Transcript Citi CMB Hungary - Central European Business Centre

Implications of Current Economic
Environment on Corporates
Laszlo Balassy
Head of Citi Markets & Banking
Citibank Zrt, Hungary
29 April 2008
Forces Shaping Corporate Finance Priorities Globally
ECONOMIC FORCES
 Slowing US and strong EM growth
 Global housing slowdown
 Declining US dollar
 Rising sovereign wealth
Corporate Finance Priorities
for 2008
 Liquidity disruption
 Repricing of risk
 Increasing volatility
 Rise and evolution of
alternative investors
 Shareholder activism
 Managing Liquidity & Capital Market
Access
 Operating in a New M&A Environment
 Tapping Alternative Capital Markets
 Navigating a New Risk Environment
 Positioning for Long-term Shifts
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 Protectionist sentiment
 Regulatory focus on
climate change
 Continued
geopolitical tensions
in the Middle East
Market Contagion – More Than Just a Subprime Crisis
What had begun as a subprime crisis in the US, morphed into a broad scale evaporation of liquidity. Understanding how this contagion occurred is key to coming to grips with the technicals that continue to dominate
market movements
 Banks had used ABCP to  As banks braced them Fundamental problem in
 Banks were already feeling
finance low-spread AAA
selves to have to take assets
subprime: many of the
overextended, as the LBO
structured credit positions
back on balance sheet, they
loans made to subprime
boom was at its peak and the
preemptively became more
borrowers should not have
banks were “on-the-hook” for  Yet following the ordeal of
reluctant to provide liquidity
been made in the first place almost $500 billion in LBO
the Canadian conduits
elsewhere
commitments
many money market funds
 From actual losses on subbecame cagey about
 Banks became reluctant to
prime loans, we rapidly
 In response, banks’ risk
funding almost any form of
lend to another (term LIBOR
moved to losses on
appetite fell, spreads for
structured
credit
at a premium) because of
tranches of CDOs backed
hedge funds widened, margin
their desire to hoard liquidity
by subprime ABS collateral
requirements were increased  SIVs in particular came
simply in case they have a
and banks started limiting their under fire because of their
need for it themselves
exposure in other areas as
lack of a 100% backstop
well
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liquidity line to a bank
Risk Got Repriced and Volatility Increased Globally
LCDX is an index of CDS covering leveraged loan market.
LevX is a European counterpart
CBOE’s Volatility Index reflects a market estimate of future volatility
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Hungary Is No Exception
10Y Hun.Govt. Bond - 10Y HUF Swap
%
Changes in lending terms for corporates -’07-2H
bps
10Yr bond-swap spread, rhs bp
10Yr HUF swap yield, lhs %
10Yr benchmark bond yield, lhs %
8.80
8.40
120
100
80
8.00
60
7.60
40
7.20
20
6.80
0
Feb-08
Dec-07
Oct-07
Aug-07
Jun-07
Apr-07
Feb-07
Dec-06
Oct-06
Aug-06
Jun-06
-40
May-06
6.00
Mar-06
-20
Jan-06
6.40
Deterioration in
bank’s
capitalisation
HU
CZ
240
PL
200
SK
160
RO
Spread of
Premium
lending rates on riskier
and funding
loans
cost
Obligors’
commitments
Unchanged
Collateral
requirements
Eased
Reasons of tightening in lending conditions
320
280
Price of
credit
commitment
fee
Strictened
Source: NBH, Lending survey of bank sector lending practices among lending officers, 2008 March
10Y Sovereign CDS Spreads
bps
Maximu
m size of
credit
facility
Deterioration in
bank’s
liquidity
position
Worsening
economic
outlook
Worsening
industry
specific
issues
Easing in
market
competition
Lower risk
apetite
BG
120
80
40
5
Mar-08
Jan-08
Nov-07
Sep-07
Jul-07
May-07
Mar-07
Jan-07
Nov-06
Sep-06
Jul-06
May-06
Mar-06
Jan-06
0
1=not significant
3=very significant
Source: NBH, Lending survey of bank sector lending practices among lending officers, 2008 March
How Does it Transmit to the Hungarian Corporate Sector?
Well capitalized and liquid firms (both corporates and banks) may see significant buying opportunities.
Banking Sector
 European banks are dominant in Central Europe
– with less direct exposure to the core of the crisis
 Though secondary impacts (e.g. repricing of risk)
will put pressure on the European banks as well
 Competition and relationship considerations may
limit their ability to pass on repricing
Corporates
 Higher funding cost
 Reduced ability of banks to
intermediate
– Amounts
– Tenors
– Terms
 Balance sheet is becoming a scarce resource
because of
– Liquidity
– Cost of Funding
– Capital Adequacy
– Return on Capital requirements
 Higher Weighted Average Cost of
Capital, lower IRR
 Acquisition financing as a large engine of
corporate banking growth to be challenged by
markets, asset prices, revaluation of collateral
 Growing importance of risk
management in the face of increased
volatility on financial markets
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 Reduced financial flexibility
 Increased refinancing risk
Responding to Changing Liquidity
The optimal capital structure during tighter liquidity can look very different from one appropriate during
robust market conditions, therefore, all companies will benefit from re-evaluating their capital structure
Scenarios
Financial Leverage
 Wider credit spreads
 Interrupted debt market access
 Higher volatility of credit spreads
 Reassess debt capacity
 Reevaluate optimal leverage ratios
 Align financial strategies
Liability
Management
 Greater rollover risk for short-term
debt
 Lengthen debt maturities
 Employ swaps and derivatives to
achieve optimal fix-floating mix
Liquidity
Management
 Increased investor and rating agency  Repatriation of overseas trapped
focus on available cash holdings
cash
Risk Management
 Lower cushion to absorb losses from  Actively hedge key exposures to
energy and commodity price changes
energy, commodity and financial risk
 Greater exposure to counterparty risk  Minimize counterparty exposure
of customers and suppliers
with derivative instruments
 Increased importance of financial
flexibility
Distribution Strategy
 Greater volatility of stock price
movements
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Action Steps
 Consider repurchases over
dividends for large distributions
 Minimize share price exposure for
buybacks using Accelerated Share
Repurchases
Some of the
Global Themes Shaping
Financial Strategy of Corporates
Private Equity: Down, But Not Out
Despite record deployment, PE Firms enter 2008 with substantial firepower. PE activity is posed to evolve
away from the mega-LBO focus of 2007 to smaller deals, less leverage, distressed securities, and a greater
focus on emerging markets and infrastructure investments in 2008.
Acquisition Multiples
15.0x
Potential LBO Targets
12.0x
12.0x
10.6x
8.8x
9.0x
7.3x
6.0x
3.0x
6.2x
5.1x
5.0x
4.6x
4.1x
0.0x
2003
2004
2005
Debt/EBITDA
2006
29%
% of US and European Firms
10.5x
22%
16%
Feasible LBOs at
Current Valuation
2007
2002 - 2007 YTD
Estimated PE capital available: 2002 – 2007
350
2,000
$310
1,750
$110
750
$80
$600
$1,000
$700
$400
500
50
250
0
0
2002
($ bn)
(US$ Billions)
1,000
$800
S&P Index
1,250
200
$80
$1,000
1,500
$240
250
2003
2004
Total Funds Raised
9
$1,200
$310
300
100
With 20% Valuation
Correction
FV/EBITDA
Global Fundraising from 2002 – 2007
150
With 10% Valuation
Correction
2005
2006
S&P 500
Notes:
(1) Expected commitments for 2007 represent Citi estimates.
Source: Citi
2007
$200
$300
$0
Global PE Funds
Raised
Total PE Funds
Spent
Available Capital
Strategic Implications of the Dollar Decline
The $-decline has implications beyond the current profitability and market share pressures in particular as it
relates to investment decisions (capex and M&A). Buying US earnings has become cheaper and firms with
cost and earnings diversification have benefited.
Currency Appreciation Trends
PE Ratio Trends
70
200
EUR
GBP
INR
RMB
EUR
BRL
178
GBP
INR
RMB
BRL
55
156
40
134
25
112
10
Ja
nA 03
pr
Ju 03
l-0
O 3
ct
J a -0 3
nA 04
pr
Ju 04
l-0
O 4
ct
J a -0 4
nA 05
pr
Ju 05
l-0
O 5
ct
J a -0 5
nA 06
pr
Ju 06
l-0
O 6
ct
J a -0 6
n
A -07
pr
Ju 07
l-0
O 7
ct
-0
7
Ja
nA 03
pr
-0
Ju 3
l-0
O 3
ct
Ja 03
nA 04
pr
-0
Ju 4
lO 04
ct
Ja 04
nA 05
pr
-0
Ju 5
lO 05
ct
Ja 05
nA 06
pr
-0
Ju 6
lO 06
ct
Ja 06
nA 07
pr
-0
Ju 7
l-0
O 7
ct
-0
7
90
US Trade Weighted Major Currency Index (1973=100)
US Trade Weighted
Major Currency Index (1973=100)
Decrease
the Cost of $1
Buying
of S&PEarnings
Earnings
Decrease in Cost
ofinBuying
of$1S&P
(2003-07)
150
80%
73%
140
70%
130
60%
120
50%
50%
110
10 Year Median, 95.6
30%
90
20 Year Median, 89.9
80
20%
70
10%
60
1979
10
38%
40%
100
28%
29%
Sterling
China
31%
31%
India
Euro
33%
35%
17%
0.0%
1984
Source: Citi
1989
1993
1998
2003
2007
Japan
Russia
S. Korea
Canada
Brazil
Oil
The Rise of Oil and Commodity Prices
Oil and commodity prices reached record levels. Higher prices and volatilities can significantly affect firms
value. This growing risk exposure requires a long–term, strategic solution that provides both earnings
stability and protection from extreme short-term price swings
Sensitivity of Selected Sectors to a 10% Increase in Underlying Commodity Price
Change in Share Price
End Users
Producers
6%
2%
Industry
-4%
Food
-4%
Airlines
Commodity
Sugar
Oil & Gas
NYMEX WTI Open Int.
3%
Food
Oil Services
3%
-1%
-3%
Transport
Food Retail
Oil & Gas
Cattle
Breakdown of energy contracts by participants
Agriculture
Grain
Grain
Oil
Integrated
E&P
Oil
Metals
Metals
Aluminum
Steel
New Dynamics in Commodity Sector:
 Increased presence of hedge funds - The number of
hedge funds focused on commodities has tripled in
the last three years and the volume of speculative
activity reached close to 50% in 2007
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
 Fundamental supply and demand are no longer the
only determinants of price, as speculative activity
can lead to sharp price swings
2000
2002
2004
Non-Commercial (Speculative)
11
2%
7%
Source: CFTC.
2006
Commercial
2007
Non-reportable
 The greater diversity of hedging opportunities and
the increased sophistication in financial instruments
are creating new solutions to manage risk for
companies
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