Channeling Growth Capital to Small and Medium-Size Businesses. Global Conference 2010

Channeling Growth Capital to Small and Medium-Size Businesses Global Conference 2010

Channeling Growth Capital to Small and Medium-Size Businesses Wednesday, April 28, 2010; 6:30-7:45 AM Moderator: Betsy Zeidman, Research Fellow and Director of the Center for Emerging Domestic Markets, Milken Institute Speakers: John Bohn, Commissioner, California Public Utilities Commission Wally Hunter, Managing Partner, EnerTech Capital Canada Ltd. Rafael Pastor, Chairman and CEO, Vistage International Stephen Watkins, Chairman and CEO, Entrex Inc. 2

Industrial and commercial loans by all depository institutions declined in 2009 Quarterly change, US$ billions 120 80 40 0-40 -80-120 2007 Q1 2007 Q2 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2 2009 Q3 2009 Q4 Source: FDIC. 3

Bank lending continues to decline Businesses and individuals draw upon existing credit lines US$ trillions 9.0 8.0 Unused commitments 7.0 6.0 Net loans and leases 50 5.0 4.0 2003 Q1 2003 Q3 2004 Q1 2004 Q3 2005 Q1 2005 Q3 2006 Q1 2006 Q3 2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 Sources: FDIC, Milken Institute. 4

Yield on the 10-year Treasury note is rebounding Yield on the 10-year Treasury note, percent 16 12 8 4 0 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 Source: Federal Reserve. 5

More businesses in bankruptcy Number of businesses filing for bankruptcy 70,000 60,000 50,000 40,000 30,000 20,000000 10,000 Source: U.S. Courts. 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 6

U.S. companies raised $831 billion from corporate bond issuance in 2009 US$ billions 1,000 900 800 700 600 500 400 300 200 100 Source: Dealogic. 2009: $831 billion 0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 7

Loan issuance in the United States Quarterly, Q1 2004 to Q1 2010 US$ billions 900 800 700 600 Investment grade Leveraged Highly leveraged 500 400 300 200 100 0 2004 2005 2006 2007 2008 2009 2010 Source: Dealogic. 8

Jobless recovery in the United States? Total employed, millions 148 146 144 142 140 138 136 Civilian unemployment rate, percent 12 10 8 6 4 2 134 1/1/2007 5/1/2007 9/1/2007 1/1/2008 5/1/2008 9/1/2008 1/1/2009 5/1/2009 9/1/2009 Source: Bureau of Labor Statistics. 0 9

Unemployment rate still high Unemploymentrate, percent of labor force 12 10 8 6 4 2 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Bureau of Labor Statistics. 10

Long-term S&P 500 price-to-earning ratios Price-earningratio of S&P 500 companies 50 Dec. 1999: 44.20 45 March 40 Sept.1929: 32.56 2010: 35 20.64 Average, 1881 to 2010: 16.36 30 25 20 15 10 March 2009: 13.32 5 Dec.1920: 4.78 June 1932: 5.57 0 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Source: Robert Shiller. 11

Volatility: Still above pre-crisis level VIX Chicago indexboard Options Exchange Volatility Index (VIX) 90 80 70 60 50 40 30 20 10 Pre-crisis average, 2004 to June 2007: 13.6 0 2004 2005 2006 2007 2008 2009 2010 Source: Bloomberg. 12

Securitization contributed to economic growth by providing cheap financing and by stimulating consumption Economic Growth Securitization Consumption Cheap Financing Source: Ares. 13

Cash flow CLOs have maintained higher rating distinctions versus CDOs collateralized by trust preferreds and other asset-backed collateral Percent of securities initially rated AAA 60 CLO 50 40 Trust preferred CDO Structured finance CDO 30 20 10 0 Aaa Aa A Baa Ba B Caa Ca C Sources: Wells Fargo, Moody s Investor s Service. 14

Total credit market debt/us GDP 1916 to 2009 Percent 400 350 300 250 200 150 100 50 0 Great Depression Today 1920 1930 1940 1950 1960 1970 1980 1990 2000 Sources: Federal Reserve, Historical Statistics of the United States, Bureau of Labor Statistics, Milken Institute. 15

A liquidity crisis Leveraged loan market: Minimal capital available to loan market from Hedge Funds, CLOs, Banks Subprime: Defaults & losses lead to uncertainty & loss of confidence Hedge funds: Marked-to-market losses, conditions to equity withdrawals and liquidations Liquidity Crisis SIVs & Conduits: Loss of confidence results in disappearance of short term funding/abcp market forcing some SIVs holding LT portfolios into default and liquidations CLOs: Bank warehousing lines frozen, AAA lender disappears, closes ABS Banks: Illiquidity and disappearance of lenders leads to overhang of loans on bank books causing markdowns and secondary price decline market 16

Bank loan and high yield bonds maturing in the next five years US$ billions 450 400 350 300 250 200 150 100 50 0 $43 $21 $22 $126 $68 $58 $156 $61 $95 $308 $93 $215 $403 $108 $294 2010 2011 2012 2013 2014 Sources: Credit Suisse Leveraged Loan Index, Merrill Lynch High Yield Master II Index, S&P LCD Quarterly Leveraging Lending Review. 17

Cash flow CLOs have maintained higher rating distinctions versus CDOs collateralized by trust preferreds and other asset-backed collateral Percent of securities initially rated AAA 60 CLO 50 40 Trust preferred CDO Structured finance CDO 30 20 10 0 Aaa Aa A Baa Ba B Caa Ca C Sources: Wells Fargo, Moody s Investor s Service. 18

Differentiating CLOs versus CDOs CLOs The Good CDOs The Bad High quality product Low quality product No AAA CLO has lost principal value More suitable leverage Ability to access underlying collateral Contributor tor to lower cost of bank debt CLOs act like a synthetic bank Provides meaningful benefit to the U.S. economy Ratings agency did not understand the correlation risks Imprudent leverage Impossible to access underlying collateral leading to decreased ability to fix systemic problems associated with the product Destroyed balance sheets of banks 19

CLOs purchased 60 70% of newly issued institutional loans from 2000 2007 vs. 45% in 2008 2009 Percent of newly issued institutional loans purchased by CLO's s 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q1 2010 Source: S&P LCD Quarterly Leveraged Lending Review. 20

CLO outstanding reinvestment period US$ billions 300 Cumulative CLO outstandings t in reinvestment period 200 Cumulative decrease in demand as reinvestment period ends 100 0-100 -200-300 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: S&P LCD Quarterly Leveraged Lending Review. 21

Small businesses account for lion s share of private sector job growth Source: BLS. 22

Ten largest U.S. state economies all depend on small business job growth Source: SBA. 23

Small business private sector job growth hit hard in current recession Quarterly, 1993Q2 2009Q2 Sources: BLS, NBER. 24

Small businesses believe they will lead the U.S. out of current recession Sources: U.S. Small Business Outlook 2010: Lessons Learned A Case for Greater Optimism, CIT in association with Forbes Insights. 25

Small business optimism index starting to rebound from March 2009 low Monthly, Jan. 1986 Feb. 2010 Sources: National Federation of Independent Business, Economy.com, NBER. 26

Majority of small businesses are optimistic about revenue growth in 2010 Sources: U.S. Small Business Outlook 2010: Lessons Learned A Case for Greater Optimism, CIT in association with Forbes Insights. 27

Net percent of small business survey respondents planning to hire in next 3 months Monthly, Jan. 1986 Feb. 2010 Sources: National Federation of Independent Business, Economy.com, NBER. 28

Small businesses still hesitant to ramp up staff levels Sources: U.S. Small Business Outlook 2010: Lessons Learned A Case for Greater Optimism, CIT in association with Forbes Insights. 29

Percent of small business survey respondents that believe now is a good time to expand Monthly, Jan. 1986 Feb. 2010 Sources: National Federation of Independent Business, Economy.com, NBER. 30

Small businesses feel left out of post-crisis recovery efforts Sources: U.S. Small Business Outlook 2010: Lessons Learned A Case for Greater Optimism, CIT in association with Forbes Insights. 31

Small business owners understand the importance of planning, but few actually do it Percentage of survey respondents 85% agreed that the recession put additional pressure on their businesses to plan more effectively. 61% indicated they would spend more time on planning & budgets in 2010 than they did in 2009. Only 44% indicated they had a strategy in place to guide growth during the coming recovery; 44% said they were working on a strategy while 11% didn t have a plan. Sources: U.S. Small Business Outlook 2010: Lessons Learned A Case for Greater Optimism, CIT in association with Forbes Insights. 32

Net percent of small business survey respondents with difficulties obtaining credit Monthly, Jan. 1986 Feb. 2010 Sources: National Federation of Independent Business, Economy.com, NBER. 33

Bank survey respondents tightening credit standards on C&I loans to small businesses Quarterly, 1992Q1 2010Q1 Sources: Federal Reserve Senior Loan Officer Survey on Bank Lending Practices, NBER. 34

Small businesses increasingly unable to obtain adequate financing Source: National Small Business Association Survey. 35

Bank survey respondents increasing spreads of small business loan rates over cost of funding Quarterly, 1992Q1 2010Q1 Sources: Federal Reserve Senior Loan Officer Survey on Bank Lending Practices, NBER. 36

Bank survey respondents indicate demand for small business C&I loans is down Quarterly, 1992Q1 2010Q1 Sources: Federal Reserve Senior Loan Officer Survey on Bank Lending Practices, NBER. 37

SBA loan volume down 57% since 2007 Fiscal Year, 2001 2009 Source: SBA. 38

SBA total loan value down 37% since 2007 Fiscal Year, 2001 2009 Source: SBA. 39

Community banks are critical to small business lending in the U.S. Community banks account for 67% of outstanding small business loans and 62% of initial dollar amount There are roughly 8,000 community banks with more than 50,000 U.S. locations Community banks constitute 97% of all banks Of all U.S. banks, 91% have assets under $1 billion and 36% have assets under $100 million Source: Independent Community Bankers of America. 40

Small businesses depend largely on bank loans and credit cards for financing Source: National Small Business Association Survey (December 2009). 41

Small businesses credit card terms typically exceed 10% interest rate Source: National Small Business Association Survey (December 2009). 42

Banking industry has changed dramatically Annual, 1993 2009 Source: FDIC. 43

Bank failures reached 140 in 2009 Annual, 1934 *2010 Source: FDIC. *through April 16, 2010 44

Small and medium sized banks commit larger share of assets to small business loans YTD (12/31/2009) Source: FDIC. 45

Smaller banks account for 57% of small business loans with only 20% of industry assets YTD (12/31/2009) Source: FDIC. Note: small & medium-sized banks defined as having less than $10 billion in total assets 46

U.S. economy beginning to add jobs Monthly, Jan. 2008 Mar. 2010 Source: BLS. 47

U.S. unemployment rate improving Monthly, Jan. 2008 Mar. 2010 Source: BLS. 48

U.S. real GDP expanding as economy recovers Quarterly, 1990Q1 2009Q4 Sources: BEA, NBER. 49

Home prices may have touched bottom in 2009 Quarterly, 1988Q1 2009Q4 Sources: S&P/FiServ, NBER. 50

U.S. household net worth beginning to rise Quarterly, 1995Q1 2009Q4 Source: Federal Reserve. 51

2009: first time on record that total U.S. household debt fell year-over-year Annual, 1945 2009 Source: Federal Reserve. 52

U.S. Vistage CEO confidence index: last four quarters 1,869 respondents Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 53

U.S. Vistage CEO confidence index: since 2003 Source: U.S. Vistage CEO Confidence Index Survey. 54

Changes in revenues, profitability and hiring: year ahead 1,869 respondents Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 55

When will CEOs hire? 1,869 respondents When do you plan to increase your firm s total number of employees over the next 12 months? Q2 2010 (13%) Q3 2010 (12%) Q4 2010 (13%) Steadily over next 12 months (22%) I don t plan to increase (45%) Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 56

Most significant business issues in 2010 1,869 respondents Economic uncertainty y( (35%) Financial issues cash flow, finances, profitability (18%) Growth growing too slowly (14%) Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 57

Biggest business challenges in 2010 1,869 respondents Customer retention and/or generation (27%) Managing costs and/or cutting staff (18%) Cash, liquidity, receivables (17%) Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 58

CEOs doing more with less 1,869 respondents 86% of CEOs say they re having to do more with less and list leveraging employee productivity as their primary solution Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 59

Entrepreneurship in America 1,869 respondents 37% of CEOs believe entrepreneurship p and business opportunities will be weaker in the U.S. in the next 3-5 years 38% say it will be stronger 25% see no change Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 60

Q1 2010 Vistage CEO confidence index: international perspectives 1,869 respondents 41% of CEOs say they are 69% of CEOs see China as doing business the biggest threat to internationally, with overtaking the United States Europe topping the list. as an economic superpower Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 61

CEO views on Washington 1,869 respondents 85% of CEOs do not believe Washington is listening to the needs of small to medium-sized business owners 65% of CEOs believe national health care legislation is bad for their business Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 62

The new business landscape: more with less As we emerge from global recession What is the new normal for your business? How do you adjust your business to: the new normal? do more with less? The new paradigms Bigger (government expansion, corporate consolidation) Smaller (budgets, workforces, consumer spending) Broader (opportunities online and internationally) Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 63

Vistage CEO confidence index vs. GDP: forecast of economy two quarters in advance Source: U.S. Vistage CEO Confidence Index Survey. Dates: March 22 April 2, 2010 64