SUB-PRIME CRISIS

PRIME LOAN


ü A loan offered to borrowers with good credit history

& good earning capacity.(Also called "A" loans)
ü
ü
ü Prime loans generally are priced lower and cost the
borrower less
 SUBPRIME LOAN
ü A Subprime loan is a loan made to customers who typically
have low credit scores and histories of payment defaults. Also
called B loan, near prime, non prime or second chance loan.
ü
ü
ü Subprime offers the opportunity for borrowers with less than
ideal credit standing to gain access to funds.
ü
ü
 PRIME LOAN SUBPRIME LOAN

ower risk of default üHigher risk of default

ower interest rate üHigher interest rate
ending to borrower of high credit record
üLending to borrower of low or nil credit re
onsumer is “buying” the product
üConsumer is “sold” the product
own Payment üLesser Down Payment
arning capacity Play a üEarning capacity doesn’t
ole matter
 WHY SUB-PRIME LOANS WERE
GIVEN?

Ø The Real Estate Boomstarted since 1997 and the housing prices began spiraling
upwards and continued through mid-2006.

Ø Borrowing and lending rates-extremely low and boosted the demand.

Ø Sub-prime mortgages-many institutions offered home loans to borrowers with
dodgy credit background


Ø Big fund investors like Hedge Funds and Mutual Funds saw sub prime loan
portfolios as attractive investment opportunities.
Ø

CONTD…

Ø Hence, they bought such portfolios from the original lenders.

This in turn meant the lenders had fresh funds to lend.


Ø Interest rate on these loans is 2 percentage more than the prime

loans.
Ø
Ø The sub prime loan market thus became a fast growing segment.
Ø

How did this turn into a crisis ?

 Step 1 - The housing boom in the US started fading out in 2007.

Step 2 - Boom had led to massive increase in supply of housing.

Step 3 - Thus House prices started falling.

Step 4 - This increased the default rate among sub-prime

 borrowers.
Step 5 - These borrowers were no longer able/willing to pay high

 price for a house that was declining in value.

Step 6 – Security/Guarantee being the house being bought , this increased

 the supply of houses for sale while lowering the demand,

 thereby lowering prices even further and setting off a
 vicious cycle.
 TRIGGER FOR SUB-PRIME
CRISIS
ØRising inflation
ØHike in the interest rates
Ø

Source: Tuatara Management Limited, 4 July

2008 9
CRISIS WORSENS...

Ø Estimates show that US housing prices have dropped by

almost 50% from their peak in 2006.


Ø Declining value of Security (Homes) means that lenders

are left with less than the value of their loans and hence
have to book losses.
BEFORE THE IMPACT OF
SUBPRIMECRISIS
 STOCK MARKETS
ØGlobal equity markets witnessed record growth

Valuations were at a record high

IMPACT OF SUB-PRIME CRISIS
 EFFECT ON INDIAN ECONOMY
Ø
Ø India is relatively insulated from these developments because of its modest exposure to the
US financial world.


 for e.g. SBI has only a $5 million exposure to Lehman Bros. from its $250 billion portfolio.
(source: TOI)

Ø But in this era of global trade and finance, any slowdown or contraction of the US economy is
bound to hurt India. India thrives on everything from them.

Ø US consumer demand for its textiles and leather.

Ø
Ø US financial sectors has generated tens of thousands of jobs in India.
IMPACT ON INDIA: THE GOOD,
BAD & UGLY
BANKING
CONTD…
Ø US sub-prime market crisis-losses worth $181 billion to the
world’s top 45 banks by the end of FY08.
Ø
Ø India’s largest private sector bank ICICI Bank was the first bank
to announce a loss of about Rs. 1056 crores owing to the sub
prime crisis of US in the FY08
Ø
Ø Punjab national Bank, Bank of India, State Bank of India, Bank of
Baroda were major banks having an exposure to the
instruments issued by Lehman and Merrill Lynch.
Ø
Ø Banking sector will face tight liquidity conditions apart from
further mark-to-market losses.
BANKING
STOCK MARKETS
STOCK MARKET

Ø July 23, 2007, Sensex touched a new

high of 15,733 points

Ø On July 27, 2007 Sensex witnessed a
huge correction because of selling by
Foreign Institutional Investors

Ø BSE Sensex fell by 615 points in a single
day on August 1, 2007.

 FII’s
Ø capital inflow into the country – impacted
Ø
Ø FIIs’ stake in infrastructure, has seen an erosion of
4 per cent to 16.5 per cent
Ø
Ø IT service companies, which were languishing last
year due to the rupee appreciation, have once
again caught the fancy of FIIs and they have
increased stakes in these companies from 25.5
per cent to 28 per cent.
Ø
Ø , FIIs’ exposure to telecom stocks has slipped
marginally from 17.7 per cent to 17.1 per cent.

CONTD…

Ø Citigroup, which reported around losses

of $18 billion in the sub-prime crisis,
reduced its holdings in 47 companies


Ø Morgan Stanley, Merrill Lynch Capital,

HSBC, Goldman Sachs and Swiss
Finance Corporation reduced their
holdings in 30 companies to below-a-
per cent each. 

REAL ESTATE &
INFRASTRUCTURE
CONTD…
Ø Adverse impact on the infrastructure companies as it disturbed the
financial atmosphere for the companies.
Ø
Ø There is no affect at the project implementation level however
there was heavy selling pressure by the sinking US financial
institutions which have an exposure to these companies.
Ø
Ø Over a period of time, fund raising by these companies could
become a problem.
Ø



 CONTD…
Ø Stocks to get affected: Reliance Infrastructure,
Prajay Engg, Triveni Engg, Pratibha Inds, Unity
Infra, BSEL Infra, Nagarjuna Construction, Sujana
Tower, Madhucon Projects, Jyoti Structures, Action
Construction.
Ø
Ø E.g.:- Vacancy levels for office space

2001- 14% 2006-2.9%

INFORMATION TECHNOLOGY
Ø
Ø Lesser probability of immediate cancellation of orders or vendor
consolidation
Ø
Ø Sales cycle would become longer and hence top line impact
should be visible after two-three quarters due to this crisis
Ø
Ø Large investment banks had significant discretionary IT spend,
which should reduce now resulting in reduction of outsourcing
pie.
Ø
Ø Negative on employee utilization as well as
productivity Perhaps pink slips would be the norm
alongwith cut down on perks, and other fringe
benefits.
 CONTD…


 SAVIORS
Ø Development and Maintenance projects (45-55% of total revenues)

Ø
Ø Vendor consolidation by clients (e.g. Bank Of America) would be
positive for some Indian IT companies like Infosys


Ø Tier 1 IT companies have USA as biggest revenue earners, yet these

companies are the safest bet.


Ø These companies are focused on profitability and growth and have

considerable revenue visibility.


Ø Currency will keep on playing its part and rupee may not be allowed to
depreciate from its current levels .Therefore rupee going up would
again impact IT sector in the short term.
 BUSINEES PROCESS
OUTSOURCING(BPOS)
Ø
Ø With the closure of mortgage companies,
outsourcing contracts have been
cancelled.
Ø
Ø The rise in rupee is a major test.


 Savior
Ø Some companies have put auto-escalation
clauses in their contracts. Eg: spanco
telesystems.
 STEPS TO BE TAKEN
Ø
Ø Sustaining and achieving GDP of 8-9% in next 5 years.
Ø
Ø Allowing foreign direct investment in more sectors so as to
maintain the growth rate.
Ø
Ø Giving prime importance to infrastructure development and
attract FDI in this sector.
Ø
Ø Keeping population under control so that everyone can satisfy
their basic needs.
Ø

CONTD…

Ø Boosting agricultural growth.

Ø
Ø Improving educational and health care facilities.
Ø
Ø Simplifying procedures and relaxing entry barriers for
business coming from outside the nation.
 Thank You