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

Impact of Sub-Prime Collapse

• n 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

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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

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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.

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Prudential Capital Group Deal Volume 2003 - 2007

$4.4 $4.5 $5.7 $5.3 $7.7

$1.3 $0.5 $1.6 $0.7 $0.5

$0.1 $0.2 $0.1 $0.3 $0.2

2 4 6 8 10 12

2003 2004 2005 2006 2007

$ Billions

IG BIG Mezz $5.0 $5.2 $6.6 $6.9 $9.5

165 129 161 104

• No. of Issuers

201

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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.

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

Scotia Capital Global Capabilities & Operations

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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.

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Where Did All the Money Go?

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“I Thought We Were Just Buying a House!”

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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.”

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Declared Bank Writedowns and Equity Infusions

Net impact approximates $41.8B

Source: S&P 1.17.2008

90,700 23,300 9,600 14,800 21,000 22,000 Amount of Writedown ($MM) 48,950 6,000 6,600 11,350 20,000 5,000 Amount of Equity Infusion ($MM) Total Others Morgan Stanley UBS Citigroup Merrill Lynch Bank

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Global Debt Capital Markets at YE 2006: $110.4T

Source: S&P 1.17.2008 Loans by Banks 39% US GSE-Backed RMBS 2% ($3.2T) U.S. Sub-prime RMBS + CDOs of ABS 1% ($1.6T) Private Label RMBS, ABS, CMBS, CDOs 9% Public Sector Debt Securities 23% Private Sector Debt Securities* 25%

$43.2T $27.2T $25.6T $9.6T

*Excluding structured finance; RMBS, ABS, CMBS, CDO, and GSE

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Current State of the Credit Markets

Investor Base Issuance Volume Pricing Trends

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Investor Base: Primary Market for Highly Leveraged Loans

0% 25% 50% 75% 100% 1994 1996 1998 2000 2002 2004 2006

Domestic Banks Finance Cos. Foreign Banks Institutional Investors Securities Firms Excludes left and right agent commitments (including administrative, syndication and documentation agent as well as arranger)

2008

Source: S&P

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Investor Base: CDOs Have Virtually Disappeared

Source: S&P 1.17.2008

50 100 150 200 250 300 350 2004 2005 2006 2007 Amount ($B)

ABS CDO CMBS RMBS Single-name synthetic

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Issuance Volume: Dramatic Decrease in Leveraged Loans

133 81 148 186 84 78 188 64 77 80 50 42 38 44 30 15 26 30 42 49 58 52 71 58 60 58 85 54 69 53 54 44 62 34 44 46 48 34 49 75 65 76 74 118

$0B $125B $250B 1Q97 1Q98 1Q99 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07

Institutional Pro Rata

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

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Pricing Trends: New Leveraged Loan Issuance Pricing Driven by Secondary Market Prices

L+0 L+100 L+200 L+300 L+400 L+500 L+600 L+700 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

BB Loans B Loans

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

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Pricing Trends: Single B Leveraged Loan Spreads Feeling Brunt of Liquidity Shortfall

350344 368 355 372 400391 419 533 437 508 447 359 292 319 266 249 273 256 271 254 287 272 220 236 387 399 253 284 300 383 383 378 287 285 284 387 401 417 374

L+200 L+300 L+400 L+500 L+600 1Q98 1Q99 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 Time Period Spread Straight Spread Upfront fee over three year assumed maturity 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

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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

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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.

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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.

22

Bank Rate (LHS) Mid Corporate Spreads (RHS)

Impact on Commercial Paper Spreads: Buyers Disappear, and So Do Funding Advantages

At mid-year 2007, there was over US$1.15 trillion in asset backed CP – this level declined by 21% in just 2-months

30 Day A1/P1 Commercial Paper Spreads

• 0.5

0.5 1 1.5 2 2.5 3 3.5 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

Date

Spread

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What Has This Done to the Cost of Borrowing?

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Libor / CA BA Rates on the Decline

Source: Bank of Canada and British Bankers Association, Federal Reserve

0% 1% 2% 3% 4% 5% 6% 7% 8% 2000 2001 2002 2003 2004 2005 2006 2007 2008

3-month Libor 3-month CA BA

Fed makes 13 rate cuts from 6.50% to 1.00% between 1/3/2001 and 6/25/2003 Fed makes 5 rate cuts from 5.25% to 3.00% between 9/18/2007 and 1/30/2008 Bank of CA makes 2 rate cuts from 4.50% to 4.00% between 7/10/2007 and 1/22/2008 Bank of CA makes 4 rate cuts from 3.25% to 2% between 7/15/2003 and 4/13/2004 Bank of CA makes 9 rate cuts from 5.50% to 2.00% between 3/6/2001 and 1/15/2002

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US and CAD Rates at All Time Lows

Source: Federal Reserve and Bank of Canada

2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 1987 1990 1993 1996 1999 2002 2005 2008

Treasury Rate

US 10-yr Treasury CA 10-yr Treasury

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US Yield Curve Returning to a Normal Slope

Source: Federal Reserve

• 1

2 3 4 5 6 2 4 6 8 10

Years Spot Yields (%)

1/31/08 12/31/07 1/31/07

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Jan 31, 2008 Dec 31, 2007 Jan 31, 2007

Canadian Yield Curve Steepening

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Investment Grade Spreads

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U.S. Spreads Rising After Historic Lows

Source: Banker Survey and Lehman U.S. Credit Index

(100) (50) 50 100 150 200 250 300 350 400 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Spread (bps)

BBB Private BBB U.S. Credit Difference

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Canada – BBB Corporate Bond Universe

Source: Scotia Capital – DEX

SPREADS

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The Net Effect: All-in-Coupons Remain at Historic Lows

Source: Banker Survey and Lehman U.S. Credit Index

5% 6% 7% 8% 9% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

All-in-Coupon

BBB All-in-Coupon

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Canada – BBB Corporate Bond Universe

Source: Scotia Capital – DEX

YIELDS

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Non-Investment Grade Spreads

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Credit is Still Cheap for Non-Investment Grade Issuers

Source: Banker Survey

4 6 8 10 12 14 16 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 All-in-Coupon

BB All-in-Coupon B All-in-Coupon

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Historical All-in Floating Rate Coupons Decreasing

Source: S&P

2 4 6 8 10 12 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 All-in-Coupon (%)

Pro-Rata B Institutional B

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Conclusion

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Concluding Thoughts

Plenty of performing companies. Specific sectors more vulnerable (i.e. homebuilding,

newsprint, etc.).

Structured finance market still working through issues. Caution exists in market, however, we see plenty of capital

available for good middle-market operating companies.

Although spreads are wide, all-in-coupons are very

attractive.

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2008 Outlook

• Per S&P ~$100bn overhang remains.
• New issuance outlook for large institutional market weak

until backlog worked out.

• Fewer issues for middle market lending.
• For both markets, spreads not likely to tighten rapidly and

terms will revert to historical norms.

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How Does This Get Fixed?

Wider spreads fueled by the erosion of investor confidence –

ultimate recovery will depend on a recovery (on a product by product basis) in confidence levels

All Central Banks work to provide more liquidity into the

markets to cheapen the cost of funds for banks and investors

All risk has been re-priced with segments still showing

volatility but investors are beginning to segment assets and risk based on issue specific criteria.