1. GRAVITAS Capital Advisors, Inc. 1 The Advantage of Innovative Thinking

2. GRAVITAS Capital Advisors, Inc. 2 Sub-prime Crisis A Structural View & Implications 2 nd Annual CAACM Conference St. Lucia – June 24, 2008 Presenter: Eric Guichard GRAVITAS Capital

3. GRAVITAS Capital Advisors, Inc. 3 Sub-prime Impact to date… u Citigroup has declared about $30+ billion in value wiped out from its balance sheet u Merrill Lynch has declared in excess of $25+ billion lost in value u In total to date about $600+ billion lost (hedge funds, insurance companies, pension funds, endowments…) u Foreclosure rates are at historical highs u Global impact…Why?

4. GRAVITAS Capital Advisors, Inc. 4 What is sub-prime? u In 90s big push to increase homeownership in US. –Freddie Mac and Fannie Mae (GSEs) push with new ways to provide loans to the needy (people with substandard credit quality) –Private sector banks balk at market share grab by GSEs –Congress allows Banks and other private financiers to enter market –Current market is about 5% - 10% of total mortgages outstanding.

5. GRAVITAS Capital Advisors, Inc. 5 House = Household Wealth Equity = Collateral Bank Loan Mortgage Bank 2 (Equity Loan) $$ Mortgage 2 Consumer Goods/Services NB: Equity grows over time

6. GRAVITAS Capital Advisors, Inc. 6 Housing pulls Economy Home Purchase Hardware Electronics Utilities $ $ $ Jobs

7. GRAVITAS Capital Advisors, Inc. 7 Old days of Relationship Banking Homeowner Bank (Owns Mortgage) Loan Mortgage NB: Bank owns loan and knows client – is part of community

8. GRAVITAS Capital Advisors, Inc. 8 HH Lender Packager (Securitization) PensionsInsurancesEndowments Rating Agencies Loan The Mortgage Market Today (A) Key Attraction: Steady Cashflows + Valuable Collateral Investment Guidelines

9. GRAVITAS Capital Advisors, Inc. 9 Securitization Process (A) Detroit Bank Hollywood Bank Florida Bank Wall Street Investment Bank (Packager) Selling/Buying Mortgages Pool A: 30%D 30%H 40%F Pool B: 70%D 10%H 10%F Insurance Pensions Banks Insurance Pensions Banks Low Yield Bonds High Yield Bonds (Sub-prime) Exotic Structures Exotic Loans

10. GRAVITAS Capital Advisors, Inc. 10 Securitization Process (B) Pool A High Credit Mid Credit Sub-Credit Hi Risk Rating Agencies AAA Banks Pensions Insurance Hedge Funds AA BB CCC Investors Exotic Structures

11. GRAVITAS Capital Advisors, Inc. 11 Workings of Mortgage Market u All mortgage originators (Countrywide) sell their loans (cash flows) to packagers u Packagers (Merrill & Citi) securitize them and sell the securities backed by mortgages to investors (pensions, insurances, endowments, hedge funds…) u Some investors (hedge funds) believing in the collateral mantra purchase these bonds with leveraged funds.

12. GRAVITAS Capital Advisors, Inc. 12 HH Lender Packager (Securitization) PensionsInsurances Banks Rating Agencies Collateral (Value?) Loan The Mortgage Market (B) (Credit Worthiness?) (Due Diligence?) (Pressures?)

13. GRAVITAS Capital Advisors, Inc. 13 Audit Committees Role? u Could Audit Committees of respective players have caught on? How? u Can an over-reliance on process be at issue? u Is auditing as stringent in good times as it is in bad? u What about the impact of incentives on behavior?

14. GRAVITAS Capital Advisors, Inc. 14 What are incentives? u $160 Trillion in Global Liquidity u Only $51 Trillion in available stock investment u Pressure on Investment Banks to create new investment vehicles = Pressure on Banks to originate u Bankers get paid irrespective of quality of loans u Rating agencies sell their ratings to investment banks.

15. GRAVITAS Capital Advisors, Inc. 15 Pressure = Origination Fraud u Incentives create dislocation and loss of accountability u Documentation is suspect and loan practices are misleading. No one pays attention u Ripple effect ensues as sub-prime borrowers default on their loans due to reset clauses (yield) and drop in housing prices (assumption).

16. GRAVITAS Capital Advisors, Inc. 16 Fraud = mistrust = credit squeeze u Corporate lending in short term market which is based on trust is shut out due to poor quality of collateral u Lack of transparency leads to mistrust and collapse of short term liquidity u This leads to credit squeeze u Central bank in dilemma…

17. GRAVITAS Capital Advisors, Inc. 17 Implications for the System? u Revive Accountability –Apply Existing Fraud Regulation u Realign Incentives –Strengthen Role of Incentive Audits –Loan performance ratios as part of reporting u Governance at Banks u Global liquidity still a challenge

18. GRAVITAS Capital Advisors, Inc. 18 In Conclusion u Mix of inexperience, poor incentives, greed, booming global liquidity pressures and oversight dislocations lead to sub-prime collapse u Sub-prime collapse leads to credit squeeze as mistrust sets in u Sub-prime still a good idea to help alleviate poverty u Accountability, Transparency and Incentives are key as challenges remain…