Economic Economic Overview & Overview & Financing Financing Strategy Strategy Financing options in a tight lending environment TIME: 12:00pm – 12:30pm DATE: Friday, January 30, 2009 WHERE: Arbutus Club Rotary
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 Social Life Monitor � Tall Party! Shut-in (604) 877-6582 Recluse axel_christiansen@vancity.com 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
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 � 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 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 50,000+ lay-offs Lane Bryant, Fashion Bug, Catherines - 150 stores announced last week! 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 290,000 financial Pep Boys - 33 stores industry lay-offs Sprint Nextel - 125 stores Ethan Allen - 12 stores Wilsons the Leather Experts – 158 stores Bombay Company - 384 stores
Phase 4 - The Economic Pain � 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)
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 SENIOR DEBT THEN NOW � Low rates � Cost of funds up and spreads increased at renewal (just because?) � Long amortizations – 25+ � Amortizations cut back and � Covenant lite appropriate for underlying asset � Diluted security requirements � Tight and numerous covenants � High loan to value � Tight security � Cash flow loans (cheap) � � Low loan to value…or none at all. Limited to no guarantees � No cash flow loans � Tolerant of covenant & payment � Collateralized guarantees breaches � Pre-emptive action in anticipation of � Seemingly limitless capital covenant breach � Far less $$ to go around
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%
Sub-debt pricing Borrowing Financing Cost Cost Risk Level & Risk to Risk to High 25% Investor Borrower Med. 15% Low 5% Senior Debt Subordinated Debt Equity (Op. credit, secured term, etc) (Vancity Capital) (Angel, VC) Unsecured & Fully Secured & Unsecured & Unproven Earnings Proven Earnings Proven Earnings
Inventory & Marketing 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 ����� ����������������� ���������������
Management Buy-Out 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 over the next 5 years and business expanding into new product areas.
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