1. © Natixis 2006 The Subprime Credit Crisis of 2007 Michel Crouhy Head of Research and Development NATIXIS Corporate and Investment Bank

2. 2 Issues to be addressed to avoid a repeat of the “subprime” crisis

3. 3  Rating agencies - Rating of bonds vs. rating of structured credit products (close to half of their income came from the rating of structured credit products) Rating of a corporate bond based largely on firm-specific risk and relies on analyst judgment Rating of a CDO tranche relies on quantitative models as it is a claim on cash flows from a portfolio of correlated assets - Ratings were based on expected loss: a bond and a CDO tranche with the same expected loss have different unexpected losses that depend on the correlation structure, prepayment behavior and the position in the capital structure of the CDO - How to deal with the volatility of ratings? What is the usefulness a very volatile rating? - Rating agencies did not perform any due diligence on the quality of the underlying loans: took for granted the accuracy of the information provided to them by the structurers

4. 4  Valuation - Better models are clearly needed to generate the loss distribution of correlated credits - Parameter estimation – forward looking: PDs, LGDs, prepayment behavior, default correlations  Transparency - Disclosure: underlying assets of CDOs and SIVs, commitments provided by banks

5. 5  Instrument design - Going forward we can expect that investors will shy away from complex structures: CDOs squared, CPPI, CPDOs and other structures exposed to “gap risk”

6. 6  Regulators and Risk Management - Lending standards - Put options to allow banks to put back mortgages to originators in the case of delinquency within a short period - Need for several risk metrics to assess the risk of complex exposures: VaR for “normal market conditions” Stress testing and scenario analysis to account for liquidity risk and other complexities (e.g., digital nature of the risk involved in holding a CDO tranche) in extreme market conditions, very unlikely, but still realistic

7. 7  The Future of Securitization - The objective of the business model “Originate & Distribute” is to allow banks to focus on what they do best originate, structure financial products and redistribute the risks to end-investors by tailoring CRT instruments to their needs - SIVs did not allow banks to redistribute the risks to the end- investors as the securitized assets are coming back to the balance sheet of the banks when liquidity evaporates

8. 8 “Dad was in ABS securitization” Conclusion