; USA Today (www.usatoday.com/money/economy/housing/2008-12-12-homeprices_N.htm) 12
  13. 13. Among the Many Causes of The Great Mortgage Bubble, Two Stand Out • The companies making crazy loans didn’t care very much if the homeowner ended up defaulting for two reasons: 1. Either they didn’t plan to hold the loan, but instead intended to pass it along to Wall Street, which would bundle, slice-and-dice it and sell it (along with any subsequent losses) to investors around the world; 2. Or, if they did plan to hold the loan, they assumed home prices would keep rising, such that homeowners could either refinance before loans reset or, if the homeowner defaulted, the losses (i.e., severity) would be minimal. • There were many other reasons, of course – a bubble of this magnitude requires what Charlie Munger calls “Lollapalooza Effects” – The entire system – real estate agents, appraisers, mortgage lenders, banks, Wall St. firms and ratings agencies – became corrupted by the vast amounts of quick money to be made – Regulators and politicians were blinded by free market ideology or the dream that all Americans should own their homes, causing them to fall asleep at the switch, not want to take the punch bowl away and/or get bought off by the industries they were supposed to be overseeing – Debt became increasingly available and acceptable in our culture – Millions of Americans became greedy speculators and/or took on too much debt – Greenspan kept interest rates too low for too long – Institutional investors stretched for yield, didn’t ask many questions and took on too much leverage – In general, everyone was suffering from irrational exuberance 13
  14. 14. As Long As Home Prices Rise Rapidly, Even Subprime Mortgages Perform Well – But If Home Prices Fall, Look Out Below! Cumulative Five-Year Loss Estimates for a Bubble-Era Pool of Subprime Mortgages 60% 50% 40% Cumulative Loss (%) 30% 20% 10% 0% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40% Home Price Appreciation Source: T2 Partners estimates 14
  15. 15. Deregulation of the Financial Sector Led to a Surge of Leverage, Profits and Compensation Ratio of Financial Services Wages to Nonfarm Private-Sector Wages, 1910-2006 • Among the most profitable areas for Wall Street firms was producing Asset-Backed Securities (ABSs) and Collateralized Debt Obligations (CDOs) • To produce ABSs and CDOs, Wall Street needed a lot of loan “product” • Mortgages were a quick, easy, big source • It is easy to generate higher and higher volumes of mortgage loans: simply lend at higher loan-to-value ratios, with ultra-low teaser rates, to uncreditworthy borrowers, and don’t bother to verify their income and assets (thereby inviting fraud) • There’s only one problem: DON’T EXPECT TO BE REPAID! Source: Ariell Reshef, University of Virginia; Thomas Philippon, NYU; Wall St. Journal, 5/14/09 15
  16. 16. Over the Past 30 Years, We Have Become a Nation Gorged in Debt – To The Benefit of Financial Services Firms 3.0% 350% Low Debt Era Rising Debt Era Financial Profits as Percent of GDP 2.5% Total Debt as Percent of GDP 300% 2.0% 250% 1.5% Total Debt Financial Profits 200% 1.0% 150% 0.5% 0.0% 100% Dec- 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 Sources: Federal Reserve, BEA, as of Q2 2007, GMO presentation 16
  17. 17. There Was a Surge of Toxic Mortgages Over the Past 10 Years $4,000 Conforming, FHA/VA Jumbo $3,500 Alt-A Subprime Seconds $3,000 $2,500 Originations (Bn) $2,000 $1,500 $1,000 $500 $0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 SOURCE: Inside Mortgage Finance, published by Inside Mortgage Finance Publications, Inc. Copyright 2009. 17
  18. 18. Private Label Mortgages (Those Securitized by Wall St.) Are 15% of All Mortgages, But Are 51% of Seriously Delinquent Mortgages Approximately two-thirds of homes have mortgages and of these, 56% are owned or guaranteed by the two government-sponsored enterprises (GSEs), Fannie & Freddie Number of Seriously Number of Mortgages (million) Delinquent Mortgages (000) Banks & Thrifts Banks & Thrifts 397 Fannie Mae 8 444 Fannie Mae Freddie Mac 18 232 Private Label 15% 8 Ginne Mae/FHA 378 Ginne Mae/FHA 6 Private Label Freddie Mac 1734 13 51% SOURCE: Freddie Mac, Q4 2008. 18
  19. 19. Percentage of Home Loans Q 4 Q 19 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 4 7 Q 19 9 4 80 Q 19 4 8 Q 19 1 4 82 Q 19 4 8 Q 19 3 4 84 Q 19 4 8 Q 19 5 4 86 Q 19 4 87 Q 19 4 88 Q 19 4 89 Q 1 99 4 0 Q 19 4 91 Q 19 4 92 Q 19 4 93 Q 19 4 9 Q 19 4 4 95 Q 19 4 9 Q 19 6 4 97 Q 19 4 9 Q 19 8 4 99 Q 20 4 0 Q 20 0 4 01 Q 20 4 0 Over 9% of Mortgages on 1-to-4-Family Homes Q 20 2 4 03 Were Delinquent or in Foreclosure as of Q1 2009 Q 20 4 0 Q 20 4 4 05 SOURCE: National Delinquency Survey, Mortgage Bankers Association. Note: Delinquencies (60+ days) are seasonally adjusted. Q 20 4 06 Q 2 00 4 7 20 08 19
  20. 20. All Types of Loans, Led by Subprime, Are Seeing a Surge in Delinquencies 45% Alt A Option ARM 40% Jumbo Subprime 35% Prime Home Equity Lines of Credit 30% Percent Noncurrent 25% 20% 15% 10% 5% 0% Q 01 Q 01 Q 99 Q 99 Q 00 Q 00 Q 02 Q 03 Q 03 Q 04 Q 04 Q 05 Q 06 Q 06 Q 07 Q 08 08 Q 07 Q 02 Q 05 20 20 20 20 20 20 20 20 20 20 20 19 19 20 20 20 20 20 20 20 3 1 1 3 3 1 1 3 1 3 3 3 1 3 1 3 1 3 1 1 Q SOURCES: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association; FDIC Quarterly Banking Profile; T2 Partners estimates. Note: Prime is seasonally adjusted. 20
  21. 21. The Decline in Lending Standards Led to a Surge in Subprime Mortgage Origination $700 25% $600 20% 20% 20% 18% % of $500 T ota l Origina tions (Bn) 15% $400 $300 10% 10% 10% 10% 10% 9% 9% 9% 8% $200 7% 8% 7% 5% $100 $0 0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: Reprinted with permission; Inside Mortgage Finance, published by Inside Mortgage Finance Publications, Inc. Copyright 2009. 21
  22. 22. The Wave of Resets from Subprime Loans Is Mostly Behind Us $35 $30 We are here $25 Loans with Payment Shock (Bn) $20 $15 $10 $5 $0 07 7 0 6 08 09 7 0 6 8 8 09 10 0 6 7 9 06 8 9 -0 -0 -1 -0 l-0 l-0 l-1 l-0 r-0 -0 -0 -1 -0 l-0 n- n- n- r- n- n- ct pr pr pr ct ct ct ct Ju Ju Ju Ju Ju Ap Ap Ja Ja Ja Ja Ja O O O O O A A A Sources: LoanPerformance, Deutsche Bank; slide from Pershing Square presentation, How to Save the Bond Insurers, 11/28/07. 22
  23. 23. Numerous Areas of the Mortgage Market Will Suffer Significant Losses Going Forward Prime Mortgage Commercial Real Estate Alt-A Other Corporate Commercial & Industrial Subprime High-Yield / Leveraged Loans Jumbo Prime Home Equity Credit Card Auto Option ARM Construction & Development Other Consumer CDO/ CLO $0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 $5.0 Amount Outstanding (Trillions) SOURCES: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial Stability Report October 2008, Goldman Sachs Global Economics Paper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data, T2 Partners estimates. 23
  24. 24. Two Waves of Losses Are Behind Us… But Three Are Looming Losses Mostly Behind Us • Wave #1: Borrowers committing (or the victim of) fraud & speculators, who defaulted quickly. Timing: beginning in late 2006 (as soon as home prices started to fall) into 2008. Mostly behind us. • Wave #2: Borrowers who defaulted when their mortgages reset due to payment shock. Timing: early 2007 (as two-year teaser subprime loans written in early 2005 started to reset) to the present. Now tapering off as low interest rates mitigate payment shock. Losses Mostly Ahead of Us • Wave #3: Prime loans (most of which are owned or guaranteed by the GSEs) defaulting due to job loss and home price declines (i.e., underwater homeowners). Timing: started to surge in early 2008 to the present. • Wave #4: Jumbo prime, second lien and HELOCs (most of which are on banks’ books) defaulting due to job loss and home price declines/ underwater homeowners. Timing: started to surge in early 2008 to the present. • Wave #5: Losses among loans outside of the housing sector, the largest of which will be in the $3.5 trillion area of commercial real estate. Timing: started to surge in early 2008 to the present. 24
  25. 25. Recent Signs of Stabilization Are Likely the Mother of All Head Fakes • Rather than representing a true bottom, recent signs of stabilization are likely due to two short-term factors: 1. Home sales and prices are seasonally strong in April, May and June due to tax refunds and the spring selling season 2. A temporary reduction in the inventory of foreclosed homes – Shortly after Obama was elected, his administration promised a new, more robust plan to stem the wave of foreclosures so the GSEs and many other lenders imposed a foreclosure moratorium – Early this year, the Obama administration unveiled its plan, the Homeowner Affordability and Stabilization Plan, which is a step in the right direction – but even if it is hugely successful, we estimate that it might only save 20% of homeowners who would otherwise lose their homes – The GSEs and other lenders are now quickly moving to save the homeowners who can be saved – and foreclose on those who can’t – This is necessary to work our way through the aftermath of the bubble, but will lead to a surge of housing inventory later this year, which will further pressure home prices 25
  26. 26. There Is a Surge of Notices of Default and Foreclosures Among the GSEs Prime Notices of Default Subprime Notices of Default Subprime Foreclosures Prime Foreclosures SOURCE: The Field Check Group. 26
  27. 27. Future Losses Will Be Driven By Three Primary Factors 1. The Economy • Especially unemployment 2. Interest rates • Ultra-low rates have helped mitigate some of the damage • But if the recent spike in rates continues, it could lead to an even greater surge in defaults and losses 3. Behavior of homeowners who are underwater • Roughly one-fourth of homeowners with mortgages are currently underwater, some deeply so • For many, it is economically rational for them to walk – so called “jingle mail” – but how many will do so? • There is little historical precedent – we are in uncharted waters • As home prices continue to fall and homeowners become more and more underwater, they are obviously more likely to default, thereby creating a vicious cycle, but what exactly will the relationship be? Have millions of foreclosures led to a diminution of the stigma of losing one’s home? • Our best guess is that there will be rough symmetry: for homeowners 5% underwater, an additional 5% will default due to being underwater; 10% underwater will lead to 10% more defaults, and so forth… 27
  28. 28. 24% of Homeowners With a Mortgage Owe More Than the Home Is Worth, Making Them Much More Likely to Default Among people who bought homes in the past five years, 30%+ are underwater* In Bubble Markets, Far More Homeowners Are Underwater Price Index Is % of Last 5 Yrs at Lowest Price Drop Purchasers Who Metro Area Level Since Since Peak Are Under Water* There Has Been a Dramatic Rise in New York 2004-Q3 -15.2% 23.0% Homeowners Who Are Underwater Los Angeles 2003-Q4 -32.0% 56.4% Boston 2002-Q2 -21.8% 27.8% 25% 24% Washington 2004-Q1 -24.8% 50.3% Miami 2004-Q1 -36.6% 65.1% San Francisco 2003-Q3 -27.8% 51.2% 20% Atlanta 2004-Q4 -10.4% 23.2% 20% San Diego 2002-Q4 -34.4% 63.9% Phoenix 2004-Q3 -37.7% 36.4% 16% Las Vegas 2003-Q4 -41.8% 61.4% Percent Underwater 15% * The actual figures are likely even worse, as this data doesn’t capture people who bought since 2003 and subsequently did a 10% cash-out refi or after-the-fact second mortgage. 50% of all subprime and Alt-A 6% loans in existence when the collapse 5% 4% happened were cash-out refis that carried a higher loan balance than the original 0% purchase loan amount. Dec-06 Dec-07 Sep-08 Dec-08 Mar-09 Source: Zillow.com Q4 08 Real Estate Market Report; Moody's Economy.com, First American CoreLogic, T2 Partners estimates 28
  29. 29. Certain Types of Loans Are Severely Underwater 80% 73% 70% 60% 50% Percent Underwater 50% 45% 40% 30% 25% 20% 10% 0% Prime Alt A Subprime Option ARM SOURCES: Amherst Securities, LoanPerformance, Standard & Poor’s. 29
  30. 30. Outlook for Housing Prices • We think housing prices will reach fair value/trend line, down 40% from the peak based on the S&P/Case-Shiller national (not 20-city) index, which implies a 5-10% further decline from where prices where as of the end of Q1 2009. It’s almost certain that prices will reach these levels • The key question is whether housing prices will go crashing through the trend line and fall well below fair value. Unfortunately, this is very likely. In the long-term, housing prices will likely settle around fair value, but in the short-term prices will be driven both by psychology as well as supply and demand. The trends in both are very unfavorable – Regarding the former, national home prices have declined for 33 consecutive months since their peak in July 2006 through April 2009 and there’s no end in sight, so this makes buyers reluctant – even when the price appears cheap – and sellers desperate. – Regarding the latter, there is a huge mismatch between supply and demand, due largely to the tsunami of foreclosures. In March 2009, distressed sales accounted for just over 50% of all existing home sales nationwide – and more than 57% in California. In addition, the “shadow” inventory of foreclosed homes already likely exceeds one year and there will be millions more foreclosures over the next few years, creating a large overhang of excess supply that will likely cause prices to overshoot on the downside, as they are already doing in California. • Therefore, we expect housing prices to decline 45-50% from the peak, bottoming in mid-2010 • We are also quite certain that wherever prices bottom, there will be no quick rebound • There’s too much inventory to work off quickly, especially in light of the millions of foreclosures over the next few years • While foreclosure sales are booming in many areas, regular sales by homeowners have plunged, in part because people usually can’t sell when they’re underwater on their mortgage and in part due to human psychology: people naturally anchor on the price they paid or what something was worth in the past and are reluctant to sell below this level. We suspect that there are millions of homeowners like this who will emerge as sellers at the first sign of a rebound in home prices • Finally, we don’t think the economy is likely to provide a tailwind, as we expect it to contract the rest of 2009, stagnate in 2010, and only then grow tepidly for some time thereafter 30
  31. 31. Percent Noncurrent (60+ days) Q 1 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 19 Q 99 3 19 Q 99 1 Are Soaring 20 Q 00 3 20 Q 00 1 20 Q 01 3 20 Q 01 1 20 Q 02 3 20 Q 02 1 20 Q 03 SOURCE: Mortgage Bankers Association National Delinquency Survey. 3 20 Q 03 1 20 Q 04 3 20 Q 04 1 20 Q 05 3 Delinquencies of Prime Mortgages 20 Q 05 1 20 Q 06 3 20 Q 06 1 20 Q 07 3 20 Q 07 1 20 Q 08 3 20 08 31
  32. 32. 15 States With the Highest Prime Mortgage Foreclosure Rates SOURCE: New York Times, 5/24/09. 32
  33. 33. Delinquencies of Prime and Alt-A Mortgages Are Soaring SOURCE: New York Times, 5/24/09. 33
  34. 34. There Are $2.4 Trillion of Alt-A Mortgages and Their Resets Are Mostly Ahead of Us $300 $10 We are $9 here $250 Estimated Cumulative Reset Amount (Bn) $8 $7 $200 $6 Amount (Bn) $150 $5 $4 $100 $3 $2 $50 $1 $0 $0 4 0 2 15 13 10 12 5 3 1 14 11 l-1 l-1 l- 1 l-1 l-1 l-1 n- n- n- n- n- n- Ju Ju Ju Ju Ju Ju Ja Ja Ja Ja Ja Ja SOURCES: Credit Suisse, LoanPerformance. 34 NOTE: This chart only shows resets for a small fraction of Alt-A loans, but is representative of all of them.
  35. 35. Percent Noncurrent (60+ days) Ja n- 0% 5% 10% 15% 20% 25% 99 Ju l-9 Ja 9 n- 0 Ju 0 l-0 Ja 0 n- 01 Ju SOURCES: Amherst Securities, LoanPerformance. l-0 Ja 1 n- 0 Ju 2 l-0 Mortgages Are Soaring Ja 2 n- 03 Ju l-0 Ja 3 n- 0 Ju 4 l-0 Ja 4 n- 05 Ju l-0 Delinquencies of Securitized Alt-A Ja 5 n- 0 Ju 6 l-0 Ja 6 n- 07 Ju l-0 Ja 7 n- 0 Ju 8 l-0 Ja 8 n- 09 35
  36. 36. Alt-A Delinquencies By Vintage Show the Collapse in Lending Standards in 2006 and 2007 30% 2007 2006 25% Percent Noncurrent (60+ days) 20% 15% 2005 10% 2004 5% 2003 0% 0 5 10 15 20 25 30 35 40 45 50 55 60 Months of Seasoning SOURCES: Amherst Securities, LoanPerformance. 36
  37. 37. Percent Noncurrent (60+ days) Ja n- 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 99 Ju l-9 Ja 9 n- 0 Ju 0 l-0 Ja 0 n- 01 Ju SOURCES: Amherst Securities, LoanPerformance. l-0 Ja 1 n- 02 Ju l-0 Mortgages Are Soaring Ja 2 n- 03 Ju l-0 Ja 3 n- 04 Ju l-0 Ja 4 n- 05 Ju l-0 Ja 5 n- 06 Ju l-0 Ja 6 n- 07 Ju l-0 Delinquencies of Securitized Jumbo Prime Ja 7 n- 08 Ju l-0 Ja 8 n- 09 37

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