The State of the Corporate Banking Industry 2008 2009 Banking Industry Crisis Andrew Cardimen, Senior Vice President Middle Market Corporate Banking Harris Bank, N.A. 1
The 2008 2009 Credit Crisis 2
~8,300 FDIC-insured banks & savings associations in the U.S. ~190 banks and savings institutions in Indiana Default, delinquency, and charge-off rates are all increasing $1.5 - $1.8 trillion in total estimated U.S. bank losses from the credit crisis (twice as high as early estimates) U.S. banks 3Q net income ($1.7B) is 2 nd lowest since 1990 (FDIC reported) The number of U.S. banks and thrifts in trouble increased to 171 at the end of 3Q many more expected through 2008 and 2009 25 U.S. banks collapsed in 2008 3 more in 2009, so far! 3
Troubled Assets Relief Program (TARP) U.S. Treasury authorized to purchase or insure up to $700B of troubled assets October 2008 revision to TARP permitted the Treasury to purchase preferred stock and warrants in American banks December 2008 revision to TARP allowed the President to declare that TARP funds may be spent on any program the President deems necessary to avert the financial crisis December 2008 -- $350B spent/allocated $276B for bank equity infusions (senior preferred equity) $ 40B to AIG $ 14B to GM/Chrysler $ 20B to Term Asset-Backed Securities Loan Facility Remaining $350B+ is on its way the need is imminent and urgent 4
TARP Beneficiaries (largest banks doing business in Indiana) Bank of America $45B JPMorgan Chase $25B Wells Fargo $25B PNC/National City $7.6B Regions $3.5B Fifth Third $3.45B KeyCorp $2.5B M&I $1.7B Huntington $1.4B Old National $150M 5
Purpose of TARP Prevent a complete collapse of the financial system Encourage banks to lend money Increase lending instead of hoarding cash to cushion against future losses from troubled assets Leading to loosening of credit Improve investor confidence in financial institutions and the markets 6
The Reality (to date) Banks funded by TARP are actually lending LESS than those without access to the program 51 lenders who received TARP money reduced loans by 2.5% in Q4 2008, compared to a 1.3% reduction by smaller peers who didn t apply for TARP funding (Bloomberg) Banks using TARP funds to: Expand their footprint acquire rival banks - further bank consolidation Bolster bank balance sheets Cover anticipated losses (unrecognized charge-offs) 7
Additional Options for Financial System Bailout - The new Financial Stability Plan (Treasury Secretary Timothy Geithner announced on February 10, 2009) Fed to make up to $1 trillion in funds available to spur auto, student, credit card, consumer, and small business lending Public-private partnership to purchase bad assets of $500 billion - $1 trillion, including mortgage backed securities that have been backed by Fannie Mae, Freddie Mac, and Ginnie Mae Continued government purchases of stock in U.S. banks $50 billion to help homeowners deal with rising foreclosures Fed to buy long-term Treasury securities Fed purchase of companies short-term term debt (Commercial Paper) More government oversight than TARP 1 8
What has been the impact on local banks underwriting standards in the Small Business and Mid-Market Market Business Segments? Small Business: $ 1M - $ 10M Annual Revenue Mid-Market Market Business: $10M - $500M Annual Revenue 9
Impact on Underwriting Standards Full retreat on new transactions considered Fewer new transactions considered more selective More stringent underwriting metrics, leading to tighter loan structures Increased sensitivity analysis on management projections Industry exclusions Increased due diligence Increased loan pricing and fee requirements Slower approval turnaround times Internal focus on portfolio administration and existing client performance 10
Impact on Underwriting Standards Increased focus and scrutiny of the management team Increased focus on the company s true financing need No funding of operating losses Working capital changes Equipment financing Real Estate Some financing flexibility is gone 11
Impact on Underwriting Standards Industry Attractiveness From Caution to Exclusion Automotive (direct to Tier 1-3 exposure) Retail Construction Transportation Real Estate (investment, development, flipping ) Brokered loans Any recession-risky risky industry segment! 12
Impact on Underwriting Standards Underwriting Metrics Increased upfront administration and due diligence Secured personal guarantees (often with spouse, assuming jointly held personal assets) Pre-closing field examinations (A/R, Inventory) Complete Business Plan with financial projections (1-3 years), including balance sheet projections 620+ credit report (SBA) 680+ traditional small business loans 13
Impact on Underwriting Standards Underwriting Metrics Loan Pricing Risk-Return Return analysis being performed by banks based on increasing internal funding costs Implementation of profitability models (including risk adjusted return on capital RAROC - hurdles) Loan Pricing: 1.50% - 4.00% increases Defined base rates (floors) Fee increases (upfront, unused, renewal, covenant waiver) 14
Impact on Underwriting Standards Underwriting Metrics Loan Covenants Minimum EBITDA levels Cash Flow Coverage >1.20x (all in) higher in certain industry segments Debt/Tangible Net Worth <3.00:1 Total Funded Debt/EBITDA <3.00:1 Senior Funded Debt/EBITDA <2.00:1 Specific dividend/distribution restrictions Borrowing Bases (A/R & Inventory based) 15
Further Impacts on Financing M&A Activity is Slowing Activities The availability of senior capital is a primary driver of M&A activity Mezzanine financing slowing much more selective investment rationale among participants 1 st 9 months of 2008 experienced a slowing of ~16% in deal volume compared to 2007 Due to increased debt pricing, purchase price multiples have begun to decline (avg. 5.5x EBITDA in 2008 vs. 6.0x EBITDA in 2007) Leverage multiples have declined (3.2x EBITDA in 2008 vs. 3.7X in 2007) 16
Current Bank Focus Strength of management team and contingency planning Ability to reduce overhead quickly Vision, focus, creative, innovative strategies Banks looking for companies with strong, historical financial performance sustainable and predictable EBITDA Market leaders Liquidity Financial/debt capacity sensitivity analysis Industry attractiveness 17
Current Bank Focus Capitalization staying power! Secondary/tertiary repayment sources Business model must be easy to explain and understand No noise in the numbers personal expenses, unnecessary expense Margins (revenue and expense) should be consistent with industry averages Clean background checks on principals (credit, other) 18
Recommendations to Raise Senior Capital in the Current Banking Environment Understand industry/segment trends and their impact on your company Understand negative impacts to revenue (degree of impact) Update monthly forecasting (focus on profitability, working capital & cash flow) Focus on margins (profitability and expense) Focus on cash flow cycle management (i.e., A/R, Inventory, A/P days) When necessary, execute on overhead reduction (don t delay difficult decisions) Consider additional equity injection (including junior indebtedness) Limit major capital expenditures detailed business case for anything other than maintenance expense Increase communication with bank (Line Management & Credit Officer) no surprises, whenever possible! 19
Summary: Senior & mezzanine capital is available (higher cost, tightened structure) Deal flow is improving TARP & Financial Stability Plan will help Beginning to see some progress in the banking markets time will tell! 20
The State of the Corporate Banking Industry 2008 2009 Banking Industry Crisis Questions Andrew Cardimen, Senior Vice President Middle Market Banking Harris Bank, N.A. 21