Current Credit Crisis

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Current Credit Crisis

• Joseph N. Boland, Principal
• The Alta Group
• LAR Miami
• November 13, 2008

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Agenda

• Overview of Current Credit Environment
• Policy/Process and Tactical Actions

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Global Credit Environment

• Concerns surfaced re U.S. 12 Trillion mortgage
  market in early/mid 2007
• Slowing of growth, then decreasing values of
  residential real estate in the U.S.now down 19
  in 20 largest US markets
• Overall Residential Mortgage Delinquency rate up
  sharply
• For sub-prime( apx 1.25-1.5T), Fitch reports the
  60delinquency rate is running 27 currently for
  the 2006 cohort
• Many mortgages rolled into securitized
  instrumentsCLO, CDOs and are widely held----and
  insured by major credit insurers
• Problems spread to consumer credit cards and
  commercial loans
• Moodys expects the junk-bond default rate, now
  2.7, will rise to 7.4 a year from now.

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Comparison of Delinquency/Loss Rates
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Moodys Mortgage Performance
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Global Credit Environment

• Major institutional problems emerge in 2008, due
  to credit concerns based on mortgage and other
  holdings---crisis of confidence
• UBS, Bear Sterns, Merrill, AIG, Fannie
  Mae/Freddie Mac, Lehman Brothers, WAMU, etc
• Major Regulatory interventionFed, ECB and other
  country based central banks----liquidity and
  merger/bailout assistance
• JPMC Total bank losses to date 681 Billion
  New capital raised645 Billion
• Reduction in global lending capacity 4.9
  Trillion
• Most recently, 700 Billion US rescue program to
  take impaired assets off the balance sheets of US
  banksevolving into investment vehicle--TARP

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Global Credit Environment

• Spreads for weaker borrowers up sharply
• BB and B spreads up 225 and 300 basis points
  since end of 2007( now about 490 and 860)
• In US, strong tightening of banks terms and
  conditions
• In US, sharp tightening of banks terms and
  conditions--General reluctance to
  lend---Interbank rates, Commercial paperboth
  very wide spreads, historically

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Global Credit Environment

• Combination of falling commodity prices, the
  credit crisis, and the related slowdown in US and
  European economies is impacting the outlook for
  many developing economies, dependent on OECD
  markets---risk level is up
• EMBI index of Emerging Market bond spreads also
  up
• 684 vs 144 in May, 2007( all time low)
• Numerous examples of spread of credit crisis to
  world economic sphere
• Russia---actions re Georgia, contract revisions
  vis British Petroleum, drop in reserves, stock
  market collapse---possible downgrading
• Venezuela----Reduced oil income, forced
  nationalization of key enterprises, increasing
  disagreements with US and Colombia
• Iceland--- banking meltdown/IMF rescue
• Pakistan crisis----seeking assistance

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Global Credit Environment--Summary

• Large asset/commodity value reductions Real
  estate, Oil, Stock markets
• Many banks and Financing companies damaged
• General level of credit losses will increase for
  several quarters
• Likely increased regulation in the future
• Risk Aversion atmosphere may persist for many
  quarters, if not years
• Terms/Conditions and pricing spreads now favoring
  the creditor
• Economic outlook gloomy---recession in
  developed/OECD countries---slower growth in
  Emerging economiescountry risk increased
• Many borrowers will be squeezed out of the
  marketdebt vs equity risk paradigm

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Global Credit EnvironmentManaging Risk and
Exploiting Opportunity

• Todays environment requires special efforts in
  the risk management area, both policy/process and
  tactical
• Better managed and capitalized financing
  organizations, however, have excellent
  opportunity to grow profit and share

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Global Credit EnvironmentManaging Risk
Policy/Process

• Review business plans and credit policies in view
  of recent events and your organizations risk
  appetite
• Review effectiveness through this cycle of the
  Risk Management functioncoverage, methodologies,
  predictiveness, protections, speed to recognize
  issues, reserving process/assumptions
• Re-assess/re-grade credit portfolios for action ,
  reserving and possible sale purposes
• Re-score automated models and manual scorecards
• Review all contract and collateral documentation
• Assess adequacy of AR and workout staffs for
  todays facts
• Increase the frequency and intensity of customer
  contacts
• Keep senior management informed of all issues

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Tactical Focus

• Low-margin, high- turnover companies such as
  retail and distribution especially vulnerable
  to volume slowdown coupled with increased
  financing costs
• Companies with high levels of floating rate debt,
  particularly at lower end of the rating scale
  increased credit spreads are exceeding base rate
  reductions (prime, LIBOR, etc.)
• Companies with expiring credit commitments from
  the banks, or with need to regularly access the
  capital markets both sources are pulling back
  on availability, and in all cases demanding
  higher spreads and tighter conditions, reducing
  the companys flexibility
• Companies with significant dependence on vendor
  financing programs to move product credit
  availability tightening (credit crunch) is likely
  to impact some vendor financing organizations
  continued commitment to the business

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Tactical Focus

• Low-margin businesses dependent on credit
  insurance backstop to support sales credit
  insurers likely to be increasing prices to
  reflect new market risk paradigm
• Any low-rated company (e.g., ltBBB) highly
  dependent on banks refinancing
• Companies in the midst of a large project or
  transition to a new business model dependent on
  longer-term financing commitments much evidence
  in the market of lenders/underwriters backing off
  commitments wherever possible
• Companies highly dependent on exports to the
  U.S. impacted by slowing economy and
  strengthening dollar conversely, companies
  dependent on increasingly higher-priced imports
  for components or finished product
• Companies buying in dollars and selling in local
  currency

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Tactical Focus

• Banks and financing companies already well
  publicized, but many in this segment highly
  dependent on credit funding and asset quality are
  suffering. Be wary especially of marginal players
  in the financing business vulnerable to
  bank/capital market pullback
• Companies selling to the banking industry, e.g.,
  specialized software companies, certain
  consultants/training companies
• Retail and distribution as noted, low-margin
  businesses vulnerable to economic slowdown,
  higher rates, and credit availability
• Construction/real estate businesses in the U.S.
  and Western Europe, and those dependent on robust
  real estate sales
• Domestic U.S. airline industry and major
  suppliers usually impacted by economic
  slowdown, but further recently impacted by higher
  fuel costs
• Domestic US auto manufacturers and suppliers
• Mortgage brokers
• Certain credit insurersincluding yours

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Tactical Focus

• Small and mid-sized businesses/enterprises
  (SMB/SME) while not an industry group,
  generally have a tough time in this type of
  environment tend to be exposed to a narrower
  client base in their own business (high
  concentration), rely heavily on bank financing,
  and may be especially vulnerable to tightening
  repayment conditions.
• If your company relies on standard application
  scoring for parts of this segment, then we
  recommend
• 1. Analyzing the portfolio performance for each
  changein credit underwriting policies for the
  past three years.2. Analyzing performance of
  industries and equipment typesadded in the past
  three years with remaining portfolio.3.
  Revalidating scoring model predictability
  traitsfor transactions added in the past three
  years

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Warning Signs

• Requests for increased lines and /or extended
  terms from your customers and distributors may
  reflect reduction of bank or other vendor credit
  availability
• Increase in disputed accounts receivable many
  actual credit-related delinquencies and
  write-offs start out as dispute claims
• Lower take-up by your customers on offered early
  payment incentives may reflect efforts to
  conserve cash at expense of financial return
• Delays in submitting financial statements or
  agreed-upon financial submissions
• Key management changes in your customers
  organization
• Oblique inquiries from other suppliers/financers
  to your client about performance

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Warning Signs

• Industry patterns in your accounts receivable
  performance e.g., if all of your retail
  business customers are slowing
• Banks and finance companies declaring exits from
  certain sectors indicates a risk/return pattern
  not favorable in that segment
• Lower PayDex or other market indicator scores
  related to your market
• Reduced risk appetite/higher pricing from your
  vendor financing partners for your customers
• On credit insurance, lower limits and /or higher
  specific prices for segments or particular
  accounts
• Loss of major contracts by the customer
• Rating agency downgrades, specific to your
  customer, or even for companies in the same
  industry segment indicates perhaps some general
  problem affecting the segment

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Global Credit EnvironmentExploiting Opportunity

• Stronger banks and financing companies, after a
  period of assessment and adjustments, will be
  poised for growth in margins and share
• Lending capacity/willingness is in short supply
• Supported by strong Risk Management operation,
  these firms can take in some portion of the deals
  currently being shunned by the market
• Spreads and better TsCs are long term favorable
• Weaker players may be forced to sell off
  portfolios at attractive prices
• In certain situations, even strong players may
  deem specific segments as non-strategic,
  creating growth/portfolio acquisition
  opportunities for others-eg leasing, SMB space,
  selected industries