Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Sub Prime Mortgage Problem

637 views

Published on

Published in: Business, Economy & Finance
  • Be the first to comment

  • Be the first to like this

Sub Prime Mortgage Problem

  1. 7. Terminology <ul><li>80/20 LOAN – The financial product that gives home buyers two loans – one for 20% of Total loan for the money down (typically 20%) </li></ul><ul><li>The second loan is for the actual home – 80%. </li></ul>
  2. 8. <ul><li>A &quot; piggyback loan &quot; is a home financing option in which a property is purchased using more than one mortgage from two or more lenders. There are three common types of piggyback loans: the 80-10-10 loan , the 80-20 loan (also known as the 80-20-0 loan) and the 80-15-5 loan . In each of the aforementioned instances, the first number indicates that 80% of the home's purchase price will be financed by a mortgage of lender number one; the second number indicates the percentage amount of a loan secured by a second mortgage with a different lender; and the third number indicates the down payment percentage. </li></ul>
  3. 9. <ul><li>The Good News - The Pros </li></ul><ul><li>Piggyback loans are used so that homebuyers can qualify for more of a home. When more than one lender is involved in a single loan transaction, the entire loan risk is spread between two lenders. This means that a homebuyer with little or no down payment should have better luck with the loan approval process on a piggyback loan than they would with a single conventional loan. </li></ul><ul><li>Yet perhaps the biggest advantage of piggyback loans is that it allows homebuyers to purchase a home with less than 20% down payment. A piggyback lending program tends to level playing field, making homeownership a possibility for more potential buyers-especially first-time homebuyers who have little equity to use as a down payment. </li></ul>
  4. 10. <ul><li>Reasons to Think Twice -The Cons </li></ul><ul><li>As compared with standard home mortgage programs, combined rates for piggyback loans are often higher than standard loans . This is because of the risk amounts that each lender is assuming. The lender who is only financing 80% of the loan amount might be willing to drop their rates a bit, but the second lender-the one who is only financing 5% to 20% of the loan-doesn't see much benefit from lending the money unless he can actualize a high interest return. </li></ul><ul><li>Also, many piggyback loans attach a large balloon payment at the end of a loan-an end-of-term payment that is substantially larger than the standard mortgage payments. This can be a bit hit, unless you plan ahead by setting aside some extra money every month. </li></ul><ul><li>And, since the premise of a piggyback loan is based on the idea of dual mortgages, if an emergency were to arise, getting an additional mortgage or home equity loan could be difficult, if not impossible. </li></ul>
  5. 21. <ul><li>Collateralized debt obligations (CDOs) </li></ul><ul><li>This is an unregulated type of asset-backed security and structured credit product. CDOs are constructed from a portfolio of fixed-income assets. These assets are divided by the ratings firms that assess their value into different tranches: </li></ul><ul><ul><li>senior tranches (rated AAA) </li></ul></ul><ul><ul><li>mezzanine tranches (AA to BB) </li></ul></ul><ul><ul><li>equity tranches (unrated) </li></ul></ul><ul><li>Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added default risk. Since 1987, CDOs have become an important funding vehicle for fixed-income assets. </li></ul>
  6. 22. <ul><li>Collateralized debt obligations (CDOs) </li></ul><ul><li>This is an unregulated type of asset-backed security and structured credit product. CDOs are constructed from a portfolio of fixed-income assets. These assets are divided by the ratings firms that assess their value into different tranches: </li></ul><ul><ul><li>senior tranches (rated AAA) ( the good) </li></ul></ul><ul><ul><li>mezzanine tranches (AA to BB) ( the not so good) </li></ul></ul><ul><ul><li>equity tranches (unrated) (the ugly) </li></ul></ul><ul><li>Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added default risk. Since 1987, CDOs have become an important funding vehicle for fixed-income assets. </li></ul>
  7. 29. <ul><li>Some news and media commentary blame the financial woes of the 2007-2008 credit crunch on the complexity of CDO products, and the failure of risk and recovery models used by credit rating agencies to value these products. </li></ul><ul><li>Some institutions buying CDOs lacked the competency to monitor credit performance and/or estimate expected cash flows. On the other hand, some academics maintain that because the products are not priced by an open market, the risk associated with the securities is not priced into its cost and is not indicative of the extent of the risk to potential purchasers. </li></ul><ul><li>As many CDO products are held on a mark to market basis, the paralysis in the credit markets and the collapse of liquidity in these products led to substantial write-downs in 2007. </li></ul><ul><li>Major loss of confidence occurred in the validity of the process used by ratings agencies to assign credit ratings to CDO tranches and this loss of confidence persists into 2008. </li></ul>
  8. 30. Mark to Market
  9. 31. US Securities & Exchange Commission (SEC)
  10. 36. <ul><li>A special purpose entity ( SPE ) (sometimes, especially in Europe, &quot; special purpose vehicle &quot; or simply SPV ) is a body corporate (usually a limited company of some type or, sometimes, a limited partnership ) created to fulfill narrow, specific or temporary objectives, primarily to isolate financial risk, usually bankruptcy but sometimes a specific taxation or regulatory risk. </li></ul><ul><li>A special purpose entity may be owned by one or more other entities and certain jurisdictions may require ownership by certain parties in specific percentages. Often it is important that the SPE not be owned by the entity on whose behalf the SPE is being set up (the sponsor). For example, in the context of a loan securitisation , if the SPE securitisation vehicle were owned or controlled by the bank whose loans were to be secured, the SPE would be consolidated with the rest of the bank's group for regulatory, accounting, and bankruptcy purposes, which would defeat the point of the securitisation. Therefore many SPEs are set up as 'orphan' companies with their shares settled on charitable trust and with professional directors provided by an administration company to ensure there is no connection with the sponsor. </li></ul>
  11. 37. <ul><li>Special purpose entities were one of the main tools used by executives at Enron , in order to hide losses and fabricate earnings, resulting in the Enron scandal of 2001 . </li></ul>
  12. 40. THE US CONGRESS
  13. 41. NO THE US CONGRESS
  14. 42. Home Price Index
  15. 43. Home Price Index
  16. 57. Tell them you failed. Maybe the government will give you money.
  17. 58. I am the Norwegian Government.
  18. 59. Sorry (evil grin). Next week – The International Effects

×