Fallout from the credit crunch

Fallout from the credit crunch

FEI Breakfast Seminar

25 November 2008

Current state of the capital marketsManaging funding requirementsJoe Healey Senior Vice-President Ernst & Young Orenda Corporate Finance Inc.204 954-5568 joe.a.healey@ca.ey.com

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Current market conditions subprime impact

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Where we are todayThe U.S. economy continues to slide towards recession Consumers continue to face enormous pressure to cut spending due to an uncertain housing market and weak job market12 million, or 16% of US homeowners owe more than their homes are worthThe IMF states that the global economy is headed for a recession in 2009 and estimates losses from the financial crisis to be $1.4 trillionThe Fed, ECB, BoC and 3 other central banks cut benchmark rates on October 8, 2008 further cuts predicted

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Subprime related lossesFinancial institutions have experienced $966 billion of asset write-downs and credit losses - $708 billion are from over 100 of the worlds largest banks and securities firmsApproximately $828 billion has been raised to meet these losses

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Subprimes impact on financial servicesIncreasing defaults in the subprime market trickled into the financial services sector in late 2006 and early 2007Credit rating agencies began to downgrade certain mortgage backed securities resulting in the evaporation of the subprime marketFinancial institutions were forced to write-down the book value of the securities held as assets on their booksSome 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 have also had writedowns

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Funding scarcityThe fallout of the credit crisis has been a scarcity of capital

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Funding scarcity (contd)In the secondary market, the average bid for multi-quote term loans is at its lowest point ever at 75.44The 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

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Market stabilization money market indicators

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Market stabilizationMarkets have not yet stabilized and the credit markets are still tightStandard & Poors predicts the credit crunch will end once four key economic and market variables are satisfied:Real estate values stabilize or increaseRebound in home salesEasing of creditDecline in crude oil prices

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Market indicatorsAlthough LIBOR has come down significantly, credit conditions remain tight3-month U.S. LIBOR is currently at levels not seen since October 2004

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Market indicators (contd)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 pointsOn October 10th, 3-month U.S. LIBOR peaked at 4.82% representing a spread over the effective FFR of over 4.00%

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Market indicators (contd)

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Market indicators (contd)Widening LIBOR-OIS spread

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Canadian perspective

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Canadian perspectiveSource: Bank of Canada

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Canadian perspective (contd)On September 5th, Canadian banking executives met for roundtable discussions The overall view is that the subprime mortgage crisis and credit crunch will significantly impact global bankingGord Nixon - The days of cheap money are over, and credit spreads across the board have, and will continue to significantly increase the cost of financing.Rick Waugh - it needs to be determined which regulators will oversee financial companies in the U.S. and that process could last a year or more

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Availability of financing

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Availability of financingCredit markets in Canada are changing dailyMany international and U.S. institutions have pulled away from the Canadian market or are in a state of uncertainty:Remaining institutions may be open for business but there is effectively no secondary market to syndicate or sell down exposureLending institutions are focused on optimizing the allocation of scarce capital

25 November 2008When the taps run dry: getting things done during a credit crunchPage *

Availability of financing (contd)Capital that may be made available for new funding has changed dramatically

Senior Debt

COVERAGELEVERAGE

EBIT / InterestDebt / Equity

5.0x2.00 : 1

4.0x1.50 : 1

3.0x1.00 : 1

2.0x0.75 : 1

1.5x0.50 : 1

1.0x0.25 : 1

AAAAAABBBBBB

2.00 : 1

1.25x

0.50 : 1

4.50x

1.00 : 1

3.00x

Investment Grade

Investment Grade with a Twist / Mid Market

Capital Structure

Capital Structure

Senior RevolverSecured by:Fixed assets

Secured by A/RInterest Rate:Prime plus 0.5% - 1.25%

Senior RevolverBA's or LIBOR plus 2% - 3%

Secured by InventoryTerm:5 - 10 Years

Represents:25% - 50% of total capital structure

SeniorLender:Banks or finance companies

Term Debt

Senior Term Debt financing is typically the second-

Subordinatedlowest-cost financing. Senior debt is typically secured

Debtby liquid assets.

Equity

Senior RevolverSecured by:Inventory and A/R

Secured by A/RInterest Rate:Prime plus 0.5% - 1.25%

Senior RevolverBA's or LIBOR plus 2% - 3%

Secured by InventoryTerm:1 - 3 Years

Represents:15% - 35% of total

SeniorLender:Banks or finance companies

Term Debt

A Senior revolving facility is usually the lowest

Subordinatedcost financing as it is secured by highly liquid assets.

DebtAdvance rates vary for inventory and A/R but generally

Equityare in the 50% - 60% and 60% - 80% range, respectively.

Senior RevolverSecured by:Second lien on fixed assets

Secured by A/RInterest Rate:Prime plus 3% - 7% plus an equity

Senior Revolverkicker, 15% to 25% overall

Secured by InventoryTerm:5 - 10 Years (maturing after senior)

Represents:10% - 25% of total

SeniorLender:Sub Debt funds, pension funds,

Term Debtinsurance and finance companies

SubordinatedSub debt financing is expensive as it is poorly secured.

DebtIt is subordinate to Senior Debt and is generally loaned

Equityagainst excess cash flow.

Senior RevolverSecured by:Unsecured

Secured by A/RInterest Rate:30% - 40%,

Senior Revolvercompounded annually

Secured by InventoryExit Strategy:3 - 7 Years

Represents:10% - 20% of total

SeniorSource:Management, employees, seller,

Term Debtoutside investors

SubordinatedEquity incurs the highest risk thereby expecting returns

Debtcommensurate with that risk. Typically, the company

Equityloses some control when it issues equity.

Securitization and Swaps

"Sell" $100M$90M Senior

ReceivablesAAA Notes

OriginatorSPVInvestors

$90M Cash$90M Cash

$10M Junior Notes

Servicing of Receivables

Fixed at Y%

Bank

SWAP DealerCompanyObligations

Floating: BAFloating: BA

Cash /

Income

Fixed at X%

Income Trust

Unitholders

TRUST

Manager

Company

OfftakeOp Co

$

Cash Distributions

Operating Income

Management Services and Fees

Management Services and Fees

Phase I

Assumptions

I/S

BS

SCFP

Availability

SAMPLE Availability Calculation - RevolverJan-03Feb-03Mar-03

Borrowing Base

(A) Committed amount ($000's)$20,000$20,000$20,000

(B) A/R @ 80%15,35215,56715,869

+ Inventory @ 50%1,1321,2111,283

Total Borrowing Base (lessor of A&B)16,48416,77817,152

Loan Outstanding0.02,0001,500

Surplus (deficiency)16,48414,77815,652

Standby Fees @ 0.375%555

Template

Scenario A - Senior Debt $10M ($ millions)

200320042005

Revenue66.768.097.0

Gross Profit13.915.122.7

EBITDA6.97.614.3

Net Income0.91.55.7

Capex4.04.05.0

Subordinated Debt0.00.00.0

Senior Debt36.632.021.5

Funded Debt/EBITDA5.63x1.90x0.79x

Senior Debt/EBITDA5.63x1.90x0.79x

Total Debt Service Coverage0.52x1.37x2.45x

Revolver Availability(3.1)4.213.0

Equity Dilution0.0%

Sheet7

RateRateEBITDA

Pre-Credit CrunchPost-Credit Crunch(Multiple)

Senior DebtBA + 150bpsBA + 300bps2.5x -