Construction institute1.16.09ii

The World’s Financial Crisis

What Happened and When will it be Over?

Robert W. FrentzelExecutive Vice President and Managing Director

The PrivateBank

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Discussion Points

State of US Economy

State of the Capital Markets

What does it mean for you?

Question & Answer

State of the U.S. Economy

State of the U.S. Economy

FROM

IRRATIONAL EXUBERANCE

TO

IRRATIONAL ANXIETY

The Future?

“HOPE IS NOT A STATEGY”New York Federal Reserve President

Timothy Geither

Credit crisis has triggered dramatic deleveraging cycle

Aggressive government and Central bank intervention has averted systemic meltdown but painful adjustment period remains

Some improvement in money markets, but capital markets remain highly strained

New issuance volume is anemic and credit spreads still at record highs

Easing cycle is over

Shift toward fiscal stimulus likely to push up long-term rates

Overview of current Financial environment

Credit writedowns exceeding $1 trillion

Government rescue package exceeding $1 trillion and contingent liabilities of $8 trillion

170,000+ lost jobs in financial services, U.S. economy lost 2.5 million jobs

Homeowner equity declined by $5 trillion (25%)

World stock market capitalization declined from $62 trillion to $28 trillion

U.S. stock market capitalization declined from $19 trillion to $10 trillion

The growing cost of the crisis

Recovery Not expected till late in 2009

Quarterly Change, AnnualizedQuarterly Change, Annualized

“Potential”

Est.

Source: U.S. Department of CommerceBlue Chip Economic Indicators, December 2008; Bureau of Economic Analysis

Credit crisis creates unprecedented interest rate volatility…

1m LIBOR, Fed Funds, and Prime

Targeted Funds Rate: Active Monetary Intervention

Source: Federal Reserve Board

Target 0 - 0.25%

Unemployment at 16 year high and likely to increase

Source: Bureau of Labor Statistics December 2008

“Trillion dollar deficits for years to come…”

Bear market wipes out five years of gains…

U.S. market capitalization has declined from $19 trillion to $10 trillion over the past year.

S&P 500 Index

0

200

400

600

800

1000

1200

1400

1600

1800

Dec-74Dec-76Dec-78Dec-80Dec-82Dec-84Dec-86Dec-88Dec-90Dec-92Dec-94Dec-96Dec-98Dec-00Dec-02Dec-04Dec-06

Jan 1975 - Jan 199510% ann gain or12% w ith dividends

Jan 1995 - Aug 2000 23% ann gain or 25% w ith dividends

Feb 2003 - Oct 2007 14% ann gain or 16% w ith dividends

Aug 2000 - Feb 2003 45% correction

Oct 2007- Nov 2008 44% correction

*estimates

Sources: Investment Company Institute; Employee Benefit Research Institute (2008 estimate); WSJ

Not many can afford To retire

Correction Will Take Time

Home Ownership Rate peaked in 2005

60%

62%

64%

66%

68%

70%

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

A Correction Seemed Likely In Certain Markets

0

20

40

60

80

100

120

140

Washington DC

FloridaCalifornia

Hawaii Nevada

US Average

Percentage %

TOP STATES FOR HOME PRICE APPRECIATION (01-06)

Source: LoanPerformance

Fed intervention pushes mortgage rates to all time lows…

Housing Market Beginning to Clear at Low Levels

Source: MDA DataQuick and KBW calculations.

Third Quarter Home Resales in California

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

3Q95 3Q96 3Q97 3Q98 3Q99 3Q00 3Q01 3Q02 3Q03 3Q04 3Q05 3Q06 3Q07 3Q08

# of CA Home Resales

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

Median CA Home Price ($)

Non-REO Resales REO Resales Median CA Home Price

Deleveraging Begins with the Consumer

Source: U.S. Department of Commerce: Bureau of Economic Analysis and KBW research.

* Personal savings as a percentage of disposable personal income. Saving from current income may be near zero or negative when outlays are financed by borrowing (including borrowing financed through credit cards or home equity loans), by selling investments or other assets, or by using savings from previous periods.

** Monthly data updated through October 2008.

Long-term rates at historic lows…

State of the Bank Markets

Source: SNL Financial. Data as of 1/8/09. The KBW Regional Banking Index (KRX) is an equal weighted index of 50 geographically diverse companies representing regional banking institutions listed on U.S. stock markets.

KBW Regional Bank Performance

KBW Regional Bank Index (KRX)

40

50

60

70

80

90

100

110

120

Subprime cracks

Investment banks freeze fund

withdrawls & inject capital

Commercial paper market disappears

Crisis in confidence in investment bank balance

sheets

New Century fails ($17B subprime

mortgage originator)Largest single month decline for leveraged

loan market

First SIV Failure - Cheyne Financial ($8B)

Bank of America Liquidates $33B

money market fund

40

50

60

70

80

90

100

110

KBW Regional Index (KRX) S & P 500

Source: SNL Financial. Data as of 1/8/09. The KBW Regional Banking Index (KRX) is an equal weighted index of 50 geographically diverse companies representing regional banking institutions listed on U.S. stock markets. Note: This graph is a continuation of the graph on the previous page.

KBW Regional Bank Performance (continued)

40

50

60

70

80

90

100

110

KBW Regional Index (KRX) S & P 500

KBW Regional Bank Index (KRX) 2008 & 2009 YTD

40

50

60

70

80

90

100

110

Bear Stearns Fails 3/14/08

IndyMac Fails7/11/08

Fannie/Freddie capital concerns

7/8/08

Leveraged loan market legs down

M arch 2008

More write-downs / capital raises for I -banks

June 2008

11 Bank Failures in '08; FDIC's "Problem Lis t"

grows to 1178/27/08

Fannie/Freddie bail out by government

9/8/08

Bank of America buys Countrywide Financial for 31% of book value

1/10/08

Lehman Bros. files for Chapter 11. BAC

acquires MER for $47B9/15/08

AIG bail out by government

9/17/08

Short selling suspended for 799 f inancials

9/18/08

Government plans on buying $700B in

banks' mortgage debt

9/19/08

WM bought out by JPM

9/25/08

C buys WB with government assistance

9/29/08

WFC acquires WB for $7 per share

without government assistance

10/3/08

Dow down 21% in last 7 trading days

10/9/08

COF buys Chevy Chase Bank

12/3/08

WFC / WB merger approved by FED

10/12/08

Treasury des ignates $250B for senior

preferred equity in large banks

10/14/08

PNC buys NCC for $2.23 per share

10/24/08

Oil hits 3 year low below $50 a barrel

11/20/08

Citigroup receives 2nd government bailout

11/24/08

Deflat ion in America rumored11/21/08

Number of problem banks and thrif ts

jumps to 17111/25/08

GS, MS, JPM, & other banks sell govt. backed

notesWeek of 11/24/08

Since Sept. 1, 19 financial companies have

become bank holding companies, including GS,

MS, AXP12/17/08

Enemployment rises to 7.2%. The highest it has

been in 16 years1/9/08

Phase I – The Sub-Prime Crisis

April 2007 – New Century, largest U.S. sub-prime lender, files for bankruptcy

July 2007 – Bear Stearns closes 2 hedge funds after banks refuse bail out, Bernanke warns crisis could cost up to $100 billion

August 9, 2007 – Interbank lending market seizes up

September 18, 2007 – Fed cuts funds rate by 50 bp to 4.75% beginning easing cycle

Jan 11, 2008 – Bank of America acquires Countrywide Financial for $4 billion

Phase II – The Liquidity Crisis

March 16, 2008 – Bear Stearns acquired by J.P. Morgan for $2 per share

July 13, 2008 – Federal regulators seize IndyMac

September 7, 2008 – Government takes over Fannie Mae & Freddie Mac

Capitalism in crisis

Phase 3 – The Solvency Crisis

September 15, 2008 – Lehman Brothers files for bankruptcy, Bank of America acquires Merrill Lynch for $50 billion

September 16, 2008 – Fed announces $85 billion rescue package for AIG

September 18, 2008 – Reserve primary fund “breaks the buck” triggering exodus from money market funds

September 19, 2008 – Bush announces plan to buy troubled assets from financial firms, Treasury guarantees money market funds

September 22, 2008 – Goldman Sachs & Morgan Stanley convert into bank holding companies

September 25, 2008 – Federal regulators seize WaMu and sell it to J.P. Morgan for $1.9 billion

September 30, 2008 – FDIC increases deposit insurance to $250,000

October 3, 2008 - House approves revised $700 billion economic rescue package by vote 263-171 and President Bush signs into law, Wachovia snubs Citigroup and agrees to be purchased by Wells Fargo for $15.1 billion


October 13, 2008 - Treasury launches Capital Purchase Program making mandatory investments of $125 billion in 9 banks

October 14, 2008 - FDIC extends unlimited deposit insurance to non-interest bearing deposit accounts

October 24, 2008 - PNC acquires Nat City for $5.2 billion using TARP funds

November 12, 2008 – Treasury abandons plan to buy up bad debt and instead says it will use remainder to help revive consumer lending

November 24, 2008 – Citigroup receives an additional $20 billion capital investment and $306 billion loan guarantee from government

November 25, 2008 - Fed announces plans to buy $600 billion of agency debt and mortgage-backed bonds and establishes $200 billion program to support consumer and small-business loans

December 12, 2008 – Senate rejects House-approved bailout plan for GM & Chrysler

December 16, 2008 - Fed cuts fed funds rate 75 bp to “target range” of 0 - .25%

December 19, 2008 - Treasury agrees to extend $13.4 billion in emergency loans to GM & Chrysler


January 8 , 2009 - U.S. employers cut 524,000 jobs in December, capping the worst year of job losses since 1945

January 12, 2009 - President-elect Obama asks President Bush to request second $350 billion installment of TARP funding

January 15, 2009 Bank of America requests additional $20 billion


Note: Period ending balance is used to calculate loan compositionSource: SNL DataSource, FDIC, and KBW Research

Loan Composition, FDIC-Insured Commercial Banks

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Residential Mortgage

Home Equity

Commercial Real Estate

Construction

Commercial

Credit Card

Other ConsumerLeasesOther

Over 50% of

portfolios~25% of

portfolios

State of the Bank Markets

Bank portfolios transitioned to higher risk, real estate heavy assets

— Higher fees and search for asset growth fueled C&D lending— Real estate represented over 50% of bank portfolios in 2007

The “securitization” of banking

Accommodative monetary policy

Mark to market accounting

Relaxed capital requirements

Affordable housing targets

Financial innovation (e.g., option ARM)

Over reliance of past performance as predictor of the future

How did we get here?

Source: SNL Financial. Data as of 9/30/08. Note: Metric is the median of the top tier consolidated banks and thrifts with assets greater than $500 million.

5B-$30B in Assets All Banks and Thrifts

Competition Among Banks Drove Behavior Net interest margins fell steadily from 1995 – 2008YTD

— Competition among lenders caused spreads to narrow substantially

— Competition for deposits created increased borrowing costs and dependence on wholesale deposit sources

— De novo banks formed at unprecedented pace heightened competitive dynamics

Financial Institutions are not being paid for the risk

Net Interest Margin (%)

3.25

3.50

3.75

4.00

4.25

4.50

4.75

5.00

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1 '08 Q2 '08 Q3 '08

Source: SNL Financial. Data as of 9/30/08. Metric displayed is the median. Note: Analysis includes top tier consolidated banks and thrifts with assets greater than $500 million. NPAs include nonperforming loans and leases, renegotiated loans and leases, and real estate owned.

Bank Loan Portfolios are Undergoing Significant Distress


NPAs have spiked over the last several quarters, increasing from $39B in December of 2006 to over $150B currently (9/30/08)

NPAs / Assets (%)

0.20

0.300.40

0.500.60

0.700.80

0.901.00

1.10

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1'08

Q2'08

Q3'08

Construction50%

Agricultural Loans 0%

Commercial 17%

Consumer & HE 13%

Multi-Family 4%

Commercial RE 14%

Foreign RE Loans

2%

Non-accrual loans for nationwide banks and thrifts with greater than $500 million in assets, excluding 1-4 Family Loans:6/30/06 9/30/08

$13.4 billion $65.4 billion

Magnitude of Nonperforming Loans

Consumer & HE15%

Commercial45%

Agricultural Loans

1%Multi-family

2%Commercial RE

18%

Foreign RE Loans

9%

Construction 7%

Source: SNL Financial. Data as of 9/30/08.

Credit write-downs reach $1 trilllion…

Writedowns ($bn)

Capital Raised ($bn)

Job Cuts

Wachovia $96.50 $11.00 8,393Citigroup $65.70 $74.00 23,660AIG $60.90 $64.90 980Freddie Mac $58.40 $7.00 -Fannie Mae $56.00 $15.60 -Merrill Lynch $55.90 $29.90 5,720UBS $48.60 $30.60 9,000Washington Mutual $45.60 $12.10 4,200HSBC $33.10 $4.90 2,780Bank of America $27.40 $55.70 11,150National City $26.20 $8.90 4,900J.P. Morgan $20.50 $44.70 4,100Wells Fargo $17.70 $41.80 500Morgan Stanley $15.70 $24.60 9,178RBS $15.10 $48.30 10,200Lehman Brothers $13.80 $13.90 13,390

* cumulative losses through November 16,2008

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

Q42008

Q32008

Q22008

Q12008

Q42007

Q32007

Prior

Cumulative job losses

$0

$200

$400

$600

$800

$1,000

$1,200

Cumulative writedowns & capital raised ($billions)

Cumul Job Losses (right axis)

Cumul Writedowns (left axis)

Cumul Capital Raised (left axis)

Historical Bank Offering Activity Levels

Source: Dealogic. Note: US and Puerto Rican bank IPO, follow-on, 144A, PIPE and Convertible offerings since 1998. As of January 9, 2009.

$213.8 $234.8 $6.0 $124.9 $421.4 $558.6 $385.0 $190.7 $77.6 $0.0

$2,277.1 $283.0 $1,867.2 $794.3 $2,537.4 $2,001.8 $1,426.1 $1,445.3 $315.7 $54,097.5

$465.0 $419.5 $2,840.4 $855.0 $3,807.5 $2,092.2 $4,500.0 $3,500.0 $6,708.3 $31,873.2

$2,955.9 $937.3 $4,713.5 $1,774.2 $6,766.3 $4,652.6 $6,311.1 $5,136.0 $7,101.6 $85,970.8

$2,956 $937 $4,714 $1,774$6,766 $4,653 $6,311 $5,136 $7,102

$85,971

$0

$10,000

$20,000$30,000

$40,000

$50,000

$60,000

$70,000$80,000

$90,000

$100,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

0

10

20

30

40

50

60

Only $44.3B Raised in the Previous

Decade

Over $151 billion if capital from

Sovereign Wealth Funds included

$213.8 $234.8 $6.0 $124.9 $421.4 $558.6 $385.0 $190.7 $77.6 $0.0

$2,277.1 $283.0 $1,867.2 $794.3 $2,537.4 $2,001.8 $1,426.1 $1,445.3 $315.7 $54,097.5

$465.0 $419.5 $2,840.4 $855.0 $3,807.5 $2,092.2 $4,500.0 $3,500.0 $6,708.3 $31,873.2

$2,955.9 $937.3 $4,713.5 $1,774.2 $6,766.3 $4,652.6 $6,311.1 $5,136.0 $7,101.6 $85,970.8

$0

$10,000

$20,000$30,000

$40,000

$50,000

$60,000

$70,000$80,000

$90,000

$100,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

0

10

20

30

40

50

60

Deal Value ($mm) # of Deals

Mill

ion

s ($

)N

um

ber o

f Deals

Reserves / Loans (%)

1.10

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1 '08 Q2 '08 Q3 '08

Reserves / NPAs (%)

50.00

100.00

150.00

200.00

250.00

300.00

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1'08

Q2'08

Q3'08

Source: SNL Financial. Data as of 9/30/08. Metric displayed is the median. Note: Analysis includes top tier consolidated banks and thrifts with assets greater than $500 million.

Accounting dictates, lax credit underwriting standards and overly optimistic reserve levels have caused under reserved balance sheets for most U.S banks, necessitating significant adjustments

Balance Sheets are Not Positioned to Cover Losses



0

56

112

168

224

280

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

0

120

240

360

480

Source: FDIC. 1/12/09.

Nationwide Bank & Thrift Failures

Bank & Thrift Failures since 1990Bank & Thrift Failures since 1990

Bank and thrift failures remain well below those levels seen in the early 1990s, though they are on the rise, with year-to-date failures already exceeding all of 2007.

Aggregate Assets ($B)

Number of Failures

# o

f F

ail

ure

sA

gg

reg

ate

As

se

ts ($

B)

2008 CountCA 5GA 5NV 2FL 2MO 2TX 2WA 1AR 1KS 1WV 1MI 1MN 1IL 1

Total 25

Searching for a Second Derivative on Credit

Source: ABX Net, company reports, and KBW calculations

Delinquency Data

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

Jan-07Feb-07Mar-07Apr-07May-07Jun-07Jul-07Aug-07Sep-07Oct-07Nov-07Dec-07Jan-08Feb-08Mar-08Apr-08May-08Jun-08Jul-08Aug-08

Subprime* Option ARMs**

0.00%

0.25%

0.50%

0.75%

1.00%

1.25%

1.50%

1.75%

2.00%

2.25%

2.50%

2.75%

3.00%

Jan-07Feb-07Mar-07Apr-07May-07Jun-07Jul-07Aug-07Sep-07Oct-07Nov-07Dec-07Jan-08Feb-08Mar-08Apr-08May-08Jun-08Jul-08Aug-08

Home Equity*** Prime****

* Total subprime delinquencies as represented by ABX.** Downey Financial NPAs, excludes total debt restructured.*** Washington Mutual: nonaccrual prime home equity loans as a percent of WM's prime home equity held for investment loan portfolio; data represents quarter (e.g., Mar-07 = 1Q07).**** Freddie Mac single-family delinquencies..

What is next?

•Home equity loans•Credit card loans•Automotive loans•Corporate bonds•Leverage financing•Commercial real estate financing

Home Equity Delinquencies and Net Charge-offs at Banks (in $ billions)

Based on Data filed with Bank regulators. Home equity loans and lines = revolving lines of credit secured by one- to four-family properties + junior lien loans secured by one- to four-family properties. Delinquent home equity = Home equity loans and lines that are more than 30 days past due or non accruing

Source: SNL Financial

Credit spreads hover near record highs…

5 yr Industrial Corporate Bond Spreads over LIBOR

But credit conditions remain tight…

Federal Reserve Senior Loan Officer Survey (% tightened standards or increased pricing)

84%

98%

-100%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

Nov-03Mar-04Jul-04Nov-04Mar-05Jul-05Nov-05Mar-06Jul-06Nov-06Mar-07Jul-07Nov-07Mar-08Jul-08

Tighter Standards

Higher Pricing over COF

Bank lending has increased…

Value of U.S. corporate debt maturing in 2009, in billions

Source: Standard & Poor’s

Significant refinance on syndicated deals

Syndicated-Loan Market / Global Borrowing via Syndicated Loans

Source: Reuters Loan Pricing Corp

Deal flow down significantly

What Does This Mean For You?

Important Underwriting Metrics

Relationships and track record

Liquidity of loan - What is the repayment?

Efficiency of capital employed

Balance sheet strength

Collateral coverage

Backlog analysis

Market expectations

Underwrite your bank

Has it applied for TARP?

Has it opted out of transaction account guarantee program?

What is its portfolio exposure to real estate, charge card, home equity, Auto, etc.

Does your banker understand your WIP?

What is the credit approval process - do they know you?

What is the market saying?

Tougher Credit Environment

The credit markets have tightened

— Higher interest rates and fees— More and tighter covenants— Shorter maturities— Lower total and senior debt multiples— Increased focus on balance sheet strength— Difficult syndication market— 100% financing less readily available— Automakers and other lenders shying away from

leasing due to depressed residual values

Relationships are Key

Relationships continue to drive loan markets

— Unfunded credit facilities exert significant pressure on lenders’ overall relationship returns

— Banks have demonstrated a willingness to commit to credits with returns below their hurdle if prospects for retaining and/or gaining ancillary business are visible

— Returns on new deals being weighted against buying discounted paper in the secondary market

Middle market (EBITDA < $50 million), non-levered (<3.0x Total Debt/EBITDA) transactions continue to get done

— Well structured, well priced transactions— Solid borrower track record— Sensible use of funds— Support from relationship lenders

Debt Market Observations

Underwritten financings designed for syndication to CLO funds

High leverage

Cheap Pricing

Commodity Lending

Quick and narrow marketing

Token diligence

Big LBOs

Dividend recaps / refinancings

“Story deals”

Covenant-lite 2nd lien junior debt

Low / modest flex provisions

Club deals

Prudent leverage

Wider spreads

Relationship lending

Longer and broader marketing process

Smaller “middle market” deals

Limited dividend recaps; growth financings / acquisitions

“Clean” deals

Non-cyclical credits

Traditional covenants

Full flex provisions (pricing, structure)

Lenders are once again underwriting new transactions based on traditional credit standards

What’s Out What’s In

Recession

- A contraction phase of the business cycle, or "a period of reduced economic activity."

- "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP growth, real personal income, employment, industrial production, and wholesale-retail sales”*

- Rule of thumb: Two quarters of negative GDP growth

The Big Question: Recession or Depression?

Depression

- An extended period of chronically weak economic performance and financial instability

- Characterized by abnormal increases in unemployment, restriction of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly devaluations.

- Rule of thumb: 10% decline in GDP

Question & Answer

Construction institute1.16.09ii

Economy & Finance

Transcript of Construction institute1.16.09ii