Impact of Sub-Prime Collapse on the Lending Market Paul Meiring, - PowerPoint PPT Presentation

Impact of Sub-Prime Collapse on the Lending Market Paul Meiring, Prudential Capital Group Engin Okaya, Prudential Capital Group Michael Costakos, Scotia Capital Jim Beninger, Scotia Capital Robert Follis, Scotia Capital February 19, 2008

Is The World Coming to an End? “Panic or Prozac? When Will Liquidity Return?…” – Citigroup, December 21, 2007 “Credit Markets Crumble…” – Fitch Ratings, January 31, 2008 “With default rates on the rise and liquidity scarce, the loan market is in a state of disruptive transition unlike anything since the early 1990’s…” – S&PLCD, February 2008 “Corporate Loan Market Is Reeling as Values Tumble Sharply…” – WSJ, February 6, 2008 “New Hitches In Markets May Widen Credit Woes…” – WSJ, February 11, 2008 2

Who is Prudential Capital Group? � Relationship focused buyside lender. � Leading provider of private capital for more than 60 years. � Middle market focus, target companies $50 – 500 million in revenue. � $42B portfolio of investments as of 12/31/2007 spread across 1,000 companies. � Originated $9.5 billion of Investment Grade, Below Investment Grade, and Mezzanine debt in 2007. 3

Prudential Capital Group Deal Volume 2003 - 2007 12 201 No. of Issuers 165 161 $9.5 10 $0.2 129 $1.6 8 104 $6.9 $6.6 $ Billions $0.3 $0.1 $7.7 $5.2 6 $0.7 $1.3 $5.0 $0.2 $0.1 $5.7 $0.5 $0.5 $5.3 4 $4.4 $4.5 2 0 2003 2004 2005 2006 2007 IG BIG Mezz 4

Who is Scotia Capital? � Full service global and corporate investment bank. � Top two Canadian bank acting as Lead Arranger / Agent and top Canadian bank in U.S. for syndicated loans. � Provides corporate lending, project finance, debt and equity capital markets underwriting, risk management, foreign exchange, and financial and M&A advisory services. � Organized by focused industry groups. 5

Scotia Capital Global Capabilities & Operations Vancouver Calgary Portland London Dublin Montreal Toronto San Francisco Halifax Chicago Denver Boston New York Houston Atlanta Monterrey Gibraltar Guadalajara Mexico City Mumbai Hong Kong Dubai Kuala Lumpur Singapore Scotia Capital ScotiaMocatta (Precious Metals) Scotia Waterous (Oil & Gas M&A) 6

Discussion Points Sub-prime issues emerged as early indicators, but were � merely a subset of a much larger structured finance market. That market was funding large LBO deals and has largely � come to a halt. Traditional middle market lending is still reasonably active. � Plenty of capital still available for middle market deals, both � traditional corporate and middle-market buyouts. Liquidity driven rather than recession driven credit crunch. � 7

Where Did All the Money Go? 8

“I Thought We Were Just Buying a House!” 9

What Happened? � Institutional lenders and Investment Banks provided large warehouse facilities to aggregate loans for structured vehicles. � Buyers of CDO tranches suffered mark-to-market writedowns due to very difficult price discovery conditions. � Both the leverage and equity component of CDO appetite disappeared. � Many CDO structures have begun to force liquidation of assets. � Banks were also underwriting the debt of larger buyouts and providing huge financial commitments. � Many of these deals are now “hung.” 10

Declared Bank Writedowns and Equity Infusions Bank Amount of Writedown Amount of Equity ($MM) Infusion ($MM) Merrill Lynch 22,000 5,000 Citigroup 21,000 20,000 UBS 14,800 11,350 Morgan Stanley 9,600 6,600 Others 23,300 6,000 Total 90,700 48,950 Source: S&P 1.17.2008 � Net impact approximates $41.8B 11

Global Debt Capital Markets at YE 2006: $110.4T U.S. Sub-prime RMBS + CDOs of ABS 1% ($1.6T) Loans by Banks US GSE-Backed 39% RMBS 2% ($3.2T) Private Label RMBS, $43.2T ABS, CMBS, CDOs $9.6T 9% $25.6T $27.2T Public Sector Debt Securities 23% Private Sector Debt Securities* 25% *Excluding structured finance; RMBS, ABS, CMBS, CDO, and GSE Source: S&P 1.17.2008 12

Current State of the Credit Markets � Investor Base � Issuance Volume � Pricing Trends 13

Investor Base: Primary Market for Highly Leveraged Loans 100% Domestic Banks Finance Cos. Foreign Banks Institutional Investors Securities Firms 75% 50% 25% 0% 2008 1994 1996 1998 2000 2002 2004 2006 Excludes left and right agent commitments (including administrative, syndication and documentation agent as well as arranger) Source: S&P 14

Investor Base: CDOs Have Virtually Disappeared 350 ABS CDO CMBS RMBS Single-name synthetic 300 250 200 Amount ($B) 150 100 50 0 2004 2005 2006 2007 Source: S&P 1.17.2008 15

Issuance Volume: Dramatic Decrease in Leveraged Loans $250B Institutional Pro Rata 186 188 148 133 118 $125B 85 84 78 81 80 77 76 75 74 71 69 65 64 62 60 58 58 58 54 54 53 52 50 49 49 46 48 44 44 44 42 42 38 34 34 30 26 30 15 $0B 1Q97 1Q98 1Q99 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 Note: These numbers comprise U.S. dollar denominated loans and are subject to revision as LCD collects additional data. Source: S&P 1.31.2008 16

Pricing Trends: New Leveraged Loan Issuance Pricing Driven by Secondary Market Prices L+700 L+600 BB Loans B Loans L+500 L+400 L+300 L+200 L+100 L+0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Note: Excludes all loans trading at 70% of par or less and facilities in default 1997 – 1/25/08 Source: S&P 1.31.2008 17

Pricing Trends: Single B Leveraged Loan Spreads Feeling Brunt of Liquidity Shortfall L+600 Straight Spread Upfront fee over three year assumed maturity 533 508 L+500 447 437 417 419 399 Spread 401 400391 387 383 383 387 L+400 378 374 372 368 359 355 350344 287 319 285 300 292 L+300 287 284 284 273 272 271 266 253 256 254 249 236 220 L+200 1Q98 1Q99 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 Time Period Assumes upfront fee is amortized evenly over an assumed three-year life; Upfront fee includes original issue discount. As of 10/5/06 LCD began using Corporate Credit Ratings by S&P and Corporate Family Ratings by Moody’s for rated spread and rated upfront fee calculations. Source: S&P 1.31.2008 18

Canadian Bank Market � Liquidity problems in the U.S. non-investment grade market and the Canadian non-bank ABCP market have caused caution and conservatism in the Canadian bank debt market. � Canadian leveraged loan market not impacted as dramatically as the U.S. � However, certain degree of Canadian bank market tightening; lenders demanding lower leverage and higher pricing. � 3.25x Senior Leverage and 4.5x Total Leverage � Spreads have increased by 50 ~ 75 bps 19

Canadian Bank Market � Arrangers are unwilling to take underwriting risks without full market flex. � Reasonably structured transactions getting done; however, more lender declines. � In some cases, the syndication processes prolonged due to lenders’ increased credit scrutiny. � Credit spreads still at relative lows on a historical basis; however, pressure to widen Canadian spreads for both investment grade and non-investment grade loans due to banks increased cost of capital. � Some banks exiting long-time relationships due to the lack of meaningful returns. 20

Canadian Bank Market � Loan Portfolio Management scrutiny (i.e. hold level and pricing discipline) is an important consideration in the credit approval process. � Drawn credits are preferred as profitability models are biased in their favor. � Terms at and beyond 3 years require significantly larger capital charges. � As market pricing for bonds, CLO and CDS increases, banks are comparing alternative returns when evaluating new transactions. � Relationship transactions continue to be well received. Ancillary economics are used to enhance overall returns for the lenders. 21

Impact on Commercial Paper Spreads: Buyers Disappear, and So Do Funding Advantages 30 Day A1/P1 Commercial Paper Spreads 3.5 3 2.5 2 Mid Corporate Spreads (RHS) Spread 1.5 1 0.5 0 Bank Rate 9/23/99 9/23/00 9/23/01 9/23/02 9/23/03 9/23/04 9/23/05 9/23/06 9/23/07 (LHS) -0.5 Date At mid-year 2007, there was over US$1.15 trillion in asset backed CP – this level declined by 21% in just 2-months 22

What Has This Done to the Cost of Borrowing? 23

Libor / CA BA Rates on the Decline 8% 3-month Libor 3-month CA BA Fed makes 5 rate cuts from 5.25% to 7% 3.00% between 9/18/2007 and 1/30/2008 6% Fed makes 13 rate cuts from 6.50% to 1.00% between 1/3/2001 and 6/25/2003 5% 4% 3% Bank of CA makes 2 rate cuts from 4.50% to 4.00% between 7/10/2007 and 1/22/2008 2% 1% Bank of CA makes 9 rate cuts from Bank of CA makes 4 rate cuts from 5.50% to 2.00% between 3/6/2001 3.25% to 2% between 7/15/2003 and and 1/15/2002 4/13/2004 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: Bank of Canada and British Bankers Association, Federal Reserve 24

US and CAD Rates at All Time Lows 12% 11% US 10-yr Treasury CA 10-yr Treasury 10% 9% 8% Treasury Rate 7% 6% 5% 4% 3% 2% 1987 1990 1993 1996 1999 2002 2005 2008 Source: Federal Reserve and Bank of Canada 25

US Yield Curve Returning to a Normal Slope 6 1/31/08 12/31/07 1/31/07 5 4 Spot Yields (%) 3 2 1 - 0 2 4 6 8 10 Years Source: Federal Reserve 26