SUBPRIME CRISIS

Sandipan Nandi Shamik Roy Uttiya Das

Some Happenings
Infosys reports a reduced Quarter on Quarter increase in profits Mindtree announces negative margin of operating profits Bench Strength of the top 5 Indian IT majors has grown at faster rate ie 48.5% compared to hiring rate growth of 38% Large companies like Oracle, IBM & Yahoo on a hiring freeze Banks like HSBC are writing of loans at the rate of $51 million a day

MAIN CREDIT LOSSES SO FAR

Citigroup: UBS: Merrill Lynch: HSBC: Bank of America: Morgan Stanley Royal Bank of Scotland: JP Morgan Chase: Washington Mutual: Deutsche Bank: Wachovia: Credit Agricole: Credit Suisse: Mizuho Financial Bear Stearns: Barclays: $40.7bn $38bn $31.7bn $15.6bn $14.9bn $12.6bn $12bn $9.7bn $8.3bn $7.5bn $7.3bn $6.6bn $6.3bn $5.5bn $3.2bn $3.2bn

Source: Bloomberg and company reports

Sub Prime Crisis- Defined

The sub prime mortgage crisis is a current economic problem characterized by contracted liquidity in the global credit markets and banking system. An undervaluation of real risk in the sub prime market ultimately resulted in cascades and ripple effects affecting the world economy generally

Some Important terms

Adjustable Rate Mortgage: A mortgage carrying an interest rate that is reset at regular intervals, typically every 12 months, after the initial low "teaser" rate expires. Resets are calculated by adding a fixed number of percentage points, or "margin," to an index that moves up and down as market conditions change. Typical indexes are the interest rate paid by U.S. Treasury bonds with one year to maturity. Margins on traditional "prime" ARMs are usually around 2.75%age points. Subprime loans often carry margins of more than 5 percentage points. Sub Prime: A classification of borrowers with a tarnished or limited credit history. Lenders will use a credit scoring system to determine which loans a borrower may qualify for. Subprime loans carry more credit risk, and as such, will carry higher interest rates as well. Approximately 25% of mortgage originations are classified as subprime.

Contd
Appraiser:
Real estate appraisers inspect homes prior to sale to determine their value, typically by comparing them to nearby properties that have recently been sold. Mortgage lenders require appraisals to assure the property is valuable enough to serve as collateral for the loan. Many critics believe that sloppy or dishonest appraisals contributed to the recent home-price bubble, setting the market up for the fall that followed

Auction-rate Security:
A type of debt security, such as a corporate or municipal bond, that carries a floating interest rate that is frequently reset through an auction process. Rates may be reset as often as daily, but rarely at intervals longer than 35 days. These securities have generally been promoted as safe, liquid investments offering higher yields than other "cash" equivalents, such as money market funds. But the credit crunch that grew out of the subprime crisis caused this market to dry up, making it difficult or impossible for investors to sell these holdings even though few, if any, of the securities' issuers had actually defaulted

Collateralized Debt Obligation:

A security backed by a pool of loans, bonds or other debt. Typically, CDOs come in slices, or tranches, with riskier ones paying higher yields

Contd.
Credit Crunch: A situation in which banks and other financial institutions cut back on lending, or raise interest rates so high that individuals, businesses and institutions reduce their borrowing. In the subprime crisis, the credit crunch arose from widespread fear that borrowers would default Discount Rate and Discount Window: The discount window is a mechanism used by the Federal Reserve to make short term loans to qualifying banks which need cash to maintain liquidity. The discount rate is the interest rate charged on these loans. Historically, the discount window was limited to overnight loans to help with temporary emergencies. When the credit crunch arising from the subprime crisis made it difficult for banks to borrow, the Fed moved to open the window wider

Foreclosure:

Contd
Foreclosure: The process of a lender taking ownership of a property after the borrower has defaulted, or stopped making monthly payments. The home is used for collateral to minimize the lender's losses. This is why mortgages charge lower interest rates than credit cards, which have no collateral. Typically, lenders resorting to foreclosure recover only about half of what they are owed, because of legal fees, the missed payments for the many months the process takes and the difficulty in selling a poorly maintained property Mortgage-backed Security: A form of security, similar to a bond that is backed up, or collateralized, by thousands of home loan bundled together by a securities firm such as an investment bank. Investors who purchase mortgaged-backed securities receive regular payments representing their share of the interest and principal payments made by homeowners

Contd.
Risk Premium:
Refers to the higher return investors demand to offset greater risks. "Junk" bonds issued by corporations with shaky finances typically pay higher interest than ultra-safe U.S. Treasury bonds, since investors worry the corporations will not make the payments promised

Securitization:
Streams of income, such as homeowners' monthly mortgage payments, can be bundled together into a form of bond that is sold to investors. Securitization allows the original lender to exchange a holding with a long-term value, such as the payments it is to receive on 30-year mortgages, into an immediate payment, providing cash for making additional loans. Securitization thus makes more mortgage money available, and it allows the risk of mortgage lending to be dispersed among investors around the world. Investors' appetite for high-yield investments may have encouraged mortgage lenders to offer more subprime loans than was wise, contributing to the subprime crisis

Contd
Subprime Mortgage: Generally understood to be a mortgage offered to borrowers with low credit ratings or some other characteristic that increases the risk they will default, or fail to make their monthly loan payments. To offset this risk, subprime loans charge higher interest rates than ordinary "prime" loans. Most subprime loans start with a low "teaser" rate charged for the first one to three years Tranche:

A slice of something bigger. Mortgages are bundled together and converted to a kind of bond sold to investors. Although the pool as a whole may be too risky to earn an AAA investment rating, the securities can be offered in a series of tranches with varying risks. A high-risk tranche would be the first to suffer losses if homeowners stop making their monthly payments, but this tranche would pay the highest yield. Other tranches would have first rights to borrowers' monthly payments, making them safer, but their yields would be lower. By concentrating risks in low-rated tranches, investment banks can create AAA-rated securities out of a mortgage pool that as a whole could not qualify for such a high rating

Some links you can visit

http://news.bbc.co.uk/1/hi/business/7096845.stm http://www.thehindu.com/2008/02/19/stories/20080219589203 00.htm http://en.wikipedia.org/wiki/Subprime_mortgage_crisis http://www.rediff.com/money/2007/sep/06perfin.htm

GLOBAL IMPACT AND AN INDIAN PERSPECTIVE

TREMORS FELT EVERYWHERE!!

Banks in 13 countries of Europe has investments worth $500 bn of exposure Credit growth in euro zone is slowing down. Bank reluctant to lend to one another Euro becoming stronger compared to dollar. Will export from euro zone sustain growth???

Woes continues
High volatility in the markets due to recessionary fears in US cash flow to US slows down which effects high current account deficit. So where the money getting invested now? ECB has postponed interest hike Germany and France has planned tax cuts to support growth

THE CLOUDS OF SUBPRIME ARE MORE LIKELY TO BRING SPOT OF RAIN RATHER THAN A STORM TO EUROPES BIGGEST ECONOMIES - ECONOMISTS (SEPT 22ND , 2007
ISSUE)

warning: only if US economy do not stumbles into Recession!!!

So how is Asia doing??

Economic growth in Asia has held up reasonably well despite market turbulence and weakening export. However, there will be indirect impact Although chinas exports faces stiff breeze from west, its domestic consumption is on rise. However, is it high enough??? Japan will take marginal hit in export. Japanese banks are not much exposed to the crisis.

INDIAN RESILIENCE- CHAK de!!!

The effect of sub prime crisis has been largely muted in India Hurray!!! India is largely a domestic consumption driven economy The banking system in India still engaged in traditional bank lending. so where is the risk?? US slowdown may cause cascading effect!!!!

Sub prime lesson for Asia

The form of crisis may change but their essence remains same Need to find the right balance between progress and prudence, innovation and caution. Credit standard must be maintained at all time Transparency is critical for financial supervision and market discipline to be effective Financial linkages must be understood

THANK YOU!!!!