Corporate Finance in Tumultuous Times presented by Charles J. Morton, Jr.

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1 Corporate Finance in Tumultuous Times presented by Charles J. Morton, Jr. On behalf of the Association of Corporate Counsel, Baltimore Chapter November 12,

2 Overview of Historical M&A Activity 2

3 Transition of Debt Capital Availability Between 2003 and early 2007, the capital markets introduced new forms of debt financing and competition began driving investors to seek returns from non-traditional vehicles Limited Sources of Debt Financing Available Prior to 2004 Revolver Term Loan Subordinated Notes Preferred Stock Common Equity Libor Libor % 27% 30% 3 Source: Lincoln International

4 Transition of Debt Capital Availability Between 2003 and early 2007, the capital markets introduced new forms of debt financing and competition began driving investors to seek returns from non-traditional vehicles Increased Sources of Debt Financing and Competition by 2007 Traditional Banks Finance Companies BDCs Hedge Funds Insurance Companies Mezzanine Funds Private Equity Funds Revolver Term Loans Last Out Senior Tranche B Second Lien Loans Enterprise Value Second Lien Loans Rate Only Sub Debt Sub Debt W/Warrants Preferred Stock Common Equity Libor Libor Libor % 17 19% 21-25% 25% 4 Source: Lincoln International

5 Market Liquidity During the second half of 2007 and the first half of 2008, there has been a reduction in both the number of lenders and the types of securities available Current Landscape of Debt Financing Traditional Banks Finance Companies BDCs Hedge Funds Insurance Companies Mezzanine Funds Private Equity Funds Revolver Term Loans Last Out Senior Tranche B Second Lien Loans Enterprise Value Second Lien Loans Rate Only Sub Debt Traditional Sub Debt Preferred Stock Common Equity Libor (Cash Flow) Libor (Cash Flow) Libor % 18-23% 20-25% 1) Traditional sub-debt must include warrants or co-investment * There is a continued decline in the number of senior and second lien lenders, and the capital providers that remain are gravitating to large companies * Senior debt with minimal amortization (Tranche B loans), as well as rate only subordinated debt, are rarely available 5 Source: Lincoln International

6 2007 was a record year for M&A Activity 2008 will be very different Global announced transactions Source: Practicing Law 6 Institute The Current M&A Environment

7 High correlation between M&A activity and stock market performance Source: Practicing Law 7 Institute The Current M&A Environment

8 Cash and cash/stock combinations account for 85% of transactions Types of consideration offered in announced U.S. domestic transactions Source: Practicing Law 8 Institute The Current M&A Environment

Prior to the credit crunch, increased leverage allowed financial sponsors to out-bid strategic players Competitions for large LBOs drove a significant increase in Purchase Prices in 2006 and 2007

9 Prior to the credit crunch, increased leverage allowed financial sponsors to out-bid strategic players Competitions for large LBOs drove a significant increase in Purchase Prices in 2006 and Multiples for large deals traded at an average of 9.9x in 2007, up from 8.5x in 2006 Starting in Q and continuing into 2008, sponsor related M&A has seen lower leverage levels and higher equity Financial buyers continue to conduct more extensive due diligence -Some financial buyers are spending upwards of $1 to $2 million on due diligence despite the risk of not winning the deal Source: Practicing Law Institute The Current M&A Environment 9

10 Recent Activity in Tumultuous Times 10

11 Source: Cowen and Company 11

12 September 8, 2008 U.S. Treasury Department Becomes Guardian of Fannie Mae and Freddie Mac Senior Preferred Stock Purchase Agreements with each to provide security to debt holders (both senior and subordinated) Each indefinite in duration with $100 billion capacity Senior preferred stock with liquidation preference Treasury received an immediate $1 billion issuance of senior preferred stock with a 10% coupon from each Warrants for common stock representing 79.9% ownership stake (fully-diluted basis at a nominal price) Quarterly fees starting in 2010 to be determined by Secretary and Conservator Retained mortgage and mortgage backed securities portfolios must not exceed $850 billion as of December 31, 2009, and must decline by 10% per year until reaching $250 billion 12

13 September 17, 2008 American International Group, Inc. Receives Credit Facility from Federal Reserve Two-year $85 billion revolving credit facility Issued Convertible Participating Serial Preferred Stock to trust held for benefit of the Treasury Interest at 3-month LIBOR plus 8.50% Initial gross commitment fee of 2% of total facility Commitment fee on undrawn amounts at 8.50%/year Preferred Stock entitled to participate in dividends paid on the common stock Holding approximately 79.9% of the aggregate voting power September 18, 2008: Drew down $28 billion October 9, 2008: Borrowed additional $37.8 billion October 24, 2008: AIG s draws totaled $90.3 billion and predicted a need greater than the total $122.8 billion available 13

14 November 10, 2008 Federal ReserveRestructures AIG Support Plan Reported $24.47 billion loss in 3Q 2008 Under TARP, Treasury to invest additional capital through purchase of $40 billion of newly issued AIG preferred shares Reducing credit facility to $60 billion Term extended to five years Interest rate eased to 3-month LIBOR plus 3% Commitment fee reduced to 75 basis points Federal Reserve Board authorized lending over $50 billion to two newly-formed LLC lending facilities Residential Mortgage-Backed Securities Facility AIG to make $1 billion subordinated loan to LLC Proceeds used to return cash collateral and for repayment and termination of $37.8 billion securities lending facility Collateralized Debt Obligations Facility AIG to make $5 billion subordinated loan to LLC 14

15 September 23, 2008 Warren Buffett Makes $5 Billion Dollar Investment in Goldman Sachs Berkshire Hathaway Inc. invested $5 billion in Goldman Sachs preferred shares Paying a 10% dividend Payout equates to roughly $1.3 million each day If Goldman retires the preferred shares, it must pay a 10% premium on face value Warrants to purchase $5 billion of Goldman shares at $115 per share Approximately, $43 million for every dollar GS trades above $115 November 7, 2008: GS stock was valued at $77.78/share 15

16 October 1, 2008 Warren Buffet Makes $3 Billion Dollar Investment in General Electric Berkshire Hathaway purchased $3 billion of perpetual preferred stock in General Electric Paying a 10% dividend Callable after three years at a 10% premium Warrants to purchase $3 billion of common stock with a strike price of $22.25 exercisable within five years Received warrants at a $2.00 discount Approximately, $135 million for every dollar GE trades above $22.25 November 7, 2008: GE stock valued at $18.86/share 16

17 Federal Government Takes Historic Actions in Support of U.S. Financial Institutions 17

18 FDIC Announces Historic and Unprecedented Actions to Encourage Institutions to Build Capital and to Strengthen Confidence and Encourage Liquidity in the Banking System Capital Purchase Program Voluntary program announced by Treasury Purchase up to $250 billion of senior preferred securities from eligible U.S. financial institutions on standardized terms Temporary Liquidity Guarantee Program Announced by FDIC in response to Capital Purchase Program FDIC guarantees certain newly-issued senior unsecured debt issued by eligible institutions on or before June 30,

19 Capital Purchase Program Treasury Department Details Application Deadline: November 14, 2008 Participation triggers certain restrictions on compensation of senior executives Participation requires standardized terms for purchase of up to $250 billion of senior preferred shares of Qualifying Financial Institutions ( QFI ) Nine large financial institutions have already agreed to participate Funding to occur by year-end

20 Eligibility and Allocation To be deemed a QFI, the issuer must be: A U.S. bank or savings association ( Bank ) not controlled by a bank or savings and loan holding company ( Holding Company ) A Holding Company that engages only in activities permitted for financial holding companies under Section 4(k) of the Bank Holding Company Act ( BHCA ) and any Bank controlled by such a Holding Company A Holding Company whose U.S. depository institution subsidiaries are the subject of an application under 4(c)(8) of the BHCA And cannot be: Controlled by foreign bank or company Grandfathered unitary thrift holding companies Industrial loan holding companies engaging in non-financial activities Once eligibility is confirmed by the Treasury, the QFI may: Issue to Treasury an amount of Senior Preferred equal to not less than 1% of the QFI s risk weighted assets, but not more than the lesser of (i) $25 billion or (ii) 3% of the QFI s risk-weighted assets Warrants: Treasury immediately receives exercisable warrants to purchase common stock with aggregate market price equal to 15% of the Senior Preferred Initial exercise price is market price for the QFI common stock Institutions not publically traded may not be eligible to participate 20

21 Dividends, Redemption and Repurchases Dividends: Cumulative quarterly dividends at 5% per annum for the first five years and 9% thereafter If not paid in full for six periods, Senior Preferred will have right to elect two directors of the QFI and will continue to have such right until dividends have been fully paid for four periods No Dividends declared or paid on other preferred or common Treasury consent required for increase in common dividends or share repurchases until the third anniversary of the investment Redemption and Repurchases: During years 1-3, Senior Preferred may only be redeemed with proceeds from the QFI s sale of Tier 1 qualifying perpetual preferred stock or common stock for cash which results in gross proceeds of not less than 25% of the Senior Preferred issue price After third anniversary, Senior Preferred may be redeemed at any time for 100% of the issue price plus accrued and unpaid dividends (subject to the QFI s regulator approval) No repurchase or redemption of any other preferred or common shares unless full dividends have been paid on the Senior Preferred Treasury may Transfer Senior Preferred to a third party at any time 21

22 Voting, Compensation and Equity Voting Rights: Voting rights of the Senior Preferred limited to class voting rights on: Authorization or issuance of higher ranking shares Amendments to the rights of the Senior Preferred Mergers, exchanges or other transactions adversely affecting Senior Preferred Executive Compensation: Shall adopt Treasury standards for corporate governance and executive compensation Applicable to CEO, CFO and the next three most highly compensated Standards include: Ensuring compensation does not encourage unnecessary and excessive risk Requiring the clawback of compensation based on materially inaccurate criteria Prohibiting golden parachute payments Agreeing not to deduct for tax purposes compensation in excess of $500,000 for senior executives 22

23 Expectations for Strong Recovery Typical Result of Tumultuous Market -Golden Years of Mezzanine Finance -Current Cash Available for Investment Questions? 23

24 Thank you. 24

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