GoldenTree Asset Management

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GoldenTree Asset ManagementMIT Golub Center for Finance and Policy3rd Annual ConferenceJoseph Naggar, Partner & Senior Portfolio ManagerSeptember 20161

Securitized Products Overview and CLO Deep Dive2

Financial Innovation Acronym Alphabet SoupStructured Investment Vehicles (SIVs)Collateralized Bond Obligation (CBO)Collateralized Debt Obligation (CDO)Derivatives Product Company (DPC) or CreditDerivatives Product Company (CPDC)Collateralized Debt Obligation Squared (CDOSquared)Collateralized Loan Obligation (CLO)Collateralized Loan Obligation Squared (CLOSquared)Residential Mortgage Backed Security (RMBS)Synthetic Collateralized Debt Obligation (SCDO)Commercial Mortgage Backed Security (CMBS)Synthetic Collateralized Debt Obligation Squared(SCDO Squared)Asset Backed Security (ABS)Student Loan Asset Backed Security (SLABS)Asset Backed Security Collateralized Debt Obligation(ABS CDO)Collateralized Proportion Debt Obligation (CPDO)Commercial Real Estate Collateralized Debt Obligation(CRE CDO)Trust Preferred Collateralized Debt Obligation (TrupCDO)Collateralized Mortgage Obligation (CMO)Synthetic Indices – ABX, LCDX, HY CDX, LEV X,ITRAX, IG CDX and Tranches on some of these;multiple seriesAsset Backed Commercial Paper (ABCP)3

What Markets Depend On Securitization?US Securitization Markets – Outstanding IssuanceCredit Cards ( 134bn)Auto loans ( 194bn)Student Loans ( 221bn)MortgagesPrime ( 2.6tr, 735 non-agency ’07)Subprime ( 243bn ’07)US Commercial Real Estate ( 600bn)High Yield LoansUS/EUR CLOs ( 400bn)Source: Barclays, Citigroup4

What Is The Size Of The Structured Products Market?Size of Structured Products Markets – Issuance Per Year through 2008European and US ABS Issuance (EUR Bn)2,500US ABS Issuance by Sector (USD Bn)USEurope1,400Student it opean and US CMBS Issuance (USD Bn)350Euro ABS Issuance by Sector (EUR Bn)European Is s uanc e700US Is s uanc e300600Whole Covered bonds200100100501997Source: 05

Structured Finance IssuanceStructured Products issuance is a fraction of Corporate issuance post 2008 crisisUS & Europe Structured Finance Issuance Vs Corporate IssuanceIssuance in TrillionsStructured Finance IssuanceCorporate Bond and Loan 0152Q20160.3x0.2xRatio of Structured Finance to Corporate Issuance2.0x1.6x1.3xAs of June 30, 2016Source: SIFMA for Structured Finance issuance; SP LCD, Barclays Research for Corporate issuance0.2x0.3x6

Securitized Products: A Market of ManySecuritized Products are an amalgam of many different investment opportunity sets, suitable for awide range of investors with varying return objectives and risk toleranceSource: Morgan Stanley Research7

Banking System Effects of the Financial Crisis BillionsHSBCJP 23381824MorganStanley471723Max Market Capitalization as of 1H2008Market Capitalization as of January 1, 2009Source: Bloomberg as of February 22, 2016Market Capitalization as of February 22, 20168

The Policy Response Plan In A Disintermediated World9Source: Morgan Stanley

Emergency Policy Initiatives Post Crisis Unprecedented global central bank intervention with goal of stabilizing housing, recapitalizing the banksystem, reviving structured products and especially lending to consumers–Conventional methods: interest rate easing–Un-conventional: “quantitative” easing and “credit” easing methods–Read Bernanke’s statements; makes for good bedtime stories Securities / Market Related Initiatives–TARP: 700 Billion program total, purchases of equity in financial institutions or assets–TLGP: Temporarily guarantee of newly issued senior unsecured debt of FDIC-insured depositoryinstitutions for 3-years (proposed to be extended to 10 years)–FDIC: Government guarantees and financing (e.g. IndyMac)–TALF: 200 Billion of non-recourse term financing of AAA consumer ABS with no re-marginingrequirements. Likely to be expanded to 1 trillion and include CMBS, and potentially others such asCLOs Initiatives Aimed at the Consumer–Loan-modification programs including principal reduction–Refinancing through Hope for Homeowners Act–New job creation through fiscal stimulus10

Policy Interaction11

Securitization and its DiscontentsLaurie GoodmanCo-Director, Housing Finance Policy CenterUrban InstituteMIT Golub Center for Finance and Policy3rd Annual ConferenceCambridge, MASeptember 28, 2016

Outline While most other securitized asset classes have come back after the financialcrises, residential MBS has not. There are 3 reasons for this: Mortgages exhibited the most severe dislocations of any asset class Mortgages were the only asset class to experience significant policy changesaffecting already outstanding securities Though the interests of investors and issuers were largely aligned in thesecuritizations of other asset classes, private-label securitization was riddled withconflicts of interest among all of the key players This cannot be explained by the much large role for the government in theMBS Market What has to change in the PLS Market to restore issuance? Standardization, introduction of a deal agent, better transparency andmonitoring on servicing2

Securitization of non-mortgage asset classes Billions250200150AutoCMBS100High-yield CLOCredit card50Student Loan02000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015Sources: Securities Industry and Financial Markets Association and Urban Institute.3

Private Label RMBS (PLS) Issuance Billions1,4001,2001,000Re-REMICs and other 2160 8770 560 160 3680Scratch and dent800Alt 07200820092010201120122013201420152016Q1-2Source: Inside Mortgage Finance and Urban Institute4

Percent change in securities issuance from2001 to 2015Types of DebtAutoCredit cardStudentHigh-yield CLOCMBSPrivate Label RMBS14.4%-22.9%-5.3%155.8%58.8%-84.2%Source: Urban Institute5

Delinquency rates by loan productPercentPercent change, 2003-2010Mortgage624.6%Auto123.9%Credit Card 51.2%Student Loan 44.9%16141211.6%10Student Loan8.2%8Credit 082009201020112012201320142015Sources: Federal Reserve Bank of New York Quarterly Report on Household Debt and Credit and Urban Institute.6

Why has the private label RMBS market not come back? Mortgages exhibited the most severe dislocations of any asset class Exposed weaknesses in the cash flow waterfall Exposed weaknesses in the collateral underwriting process Exposed the lack of consistent loan level information Exposed the sloppy due diligence Mortgages were the only asset class the experience significant policy changes after the crises Lack of disclosure for the wave of mortgage modifications Servicing settlements Expansion of timelines Eminent domain7

Why has the private label RMBS market not come back? Securitizations of other asset classes have better alignment of interests between the issuer and investors. Major Issues Include: Enforcement of reps and warranties Misplaced incentives due to ownership of second liens Vertical integration in the servicing process8

Cumulative Modifications and LiquidationsNumber of loans (millions)8.1986.376HAMP mods5Proprietary mods4Liquidations1.6321Sources: Hope Now Reportsand Urban Institute.Note: Liquidations includesboth foreclosure sales andshort 2016July 20169

First Lien Share by Funding Source( trillions) 4.0PortfolioPLS securitization 3.5FHA/VA securitizationGSE securitization 3.0 2.5 2.0 1.5 1.00.300.0040.20 0.50.38 22013201420152016Q1-2Sources: Inside Mortgage Finance and Urban Institute10

A Security Design Crisis in the Plumbing of U.S.Mortgage OriginationNancy WallaceHaas School of BusinessReal Estate and Financial Markets LaboratoryFisher Center for Real Estate and Urban EconomicsMIT GCFP ConferenceSeptember 28, 20161

/GSE pipeline risksI Secondary mortgage market is heavily federalized.I GNMA/GSE securitization volume is now dominated by non-depositorymortgage originators. CFPB, HUD and state-level oversight – no stress testing. Reliance on short-term bi-lateral repo funding. Short-run risks – covenants on repo, slowing of mortgage refi’s (reducedfee income), underfunding for servicing advances, other balance sheetfailures. Liquidity risks – changes in forward funding markets (hedging costs),repo pricing. Systemic risks – Repo runs (short-run triggers and BAPCPA 2005),mortgage fire sales, unfunded rep and warranty guarantees, risk toorigination capacity.2

house Lending and Repurchase AgreementsStructured InvestmentVehicle (SIV): Repo BuyerWarehouse Lender:Repo BuyerStructured InvestmentVehicle (SIV): Repo BuyerWarehouse Lender:Repo BuyerMort. Note Mortgage Originator: Repo Seller Mort. NoteMort. Note Mortgage Originator: Repo SellerBailee Sale Bailee SaleBorrowersMort.Private-LabelSPE or GSE SPE(a) Repo SetupPrivate-LabelSPE or GSE SPE(b) Repo Unwind3Mort. Note

ralization of Secondary Residential Mortgage Market(Source: HMDA)4

rtance of Non-Depository Origination for GSE and GNMASecuritization5

nant Non-Depository Funding Facility: MortgageRepurchase AgreementsI Summary of Contract Features: Strict capital and accounting covenants.Significant roll-over risk (short term maturities).Often highly concentrated repo buyer exposure.Risk of haircuts and dynamic margins.Exempt from automatic stay under BAPCPA 2005 (repo buyer holdsperfected mortgage collateral). Rep and warranty risk resides with originator (repo seller with littlecapital). Mortgage servicing positions at risk: liquidity needs for advances.6

nance of Master Repurchase Agreements (SIC 6162, 6163,6798)7

omes for 2006 Top Forty Originators8

BackgroundMRAsPre-CrisisPost-CrisisConclusionsRepo was/is a Bet on Loan-level Securitization Speeds: Mean andStandard Deviation by 30 Day Bins9

BackgroundMRAsPost-CrisisPre-CrisisConclusionsTop 2016 Public IMCs are heavily reliant on MRAs10

entrated Repo Buyer Commitments (Not including hedgefunds or foreign banks)11

lusionsI Significant pipeline risk exposure for GNMA and GSEs. Dominance of imperfectly monitored bi-lateral repo funding. Importance of risk segmentation between repo buyers and sellers.I Non-depository pipeline funding is fragile: Pre-crisis mortgage origination funding structures are still dominantespecially master repurchase agreements (MRAs). MRA funding structures are vulnerable to: 1) roll-over risk; 2) many otherdebt covenants (especially accounting triggers) – this was a veryimportant pre-crisis problem leading to the collapse of lendinginfrastructure and many firm bankruptcies. MRAs have repo status so they are exempt from automatic stay–Warehouse lenders (Repo Buyers) will run when market softens. Non-depository warehouse borrowers (repo sellers) have no capital, butthey bear the rep and warranty risk – is this sensible?12

Source: SIFMA for Structured Finance issuance; SP LCD, Barclays Research for Corporate issuance Structured Products issuance is a fraction of Corporate issuance post 2008 crisis Structured Finance Issuance US & Europe Structured Finance I

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