Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and...

54
Dan Hesse Dan Hesse Mike Milken Mike Milken Marc Rowan Marc Rowan Scott Sperling Scott Sperling Capital Structure Matters Capital Structure Matters Randall Wooster Randall Wooster

Transcript of Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and...

Page 1: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Dan

Hesse

Dan

HesseMike

Milken

Mike Milken

Marc Rowan

Marc Rowan

Scott Sperling

Scott Sperling

Capital Structure MattersCapital Structure Matters

Randall Wooster

Randall Wooster

Page 2: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

U.S. corporate bond issuance started to catch up in recent quarters

United States

$156$136

$154 $141

$202$182 $169

$222$260 $268

$172 $177 $175

$265

$71

$170

$259

0

50

100

150

200

250

300

2005 2006 2007 2008 2009

Quarterly corporate bond issuance, US$ billions

Sources: Dealogic, Milken Institute.

Page 3: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Companies worldwide raised $900 billion in Q1 2009 through corporate bond issuance

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

US$ trillions 2009: annualized based on Q1 data

Sources: Dealogic, Milken Institute.

Page 4: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

U.S. companies raised $316 billion worldwide

in Q1 2009 through corporate bond issuance

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

US$ trillions 2009: annualized based on Q1 data

Page 5: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Distressed bonds

Daily, January 17, 2008–April 16, 2009

0

500

1000

1500

2000

2500

3000

01/2008 04/2008 07/2008 10/2008 01/2009 04/2009

Number of distressed bonds traded during the day

Distressed is defined as any bond that trades at 1,000 bps or more over the benchmark treasury.

March 13, 2009: 2,674

Sources:

Bloomberg, Milken Institute.

Page 6: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Liquidity freeze: spread between 3-month LIBOR and overnight index swap

rate Daily, July 1, 2007—March 31, 2009

0

50

100

150

200

250

300

350

400

07/2007 09/2007 11/2007 01/2008 03/2008 05/2008 07/2008 09/2008 11/2008 01/2009 03/2009

Average since December 2001: 31 bps

October 10, 2008: 364 bps

Basis points

Average since July 2007: 94 bps

Sources: Bloomberg, Milken Institute.

Page 7: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

TED Spread reached historical high in 2008

Daily, December 31, 2005—March 31, 2009

Sources: Bloomberg, Milken Institute.

050

100150200250300350400450500

12/2005 12/2006 12/2007 12/2008

Historical high before 2008November 1987: 255 bps

August 20, 2007: 240 bps

Average since 2005: 93 bps

Average since August 2007: 146 bps

Basis pointsOctober 10, 2008: 463.6 bps

Aug. 16, 2007: Countrywide takes emergency loan of $11 billion from a group of banks.

Sept. 16, 2008: Fed rescues AIG for $85 billion.

Page 8: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Sources: Federal Reserve, Moody’s Economy.com, Milken Institute.

Commercial paper issuance dries up

-300-250-200-150-100

-500

50100150

Q12006

Q22006

Q32006

Q42006

Q12007

Q22007

Q32007

Q42007

Q12008

Q22008

Q32008

Q42008

Q12009

Issuers of asset-backed securities

Other issuers

Quarterly change in outstanding amount, US$ billions

Page 9: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Global IPO market froze in first quarter 2009

Source: Dealogic.

8 24 315

83

299

256

174137

515988

209163

105107105747568

0

50

100

150

200

250

300

350

1990 1994 1998 2002 2006

Amount raised, US$ billions

* 2009 number is annualized.

2009*

Page 10: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Does low price-earning ratio imply great investment opportunity?

Monthly, January 1954–March 2009

0

5

10

15

20

25

30

35

1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009

Price-earning ratio for S&P 500 index

June 1999: 29.7x

March 2009: 11.8x

April 1980: 7.0x

Average since 1954: 16.4x

Sources: Bloomberg, Milken Institute.

Page 11: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Costly stock buybacks

Selected companies, 2006-2008

Shares repurchased in 2006, 2007 and

2008 (millions)

Average purchase

price (US$)

Total paid (US$ billions)

Stock price on March 15, 2009

(US$)

Loss to stockholders (US$ billions)

General Electrics 785 36.09 28.3 10.13 20.4Disney 544 31.90 17.4 17.70 7.7

Home Depot 492 36.51 18.0 22.44 6.9Macy's 148 39.42 5.8 8.76 4.5Alcoa 113 35.24 4.0 6.40 3.3Sears 39 115.82 4.5 40.09 2.9Yahoo 123 28.05 3.4 13.74 1.8

Nordstrom 51 42.32 2.2 15.26 1.4Altria 54 21.81 1.2 16.69 0.3

Sources: Companies’

financial reports, Milken Institute.

Page 12: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

S&P 500 companies spent $1.4 trillion on stock buybacks and dividends in 2007 and 2008

0

100

200

300

400

500

600

700

1999 2000 2001 2002 2003 2004 2005 2006 2007 20080

200

400

600800

1000

1200

1400

1600

Stock buybacks (left axis)

Dividends (left axis)

S&P 500 index (year-end level, right axis)

US$ billions S&P 500 composite index

Sources:

S&P, Milken Institute.

Page 13: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Companies leveraged up in the past 30 years

Sources: Bloomberg, Milken Institute.

0.0

1.5

3.0

4.5

6.0

7.5

9.0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Asset-to-equity ratio for Dow Jones industrial average component companies

Page 14: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Companies leveraged up in the past 30 years

Sources: Bloomberg, Milken Institute.

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

LT debt-to-equity ratio for Dow Jones industrial average component companies

Page 15: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Companies rely more on short-term financing

Sources: Bloomberg, Milken Institute.

0.0

0.2

0.4

0.6

0.8

1.0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Long-term debt-to-total debt ratio for Dow Jones industrial average component companies

Page 16: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Banks lend less, while businesses and individuals draw upon existing credit lines Quarterly, Q1 2000–Q4 2008

0

2

4

6

8

2000 2001 2002 2003 2004 2005 2006 2007 20080

100

200

300

400

500

600US$ trillions US$ billions

Unused loan commitments (right axis)Change from Q1 2008 to Q4 2008: -11%

Total loans and leases (left axis)Change from Q1 2008 to Q4 2008: -21%

Sources: Moody’s Economy.com, FDIC, Milken Institute.

Page 17: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Declining leverage at all U.S. commercial banks

89

101112131415161718

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Percent

Sources: FDIC.

Page 18: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Leverage ratios of selected financial firms December 2008

9.3

10.6

11.1

31.6

26.2

21.5

67.9

0 10 20 30 40 50 60 70 80

Credit unions

Commercial banks

Saving institutions

Brokers/hedge funds

Federal Home Loan Banks

Fannie Mae

Freddie Mac

Leverage ratio, total assets/common equity

Note: Leverage ratios for

Freddie Mac and Fannie Mae are as of June 2008. The two institutions have negative common equities as of December 2008.Sources: FDIC, FHL Banks Office of Finance, National Credit Union Administration, Freddie Mac, Fannie Mae, Milken Institute.

(June 2008)

(June 2008)(June 2008)

Savings institutions

Page 19: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Too much dependence on debt?

Leverage ratios at biggest investment banks

2219

28 26

18

31

19

2724 23

33 32 3431

13

33 34

2422

13

0

5

10

15

20

25

30

35

40

Morgan Stanley Merrill Lynch Bear Stearns Lehman Brothers Goldman Sachs

2000 2005 2007 2008

Total assets/total shareholder equity

March 2008

June 2008

Sources: Bloomberg, Milken Institute.

Page 20: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Marc RowanCo-Founding Partner Apollo

Page 21: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Capital Structure Matters!

Leverage Levels Depend on Stability of Cashflow–

Cable vs. semiconductor cash flow•

Liquidity–

Short term vs. long term•

Maturity –

Required refinance “during”

or “after”

a business cycle•

Bank Debt vs. Bonds –

“Pro-rata”

provisions vs. freely available •

Flexibility–

PIK Toggle / Equity Cures / Second Lien Capability–

Covenant vs. “Covenant Light”

Page 22: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Large LBOs

2005–2007Original Mark to Market

LBO Date TEV Purchase Multiple Equity DebtCurrent Equity

Current Debt

TXU 10/01/07 $43.5 10.2x $8.5 $35.0 n/a $20.3HCA 07/24/06 33.1 7.6x 4.8 28.3 n/a 24.8Harrah’s 01/25/08 30.0 10.4x 6.1 23.9 n/a 12.2First Data 09/24/07 29.0 12.0x 5.6 23.4 n/a 16.1Hilton 10/24/07 26.9 16.4x 5.6 21.3 n/a 10.7Clear Channel 07/30/08 26.7 10.7x 3.2 23.5 n/a 9.9Alliance Boots 06/27/07 24.5 12.8x 7.6 16.8 n/a 11.4Freescale

Semiconductor 12/04/06 19.7 8.4x 8.2 11.5 n/a 5.2Intelsat 02/04/08 16.4 9.7x 1.5 14.9 n/a 13.2Univision 03/29/07 14.0 17.2x 4.0 10.0 n/a 5.3SunGard Data Systems 08/11/05 11.8 10.0x 3.9 7.9 n/a 7.2Nielsen 03/08/06 11.0 11.4x 3.4 7.6 n/a 6.4Dollar General 07/06/07 7.5 11.4x 2.8 4.7 n/a 4.5US Foodservice 06/26/07 7.3 12.7x 2.2 5.1 n/a 3.9Servicemaster 07/24/07 5.7 12.0x 1.4 4.3 n/a 2.8

$307.1 11.5x $68.9 $238.1 ? $153.9Average Equity % = 24.9% Average S&P Decline Since LBO Avg. Close = -43.7%Note: Totals may not add due to rounding. Current debt as of 4/17/09

Page 23: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Capital Structures Are Not Fixed

Exchange Offers

Amendments/modifications

Asset Swaps

Restructuring In/Out of Court

Page 24: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Maturity Waves

$1,388 $1,807 $2,557 $6,101

$48,644 $52,191

$17,752 $12,754 $5,310

$69,369

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Aggregated Maturities of Large –

LBOs

2005–2007

Weighted Average Maturities of Large LBOs

2005–2007

20092010201120122013201420152016

Hilton HCANielsen

FreescaleSunGard

Univision

Servicemaster

US Foodservice

Clear ChannelFirst Data TXU

Dollar General

Alliance BootsIntelsat

Harrah's

Page 25: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

0%

20%

40%

60%

80%

100%

Univision

Allianc

e Boots

Clear Cha

nnel

Nielsen

Freesca

le

Service

Master

Sunga

rdTXU

US Foods

ervice

Dollar G

enera

lFirs

t DataHCA

Harrah's

Hilton

Intels

atBank Debt vs. Bonds

Average

56%% o

f Tot

al D

ebt

Bank Debt

Bonds

Page 26: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

0%

20%

40%

60%

80%

100%

Dollar G

enera

lSun

gard

Intels

atHCA

Nielsen

US Foods

ervice

First D

ata

Allianc

e Boots

Service

Master TXU

Univision

Harrah's

Hilton

Freesca

le

Clear Cha

nnel

Average

65%

% o

f Par

Current market valueas of 4/17/09

Opportunity to capture discount

Mark-to-Market Discount

Page 27: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Surviving Market Downturns

Headlines

Performance Reality

“Buyout Deals Take a Hit During Debt Woes”

11%3%

-3%

Upper Medium Lower

“Even the Smartest Money Can Slip Up”

The New York TimesDecember 2001

“Market Volatility Derails LBOS”

High Yield ReportDecember 2000

Buyouts January 2001

1998 Vintage IRRs

Source:

Venture Economics Vintage Year Performance as of 12/31/08. Represents all private equity funds. Returns are net of fees and expenses.

Page 28: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Randy Wooster slides

Randy WoosterCo-FounderImperial Capital Group

Page 29: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Capital structure opportunities in today’s market environment

Debt repurchase

Deleveraging/ increase of shareholders equity

Reduce interest expense

Stimulus plan tax benefits

Best bid in an illiquid market

Corporate acquisitions

Distressed debt creates purchase at significant discounts

Debt for asset swaps

Avoid 13D disclosures

Off balance sheet

Completion guarantees

Trade claims

Source: Imperial Capital.

Page 30: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Expertise in legal and regulatory process

Legal Regulatory

Deep understanding of the entire capital structure

Structured to avoid characterization as tender or exchange

Use of “Big Boy”

letters

Pure debt repurchases are less burdensome than equity buy backs–Not on an exchange–Not subject to price/volume restrictions

Regulation FD –

Disclosure of material non-public information in private negotiations

Source: Imperial Capital.

Page 31: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

The “Imperial”

model

Back Office•

Experienced settlement team

Bank of New York clearing agent

Capital Markets•

Comprehensive understanding of current pricing environment

Significant experience in developing strategy based on current market conditions

Research, Sales & Trading•

Daily contact with over 1,200 institutions

Reputation for discreet execution

Open market purchase expertiseInvestment Banking

Leverage corporate relationships across Sales & Trading platforms

Expertise in M&A financings and Restructuring

Significant Industry experience

Client

Source: Imperial Capital.

Page 32: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

American Greetings Case Study

Exclusive financial advisor to American Greetings in its $140 million acquisition of Recycled Paper Greetings (RPG), completed in February 2009

Imperial identified the opportunity to gain control of RPG through the purchase of bank debt and proposed the transaction to American Greetings management

Imperial’s Sales and Trading Group created a market for RPG’s bank debt and executed anonymous purchases of its 1st Lien Term Loan through a holding company on

behalf of American Greetings

American Greetings ultimately acquired 54% of the 1st Term Loan at an average price of 67% of face value

Imperial’s Investment Banking Group then leveraged American Greeting’s position as creditor to negotiate a consensual transaction with RPG and remaining creditors

American Greetings acquired RPG through a pre-packaged Chapter 11 reorganization process endorsed by RPG’s secured creditors

The Chapter 11 reorganization is expected to provide meaningful tax benefits compared to alternative acquisition structures

Source: Imperial Capital.

Page 33: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

The model In practice

Back Office•

Assisted Investment Banking in creating SPV to acquire securities

Settled transaction in timely manner

Coordinated settlement with counsel

Capital Markets•

Used proprietary “Imperial”

database which identified capital structure opportunity\

Communicated opportunity to company management

Research, Sales & Trading•

Maintained database for pricing distressed private securities•

Identified holders of securities•

Discretely contacted potential sellers•

Discussed with Management appropriate levels

to bid for securities•

Executed trade at proper priceInvestment Banking

Advised Company Management and board to optimal structure and approach

Worked with Back Office to form “Special Purpose Vehicle (SPV)”

to acquire securities in a discrete manner

Advised Company on pre-packaged chapter 11 process

Source: Imperial Capital.

Page 34: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Scott Sperling

slides

Scott Sperling

Page 35: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

6.3x 6.1x6.5x

7.1x 7.4x8.2x

8.6x

9.8x 9.5x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

2000 2001 2002 2003 2004 2005 2006 2007 2008

LBO Purchase Price Multiple

Source: S&P Q1 2009 Leveraged Buyout Review

TEV / LTM EBITDA(Average of Issuers with EBITDA greater than $50 million)

Page 36: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

4.2x 4.1x 4.0x

4.6x4.8x

5.3x 5.4x

6.2x

4.9x

0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

7.0x

2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: S&P Q1 2009 Leveraged Buyout Review

Total Debt / LTM EBITDA(Average of Issuers with EBITDA greater than $50 million)

Leverage Multiple

(excludes Media and Telecom loans)

Page 37: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

50%43%

37% 38%44%

52% 55% 57%46%

14%19%

22% 23%23%

15% 10% 6%

9%

34% 38% 39% 36%32% 31% 33% 36%

43%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Senior Debt Sub Debt Equity Other

3.2x 2.6x 2.4x 2.7x 3.2x4.3x 4.7x

5.6x4.4x

0.9x1.1x 1.4x

1.6x1.7x

1.2x 0.9x0.6x

0.8x2.2x 2.3x 2.5x

2.6x2.3x

2.6x 2.9x

3.5x4.1x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

2000 2001 2002 2003 2004 2005 2006 2007 2008

Senior Debt/EBITDA Sub Debt/EBITDA Equity/EBITDA Other

Purchase Price Breakdown

Source: S&P Q1 2009 Leveraged Buyout Review

Multiple of LTM EBITDA % Contribution

Page 38: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

US Business Debt

US Business Debt Outstanding US Business Debt Outstanding / GDP

Source: Federal Reserve, US Bureau of Economic Analysis

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Nonfinancial Business Debt Financial Business Debt

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Nonfinancial Business Debt Financial Business Debt

($ billions) (%)

Page 39: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

US Household Debt

US Household Debt Outstanding

Source: Federal Reserve, US Bureau of Economic Analysis

US Household Debt Outstanding / GDP

($ billions)

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Mortgage Debt Consumer Debt Other Household Debt

0%

20%

40%

60%

80%

100%

120%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Mortgage Debt Consumer Debt Other Household Debt

(%)

Page 40: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

SocietySociety

Econ

omy

Econ

omy

Industry

Industry

Capital

MarketsCapital

Markets

RegulationRegulation

CompanyCompany

Page 41: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

Fallacy:“Any loan to real estate is a good loan … ”

Fallacy:“Any loan to real estate is a good loan … ”

Page 42: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

19901990

The latest run-up of home prices

was extraordinary

The latest run-up of home prices

was extraordinary

Sources: Robert Shiller, Milken Institute (Annualized growth rate of nominal home index: 3.4%)

18901890 19001900 19101910 19201920 19301930 19401940 19501950 19601960 19701970 19801980 20002000 20102010

WWIWWI WWIIWWIIGreat

Depression

Great

Depression70’s

Boom

70’s

Boom80’s

Boom

80’s

Boom

Latest

Boom

Latest

Boom250250

200200

150150

100100

5050

Index: 2000 = 100

Long-term

trend line

Long-term

trend line

Page 43: Capital Structure Matters - Milken Institute...Liquidity freeze: spread between 3-month LIBOR and overnight index swap rate Daily, July 1, 2007—March 31, 2009 0 50 100 150 200 250

19901990

Home prices don’t go up forever

Change in home prices in 100-plus years

Home prices don’t go up forever

Change in home prices in 100-plus years

Sources: Robert Shiller, Milken Institute.

18901890 19001900 19101910 19201920 19301930 19401940 19501950 19601960 19701970 19801980 20002000 20102010

WWIWWI WWIIWWIIGreat

Depression

Great

Depression70’s

Boom

70’s

Boom80’s

Boom

80’s

BoomLatest

Boom

Latest

Boom30%30%

20%20%

10%10%

0%0%

-10%-10%

-20%-20%

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First RepublicBank CorporationFirst RepublicBank Corporation

Most Texas Banks were AAA in the 1980sMost Texas Banks were AAA in the 1980s

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The prices of residential estate in Houston (in real terms) declined 40% from 1983-1988.

-

OFEHO Housing Index / FRB study

The prices of residential estate in Houston (in real terms) declined 40% from 1983-1988.

-

OFEHO Housing Index / FRB study

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Foreclosures in HoustonForeclosures in Houston

30,00030,000

20,00020,000

19801980

10,00010,000

1,0001,00019861986 19921992

Source: Harris County Foreclosure Listing ServiceSource: Harris County Foreclosure Listing Service

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Annual U.S. Bank Failures 1979-2007Annual U.S. Bank Failures 1979-2007

Source: FDIC

200200

150150

100100

5050

19801980 19851985 19901990 19951995 20002000 20052005

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The Mortgage Problem in PerspectiveThe Mortgage Problem in Perspective

80 million houses80 million houses25 million (31%) are paid off25 million (31%) are paid off

55 million have mortgages 55 million have mortgages 49 million (89%) are paying on time49 million (89%) are paying on time

6 million are behind6 million are behind(11% of 55 million with 3% in foreclosure)(11% of 55 million with 3% in foreclosure)

Sources: U.S. Treasury, Milken Institute / 4-23-09

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The Mortgage Problem in PerspectiveThe Mortgage Problem in Perspective

(9.2% of 53 million with 2.8% in foreclosure)(9.2% of 53 million with 2.8% in foreclosure)

This compares to 50%

seriously delinquent in

the 1930s.

80 million houses80 million houses

55 million have mortgages 55 million have mortgages 49 million (89%) are paying on time49 million (89%) are paying on time

6 million are behind6 million are behind

Sources: U.S. Treasury, Milken Institute / 4-23-09

25 million (31%) are paid off25 million (31%) are paid off

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Microsoft•

ADP•

Exxon-Mobil•

Johnson &

Johnson

Microsoft•

ADP•

Exxon-Mobil•

Johnson &

Johnson

AAA-rated Industrial Companies

in the U.S.

AAA-rated Industrial Companies

in the U.S.

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AAA

16,907AA+

240AA

2,098AA-

3,414A 2,602A-

2,027BBB+

903BBB

1,371BBB-

1,359

AAA

16,907AA+

240AA

2,098AA-

3,414A 2,602A-

2,027BBB+

903BBB

1,371BBB-

1,359

BB+

238BB

313BB-

331B+

339B

330B-

1,189CCC+

293CCC

214CCC-

104CC

36C 11

BB+

238BB

313BB-

331B+

339B

330B-

1,189CCC+

293CCC

214CCC-

104CC

36C 11

Investment-Grade SecuritiesInvestment-Grade Securities Non-investment Grade SecuritiesNon-investment Grade Securities

Source: Bloomberg 11/6/08

Standard &

Poor’s Ratings

New Issues: 1/1/2000 to 9/30/2008

Standard &

Poor’s Ratings

New Issues: 1/1/2000 to 9/30/2008

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2%BB-Unrated3%BBB4%A11%AA80%AAA

1%Unrated1%BBB2%A3%AA5%Junior AAA88%Senior AAA

Mortgage bondsMortgage bonds

Mortgage loansMortgage loans

High-grade structured-finance CDOHigh-grade structured-finance CDO

4%Unrated6%BBB6%A8%AA14%Junior AAA62%Senior AAA

2%Unrated3%BBB3%A4%AA27%Junior AAA60%Senior AAA

Mezzanine structured-finance CDOMezzanine structured-finance CDO CDO-SquaredCDO-Squared

Source: International Monetary Fund.

When is a AAA not a AAA?When is a AAA not a AAA?

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Secondary Market Prices of Third-World Debt

Secondary Market Prices of Third-World Debt

2020

3030

4040

5050

6060

7070

8080

100100

19821982 19831983 19841984 19851985 19861986 19871987 19881988 19891989

Cents on the dollarCents on the dollar

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U.S. Lending to Third-World Countries

At Face Value

U.S. Lending to Third-World Countries

At Face Value

$700$700

$900$900

$1,100$1,100

$1,300$1,300

$1,500$1,500

19821982 19831983 19841984 19851985 19861986 19871987 19881988 19891989

$ billions$ billions