Download - Construction institute1.16.09ii
The World’s Financial Crisis
What Happened and When will it be Over?
Robert W. FrentzelExecutive Vice President and Managing Director
The PrivateBank
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Discussion Points
State of US Economy
State of the Capital Markets
What does it mean for you?
Question & Answer
State of the U.S. Economy
State of the U.S. Economy
FROM
IRRATIONAL EXUBERANCE
TO
IRRATIONAL ANXIETY
The Future?
“HOPE IS NOT A STATEGY”New York Federal Reserve President
Timothy Geither
Credit crisis has triggered dramatic deleveraging cycle
Aggressive government and Central bank intervention has averted systemic meltdown but painful adjustment period remains
Some improvement in money markets, but capital markets remain highly strained
New issuance volume is anemic and credit spreads still at record highs
Easing cycle is over
Shift toward fiscal stimulus likely to push up long-term rates
Overview of current Financial environment
Credit writedowns exceeding $1 trillion
Government rescue package exceeding $1 trillion and contingent liabilities of $8 trillion
170,000+ lost jobs in financial services, U.S. economy lost 2.5 million jobs
Homeowner equity declined by $5 trillion (25%)
World stock market capitalization declined from $62 trillion to $28 trillion
U.S. stock market capitalization declined from $19 trillion to $10 trillion
The growing cost of the crisis
Recovery Not expected till late in 2009
Quarterly Change, AnnualizedQuarterly Change, Annualized
“Potential”
Est.
Source: U.S. Department of CommerceBlue Chip Economic Indicators, December 2008; Bureau of Economic Analysis
Credit crisis creates unprecedented interest rate volatility…
1m LIBOR, Fed Funds, and Prime
Targeted Funds Rate: Active Monetary Intervention
Source: Federal Reserve Board
Target 0 - 0.25%
Unemployment at 16 year high and likely to increase
Source: Bureau of Labor Statistics December 2008
“Trillion dollar deficits for years to come…”
Bear market wipes out five years of gains…
U.S. market capitalization has declined from $19 trillion to $10 trillion over the past year.
S&P 500 Index
0
200
400
600
800
1000
1200
1400
1600
1800
Dec-74Dec-76Dec-78Dec-80Dec-82Dec-84Dec-86Dec-88Dec-90Dec-92Dec-94Dec-96Dec-98Dec-00Dec-02Dec-04Dec-06
Jan 1975 - Jan 199510% ann gain or12% w ith dividends
Jan 1995 - Aug 2000 23% ann gain or 25% w ith dividends
Feb 2003 - Oct 2007 14% ann gain or 16% w ith dividends
Aug 2000 - Feb 2003 45% correction
Oct 2007- Nov 2008 44% correction
*estimates
Sources: Investment Company Institute; Employee Benefit Research Institute (2008 estimate); WSJ
Not many can afford To retire
Correction Will Take Time
Home Ownership Rate peaked in 2005
60%
62%
64%
66%
68%
70%
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
A Correction Seemed Likely In Certain Markets
0
20
40
60
80
100
120
140
Washington DC
FloridaCalifornia
Hawaii Nevada
US Average
Percentage %
TOP STATES FOR HOME PRICE APPRECIATION (01-06)
Source: LoanPerformance
Fed intervention pushes mortgage rates to all time lows…
Housing Market Beginning to Clear at Low Levels
Source: MDA DataQuick and KBW calculations.
Third Quarter Home Resales in California
-
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
200,000
3Q95 3Q96 3Q97 3Q98 3Q99 3Q00 3Q01 3Q02 3Q03 3Q04 3Q05 3Q06 3Q07 3Q08
# of CA Home Resales
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
500,000
Median CA Home Price ($)
Non-REO Resales REO Resales Median CA Home Price
Deleveraging Begins with the Consumer
Source: U.S. Department of Commerce: Bureau of Economic Analysis and KBW research.
* Personal savings as a percentage of disposable personal income. Saving from current income may be near zero or negative when outlays are financed by borrowing (including borrowing financed through credit cards or home equity loans), by selling investments or other assets, or by using savings from previous periods.
** Monthly data updated through October 2008.
Long-term rates at historic lows…
State of the Bank Markets
Source: SNL Financial. Data as of 1/8/09. The KBW Regional Banking Index (KRX) is an equal weighted index of 50 geographically diverse companies representing regional banking institutions listed on U.S. stock markets.
KBW Regional Bank Performance
KBW Regional Bank Index (KRX)
40
50
60
70
80
90
100
110
120
Subprime cracks
Investment banks freeze fund
withdrawls & inject capital
Commercial paper market disappears
Crisis in confidence in investment bank balance
sheets
New Century fails ($17B subprime
mortgage originator)Largest single month decline for leveraged
loan market
First SIV Failure - Cheyne Financial ($8B)
Bank of America Liquidates $33B
money market fund
40
50
60
70
80
90
100
110
KBW Regional Index (KRX) S & P 500
Source: SNL Financial. Data as of 1/8/09. The KBW Regional Banking Index (KRX) is an equal weighted index of 50 geographically diverse companies representing regional banking institutions listed on U.S. stock markets. Note: This graph is a continuation of the graph on the previous page.
KBW Regional Bank Performance (continued)
40
50
60
70
80
90
100
110
KBW Regional Index (KRX) S & P 500
KBW Regional Bank Index (KRX) 2008 & 2009 YTD
40
50
60
70
80
90
100
110
Bear Stearns Fails 3/14/08
IndyMac Fails7/11/08
Fannie/Freddie capital concerns
7/8/08
Leveraged loan market legs down
M arch 2008
More write-downs / capital raises for I -banks
June 2008
11 Bank Failures in '08; FDIC's "Problem Lis t"
grows to 1178/27/08
Fannie/Freddie bail out by government
9/8/08
Bank of America buys Countrywide Financial for 31% of book value
1/10/08
Lehman Bros. files for Chapter 11. BAC
acquires MER for $47B9/15/08
AIG bail out by government
9/17/08
Short selling suspended for 799 f inancials
9/18/08
Government plans on buying $700B in
banks' mortgage debt
9/19/08
WM bought out by JPM
9/25/08
C buys WB with government assistance
9/29/08
WFC acquires WB for $7 per share
without government assistance
10/3/08
Dow down 21% in last 7 trading days
10/9/08
COF buys Chevy Chase Bank
12/3/08
WFC / WB merger approved by FED
10/12/08
Treasury des ignates $250B for senior
preferred equity in large banks
10/14/08
PNC buys NCC for $2.23 per share
10/24/08
Oil hits 3 year low below $50 a barrel
11/20/08
Citigroup receives 2nd government bailout
11/24/08
Deflat ion in America rumored11/21/08
Number of problem banks and thrif ts
jumps to 17111/25/08
GS, MS, JPM, & other banks sell govt. backed
notesWeek of 11/24/08
Since Sept. 1, 19 financial companies have
become bank holding companies, including GS,
MS, AXP12/17/08
Enemployment rises to 7.2%. The highest it has
been in 16 years1/9/08
Phase I – The Sub-Prime Crisis
April 2007 – New Century, largest U.S. sub-prime lender, files for bankruptcy
July 2007 – Bear Stearns closes 2 hedge funds after banks refuse bail out, Bernanke warns crisis could cost up to $100 billion
August 9, 2007 – Interbank lending market seizes up
September 18, 2007 – Fed cuts funds rate by 50 bp to 4.75% beginning easing cycle
Jan 11, 2008 – Bank of America acquires Countrywide Financial for $4 billion
Phase II – The Liquidity Crisis
March 16, 2008 – Bear Stearns acquired by J.P. Morgan for $2 per share
July 13, 2008 – Federal regulators seize IndyMac
September 7, 2008 – Government takes over Fannie Mae & Freddie Mac
Capitalism in crisis
Phase 3 – The Solvency Crisis
September 15, 2008 – Lehman Brothers files for bankruptcy, Bank of America acquires Merrill Lynch for $50 billion
September 16, 2008 – Fed announces $85 billion rescue package for AIG
September 18, 2008 – Reserve primary fund “breaks the buck” triggering exodus from money market funds
September 19, 2008 – Bush announces plan to buy troubled assets from financial firms, Treasury guarantees money market funds
September 22, 2008 – Goldman Sachs & Morgan Stanley convert into bank holding companies
September 25, 2008 – Federal regulators seize WaMu and sell it to J.P. Morgan for $1.9 billion
September 30, 2008 – FDIC increases deposit insurance to $250,000
October 3, 2008 - House approves revised $700 billion economic rescue package by vote 263-171 and President Bush signs into law, Wachovia snubs Citigroup and agrees to be purchased by Wells Fargo for $15.1 billion
Capitalism in crisis
October 13, 2008 - Treasury launches Capital Purchase Program making mandatory investments of $125 billion in 9 banks
October 14, 2008 - FDIC extends unlimited deposit insurance to non-interest bearing deposit accounts
October 24, 2008 - PNC acquires Nat City for $5.2 billion using TARP funds
November 12, 2008 – Treasury abandons plan to buy up bad debt and instead says it will use remainder to help revive consumer lending
November 24, 2008 – Citigroup receives an additional $20 billion capital investment and $306 billion loan guarantee from government
November 25, 2008 - Fed announces plans to buy $600 billion of agency debt and mortgage-backed bonds and establishes $200 billion program to support consumer and small-business loans
December 12, 2008 – Senate rejects House-approved bailout plan for GM & Chrysler
December 16, 2008 - Fed cuts fed funds rate 75 bp to “target range” of 0 - .25%
December 19, 2008 - Treasury agrees to extend $13.4 billion in emergency loans to GM & Chrysler
Capitalism in crisis
January 8 , 2009 - U.S. employers cut 524,000 jobs in December, capping the worst year of job losses since 1945
January 12, 2009 - President-elect Obama asks President Bush to request second $350 billion installment of TARP funding
January 15, 2009 Bank of America requests additional $20 billion
Capitalism in crisis
Note: Period ending balance is used to calculate loan compositionSource: SNL DataSource, FDIC, and KBW Research
Loan Composition, FDIC-Insured Commercial Banks
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Residential Mortgage
Home Equity
Commercial Real Estate
Construction
Commercial
Credit Card
Other ConsumerLeasesOther
Over 50% of
portfolios~25% of
portfolios
State of the Bank Markets
Bank portfolios transitioned to higher risk, real estate heavy assets
— Higher fees and search for asset growth fueled C&D lending— Real estate represented over 50% of bank portfolios in 2007
The “securitization” of banking
Accommodative monetary policy
Mark to market accounting
Relaxed capital requirements
Affordable housing targets
Financial innovation (e.g., option ARM)
Over reliance of past performance as predictor of the future
How did we get here?
Source: SNL Financial. Data as of 9/30/08. Note: Metric is the median of the top tier consolidated banks and thrifts with assets greater than $500 million.
5B-$30B in Assets All Banks and Thrifts
Competition Among Banks Drove Behavior Net interest margins fell steadily from 1995 – 2008YTD
— Competition among lenders caused spreads to narrow substantially
— Competition for deposits created increased borrowing costs and dependence on wholesale deposit sources
— De novo banks formed at unprecedented pace heightened competitive dynamics
Financial Institutions are not being paid for the risk
Net Interest Margin (%)
3.25
3.50
3.75
4.00
4.25
4.50
4.75
5.00
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1 '08 Q2 '08 Q3 '08
Source: SNL Financial. Data as of 9/30/08. Metric displayed is the median. Note: Analysis includes top tier consolidated banks and thrifts with assets greater than $500 million. NPAs include nonperforming loans and leases, renegotiated loans and leases, and real estate owned.
Bank Loan Portfolios are Undergoing Significant Distress
5B-$30B in Assets All Banks and Thrifts
NPAs have spiked over the last several quarters, increasing from $39B in December of 2006 to over $150B currently (9/30/08)
NPAs / Assets (%)
0.20
0.300.40
0.500.60
0.700.80
0.901.00
1.10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1'08
Q2'08
Q3'08
Construction50%
Agricultural Loans 0%
Commercial 17%
Consumer & HE 13%
Multi-Family 4%
Commercial RE 14%
Foreign RE Loans
2%
Non-accrual loans for nationwide banks and thrifts with greater than $500 million in assets, excluding 1-4 Family Loans:6/30/06 9/30/08
$13.4 billion $65.4 billion
Magnitude of Nonperforming Loans
Consumer & HE15%
Commercial45%
Agricultural Loans
1%Multi-family
2%Commercial RE
18%
Foreign RE Loans
9%
Construction 7%
Source: SNL Financial. Data as of 9/30/08.
Credit write-downs reach $1 trilllion…
Writedowns ($bn)
Capital Raised ($bn)
Job Cuts
Wachovia $96.50 $11.00 8,393Citigroup $65.70 $74.00 23,660AIG $60.90 $64.90 980Freddie Mac $58.40 $7.00 -Fannie Mae $56.00 $15.60 -Merrill Lynch $55.90 $29.90 5,720UBS $48.60 $30.60 9,000Washington Mutual $45.60 $12.10 4,200HSBC $33.10 $4.90 2,780Bank of America $27.40 $55.70 11,150National City $26.20 $8.90 4,900J.P. Morgan $20.50 $44.70 4,100Wells Fargo $17.70 $41.80 500Morgan Stanley $15.70 $24.60 9,178RBS $15.10 $48.30 10,200Lehman Brothers $13.80 $13.90 13,390
* cumulative losses through November 16,2008
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
Q42008
Q32008
Q22008
Q12008
Q42007
Q32007
Prior
Cumulative job losses
$0
$200
$400
$600
$800
$1,000
$1,200
Cumulative writedowns & capital raised ($billions)
Cumul Job Losses (right axis)
Cumul Writedowns (left axis)
Cumul Capital Raised (left axis)
Historical Bank Offering Activity Levels
Source: Dealogic. Note: US and Puerto Rican bank IPO, follow-on, 144A, PIPE and Convertible offerings since 1998. As of January 9, 2009.
$213.8 $234.8 $6.0 $124.9 $421.4 $558.6 $385.0 $190.7 $77.6 $0.0
$2,277.1 $283.0 $1,867.2 $794.3 $2,537.4 $2,001.8 $1,426.1 $1,445.3 $315.7 $54,097.5
$465.0 $419.5 $2,840.4 $855.0 $3,807.5 $2,092.2 $4,500.0 $3,500.0 $6,708.3 $31,873.2
$2,955.9 $937.3 $4,713.5 $1,774.2 $6,766.3 $4,652.6 $6,311.1 $5,136.0 $7,101.6 $85,970.8
$2,956 $937 $4,714 $1,774$6,766 $4,653 $6,311 $5,136 $7,102
$85,971
$0
$10,000
$20,000$30,000
$40,000
$50,000
$60,000
$70,000$80,000
$90,000
$100,000
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
0
10
20
30
40
50
60
Only $44.3B Raised in the Previous
Decade
Over $151 billion if capital from
Sovereign Wealth Funds included
$213.8 $234.8 $6.0 $124.9 $421.4 $558.6 $385.0 $190.7 $77.6 $0.0
$2,277.1 $283.0 $1,867.2 $794.3 $2,537.4 $2,001.8 $1,426.1 $1,445.3 $315.7 $54,097.5
$465.0 $419.5 $2,840.4 $855.0 $3,807.5 $2,092.2 $4,500.0 $3,500.0 $6,708.3 $31,873.2
$2,955.9 $937.3 $4,713.5 $1,774.2 $6,766.3 $4,652.6 $6,311.1 $5,136.0 $7,101.6 $85,970.8
$0
$10,000
$20,000$30,000
$40,000
$50,000
$60,000
$70,000$80,000
$90,000
$100,000
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
0
10
20
30
40
50
60
Deal Value ($mm) # of Deals
Mill
ion
s ($
)N
um
ber o
f Deals
Reserves / Loans (%)
1.10
1.20
1.30
1.40
1.50
1.60
1.70
1.80
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1 '08 Q2 '08 Q3 '08
Reserves / NPAs (%)
50.00
100.00
150.00
200.00
250.00
300.00
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1'08
Q2'08
Q3'08
Source: SNL Financial. Data as of 9/30/08. Metric displayed is the median. Note: Analysis includes top tier consolidated banks and thrifts with assets greater than $500 million.
Accounting dictates, lax credit underwriting standards and overly optimistic reserve levels have caused under reserved balance sheets for most U.S banks, necessitating significant adjustments
Balance Sheets are Not Positioned to Cover Losses
5B-$30B in Assets All Banks and Thrifts
5B-$30B in Assets All Banks and Thrifts
0
56
112
168
224
280
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
0
120
240
360
480
Source: FDIC. 1/12/09.
Nationwide Bank & Thrift Failures
Bank & Thrift Failures since 1990Bank & Thrift Failures since 1990
Bank and thrift failures remain well below those levels seen in the early 1990s, though they are on the rise, with year-to-date failures already exceeding all of 2007.
Aggregate Assets ($B)
Number of Failures
# o
f F
ail
ure
sA
gg
reg
ate
As
se
ts ($
B)
2008 CountCA 5GA 5NV 2FL 2MO 2TX 2WA 1AR 1KS 1WV 1MI 1MN 1IL 1
Total 25
Searching for a Second Derivative on Credit
Source: ABX Net, company reports, and KBW calculations
Delinquency Data
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
Jan-07Feb-07Mar-07Apr-07May-07Jun-07Jul-07Aug-07Sep-07Oct-07Nov-07Dec-07Jan-08Feb-08Mar-08Apr-08May-08Jun-08Jul-08Aug-08
Subprime* Option ARMs**
0.00%
0.25%
0.50%
0.75%
1.00%
1.25%
1.50%
1.75%
2.00%
2.25%
2.50%
2.75%
3.00%
Jan-07Feb-07Mar-07Apr-07May-07Jun-07Jul-07Aug-07Sep-07Oct-07Nov-07Dec-07Jan-08Feb-08Mar-08Apr-08May-08Jun-08Jul-08Aug-08
Home Equity*** Prime****
* Total subprime delinquencies as represented by ABX.** Downey Financial NPAs, excludes total debt restructured.*** Washington Mutual: nonaccrual prime home equity loans as a percent of WM's prime home equity held for investment loan portfolio; data represents quarter (e.g., Mar-07 = 1Q07).**** Freddie Mac single-family delinquencies..
What is next?
•Home equity loans•Credit card loans•Automotive loans•Corporate bonds•Leverage financing•Commercial real estate financing
Home Equity Delinquencies and Net Charge-offs at Banks (in $ billions)
Based on Data filed with Bank regulators. Home equity loans and lines = revolving lines of credit secured by one- to four-family properties + junior lien loans secured by one- to four-family properties. Delinquent home equity = Home equity loans and lines that are more than 30 days past due or non accruing
Source: SNL Financial
Credit spreads hover near record highs…
5 yr Industrial Corporate Bond Spreads over LIBOR
But credit conditions remain tight…
Federal Reserve Senior Loan Officer Survey (% tightened standards or increased pricing)
84%
98%
-100%
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
Nov-03Mar-04Jul-04Nov-04Mar-05Jul-05Nov-05Mar-06Jul-06Nov-06Mar-07Jul-07Nov-07Mar-08Jul-08
Tighter Standards
Higher Pricing over COF
Bank lending has increased…
Value of U.S. corporate debt maturing in 2009, in billions
Source: Standard & Poor’s
Significant refinance on syndicated deals
Syndicated-Loan Market / Global Borrowing via Syndicated Loans
Source: Reuters Loan Pricing Corp
Deal flow down significantly
What Does This Mean For You?
Important Underwriting Metrics
Relationships and track record
Liquidity of loan - What is the repayment?
Efficiency of capital employed
Balance sheet strength
Collateral coverage
Backlog analysis
Market expectations
Underwrite your bank
Has it applied for TARP?
Has it opted out of transaction account guarantee program?
What is its portfolio exposure to real estate, charge card, home equity, Auto, etc.
Does your banker understand your WIP?
What is the credit approval process - do they know you?
What is the market saying?
Tougher Credit Environment
The credit markets have tightened
— Higher interest rates and fees— More and tighter covenants— Shorter maturities— Lower total and senior debt multiples— Increased focus on balance sheet strength— Difficult syndication market— 100% financing less readily available— Automakers and other lenders shying away from
leasing due to depressed residual values
Relationships are Key
Relationships continue to drive loan markets
— Unfunded credit facilities exert significant pressure on lenders’ overall relationship returns
— Banks have demonstrated a willingness to commit to credits with returns below their hurdle if prospects for retaining and/or gaining ancillary business are visible
— Returns on new deals being weighted against buying discounted paper in the secondary market
Middle market (EBITDA < $50 million), non-levered (<3.0x Total Debt/EBITDA) transactions continue to get done
— Well structured, well priced transactions— Solid borrower track record— Sensible use of funds— Support from relationship lenders
Debt Market Observations
Underwritten financings designed for syndication to CLO funds
High leverage
Cheap Pricing
Commodity Lending
Quick and narrow marketing
Token diligence
Big LBOs
Dividend recaps / refinancings
“Story deals”
Covenant-lite 2nd lien junior debt
Low / modest flex provisions
Club deals
Prudent leverage
Wider spreads
Relationship lending
Longer and broader marketing process
Smaller “middle market” deals
Limited dividend recaps; growth financings / acquisitions
“Clean” deals
Non-cyclical credits
Traditional covenants
Full flex provisions (pricing, structure)
Lenders are once again underwriting new transactions based on traditional credit standards
What’s Out What’s In
Recession
- A contraction phase of the business cycle, or "a period of reduced economic activity."
- "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP growth, real personal income, employment, industrial production, and wholesale-retail sales”*
- Rule of thumb: Two quarters of negative GDP growth
The Big Question: Recession or Depression?
Depression
- An extended period of chronically weak economic performance and financial instability
- Characterized by abnormal increases in unemployment, restriction of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly devaluations.
- Rule of thumb: 10% decline in GDP
Question & Answer