An Understanding of the Capital Markets By: Mario Espinosa Managing Director and Co-Head of Latin America Credit Markets The Financial Professionals Forum 2012 1 Table of Contents 1. Capital Markets Overview 3 2. Alternatives for Corporate Debt Financing 12 3. Banking Environment 14 4. Citi’s Presence and Franchise 19 The Financial Professionals Forum 2012 1. Capital Markets Overview The Advantages of the Emerging Markets Emerging market economies have weathered the storm better than industrialized nations and have outpaced developed nations in growth terms Responsible fiscal policies by most EM nations have allowed them to bounce back quicker than the majority of industrialized nations – As a result, the European debt crisis has not directly affected LatAm The economies of the emerging countries enjoy strong investment and capital inflows as well as established and well-capitalized banking institutions For the most part since January 2007, the equity indexes of BRIC nations (Brazil, Russia, India and China) have outperformed those of industrialized nations GDP Growth Equity Performance EM vs. Industrialized Nations 8.0% 6.2% 6.0% 5.7% 6.0% 40% 4.2% 4.1% 4.0% 2.0% 1.7% 20% 3.3% 2.9% -- 2.8% 2.2% 1.3%1.5% 60% 2.2% 2.1% 1.6% 1.3% 0.7% (20%) (40%) (60%) 0.0% 2011 2012F -0.4% 2013F (80%) Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 -2.0% Global U.S. LatAm Developed Nations Eurozone Emerging Markets U.K. U.S. Brazil China India The Financial Professionals Forum 2012 2 Current Global Growth vs Pre-Crisis Average For most regions of the world, economic growth between 2000 and 2007 was much higher than it is today, whereas emerging markets have more growth today than they did back then, placing this region, and most notably Latin America, as an attractive asset class with strong fundamentals Latin America and the Caribbean: A Promising Story of Growth and Development Below (2.0%) Between (2.0%) and 0.0% Between 0.0% and 2.0% Above 2.0% Insufficient Data (Legend’s colors indicate %Growth 2011-2012 minus %Growth 2000-2007) The Financial Professionals Forum 2012 3 Introduction to Financing Alternatives in the Debt Markets Corporates, Governments, Quasi Sovereigns and Financial Institutions have three main sources for securing financing… Hedge Funds Pension Funds Private Banks Corporates Local Banks Regional Banks QuasiSovereigns International Banks Asset Managers Insurance Companies Financial Institutions Governments Regional Banks Hedge Funds Local Pension Funds Asset Managers International Bond Markets Regional Banks Regional Markets Insurance Companies International Banks Local Banks Syndicated Loan market The Financial Professionals Forum 2012 4 Capital Markets at Citigroup What Do We Do? – CMO advises corporate clients on debt and hybrid capital solutions in the fixed income markets, both in the U.S. and internationally Who Do We Work With? – CMO works closely with coverage in Investment & Corporate Banking, Product Partners in Equity and Fixed Income and with Syndicate. Why Access the Market? Issuer Refinancing; M&A; Growth Capital ;Capital Structure Optimization Investment Bank / Corporate Bank Issuer Considerations Equity Capital Markets Financial Impact; Ratings; Regulatory; Tax Legal Syndicate Sales and Trading Market Considerations Public vs. Private; USD vs. Non-USD; Institutional vs. Retail; Size, Timing, Maturity; Marketing; Market Conditions Capital Markets Origination Private Public Investors CMO Product Partners • • • • • Derivatives New Products Liability Management Structured Bonds Capital Strategies The Financial Professionals Forum 2012 5 Historical Debt Issuance in LatAm DCM International LatAm Capital Markets Regional LatAm Bond Markets ▲ 05-11 CAGR: 17.9% ▲ 05-11 CAGR: 2.6% 90.7 80.0 94.4 35.0 69.5 67.2 60.0 42.7 40.0 35.1 33.9 19.5 Volume (US$ BN) Volume (US$ BN) 100.0 20.0 29.6 28.0 25.2 24.1 21.0 13.8 14.0 0.0 2005 2006 2007 2008 2009 2010 2011 2012 2005 Syndicated LatAm Loan Market 2006 ▲ 05-11 CAGR: 6.9% 74.2 63.0 51.5 43.3 46.5 44.3 40.0 22.2 20.0 Volume (US$ BN) 82.9 60.0 2008 2009 2010 ▲ 05-11 CAGR: 10.3% 200.0 80.0 2007 2011 2012 Cumulative LatAm Credit Markets 100.0 Volume (US$ BN) 18.8 17.8 17.8 7.0 0.0 186.9 164.6 160.0 132.2 120.0 143.3 131.6 110.5 103.6 84.8 80.0 40.0 0.0 0.0 2005 2006 2007 Source all graphs: Dealogic as of August 2012 6 29.5 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 The Financial Professionals Forum 2012 Traditional International Capital Markets Issuers generally access institutional U.S. market with a 144A/Reg S transaction – Enhances speed of execution and simplicity – Sale of securities on a firm commitment basis Subsequent resale to non-U.S. investors and to qualified institutional buyers (“QIBs”) – 144A / Reg S are the most common securities in LatAm, however, frequent issuers also access through registered transactions In recent years we have also witnessed offerings in non US markets in currencies such as EUR/GBP/CHF/JPY/AUD An offering in the International Capital Markets generally takes 8 weeks for infrequent/first-time issuers but a frequent SEC-registered issuer can access the market within one week Pros Cons ▲ Largest pocket of liquidity ▼ Ratings required ▲ Longest possible tenors (30 years and Perps) ▼ Standard terms for draw downs (only one) and prepayment (bullet) ▲ Free up cash flow given bullet payment at maturity ▲ Significant structural flexibility, incurrence test for non-investment grade issuers and no financial covenants for investment grade ▼ Limited prepayment flexibility ▼ Typically more expensive than bank financing The Financial Professionals Forum 2012 7 Traditional International Capital Markets (Cont’d) International Issuance Breakdown 2012 YTD Country Sector Tenor 12% 5% 21% 3% 4% 2% 15% 5% 6% 50% 52% 19% 60% 24% Brazil Mexico Peru Colombia Chile Other Corporate Sovereign Financial 22% >7-10 years 2-3 years < 2 years >10 years Perp >3-5 years >5-7 years Source all graphs: Dealogic as of 2012YTD The Financial Professionals Forum 2012 8 LatAm Syndicated Loan Market Review LatAm Loan Spreads LatAm Loan Share by Tenor Average spreads in 2Q’12 have come down from the previous quarter Tenors between 1 to 5 years remain most tapped Source all graphs: Dealogic as of 2Q 2012 The Financial Professionals Forum 2012 9 LatAm Syndicated Loan Market Review (cont’d) LatAm Issuance by Loan Type LatAm Loan Issuance by Purpose 2Q’12 Term Loans comprise bulk of LatAm lending in 2Q’12 Project and Trade Financing comprise over half of issuance in 2Q’12 4% 3% Project Financing 5% Trade Financing 6% 31% Acquisitions Refinancing 7% Other GCP 8% Repayment ECA Capex 11% 25% Other denotes: Bridge Facilities, Export Credit, Mezzanie Loans, Buyer Credit and L/C Facilities Other denotes: Working Capital, Debt CP Support, Dividend Recapitalization and Shipping Source all graphs: Dealogic as of 2Q 2012 The Financial Professionals Forum 2012 10 2. Alternatives for Corporate Debt Financing Understanding the Company’s Objectives International Bond Market Syndicated Loan Market Upside Upside ▲ Largest pocket of liquidity ▲ Relationship focused ▲ Longest possible tenors (10, 30 years) ▲ Experience in assessing risks and projected cashflows ▲ Structural flexibility – Non-Investment Grade: Incurrence Covenants ▲ Prepayment flexibility ▲ Taps into Mexican bank peso liquidity – Investment Grade: No financial covenants Downside – No need to pledge security ▼ Amortization payments Downside ▼ Ratings required ▼ One Draw Down and One Payment ▼ Maintenance covenant packages ▼ Shorter tenors than bond market ▼ Cross sell required by banks to meet returns ▼ Often requires asset or stock security The Financial Professionals Forum 2012 11 Understanding the Company’s Optimal Leverage The optimal amount of leverage is a trade-off between the benefits of the tax shield, the higher likelihood of financial distress and rising cost of capital. Implications of Higher Leverage For a typical US C-corporation, increasing leverage provides a ‘tax shield’ by reducing taxable income with interest expense More leverage implies a higher likelihood of financial distress Possible Financial Distress Possible costs include: – Diverting management’s focus – Loss of capital markets access – Suppliers and clients reluctant to do business Increased Cost of Capital Loss of Financial Flexibility Costs Tax Shield Higher leverage = lower credit ratings and higher cost of debt Value of tax shields depends on the company’s ability to generate positive earnings Estimated by (tax rate * taxable income after considering NOLs) Cost of equity increases as equity holders require compensation for increased risk Less capacity to use debt for funding strategic initiatives (such as acquisitions or capex) – Provides a benefit to the company’s cost of capital Improved Incentives Increased leverage increases management’s incentive to extract operating efficiencies, as interest expense creates a ‘hurdle rate’ of return on capital that must be cleared – Agency costs are reduced Benefits The Financial Professionals Forum 2012 12 3. Banking Environment European Banks’ Key Indicators: Snapshot Market Cap of Top 30 EU Banks (1) More Than Halved Credit Ratings Have Been Adjusted (2) Loss in Market Cap: 61% 1,200 1,174 1,020 500 Total Return of Euro Stoxx Banks since Jan 2006: (69.8%) 1,000 400 727 700 300 600 469 461 200 400 408 100 200 - 0 2006 2007 2008 Market Cap European Banks 2009 2010 2011 2012YTD EURO STOXX BANKS - Performance Source: Moody’s, SNL, Bloomberg, FactSet as of June 25, 2012. Notes: (1) 30 largest listed European banks, by market capitalisation as at June 25, 2012. (2) Moody’s ratings of main operating banking entities. 13 Price (EUR) Market Cap (ERU bn) 800 BBVA Banco Santander Bank of America ML Danske Bank OTP RBS Plc. Citibank N.A. Lloyds TSB Bank Plc. UBS Barclays Bank Plc BNP Paribas Credit Agricole Deutsche Bank Intesa Sanpaolo KBC Bank NV Societe Generale UniCredit Credit Suisse DnB Erste Bank JPMorgan Chase Bank N.A. Morgan Stanley Bank N.A. Natixis Nomura Holdings Plc. Royal Bank of Canada Goldman Sachs Banks USA Nordea Macquarie Bank Dec. '07 Aug. '12 Notches Aa1 Aa1 Aaa Aa1 A2 Aaa Aa1 Aaa Aaa Aa1 Aa1 Aa1 Aa1 Aa2 Aa2 Aa1 Aa2 Aa1 Aa1 Aa3 Aaa Aa3 Aa2 A3 Aaa Aa3 Aa1 A1 Baa3 Baa2 Baa2 Baa1 Ba2 Baa1 A3 A2 A2 A3 A2 A2 A2 Baa2 A3 A2 Baa2 A2 A1 A3 A2 Baa1 A2 Baa3 Aa3 A3 Aa3 A2 (9) (7) (8) (6) (6) (7) (5) (5) (5) (2) (4) (4) (4) (6) (4) (4) (6) (4) (3) (3) (5) (4) (3) (3) (3) (3) (2) (1) European Banks Non-European Banks The Financial Professionals Forum 2012 Banking Sector – the New Norm? Change in Banking Sector Drivers New World Old World 1 Strong credit fuelled growth 1 Low growth & pressure from sovereign crisis 2 Low provisions 2 Deteriorating asset quality 3 Robust NIMs 3 Record low interest rates 4 Light touch regulation 4 Higher capital requirements / deleveraging needs 5 Abundance of liquidity 5 Higher funding costs and liquidity requirements Higher leverage = Maximize RoE Lower leverage to reduce risk = Lower RoE The Financial Professionals Forum 2012 14 Implications of Basel III As Basel III is incorporated throughout the market, cost of funds and return hurdles for ALL BANKS are expected to increase, especially for non-investment grade credits. Basel III Main Enhancements from Basel II and Basel I Minimum Capital Ratios Liquidity Requirements Constituents of Capital Leverage Requirements The Financial Professionals Forum 2012 15 Implications of Basel III (cont’d) Basel III will increase the cost of debt for lowered rated companies Break-even Pricing Implication (in bps) for a $100MM Unsecured 5yr Loan to maintain Returns on Risk Rated Capital 10.0% ~ 250 bps Illustrative HY IG 9.5 9.0 75 to 100 bps Lowest Cost (Basel I) Basel I Lowest Cost (Basel II) Cost of Capital (%) Basel II / III 8.5 8.0 0 10 20 30 40 0 bps -30 to -20 bps -30 to -20 bps 50 60 AA A BBB BB B Total Debt / Total Capitalization (%, Market Value) The Financial Professionals Forum 2012 16 How Much Capital Will Banks be Required To Hold? 11% 9.5% 8.5% 7% 6% 4.5% 5% Basel III Minimum + Buffer + G-SIB Surcharge 6% Basel III Minimum + Buffer + GSIB Surcharge (2.5%) Basel III Minimum + Buffer Basel III Minimum + Buffer (2.5%) Basel III Minimum Basel III Minimum Basel I Minimum Basel I Minimum Tier 1 Common Tier 1 Capital The Financial Professionals Forum 2012 17 4. Citi’s Presence and Franchise Citi’s Presence in LatAm & CCA International Bonds LTM Ranking Bookrunner Proceeds (US$MM) No. Deals Domestic Bonds LTM Share Ranking Bookrunner Syndicated Loans LTM Proceeds (US$MM) No. Deals 2,965 27 11.8% 1 2,908 38 11.6% 2 3 Share 1 Deutsche Bank 14,583 35 13.9% 1 2 HSBC 12,687 43 12.1% 2 12,261 40 11.7% 3 HSBC 2,226 26 8.9% 10,283 33 9.8% 4 BBVA 2,153 37 8.6% 3 4 JPMorgan Itau BBA Source: SDC Thomson Reuters as of April 14, 2011 5 Credit Suisse 9,213 27 8.8% 5 Bradesco BBI 1,851 19 7.4% 6 BAML 7,009 28 6.7% 6 Santander 1,823 29 7.3% 7 Morgan Stanley 5,331 16 5.1% 7 Banco do Brasil 1,495 10 6.0% 8 Santander 5,137 16 4.9% 8 BTG Pactual 1,449 14 5.8% 9 Goldman Sachs 4,136 16 3.9% 9 BCP 588 13 10 Itau BBA 3,587 19 3.4% 10 Bancolombia 417 9 Ranking 4 No. Deals Share 2,990 21 6.5% HSBC 2,226 11 4.9% Itau BBA 1,966 15 4.3% 1,578 6 3.5% Bookrunner BNP Paribas Proceeds (US$MM) 5 JPMorgan 1,478 11 3.2% 6 Sumitomo Mitsui 1,200 8 2.6% 7 BBVA 1,178 6 2.6% 8 Credit Agricole 1,118 8 2.4% 2.3% 9 ING 974 7 2.1% 1.7% 10 BAML 936 6 2.1% Source: Dealogic as of August 21, 2012 The Financial Professionals Forum 2012 18 IRS Circular 230 Disclosure: Citigroup Inc. and its affiliates do not provide tax or legal advice. 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