The Changing Shape of Global Finance Tuesday, May 1, 212; 8: AM - 9:15 AM Moderator: Timothy O'Hara, Managing Director and Co-Head of Global Securities, Credit Suisse Speakers: Richard Baker, President and CEO, Managed Funds Association Evan Bayh, Senior Advisor, Apollo Global Management; former U.S. Senator Joshua Friedman, Co-Chairman and Co-CEO, Canyon Partners, LLC Bennett Goodman, Senior Founding Member, GSO Capital Partners Tom Joyce, Chairman and CEO, Knight Capital Group, Inc. Carey Lathrop, Managing Director and Head of Global Credit Markets, Citi 1
Timothy O'Hara s slides 2
The financial sector has yet to return to pre-crisis equity values despite government stimulus and regulations US Dow Jones Financial Services Index 15 Europe Stoxx 6 Banks 6 5 1 4 3 5 2 1 Jan-6 May-7 Jul-8 Oct-9 Jan-11 Apr-12 Jan-6 May-7 Sep-8 Feb-1 Jun-11 Source: Bloomberg, Credit Suisse 3
Funding costs for Banks and Brokers were similar to those of the best industrials CDS Spreads as of 1/1/28 23 28 28 32 33 35 46 46 49 49 67 72 Lockheed Martin IBM United Tech Glaxo Dupont Siemens CS Barc JPM BoA GS Citi Source: Bloomberg, Credit Suisse 4
But are now significantly higher CDS Spreads as of 4/2/212 17 26 262 269 239 67 3 72 52 45 74 18 Lockheed Martin IBM United Tech Glaxo Dupont Siemens CS Barc JPM BoA GS Citi Source: Bloomberg, Credit Suisse 5
Banks and Broker/Dealers have significantly reduced securities positions Aggregate Securities Positions of Primary Dealers $25bn $2bn $15bn Peak: $233bn (Sep-7) Latest: $43bn (Apr-12) $1bn $5bn $bn Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Apr-12 Source: Federal Reserve, Credit Suisse 6
Challenges for Banks under Basel III Recalibrating to Basel III Implications 16% 14% 12% 1% 8% 6% 4% 2% % 8% Tier 2 4.% Hybrid T1 2.% CET 1 2.% Basel I & II 15.5% CET 1 2.5% CET 1 2.5% CET 1 2.5% Tier 2 2.% HT1 1.5% CET 1 4.5% Basel III Surcharge for Global SiFI Countercyclical Buffer Capital Conserv. Buffer B3 Minimum CET1 $485bn Balance Sheet (RWA) Funding ( NSFR ) $1T $4T Source: The Quantitative Impact Study Group of the Basel Committee on Banking Supervision, Credit Suisse 7
Traditional investment strategies not meeting return hurdles Yield on Moody s Aggregate Corporate Bond Index Value of S&P 5 2% 1,6 15% 1% 5% 1,4 1,2 1, 8 % Jan-6 Jan-73 Jan-86 Jan-99 Jan-12 6 Jan- Oct-1 Jul-3 Apr-5 Jan-7 Oct-8 Jul-1 Apr-12 Source: Moody s, Bloomberg, Credit Suisse 8
AUM in many traditional long only strategies has not grown from 27 Assets Under Management of Long-only Equity and Bond Income Mutual Funds ($ in millions) 1,679 2,27 2,633 2,886 1,566 6,521 3,74 4,959 5,588 5,25 27 28 29 21 211 Source: ICI, Credit Suisse Equity Bond 9
In favor of ETFs or higher returning alternative investment strategies ETF AUM 1,2 Alt. Mutual Fund AUM 25 Hedge Fund AUM 2,5 1, 8 6 4 2 2 15 1 5 2, 1,5 1, 5 '8 '9 '1 '11 '8 '9 '1 '11 '8 '9 '1 '11 Source: SIMFUND, Hedge Fund Research, Credit Suisse 1
Carey Lathrop s slides 11
Nominal GDP growth % More borrowing = more growth Over the last thirty years, growth has become steadily more growth-dependent GDP has always been correlated with borrowing US debt growth vs nominal GDP growth, 1916-21 but if anything our dependence is increasing Credit growth per unit of GDP growth, rolling 5yr avg 4 3 2 R 2 =.4765 1 9 8 7 Real credit (%) Credit per unit of GDP (ratio) 7 6 5 1-1 -2-3 -1 1 2 3 Debt growth % 6 5 4 3 2 1 Real GDP (%) 6 7 8 9 1 4 3 2 1 Source: Federal Reserve, Haver Analytics, Historical Statistics of the United States. Source: Haver Analytics, Federal Reserve. 12
More borrowing = more growth Debt has now reached unsustainable levels. But deleveraging will have implications for growth too. That 193s feeling US debt/gdp across nonfinancial sectors (%) 3 The growth triangle Love triangle, or pyramid scheme? 25 2 Household Corporate Government GSE Credit growth Bust 15 1 5 Asset price growth Economic growth 192 194 196 198 2 Source: Federal Reserve, Haver Analytics, Historical Statistics of the United States. Source: Citi. 13
Additional slides 14
Growth of the biggest U.S. bank holding companies over 4 years Percent 1 Combined assets of the 5 biggest U.S. bank holding companies (% of U.S. GDP) 98% 8 6 4 49% 2 25% 33% 33% Sources: The Banker, Milken Institute. 197 198 199 2 211 15
Large banks become larger Share of assets of all U.S. depository institutions Percent of total banking assets 9 8 7 6 5 4 3 2 1 Smaller banks Large banks 1985 1987 1989 1991 1993 1995 1997 1999 21 23 25 27 29 211 Note: Large banks are banks with assets > $1 billion. Source: Federal Deposit Insurance Corporation. 16
Importance of banks, stock and bond markets Selected countries and country groups Bank assets Bonds Equities Total financial assets (US$ trillions, 21) $2.5 $14.8 $23.4 $11.8 $25.1 $64.2 17.6% 11.9% 28.5% 12.1% 22.% 26.9% 23.3% 35.% 2.1% 45.5% 37.9% 5.7% 59.1% 53.1% 51.3% 42.3% 4.% 22.3% United Kingdom France Emerging Asia Germany World United States Source: IMF Global Financial Stability Report. 17
Banks hold more capital % Capital ratios: All FDIC-insured financial institutions 16 15 14 Total risk-based capital Tier 1 risk-based capital 13 12 11 1 Equity capital to assets 9 Leverage ratio 8 7 6 Q4 26 Q4 27 Q4 28 Q4 29 Q4 21 Source: Federal Deposit Insurance Corporation. 18
Return on equity in banking was worse than other sectors (%) 25 2 Return on equity for the U.S. publicly traded companies Non financial corporations 15 1 5 Non-bank financials Banks -5 Source: Bloomberg. 19
Growing importance of the U.S. parallel banking system 1945 Total financial assets: US$.24 trillion 211 Total financial assets: US$63 trillion Depository institutions 7% Contractual institutions 24% Parallel banking institutions 6% Contractual institutions 28% Depository institutions 28% Parallel banking institutions 44% Sources: Federal Reserve Board, Flow of Funds Accounts, Milken Institute. 2
U.S. BHCs rely more heavily on borrowing to finance their activities (Liability composition of U.S. BHCs) Long-term funding, 2.8% Equity, 5.7% 1986 Total BHC assets = US$2.4 trillion Other liabilities, 5.5% Equity, 9.8% 211 Total BHC assets = US$16.8 trillion Other liabilities, 11.2% Shortterm funding, 14.4% Deposits, 71.6% Long-term funding, 11.2% Shortterm funding, 19.4% Deposits, 48.4% Note: The 211 data are as of Q3. Sources: Reserve Bank of Chicago; Milken Institute. 21
The world s 5 biggest banks have gotten even bigger Percent 1 Combined assets of the world's 5 biggest banks (% of world GDP) 8 94% 6 66% 4 45% 2 15% 24% 197 198 199 2 211 Sources: The Banker, Milken Institute. 22
Many large banks work broadly across the global financial system 1 % Foreign assets (% of total bank assets) 8 6 4 2 Data as of 21 Sources: Bloomberg. 23
Government bailouts worldwide Government capital investments in financial firms Outstanding balance: US$414 billion Data as of April 12, 212 Netherlands, $15 France, $6 Rest of the world, $29 Ireland, $28 Germany, $44 United States, $196 United Kingdom, $97 Source: Bloomberg. 24
Credit default swap spreads for European banks are narrowing CDS spreads (basis points) 7 6 5 4 3 Northern Rock taken over by U.K. Treasury (2/17/28) Lehman Brothers files for bankruptcy (9/15/28) Europe subordinated financial Europe senior financial Europe index Greek bailout (5/2/21) 2 1 27 28 29 21 211 212 Source: Bloomberg. 25
Emerging markets lead a global rebound January 26 = 1 2 16 Emerging markets 12 8 S&P 5 Europe 4 26 27 28 29 21 211 212 Source: Datastream. 26
U.S. bond issuance Up sharply in 212 Monthly issuance (US$ billions) 18 16 14 12 1 8 6 4 2 Investment grade High yield Source: Securities Industry and Financial Markets Association. 27
U.S. bond issuance 1996-212 Total issuance (US$ billions) 1,8 1,6 Investment grade 1,4 High yield 1,2 1, 8 6 4 2 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211 212* * 212 data are annualized based on January March data. Source: Securities Industry and Financial Markets Association. 28
U.S. high-yield bond spreads slightly widen Basis points 2,5 Spread of the ML high-yield index over 1-year Treasury bonds 2, 1,5 1, 5 27 28 29 21 211 212 Source: Bloomberg. 29
Volatile market Chicago Board Options Exchange Market Volatility Index (VIX) Index 8 7 Volatility index (VIX) VIX long-term average,199-212 Lehman Brothers collapsed (September 28) 6 5 4 3 2 1 Long-Term Capital Management bailout (September 1998) Dot-com bubble burst (March 2) 199 1992 1994 1996 1998 2 22 24 26 28 21 212 Source: DataStream. 3
Global growth forecasts Key countries/regions, 212-215 8.2% 7.9% 6.5% 4.4% 4.1% 2.5% 2.1% 1.4%.6% China India Asia (excluding Japan) MENA Latin America Eastern Europe U.S. Japan Western Europe Source: Economist Intelligence Unit. 31
U.S. stock market s share is shrinking Share of the world s market capitalization 23 Total market cap = US$27 trillion 212 Total market cap = US$5 trillion Hong Kong 3% U.K. 8% Japan 1% China 2% Rest of the world 33% U.S. 44% U.K. 6% Japan 7% Hong Kong 6% China 6% Rest of the world 42% U.S. 33% Note: The 212 data are as of April 11, 212. Source: Bloomberg. 32