Fallout from the credit crunch

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Fallout from the credit crunch. FEI Breakfast Seminar 25 November 2008. Current state of the capital markets Managing funding requirements. Joe Healey Senior Vice-President Ernst & Young Orenda Corporate Finance Inc. 204 954-5568 joe.a.healey@ca.ey.com. - PowerPoint PPT Presentation

Text of 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 -