Fallout from the credit crunch_1_

Fallout from the credit crunch FEI Breakfast Seminar 3 December 2008 Current state of the capital markets FEI: Managing funding requirements Stephen Lewis, CA , MBA Senior Vice-President Ernst & Young Orenda Corporate Finance Inc. 416-943-2659 Stephen.E.Lewis@ca.ey.com Table of contents Current Market Conditions – Subprime Impact ► Market Stabilization – Money Market Indicators ► Canadian Perspective ► Availability of Financing ► Treasury – Focus on Short Term Liquidity ► Financing Today – Conclusion ► 3 December 2008 Page 3 When the taps run dry: getting things done during a credit crunch Current market conditions – subprime impact 3 December 2008 Page 4 When the taps run dry: getting things done during a credit crunch Where we are today ► Despite repeated efforts by Congress and the Federal Reserve, including the passing of the $700 billion bailout and the takeover of Fannie Mae and Freddie Mac and the reduction in the benchmark rate, the U.S. economy continues to slide towards recession ► ► Consumers face pressure to cut spending due to an uncertain housing market and weak job market Of the 75.5 million U.S. households that own their homes, 16% owe more than their homes are worth1 ► The International Monetary Fund states that the global economy is headed for a recession in 2009 and estimates losses from the financial crisis to be $1.4 trillion Economy.com 1Moody’s 3 December 2008 Page 5 When the taps run dry: getting things done during a credit crunch Subprime related losses ► To date, financial institutions have incurred $966 billion of asset write-downs and credit losses - $708 billion are from over 100 of the world’s largest banks and securities firms Worldwide Subprime- Relat ed Losses t o Dat e $1,200 U.S. $1,000 $800 $600 $400 $200 $0 Losses Banks Capit al Raised Losses Capit al Raised Europe Asia All Financial Inst it ut ions 3 December 2008 Page 6 When the taps run dry: getting things done during a credit crunch Subprime’s impact on financial services ► The impact of the increasing defaults in the subprime market began to trickle into the financial services sector in late 2006 and early 2007 ► In July 2007, credit rating agencies began to downgrade certain mortgage backed securities resulting in the evaporation of the subprime market ► Financial institutions were forced to write-down the value of the securities held as assets on their books ► ► Some of the highest losses have been incurred by U.S. banks such as Citigroup ($68B), Merrill Lynch ($56B), UBS ($44B) and Wachovia ($97B) Canadian banks CIBC and RBC have also had write-downs Page 7 When the taps run dry: getting things done during a credit crunch 3 December 2008 Subprime’s impact on financial services (cont’d) ► As a result of these write-downs, lenders further tightened borrowing terms to preserve their remaining capital ► Covenant lite loans disappeared while the use of PIKs became heavily restricted ► ► The subprime crisis came to a dramatic head when the Federal Reserve facilitated the purchase of Bear Stearns by JP Morgan in the spring of 2008 And credit markets, which began seizing up after BNP Paribas SA halted withdrawals on three funds in August 2007, froze after Lehman Brothers Holdings Inc. collapsed on September 15, 2008, negatively impacting lenders’ confidence of repayment Page 8 When the taps run dry: getting things done during a credit crunch 3 December 2008 Funding scarcity ► ► The fallout of the credit crisis has been a scarcity of capital as the lender base continues to shrink and remaining banks look to governments for help in repairing their balance sheets U.S. loan issuance, particularly leveraged and investment grade loans, have significantly declined since the credit crunch took hold in the summer of 2007 3 December 2008 Page 9 When the taps run dry: getting things done during a credit crunch Funding scarcity U.S. Loan Issuance $600 Leverage $500 Invest ment Grade Ot her $400 $300 $200 $100 $0 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3 December 2008 Page 10 When the taps run dry: getting things done during a credit crunch 3Q08 Funding scarcity (cont’d) ► ► In the secondary market, the average bid for multi-quote term loans is at its lowest point ever with loans available for purchase at just over 75 cents on the dollar As of October 2008, it appeared that the bailout had not stopped the downhill trend in bid prices Hist oric Average Bid Prices 100 Avg. bid (%of par) 95 90 85 80 75 J an-00 J an-01 J an-02 J an-03 J an-04 J an-05 J an-06 J an-07 J an-08 3 December 2008 Page 11 When the taps run dry: getting things done during a credit crunch Funding scarcity (cont’d) ► ► The bid/ask spreads for both U.S. and European loans also indicates lower levels of liquidity As of October 2008, spreads were 219 basis points in the U.S. and 266 basis points in Europe U.S. and European Bid/ Ask Spreads 300 250 200 150 100 50 0 U.S. liquid loans European liquid loans Bid/ ask spr ead (bps) Feb-07 Sep-07 Feb-08 Aug-07 Nov-07 Dec-07 Aug-08 Sep-08 J an-07 J un-07 J an-08 J un-08 Apr-07 Oct -07 Apr-08 Mar-07 Mar-08 May-07 3 December 2008 Page 12 When the taps run dry: getting things done during a credit crunch May-08 Oct -08 J ul-07 J ul-08 Defaults in the global bond markets ► Moody’s is forecasting default rates to climb to 6.3% globally and 7.2% in the U.S. ► The U.S. speculative grade default rate has also increased from 2.5% in Q208 to 3.4% in Q308 (it was 1.2% in Q307) Number of U.S. Speculat ive Grade Default s 10 9 8 7 6 5 4 3 2 1 0 Dec-07 Feb-07 Sep-07 Feb-08 May-07 May-08 Mar -07 Aug-07 Mar -08 3 December 2008 Page 13 When the taps run dry: getting things done during a credit crunch Aug-08 Nov-07 Sep-08 J an-07 J un-07 J an-08 J un-08 Apr -07 Oct-07 Apr -08 J ul-07 J ul-08 Market stabilization – money market indicators 3 December 2008 Page 14 When the taps run dry: getting things done during a credit crunch Market stabilization ► ► Markets have not yet stabilized; credit markets are still tight According to Standard & Poor’s, the credit crunch will come to an end once four key economic and market variables are satisfied: 1. 2. 3. 4. Real estate values stabilize or increase Rebound in home sales Easing of credit Decline in crude oil prices 3 December 2008 Page 15 When the taps run dry: getting things done during a credit crunch Market stabilization ► (cont’d) ► The October 2008 bankruptcy of Lehman Bros. had a major impact on credit and financial markets by escalating the severity of the crisis The significant steps taken by the U.S. government and governments worldwide will hopefully help restore confidence in the coming months 3 December 2008 Page 16 When the taps run dry: getting things done during a credit crunch Market indicators ► Although LIBOR has come down significantly from its high of 4.81% on October 10, 2008, credit conditions remain tight ► ► 3-month U.S. LIBOR is currently at levels not seen since October 2004 The cause for the decline is primarily due to the provision of virtually unlimited funding from central banks as well as government offered bailouts and guarantees to financial institutions 3 December 2008 Page 17 When the taps run dry: getting things done during a credit crunch Market indicators (cont’d) 3- Mont h U.S. LIBOR 5.00% 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% Sept ember 1, 2008 Oct ober 1, 2008 November 1, 2008 3 December 2008 Page 18 When the taps run dry: getting things done during a credit crunch Market indicators (cont’d) ► ► ► ► Prior to the credit crunch the average spread between the 3-month U.S. LIBOR rate and the effective Federal funds rate was approximately 12 basis points On October 10th, 3-month U.S. LIBOR peaked at 4.82% representing a spread over the effective FFR of over 4.00% The spread is currently just over 160 basis points A narrowing of this spread to 25 basis points would be positive, however forward markets indicate that this will not happen until the middle of 2010 3 December 2008 Page 19 When the taps run dry: getting things done during a credit crunch Market indicators (cont’d) LIBOR vs U.S. Federal Funds Rat e 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% J an-98 J an-99 J an-00 J an-01 J an-02 J an-03 J an-04 J an-05 J an-06 J an-07 J an-08 Effect ive Federal Funds Rat e 3-Mont h U.S. LIBOR 3 December 2008 Page 20 When the taps run dry: getting things done during a credit crunch Market indicators (cont’d) Federal Funds Effect ive Rat e 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% T EC H B U B B LE LOW IN T ER EST R A T ES HOU SIN G B U B B LE SU B PR IM E 0.00% J an-98 J an-99 J an-00 J an-01 J an-02 J an-03 J an-04 J an-05 J an-06 J an-07 J an-08 ► The daily effective federal funds rate is a volume-weighted average of rates on trades arranged by major brokers and is calculated by the Federal Reserve Bank of New York Page 21 When the taps run dry: getting things done during a credit crunch 3 December 2008 Market indicators (cont’d) ► A key indicator of credit conditions is the LIBOR-OIS spread which compares the 3-month U.S. LIBOR rate and the overnight index swap (OIS) rate ► A widening spread indicates that banks believe other banks to which they are lending have a higher risk of default so they charge a higher interest rate to offset this risk ► The spread, currently around 170 bps, compares with 87 bps on the last trading day before Lehman declared bankruptcy, and an average of 11 bps in the five years prior to the financial crisis 3 December 2008 Page 22 When the taps run dry: getting things done during a credit crunch Market indicators (cont’d) LIBOR - OIS Spread 6.0% OIS Rate 3-Month LIBOR 4.0% 3.5% 3.0% 5.0% LIBOR spr ead over OIS 4.0% 2.5% Rat e Spread 3.0% 2.0% 1.5% 2.0% 1.0% 1.0% 0.5% 0.0% Sept ember 1, 2008 Oct ober 1, 2008 November 1, 2008 0.0% 3 December 2008 Page 23 When the taps run dry: getting things done during a credit crunch Canadian perspective 3 December 2008 Page 24 When the taps run dry: getting things done during a credit crunch Canadian perspective ► The Canadian market has also been impacted by the U.S. financial crisis as evidenced by the widened spread between the 3-month Canadian T-bills and 3-month BAs in Q2 and Q3 of 2008 3- Mont h BAs over 3- Mont h Canadian Treasuries 6.0% 3-Month Tr easur ies 3.0% 3-Month BAs Spr ead 5.0% 4.0% 2.5% 2.0% Spread Rat e 3.0% 2.0% 1.0% 0.0% 1.5% 1.0% 0.5% 0.0% Sep-07 Feb-08 Aug-07 Nov-07 Dec-07 Aug-08 Sep-08 3 December 2008 Page 25 When the taps run dry: getting things done during a credit crunch May-08 Nov-08 J an-08 J un-08 Oct -07 Apr-08 Mar-08 Oct -08 J ul-07 J ul-08 Canadian perspective (cont’d) ► On September 5th, Canadian banking executives met for roundtable discussions and the overall view is that the subprime mortgage crisis and credit crunch will significantly impact global banking ► ► “The days of cheap money are over, and credit spreads across the board have, and will continue to significantly increase the cost of financing.” – Gord Nixon, CEO, of Royal Bank of Canada “It needs to be determined which regulators will oversee financial companies in the U.S….that process could last a year or more” – Rick Waugh, CEO, Bank of Nova Scotia ► Overall, the banking industry is facing more transparency and scrutiny of their balance sheets and the expectation is that regulatory capital requirements will be increased Page 26 When the taps run dry: getting things done during a credit crunch 3 December 2008 Canadian perspective (cont’d) “Three major interrelated developments are having a profound impact on the Canadian economy. First, the intensification of the global financial crisis has led to severe strains in financial markets. The associated need for the global banking sector to continue to reduce leverage will restrain growth for some time. Second, the global economy appears to be heading into a mild recession, led by a U.S. economy already in recession. Third, there have been sharp declines in many commodity prices. The outlook for growth and inflation in Canada is now more uncertain than usual.” - Bank of Canada press release dated October 21, 2008 3 December 2008 Page 27 When the taps run dry: getting things done during a credit crunch Availability of financing 3 December 2008 Page 28 When the taps run dry: getting things done during a credit crunch Availability of financing ► ► Credit markets in Canada are changing daily Many international and U.S. institutions have pulled away from the Canadian market or are in a state of uncertainty: ► ► ► CIT GMAC Wachovia ► ► ► GE Capital Deutsche Bank ABN Amro / LaSalle ► Remaining institutions may be “open for business” but there is effectively no secondary market to syndicate or sell down exposure ► Lending institutions are focused on optimizing the allocation of scarce capital 3 December 2008 Page 29 When the taps run dry: getting things done during a credit crunch Availability of financing ► (cont’d) Capital that may be made available for new funding has changed dramatically, as illustrated below: Rat e Pre-Credit Crunch Rat e Post -Credit Crunch EBITDA (Mult iple) Senior Debt Tradit ional/ Asset Based Loans Second Lien Loans Subordinated / Mezzanine Debt Equity BA + 150bps BA + 300bps 2.5x - 3.0x BA + 500bps BA + 1,000bps 3.0x - 4.0x 12%- 14% 15%- 20% 3.0x - 4.0x < 20% > 25% 3 December 2008 Page 30 When the taps run dry: getting things done during a credit crunch Availability of financing ► (cont’d) Lending is being governed by greater discipline as underwriting standards have become more stringent resulting in lower multiples, higher pricing and tighter covenants ► ► The impact of the credit crunch to senior cash flow lending has resulted in lower debt to EBITDA multiples which are currently in the 2.5 – 3.0x range with up to 1.5x incrementally available from mezzanine lenders Moreover, subjective “addbacks,” “adjustments” or “normalizing entries” to earnings are also coming under greater scrutiny 3 December 2008 Page 31 When the taps run dry: getting things done during a credit crunch Availability of financing ► (cont’d) ► Borrowers are being faced with increased due diligence from an ever shrinking base of lenders resulting in elongated deal timetables “Fully underwritten” transactions are history ► Borrowers are being forced to piece together club deals to meet capital needs 3 December 2008 Page 32 When the taps run dry: getting things done during a credit crunch What can get done? ► Asset based loans are becoming increasingly attractive to certain borrowers ► ► ► Loans > $30MM pose a syndication risk Market flex risk on terms, structure, pricing, etc. Spreads in the range of 300 bps ► Cashflow loans to borrowers of “strategic relevance” to lenders ► ► ► ► Leverage < 3.0x Industry specific Sponsor makes deal “easier” Spreads in the range of 400 bps 3 December 2008 Page 33 When the taps run dry: getting things done during a credit crunch Treasury – focus on short term liquidity 3 December 2008 Page 34 When the taps run dry: getting things done during a credit crunch Treasury – focus on short term liquidity Current market dislocations require Treasurers to more closely focus on short term liquidity ► A more disciplined approach is in order ► ► ► Stronger focus on quality of investments Better understanding of organizations liquidity requirements 3 December 2008 Page 35 When the taps run dry: getting things done during a credit crunch Treasury – focus on short term liquidity (cont’d) ► A portfolio approach to manage risk makes sense: ► ► ► Understand the liabilities, i.e. the liquidity needs of the company Measurement/forecasting needs to be done on a weekly if not daily basis Manage investments or borrowings to meet that liability stream ► Manage portfolio to: 1. 2. Understand degree of counterparty risk ► Review investment policy Align maturities with requirements ► Limit exposure to any single point in time ► Ladder portfolio to reduce exposure to short term market dislocations Page 36 When the taps run dry: getting things done during a credit crunch 3 December 2008 Treasury – focus on short term liquidity (cont’d) ► Manage counterparty risk ► ► Traditional approach of heavy reliance on debt ratings needs review Additional due diligence required ► Clearly define goal of investment policy: income generation, or secure and efficient store of liquidity ► Increase requirement for lower yielding but more secure investments ► Governments ► BAs from Canadian chartered banks ► Careful review of money market funds 3 December 2008 Page 37 When the taps run dry: getting things done during a credit crunch Financing today – conclusion 3 December 2008 Page 38 When the taps run dry: getting things done during a credit crunch Financing today – conclusion ► ► ► ► To obtain financing in today’s market, businesses need to be cognisant of the supply and demand constraints with which they are faced Transactions are subject to more scrutiny and aggressive due diligence requirements The terms under which different lending institutions are willing to lend may vary significantly To succeed in this market, businesses must recognize that the path to funding starts significantly ahead of the formal financing process 3 December 2008 Page 39 When the taps run dry: getting things done during a credit crunch Financing today – conclusion (cont’d) ► Plan early to deal with debt maturities ► ► ► Expect increased pricing and tighter covenants Expect a reduction in unutilized credit availability/carve back of acquisition and expenditure accommodations In large syndicates, plan for fall-out of fringe participants ► Review short to mid-term capital needs and strive to preserve capital ► ► ► Review working capital cycle Capital expenditures Sale of non-core/redundant assets Page 40 When the taps run dry: getting things done during a credit crunch 3 December 2008 Taxes: Creating value and minimizing risk in turbulent times Steve Landau, Partner Transaction Advisory Services Transaction Tax Ernst & Young LLP 416-943-2067 Steve.Landau@ca.ey.com Grant Smith, Senior Manger Transaction Advisory Services Transaction Tax Ernst & Young LLP 613-598-4348 Grant.Smith@ca.ey.com Agenda ► ► Tax perspective of the current economic conditions Issues to consider Tax strategies to preserve cash ► 3 December 2008 Page 42 When the taps run dry: getting things done during a credit crunch Tax perspective of the current economic conditions ► The current economic climate is a crucial time to leverage tax opportunities to create and preserve value ► Tax strategies may need to shift in focus to: cash ►Reducing costs ►Efficient refinancing/restructuring ►Releasing 3 December 2008 Page 43 When the taps run dry: getting things done during a credit crunch What is the impact to your business? Acquisitions Cash Divestments Current Market Conditions Closures Tax function Accounting for tax Refinancing or Recaps Structures 3 December 2008 Page 44 When the taps run dry: getting things done during a credit crunch Cash ► [ Converting tax assets to cash ► ► ► Review capital and current expenditures Utilization of losses Tax instalments, payments and refunds ► Realizing or securing tax benefits ► ► ► ► SR&ED tax credits Carry back of losses Clearing out Capital Dividend Account before losses Crystallize Capital Gains Exemption while eligible 3 December 2008 Page 45 When the taps run dry: getting things done during a credit crunch Cash ► [ Deferral of Tax ► ► ► Timing of recognition of profits Capitalize new business Intellectual property planning ► Repatriation and Cross Border ► ► Tax efficient repatriation of cash Review existing transfer pricing and financing structures 3 December 2008 Page 46 When the taps run dry: getting things done during a credit crunch Cash Factoring receivables ► Sale and lease back ► Loss planning ► ► Crystallizing losses when required and preserving losses and adjusted cost base ► Accuracy of forecasts ► Ensure tax assumptions reflect business expectations in a downturn – can tax payments be deferred, are instalments correct ► Tax Audit Management Page 47 When the taps run dry: getting things done during a credit crunch 3 December 2008 Cash ► Commodity taxes - Apply a variety of strategies to improve commodity taxes cash flow: ► ► ► Offsetting payroll remittances against GST/HST/QST refunds Accelerating GST/HST/QST input tax credit For significant purchases with GST/HST/QST payable, use a legal entity that is in a net GST/QST payable position for the purchase and resupply 3 December 2008 Page 48 When the taps run dry: getting things done during a credit crunch Review of current structure ► Is the current group / tax structure optimal for the current downturn? ► ► ► ► Matching profits and losses Reviewing tax structures for revised profit or loss forecast Taxable reorganization of corporate group Revisit management compensation planning ► Transfer pricing ► ► Determine if intercompany transactions are being created to deal with cash shortages and to crystallize losses in certain jurisdictions Review current practice to ensure compliance with transfer pricing rules ► International Assignment Policy ► ► ► Review international assignment policies to introduce cost efficiencies Social security tax agreements should be reviewed for employer tax savings Are there outstanding tax equalizations for assignees that should be completed Page 49 When the taps run dry: getting things done during a credit crunch 3 December 2008 Refinancing or recaps ► Refinancing ► ► Debt/equity swaps – ensuring debt is not inadvertently extinguished and taxed under debt forgiveness rules Thin capitalization – determine how the position will change subsequent to refinancing and changes in the balance sheet ► Acquisition of debt at a discount ► Ensure undertaken in most tax efficient manner 3 December 2008 Page 50 When the taps run dry: getting things done during a credit crunch Closures ► Closure costs ► Maximize tax relief for costs e.g., which entity should incur the costs, when costs are incurred ► Redundancies ► Maximize tax relief for costs and consider impact on share valuations ► Losses ► ► Efficient utilization of losses and potential creation of losses as a result of closures Timing for merging of entities to optimize use of tax attributes ► Pensions ► Maximize tax relief for contributions 3 December 2008 Page 51 When the taps run dry: getting things done during a credit crunch Divestitures ► Preparation for exit ► ► ► ► Tax efficient restructuring to package assets/companies for sale, including elimination of intercompany debts Maximizing value when selling companies with losses by preserving tax attributes Consider US golden parachute provisions for any US executives Tax efficient exercise of incentive compensation plans ► ► Using an insolvency process to effect the sale of assets Tax planning to ensure divestitures are tax efficient ► ► ► Creation of losses to offset gains on disposal Any unrealized losses in the group that can be accessed? Consider deferral mechanisms on sale such as capital gains reserves and timing of sale 3 December 2008 Page 52 When the taps run dry: getting things done during a credit crunch Financial reporting implications of current market conditions Deanna Monaghan, FCA Managing Partner Ernst & Young LLP 613-598-4305 Deanna.J.Monaghan@ca.ey.com Fair value in financial reporting - the debate ► ► ► ► Debate about merits of fair value in financial reporting ► Contributed to the current credit crunch conditions ► Or has the credit crisis highlighted the benefits of fair value in financial reporting while exposing some of its limitations Fair value measures necessarily reflect conditions at the balance sheet date; they are not forecasts of future market prices Nonetheless investors want current fair value information and that transparency about fair values is important Implications ► Fair value in financial reporting is not going away ► New guidance provided for making fair value estimates ► Good modelling and scenario analysis capabilities are required when active market prices do not exist ► Critical to have disclosure of assumptions and sensitivities 3 December 2008 Page 54 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations Valuation of investments ► Measuring the fair values of certain asset classes has been challenging in the current environment ► The number of factors affecting an investments fair value can be extensive ► Evidence supporting the fair value may not come from trading in active primary or secondary markets ► Valuation models should reflect assumptions that market participants would use in pricing an asset in a current transaction (fair value is a current value and not a potential future value) and therefore should reflect current credit, interest, liquidity and risk premium conditions ► Inputs should be restricted to information available to market participants at the reporting date ► No forward looking perspective 3 December 2008 Page 55 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations ► Valuation of Investments (cont’d) ► IAS 39 Amendments – Reclassifications of financial assets ► Allowed to reclassify out of HFT or AFS in certain circumstances and intended to more closely align IAS 39 with US GAAP ► Distinguishes loans and receivables from other securities ► Loans and receivables may be reclassified from HFT or AFS to loans and receivables if intentions have changed such that ► not held for the purpose of trading in the near term; and ► intention and ability to hold for the foreseeable future ► Other securities (excluding derivatives and those designated at FVTPL at inception) may be reclassified out of HFT into AFS or HTM “in rare circumstances” ► IASB has indicated that current financial market conditions are such a “rare circumstance” ► Also must no longer be held for the purpose of trading in the near term ► Reclassification to take place at fair value ► Effective date is July 1, 2008, entities can make transfers as of that date provided this aligns with intent as of that date ► Extensive disclosure requirements when reclassifications are made 3 December 2008 Page 56 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations ► Valuation of Investments (cont’d) ► CICA Amendments to Canadian Accounting Standards ► “Trading” securities are carried at fair value and changes in fair value are included in earnings. ► Reclassifications out of trading were not permitted – abuse of hindsight ► Accounting Standards Board has introduced amendments to CICA 3855 in response to the similar recent IAS 39 amendments ► Permit reclassifications of securities (excluding derivatives and securities designated as trading at inception) out of trading (to AFS or HTM) ► “in rare circumstances” and ► no longer held for the purpose of trading ► To be effective for reclassifications made on or after July 1, 2008 provided statements have not previously been issued ► Amendments implemented on emergency basis without public comment period ► Amendments posted to the CICA AcSB website 3 December 2008 Page 57 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations Internal controls over financial reporting ► Current market conditions have changed the nature and extent of risks and the related internal and disclosure controls & procedures necessary to address them ► ► ► ► ► ► Processes and controls relating to the development of inputs and assumptions for the valuation of significant assets and liabilities Review of assets for recoverability or impairment The need for external specialists (e.g. valuation or actuarial expert) to assist in the determination of the recorded amounts of certain assets and liabilities Processes and controls for monitoring compliance with covenants Internal auditors should reconsider their current audit plans in light of any new or increased risks facing the company Potential changes to disclosure controls to ensure risks are identified and disclosure obligations are met (financial statements and MD&A disclosures including market and liquidity risk, capital resources, material events, discussion of risk factors, significant estimates) 3 December 2008 Page 58 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations ► Credit risk and derivatives ► ► ► Non-performance risk (including credit risk) of both parties impacts fair value Recent events may have effected the credit worthiness of both parties to a derivative instrument Deterioration of a derivative counterparty’s credit worthiness or company’s own creditworthiness can cause hedge ineffectiveness 3 December 2008 Page 59 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations ► Impairment of depreciable long-lived assets ► Impairment indicators are more likely to be prevalent, requiring assets to be evaluated for impairment ► Long-lived assets to be held and used are reviewed for impairment and tested for impairment whenever impairment indicators are present ► Due to the current economic environment, it may be more likely that impairment indicators exists ► Impairment must be considered at both interim and annual reporting dates ► When a long-lived asset is tested for recoverability, it may also be necessary to review depreciation and amortization estimates and methods 3 December 2008 Page 60 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations ► Impairment of goodwill and indefinite life intangible assets ► Impairment test for goodwill and indefinite life intangible assets may be required to be performed on more than an annual basis ► Tests for impairment of goodwill are required between annual tests if circumstances suggest it is more likely than not that the fair value is less than its carrying value ► Tests for impairment of indefinite life intangible assets are required between annual tests if circumstances indicate the asset might be impaired ► Current economic and market conditions increase the risk that impairment indicators exist 3 December 2008 Page 61 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations Income taxes ► Losses in recent years must be considered in evaluating deferred tax assets for realization ► Sufficient taxable income must exist to support realization ► Cumulative losses or expectations of cumulative losses generally indicate the need for valuation allowance ► Appropriate disclosures should be made to support either the absence or existence of the valuation allowance ► Liquidity concerns may cause companies to consider repatriation of earnings from foreign operations ► Such cash transfers could have tax implications. 3 December 2008 Page 62 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations Inventory ► Excess or obsolete inventories and lower of cost or market adjustments may be necessary ► Current market conditions and corresponding effects on spending may result in excess and obsolete inventories ► Financial condition of major customers could impair the recoverability of inventory on hand ► Valuation issues associated with returns from merchants and leftover merchandise from the retail season ► SEC staff has recently issued comments asking registrants how they have determined that inventories are stated at a lower cost or market ► Companies should disclose the manner in which lower of cost or market is determined 3 December 2008 Page 63 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations Post retirement benefits ► ► ► ► Current market conditions suggest that benefit plan accounting expense and funding requirements will increase Increased credit risk and reduced liquidity in the marketplace have likely affected the fair value of plan assets used in determining funded status and resulted in experience losses These factors will also make it challenging to choose an appropriate discount rate Assumed returns on plan assets should reflect current expectations about long term rates of return 3 December 2008 Page 64 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations Debt ► ► ► Compliance with provisions in covenants Ability to refinance maturing debt Classification of debt as long-term vs. current Share-based payments ► Accounting impacts of modifying, cancelling or replacing a sharebased payment award ► Modifications of share-based payment awards may result in the recognition of additional compensation cost ► Impacts of equity restructuring on share-based payment awards 3 December 2008 Page 65 When the taps run dry: getting things done during a credit crunch Recent market events: accounting and reporting considerations ► Revenue recognition ► Impact of any enhanced rights of return will require more attention on estimating returns ► Customer requests for extended payment terms could change the timing of revenue recognition ► Disclosure requirements Re-evaluate financial statement and MD&A disclosure around interest, FX, credit and liquidity risks Re-evaluate financial statement and MD&A disclosure around capital management Re-evaluate critical accounting estimates disclosures Assess going concern based on current market conditions 3 December 2008 Page 66 When the taps run dry: getting things done during a credit crunch Q&A 3 December 2008 Page 67 When the taps run dry: getting things done during a credit crunch