Overview: Financial Services Industry What Went Wrong

1
Overview Financial Services Industry - What
Went Wrong What Does it Mean?

• P. Olivier SarkozyManaging Director Financial
  Services Group Head
• November 20, 2008

2
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3
Executive Summary

• What Happened?
• What Role Will Private Equity Play?
• Why We Believe Carlyle is Uniquely Positioned

4
I. What Happened? A Crisis by Many Names
Wachovia Hypo RE Fortis BB Dexia
Lehman AIG WaMu
Money Market Funds
Ireland Euro Summit TARP!
August 2007
Today

• Auto Credit Card Loans
• Commercial Real Estate
• Emerging Market Credit
• U.S. Dollar Weakness

To Come
and One Underlying Common Theme
5
Leverage!

• Reversal of Glass-Steagall in 1999 set off a
  leverage race on Wall Street
• Leverage outside the banking system largely
  unregulated / misunderstood
• Explosion of credit markets allowed each segment
  of risk to be isolatedand further leveraged
• Tiering of risk allowed for multiple layers of
  leverage with limited transparency
• Investors became complacent while regulators
  became overwhelmed

6
While Current Crisis in Many Ways Mirrors Past
Credit Cycles

• Inflated housing real estate values
• Lax monetary policy that lasted too long
• Flat yield curve
• Cheap credit compounded by loss of investor
  discipline
• Weak regulatory framework

Loss of confidence
7
Impact and Extent of Leverage is a
Differentiating Feature

• Total U.S. Credit Market Debt Has Risen to 350
  of GDP
• European Credit Market Debt is More Than 300 GDP

Total Credit Market Debt / U.S. GDP (1)
Euro Area Credit Market Debt / GDP (2)
325

350

Today
300
310
275
Great Depression
270
250
230
190
225
150
200
1925
1935
1945
1955
1965
1975
1985
1995
2005
2000Q1
2002Q1
2004Q1
2006Q1
2008Q1

• Ned Davis Research, 2008
• European Central Bank. Data provided 11/08

8
Impact and Extent of Leverage is a
Differentiating Feature

• Leverage largely put on outside the regulated
  banking market

Share of Intermediation Through Banks
Securities Markets (1)
Global Issuance of Structured Finance Products
(2)

(1) Morgan Stanley. Levered Losses Lessons
Learned from the Mortgage Market Meltdown
2/08 (2) Lehman Brothers. Data provided 8/28/08
9
Impact and Extent of Leverage is a
Differentiating Feature

• As both Wall Street and traditional commercial
  banks enhanced their leverage

Total Assets of Top 5 Brokers (1)( tril)
Bank Leverage (2)
16 CAGR
6 CAGR
Q3 08
(1) SNL Financial. Top brokers traded on the NYSE
and NASDAQ (2) Source SNL Financial. Data as of
11/08
10
Anecdotes of Leverage

• Total assets of the top 5 brokerage houses in the
  U.S. equaled approximately 35 of the total U.S.
  annual GDP. Balance sheets were levered on
  average 301(1)
• In 1998, failure of Long Term Capital brought
  markets to their knees, based on a loss of 4.6
  bil.(2) To-date system has incurred more than
  100x(3) this amount. Industrys capital base
  increased by only 2.5x that during this time(4)
• 2.3 tril in AAA guarantees supported by six
  monolines with less than 20 bil in equity
  (0.8)(5)
• In June 2007, financials made up 20.9 of SP
  500(6)
• Implies that approximately 30 of every dollar
  earned by an SP 500 company was earned by a
  financial services firm

• SNL Financial. Data as of Q4 2007
• Financial Times. Bank bailout shows need to
  intervene, 6/08
• Loss estimate to-date of 550 bil provided by
  Goldman Sachs. Data provided on 10/10/08.
  Inflation data provided by the U.S. department
  of Labor
• SNL Financial. As measured by tangible capital
  base of top 25 U.S. financial institutions
  (excluding insurance companies, from 1998 to Q2
  2008)
• Pershing Square Capital Management. How to Save
  the Bond Insurers, 11/07
• Standard Poors

11
The Leverage Game
Consumer
10 to 1
Mortgages
Cash
Loan Origination
50 to 1 (Warehouse)
Cash
Mortgages
Wall Street
50 to 1
Mortgages
Cash Fees
15 to 1
Structured ABS Ratings Agencies
Cash
AA Below
AAA
Cash
70FNMAFHLMC
30 BankInsurance Companies
CDOs
Wall Street
Cash
Notes
AAAs, AA, A, BBB, BB
400 to 1 Leverage
Equity
30 to 1
Source Wachovia Securities, Lifestyles of the
Rich and Living Rich,A Tale of Two Consumers,
2005
12
Risk vs. Information
Those who knew the most held the least amount of
the risk
Originator
Warehouse Provider
Senior Bonds
Underlying Collateral Knowledge
Mezzanine Bonds
Sub Bonds
Efficient Frontier
Residual Notes
CDO Equity
Least
Most
Performance Risk
while those who knew the least ended up holding
the most risk
Source Wachovia Securities, Lifestyles of the
Rich and Living Rich,A Tale of Two Consumers,
2005
13
Make No Mistake We Are at the Early Stages of
This Crisis

• As shown by the inability of the nations 20
  largest banks to deleverage, transition will take
  time

• Consumer slow to react has yet to adjust to new
  realities
• We have yet to talk about the impact of looming
  issues autos, credit card commercial RE
• Weak political leadership will prolong recovery

Total Assets of Top 20 Banks (tril)

Source SNL 11/08 Top banks traded on the NYSE
and NASDAQ
14
Still in Early Innings

• Industry has taken less than 50 of losses
  estimated by most responsible analysts
• Pimco 1.0 tril(1)
• Federal Reserve 1.2(2)
• Paulson Co. 1.3(3)
• IMF 1.4(4)
• Goldman Sachs 1.6(5)

Loss Estimates
Losses Realized To-date
Rest of
world
(
figures in bil)
U.S.
Europe
Total
Brokers
98
79
1
178
Banks
211
109
14
334
Specialty Finance
37
--
--
37
Insurance Asset
--
7
39
Mgr
45
Total
385
193
15
594
Source Goldman Sachs Research. Data provided
10/29/08

• Bill Gross of Pimco. Investment Outlook
  Mooooooo! 7/08
• Federal Reserve Board, Foreign Exposure to
  Asset-Backed Securities of U.S. Origin 8/08
• Bloomberg, Paulson Co. Says Writedowns May
  Reach 1.3 Trillion, 6/08
• International Monetary Fund, Global Financial
  Stability Report, 10/08
• Goldman Sachs, Americas Financial Services
  11/08

15
Consumer Access to Credit Is Dwindling

• Credit conditions are dire
• US Consumer credit fell by a record 7.9 billion
  in August, the first drop since 1998 and the
  largest decline in history(1)
• Consumer no longer able to use house as an ATM
• Home equity withdrawals shrinking from
  approximately 700 bil in 2006 to under 150 bil
  today(2)
• Private sector interest rates are not abating, at
  8 despite Fed rate cuts

Monthly Net Increase in Consumer Credit
Outstanding(3)

• Federal Reserve, Consumer Statistical Release,
  10/07/08. Federal Reserve began tracking consumer
  credit in 1943.
• Nouriel Roubini, 9/08
• Greed Fear, 10/09/08

16
The Recession Will Broaden And Intensify

• Tighter credit and lower house prices will
  severely depress consumption (73 of US GDP in
  2007)(1)

• Data provided by the Bureau of Economic Analysis,
  10/08
• The Federal Reserve Bank Officer Lending Survey,
  07/08
• Zellman and Associates. 09/07

17
The Recession Will Broaden And Intensify

• The already stretched consumer will become a
  distressed consumer

Consumer Spending on Energy, Interest Payments,
Medical Expenses, Food and Taxes as a Share of
Personal Income (), 1980-2008
()
Source The Gloom, Boom Doom Report (David
Rosenberg, Merrill Lynch Federal Reserve Board)
8/08
18
The Credit Crisis Has Struck Europe With A
Vengeance
21x

• We believe Europes economies are at least as
  vulnerable as the United States
• Leverage levels are higher, house prices are
  inflated, and economies are more service-focused

Bank Leverage Europe vs. USA(1) (Assets/Equity)
UK Household Debt/Income ()(1)
USA
Europe
Source (1) Citibank, A Downward Spiral.
09/17/08
19
Much of the Rest of the World Will Follow in
America Europes Footsteps

• Economists are ratcheting down global growth
  estimates
• Key factors likely to suppress growth
• Global deleveraging
• Lower capital flows to emerging markets
• Reduced G-7 demand for imports
• Lower demand for commodities
• Key 2009 GDP growth forecasts(1)

(1) Goldman Sachs, 10/08
20
Landscape of the Financial Services Industry Will
Look Markedly Different

• Financial services industry will restructure
• Investment banks will have to dramatically
  de-lever
• Non-traditional consumer borrowing will largely
  disappear
• Wholesale funding models may never come back
• Flight to quality will (has) force(d) high level
  of consolidation
• Heightened levels of receivership
• Those without differentiation will merge
• Other sectors likely to experience change
  include
• Wealth management sector in the U.S. will more
  closely resemble European model to the detriment
  of brokers
• Wall Street firms will lose share to specialty
  providers
• Commercial banks that survive will experience a
  golden age as re-intermediation drives outsized
  growth

21
Some Predictions
We Believe The Worst Has Yet To Come

• Problems with commercial real estate and auto
  lending will be as big of a story as
  residential real estate has been
• TARP will temporarily re-lubricate, but will fail
  to bring markets back towards equilibrium
• Financial Services Sector will shrink to be
  approximately 10 of the SP 500
• Recent dollar strength will prove to be temporary
  

22
II. What Role Will Private Equity Play?

• A unique role in the recapitalization of
  the industry
• High volatility / low transparency limits the
  role of the public markets
• Equivalent of buying a lottery ticket absent an
  ability to complete significant due diligence
• Private equity has the capacity, competency and
  mandate to undertake due diligence evaluate /
  structure transactions
• However, limited financial services expertise
  currently exists in the industry
• While governments are able to provide cheap
  capital, we believe only private sources of
  capital can provide the confidence that these
  institutions need to reestablish
• Will result in private and government capital
  working together

23
Private Equity to Play a Unique Role

• Supply / demand imbalance will allow for
  outsized returns
• Industry still likely to need close to 500 bil
  in new equity
• Top 3 PE funds dedicated to Financial Services
  have less than 20 bil in capacity(1)
• While co-investment by LPs could increase
  available capital by 2-3x, lack of available /
  advisable leverage limits available capital
• Should allow PE to be thoughtful and demanding
  (has not generally been the case to date)
• Importantly, PE shops able to instill confidence
  (in addition to injecting capital) will be able
  to charge dearly for their capital

(1) Carlyle estimates
24
Non-Credit Situations The Current Opportunity

• We believe growth capital opportunities are
  currently plentiful and attractively priced
• High growth, non-credit exposed opportunities
  available at 20 pre-tax cash returns exist in
• HNW Industry to restructure with traditional
  platforms benefitting at the expense of brokerage
  channels
• Agency brokerage Taking share from Wall Street
  benefits from market volatility
• Start-up opportunities also potentially of
  interest
• Formulation of a new rating agency paradigm
• Opportunity to roll up seized and / or troubled
  community banks
• In each of theses instances, we believe the value
  of Carlyles brand and capabilities puts us at a
  unique advantage

25
Credit Situations A New Approach Is Required

• While still too early, credit situations will
  eventually represent a very large opportunity
• Traditional approval based on industrial
  experience simply does not work
• Reestablishing counterparty confidence is as
  important, if not more important, than the
  capital being infused
• You have to do the work - may be boring, but its
  a sine qua non
• Recapitalization must solve the problem
  subsequent dilution too expensive / onerous
• Government will oftentimes need to act as a
  partner

26
Carlyle Team Ideally Suited for Current Market
Opportunity
Investment Team
Core Strengths
Investment Team

• Strategic access to and trust of impacted
  management teams boards
• Significant investment banking experience
• First class management due diligence experience
• Ease of access to all relevant regulatory
  agencies
• 20 years of proven investment experience within
  Carlyle Platform

James H. Hance, Jr. Investment Committee Former
Vice Chairman CFO at Bank of America
Christopher V. Dodds Senior Advisor Former EVP
CFO at Charles Schwab Corporation
Randal K. Quarles Managing Director Former
Undersecretary of the Treasury
P. Olivier Sarkozy Managing Director Former
Global Head of FIG Investment Banking at UBS
John C. Redett Principal Former VP at Goldman
Sachs, JP Morgan CSFB
James F. Burr Managing Director Former Treasurer
at Wachovia
R. Keith Taylor, Jr. Vice President Former VP at
Goldman Sachs JP Morgan
A. Reed Deupree Vice President Former Analyst at
Legg Mason Capital Management
One Carlyle Platform