The World’s Financial Crisis What Happened and When will it be Over?
QuickTime™ and a decompressor are need ed to see this picture.
Robert W. Frentzel
Executive Vice President and Managing Director The PrivateBank
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
Overview of current Financial environment
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 longterm rates
The growing cost of the crisis
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
Recovery Not expected till late in 2009
Quarterly Change, Annualized
8% 6% 4% 2% 0%
“Potential”
-2%
-4% -6% 2005 2006 2007 2008
Est.
Source: U.S. Department of Commerce Blue 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
Target 0 - 0.25%
Source: Federal Reserve Board
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 $10 trillion over the past year.
S&P 500 Index
1800 1600 1400 1200 1000 800 600 400 200 0 Jan 1975 - Jan 1995 10% ann gain or 12% w ith dividends Aug 2000 - Feb 2003 45% correction Oct 2007- Nov 2008 44% correction Jan 1995 - Aug 2000 23% ann gain or 25% w ith dividends Feb 2003 - Oct 2007 14% ann gain or 16% w ith dividends
Dec-74
Dec-76
Dec-78
Dec-80
Dec-82
Dec-84
Dec-86
Dec-88
Dec-90
Dec-92
Dec-94
Dec-96
Dec-98
Dec-00
Dec-02
Dec-04
Dec-06
Not many can afford To retire
*estimates
Sources: Investment Company Institute; Employee Benefit Research Institute (2008 estimate); WSJ
Correction Will Take Time
Home Ownership Rate peaked in 2005
70% 68% 66% 64% 62% 60%
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
A Correction Seemed Likely In Certain Markets
TOP STATES FOR HOME PRICE APPRE CIATION (01-06)
140 120
Percentage %
100 80 60 40 20 0
ev ad a N
ai i
Ca lif or ni a
in g
W
Source: LoanPerformance
as h
US
Av er ag e
D C
Fl or id a
to n
H
aw
Fed intervention pushes mortgage rates to all time lows…
Housing Market Beginning to Clear at Low Levels
Third Quarter Home Resales in California
200,000 180,000 160,000 500,000 450,000 400,000
Median CA Home Price ($)
# of CA Home Resales
140,000 120,000 100,000 80,000 60,000 40,000 20,000 3Q95 3Q96 3Q97 3Q98 3Q99 3Q00 3Q01 3Q02 3Q03 3Q04 3Q05 3Q06 3Q07 3Q08 Non-REO Resales REO Resales Median CA Home Price
350,000 300,000 250,000 200,000 150,000 100,000 50,000 0
Source: MDA DataQuick and KBW calculations.
Deleveraging Begins with the Consumer
* 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.
Source: U.S. Department of Commerce: Bureau of Economic Analysis and KBW research.
Long-term rates at historic lows…
State of the Bank Markets
KBW Regional Bank Performance
KBW Regional Bank Index (KRX)
120 110 100 90 80 70 60 50 40
07 b0 7 Ja nFe
Subprime cracks
KBW Regional Crisis in Index (KRX) Bank confidence in
investment bank balance sheets
First SIV Failure - Cheyne Financial ($8B)
110 100 90
Subpri me New Century fails cracks 70 subprime ($17B mortgage originator)
80
60 50 40
M Ja a n- r0707 Fe bAp07 M r-0 ar 7 -0 7
Commercial paper market disappears Commercial paper market Largest single month disappears Investment banks New Century Largest single leveraged decline for freeze fund Investment loan fails ($17B month declinemarket withdrawls & inject banks freeze subprime for leveraged Crisis in capital fund mortgage loan market confidence in withdrawls & investment inject capital bank balance
Bank of America Liquidates $33B money market fund
AM pra y -00 77 M ay -0 Ju 7 Ju n-0 n- 7 07
JuJ l-u0l707 Au gAu 07 Se g-0 p- 7 07
OS cte -0 p707 N ov -0 O 7 D ct-0 ec 7 -0 7
07
ov -
N
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.
D
ec
-0 7
KBW Regional Bank Performance (continued)
KBW Regional Bank Index (KRX) 2008 & 2009 YTD
AIG bail out by government 9/17/08 Leveraged loan market legs down March 2008 Government plans on Short selling suspended buying $700B in banks' mortgage for 799 financials debt 9/18/08 9/19/08
KBW Regional Bank Index (KRX)
C buys WB with government assistance 9/29/08
110 100 90 80 70
110 100 90 80 70 60 50 40
08 8
Bank of America buys Countrywide Financial for 31% of book value 1/10/08
More write-downs / capital raises for I-banks June 2008
Treasury designates $250B for senior PNC buys NCC for preferred equity in $2.23 per share large banks 10/24/08 10/14/08 Dow down 21% in Oil hits 3 year low below last 7 trading days $50 a barrel 10/9/08 11/20/08 Deflation in America rumored 11/21/08 Citigroup receives 2nd government bailout 11/24/08 GS, MS, JPM, & other banks sell govt. backed notes Week of 11/24/08 COF buys Chevy Chase Bank 12/3/08 Enemployment rises to 7.2%. The highest it has been in 16 years 1/9/08 Since Sept. 1, 19 financial companies have become bank holding companies, including GS, MS, AXP 12/17/08 Number of problem banks and thrifts jumps to 171 11/25/08
Lehman Bros. files for Chapter 11. BAC acquires MER for $47B 9/15/08
WFC acquires WB for $7 per share without government assistance 10/3/08
Subpri me cracks
Fannie/Freddie bail out by government Commercial 9/8/08
60
Bear Stearns Fails 3/14/08
50 40
paper market IndyMac Fails 11 Bank Failures in '08; disappears FDIC's "Problem List" 7/11/08 New Century Largest single grows to 117 Investment fails ($17B month decline 8/27/08 banks freeze subprime for leveraged fund Fannie/Freddie capital loan market mortgage WFC / WB merger concerns withdrawls & WM bought out by approved by FED 7/8/08 JPM inject capital 10/12/08
9/25/08
Crisis in confidence in investment bank balance
Ju Au l-0 g7 -0 8 Au gSe07 Se p-0 p- 8 07 O O ct ct -0 -0 7 8
o07 v08
Ja n0 Ap 7 Fe r-08 b07 MM ar ay -0 -0 78
un7 -0 ay 8
-0 8 7
8
ar -0 8
Ju Juln 0
b0
Ja n-
7
-0
Ap r J-0
Fe
ov N-
M
ec -
M
N
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.
D
D
Ja n-
07
-0
ec
09
Capitalism in crisis
Phase I – The Sub-Prime Crisis
April 2007 –
July 2007 – August 9, 2007 – September 18, 2007 – Jan 11, 2008 –
New Century, largest U.S. sub-prime lender, files for bankruptcy
Bear Stearns closes 2 hedge funds after banks refuse bail out, Bernanke warns crisis could cost up to $100 billion Interbank lending market seizes up Fed cuts funds rate by 50 bp to 4.75% beginning easing cycle Bank of America acquires Countrywide Financial for $4 billion
Phase II – The Liquidity Crisis March 16, 2008 – July 13, 2008 – Bear Stearns acquired by J.P. Morgan for $2 per share 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 – September 16, 2008 – September 18, 2008 – September 19, 2008 – September 22, 2008 – September 25, 2008 – September 30, 2008 – October 3, 2008 Lehman Brothers files for bankruptcy, Bank of America acquires Merrill Lynch for $50 billion Fed announces $85 billion rescue package for AIG Reserve primary fund ―breaks the buck‖ triggering exodus from money market funds Bush announces plan to buy troubled assets from financial firms, Treasury guarantees money market funds Goldman Sachs & Morgan Stanley convert into bank holding companies Federal regulators seize WaMu and sell it to J.P. Morgan for $1.9 billion FDIC increases deposit insurance to $250,000 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 October 14, 2008 October 24, 2008 -
Treasury launches Capital Purchase Program making mandatory investments of $125 billion in 9 banks FDIC extends unlimited deposit insurance to non-interest bearing deposit accounts PNC acquires Nat City for $5.2 billion using TARP funds
November 12, 2008 –
November 24, 2008 – November 25, 2008 -
Treasury abandons plan to buy up bad debt and instead says it will use remainder to help revive consumer lending
Citigroup receives an additional $20 billion capital investment and $306 billion loan guarantee from government Fed announces plans to buy $600 billion of agency debt and mortgagebacked bonds and establishes $200 billion program to support consumer and small-business loans Senate rejects House-approved bailout plan for GM & Chrysler Fed cuts fed funds rate 75 bp to ―target range‖ of 0 - .25% Treasury agrees to extend $13.4 billion in emergency loans to GM & Chrysler
December 12, 2008 – December 16, 2008 December 19, 2008 -
Capitalism in crisis
January 8 , 2009 January 12, 2009 January 15, 2009
U.S. employers cut 524,000 jobs in December, capping the worst year of job losses since 1945
President-elect Obama asks President Bush to request second $350 billion installment of TARP funding Bank of America requests additional $20 billion
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
Loan Composition, FDIC-Insured Commercial Banks
100% 90% 80% 70% 60% 50% 40% 30% Construction Commercial Real Estate Home Equity Residential Mortgage Other Leases Other Consumer Credit Card Commercial 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
~25% of portfolios
20% 10% 0%
Over 50% of portfolios
Note: Period ending balance is used to calculate loan composition Source: SNL DataSource, FDIC, and KBW Research
How did we get here?
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
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 Net Interest Margin (%) competitive dynamics
5.00 4.75 4.50 4.25 4.00 3.75 3.50 3.25
Financial Institutions are not being paid for the risk
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1 '08 Q2 '08 Q3 '08
5B-$30B in Assets All Banks and Thrifts
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.
Bank Loan Portfolios are Undergoing Significant Distress
NPAs have spiked over the last several quarters, increasing from $39B in December of 2006 to over $150B currently (9/30/08)
NPAs / Assets (%)
1.10 1.00 0.90 0.80 0.70 0.60 0.50 0.40 0.30 0.20
5B-$30B in Assets
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
All Banks and Thrifts
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.
Magnitude of Nonperforming Loans
Non-accrual loans for nationwide banks and thrifts with greater than $500 million in assets, excluding 1-4 Family Loans:
6/30/06
Agricultural Loans Multi-family 1% 2% Commercial RE 18%
9/30/08
Foreign RE Loans Commercial RE 2% 14% Multi-Family 4% Agricultural Loans 0% Commercial 17% Construction 50%
Commercial 45%
Foreign RE Loans 9% Construction 7%
Consumer & HE 15%
Consumer & HE 13%
$13.4 billion
Source: SNL Financial. Data as of 9/30/08.
$65.4 billion
Credit write-downs reach $1 trilllion…
$1,200 Cumul Job Losses (right axis) 180,000 Cumul Writedowns (left axis) $1,000 Cumul Capital Raised (left axis) 140,000 $800 120,000 100,000 $600 80,000 $400 60,000 40,000 $200 20,000 $0 Prior Q3 Q4 Q1 Q2 Q3 Q4 2007 2007 2008 2008 2008 2008 0 160,000
Wachovia Citigroup AIG Freddie Mac Fannie Mae Merrill Lynch UBS Washington Mutual HSBC Bank of America National City J.P. Morgan Wells Fargo Morgan Stanley RBS Lehman Brothers
Writedowns ($bn) $96.50 $65.70 $60.90 $58.40 $56.00 $55.90 $48.60 $45.60 $33.10 $27.40 $26.20 $20.50 $17.70 $15.70 $15.10 $13.80
Capital Raised ($bn) $11.00 $74.00 $64.90 $7.00 $15.60 $29.90 $30.60 $12.10 $4.90 $55.70 $8.90 $44.70 $41.80 $24.60 $48.30 $13.90
Job Cuts 8,393 23,660 980 5,720 9,000 4,200 2,780 11,150 4,900 4,100 500 9,178 10,200 13,390
Cumulative writedowns & capital raised ($billions)
Cumulative job losses
* cumulative losses through November 16,2008
Historical Bank Offering Activity Levels
Over $151 billion if capital from Sovereign Wealth Funds included
Only $44.3B Raised in the Previous Decade
Deal Value ($mm) $100,000 $90,000 $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0
Millions ($)
# of Deals 60 50 40 30 20
Number of Deals
$85,971
$2,956 1999
$937 2000
$4,714 2001
$1,774 2002
$6,766 2003
$4,653 2004
$6,311 2005
$5,136 2006
$7,102
10 0
2007
2008
Year
1999
2000
2001
Deal 2002 Value ($mm) 2003
2004
#2005 of Deals
2006
2007
2008
IPO 14 6 1 5 5 9 9 5 2 0 $100,000 $85,971 $213.8 $234.8 $6.0 $124.9 $421.4 $558.6 $385.0 $190.7 $77.6 $0.0 $90,000 $80,000 Source: Dealogic. Note: US and Puerto Rican bank IPO, follow-on, 144A, PIPE and Convertible offerings since 1998. As of January 9, 2009.
60 50
Balance Sheets are Not Positioned to Cover Losses
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 Reserves / NPAs (%)
300.00 250.00 200.00 150.00 100.00 50.00 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
All Banks and Thrifts
5B-$30B in Assets
Reserves / Loans (%) 1.80 1.70 1.60 1.50 1.40 1.30 1.20 1.10 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Q1 '08
Q2 '08
Q3 '08
2007 Q1 '08 Q2 '08 Q3 '08
5B-$30B in Assets
All Banks and Thrifts
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 $500 million.
Nationwide Bank & Thrift Failures
Bank and thrift failures remain well below those levels seen in the early 1990s, though they are on the rise, with year-to-date failures already exceeding all of 2007.
Bank & Thrift Failures since 1990
280
2008 CA GA NV FL MO TX WA AR KS WV MI MN IL Total Count 5 5 2 2 2 2 1 1 1 1 1 1 1 25
480
224
360
Aggregate Assets ($B)
# of Failures
168
240
112
120 56
0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Aggregate Assets ($B) Source: FDIC. 1/12/09. Number of Failures
0
Searching for a Second Derivative on Credit
Delinquency Data
Subprime* 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Option ARMs**
3.00% 2.75% 2.50% 2.25% 2.00% 1.75% 1.50% 1.25% 1.00% 0.75% 0.50% 0.25% 0.00% Home Equity*** Prime****
Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08
* 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. . Source: ABX Net, company reports, and KBW calculations
Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08
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)
100% 80% 60% 40% 20% 0% -20% -40% -60% -80% -100%
Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Jul-04 Jul-05 Jul-06 Jul-07 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Jul-08
98% Tighter Standards Higher Pricing over COF 84%
Bank lending has increased…
Significant refinance on syndicated deals
Value of U.S. corporate debt maturing in 2009, in billions
Source: Standard & Poor’s
Deal flow down significantly
Syndicated-Loan Market / Global Borrowing via Syndicated Loans
Source: Reuters Loan Pricing Corp
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
Lenders are once again underwriting new transactions based on traditional credit standards
What’s Out What’s In
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)
The Big Question: Recession or Depression?
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
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