Economic Economic Overview & Overview & Financing - - PowerPoint PPT Presentation

Financing options in a tight lending environment

TIME: 12:00pm – 12:30pm DATE: Friday, January 30, 2009 WHERE: Arbutus Club Rotary

Economic Overview & Financing Strategy Economic Overview & Financing Strategy

Summary

The real problem Phase 1 – the trigger Phase 2 – asset decline Phase 3 – the US consumer is finished Phase 4 – the economic pain Going forward Food for thought Financing in the new world Sub-debt Client Profiles

Axel Christiansen

BA Econ UBC MBA CFA Investment Manager, Vancity Capital 15+ years sub-debt finance Tall (604) 877-6582 axel_christiansen@vancity.com

Social Life Monitor

Shut-in Party! Recluse Pathetic

The Real Problem

Problem was built in the US and exported to the world 20 years in the making Too much debt and not enough income US financial industry increasingly unregulated Cultural shift in US away from a production to debt funded consumption

The Real Problem

Problem was built in the US and exported to the world 20 years in the making Too much debt and not enough income US financial industry increasingly unregulated Cultural shift in US away from a production to debt funded consumption

Sub-prime the catalyst but not root of problem - triggers banking crisis Less than 10% of total mortgage market High default rate in subprime mortgages erodes capital base of lenders Lack of regulation and high leverage of ‘shadow banks’ means capital erosion results in magnified reduction in lending capacity Banks hoarding TARP stimulus money

Phase 1 – The Trigger

Sub-prime the catalyst but not root of problem - triggers banking crisis Less than 10% of total mortgage market High default rate in subprime mortgages erodes capital base of lenders Lack of regulation and high leverage of ‘shadow banks’ means capital erosion results in magnified reduction in lending capacity Banks hoarding TARP stimulus money

Phase 1 – The Trigger

Sub-prime the catalyst but not root of problem - triggers banking crisis Less than 10% of total mortgage market High default rate in subprime mortgages erodes capital base of lenders Lack of regulation and high leverage of ‘shadow banks’ means capital erosion results in magnified reduction in lending capacity Banks hoarding TARP stimulus money

Phase 1 – The Trigger

Phase 2 – Asset Decline

Debt explosion drove asset appreciation Deleveraging causing all asset values to decline simultaneously (a rare occurrence)

Phase 2 – Asset Decline

Debt explosion drove asset appreciation Deleveraging causing all asset values to decline simultaneously (a rare occurrence)

Phase 2 – Asset Decline

Debt explosion drove asset appreciation Deleveraging causing all asset values to decline simultaneously (a rare occurrence)

Four Bears

Phase 2 – Asset Decline

Debt explosion drove asset appreciation Deleveraging causing all asset values to decline simultaneously (a rare occurrence)

Phase 2 – Asset Decline

Debt explosion drove asset appreciation Deleveraging causing all asset values to decline simultaneously (a rare occurrence)

Phase 3 – US Consumer Done

Net worth in retreat (housing, investments plunging) – negative wealth effect. Access to financing to fuel consumption gone (home ATM to credit cards to…saving money?) Consumer and business confidence plunging – US & Canada Consumer spending is 65%+ of US GDP! Very similar profile in BC – highly geared to consumer spending Fixing personal balance sheets will hit the economy hard and long

Phase 3 – US Consumer Done

Net worth in retreat (housing, investments plunging) – negative wealth effect. Access to financing to fuel consumption gone (home ATM to credit cards to…saving money?) Consumer and business confidence plunging – US & Canada Consumer spending is 65%+ of US GDP! Very similar profile in BC – highly geared to consumer spending Fixing personal balance sheets will hit the economy hard and long

Phase 4 - The Economic Pain

Ann Taylor - 117 stores Eddie Bauer - 27 stores Cache - 23 stores Lane Bryant, Fashion Bug, Catherines - 150 stores Talbots – 100 stores Gap - 85 stores Foot Locker - 140 stores Zales, Piercing Pagoda - 105 stores Home Depot - 15 stores CompUSA (gone) Linen’s N Things (gone) Macy's - 9 stores Pacific Sunwear - 153 stores Pep Boys - 33 stores Sprint Nextel - 125 stores Ethan Allen - 12 stores Wilsons the Leather Experts – 158 stores Bombay Company - 384 stores 50,000+ lay-offs announced last week! 290,000 financial industry lay-offs

Growing unemployment Further downward pressure on home prices as prime loan defaults spike, reduction in consumer spending Unique downturn in that finance sector caused economy to slow which will come around to hit the financial sector again (i.e. double whammy recession for financial sector)

Phase 4 - The Economic Pain

Food For Thought

Nouriel Roubini Professor of Economics, New York University www.rgemonitor.com & www.youtube.com Peter Schiff Euro Pacific Capital www.europac.net & www.youtube.com Andrew Bacevich Professor or International Relations, Boston University www.pbs.com Nassim Nicholas Taleb Professor of Science of Uncertainty, University of Mass. www.fooledbyrandomness.com

BC’s Economic Drivers

Forestry (US new construction at record lows) Mining & Oil (commodities dropping fast) Construction (residential and commercial in decline) US Trade (our biggest customer is weak) Consumer (confidence down, 65%+ of GDP) Olympics (infrastructure ending…short term boost) Government Stimulus

BC’s Economic Drivers

Forestry (US new construction at record lows) Mining & Oil (commodities dropping fast) Construction (residential and commercial in decline) US Trade (our biggest customer is weak) Consumer (confidence down, 65%+ of GDP) Olympics (infrastructure ending…short term boost) Government Stimulus

Going Forward

Past recessions were ‘income statement’ recessions – expense shock to system. This is a ‘balance sheet’ recession

Too much leverage is the problem – not solved with more debt Debt must be worked down – that takes time and deleveraging is painful

Much more regulation in financial industry. Industry likely changed for a generation. Cheap is the new black – consumption not cool. Hyper inflation?

Financing In The New World

• Low rates
• Long amortizations – 25+
• Covenant lite
• Diluted security requirements
• High loan to value
• Cash flow loans (cheap)
• Limited to no guarantees
• Tolerant of covenant & payment

breaches

• Seemingly limitless capital

THEN

• Cost of funds up and spreads

increased at renewal (just because?)

• Amortizations cut back and

appropriate for underlying asset

• Tight and numerous covenants
• Tight security
• Low loan to value…or none at all.
• No cash flow loans
• Collateralized guarantees
• Pre-emptive action in anticipation of

covenant breach

• Far less $$ to go around

NOW

SENIOR DEBT

Subordinated Debt

Cash flow based financing - no asset coverage Requires capable, experienced and committed management, proven cash flow, & healthy market Term debt - monthly payments, 3-7 year amort. Limited personal guarantees Passive investment Working capital (growth or defensive), management buy-outs, strategic acquisitions Target return of 14% to 18%

Senior Debt (Op. credit, secured term, etc) Fully Secured & Proven Earnings Subordinated Debt (Vancity Capital) Unsecured & Proven Earnings Equity (Angel, VC) Unsecured & Unproven Earnings

Borrowing Cost

5% 25% 15%

Financing Cost

Sub-debt pricing

High Med. Low Risk Level

& Risk to Investor Risk to Borrower

Coastal Contacts

Rapidly growing, Vancouver-based online marketer of brand name contact lenses. Experienced founder with extensive industry background. Profitable and cash flow positive within first 7 months of operation. Perfect internet product - low shipping costs, low storage requirement, precise product specifications.

Inventory & Marketing

Coastal Contacts

Requirement: Working capital support for inventory acquisition and longer-term financing for aggressive marketing. Challenge: Retail nature of operations, highly mobile inventory and tech out of favour = low senior debt availability. Solution: Vancity Capital sub-debt! Now: $75M annual revenues, $65M value

Inventory & Marketing

Coastal Contacts

• Inventory & Marketing

Marcon Metal Fab

Family-owned metal fabrication shop – specializing in bridge work. Elderly founder looking to retire and sell business. Revenues and profits growing significantly over recent years – largely due to two younger key staff members. Significant level of bridgework required in BC

• ver the next 5 years and business expanding

into new product areas.

Management Buy-Out

Marcon Metal Fab

Requirement: Two managers seeking to buy out retiring

• wner

Challenge: Senior debt + purchasers equity + vendor financing < purchase price (no deal?) No collateral behind goodwill component of sale Solution: Vancity Capital sub-debt!

Management Buy-Out

Marcon Metal Fab

Before the deal: Two hard working young guys with almost no net worth, young kids…like to weld stuff Three years after the deal: Debt almost fully retired Record performance, company value tripled Two hard working guys driving fancy cars Five years after the deal: Own their own 20,000 sq.ft. premises ROE >>> 60% Net worths >>> Axel’s

Management Buy-Out

Vancity Capital

Founded in 1998 with over 200 deals to date Specialize in subordinated debt financing Loans $250,000 to $5,000,000 – all industries Management buy-outs (MBO), leveraged buy-

• uts (LBO), strategic acquisitions (roll-ups),

growth working capital Work with all senior and sub lenders Largest, most experienced and most active sub-debt group in BC Fast, flexible, local and active!

Some clients…

Questions?

Q&A