23 rd Annual CFO Roundtable & Tax Director Workshop Las Vegas, Nevada September 24-26, 2017 2017 Credit Discussion Presented by: Shahrokh Shah – MD/Group Head, Engineering & Construction – BMO Financial Group Matthew Gibbons – MD/Group Head, Construction & Engineering – CIBC
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23rd Annual CFO Roundtable & Tax Director Workshop
Las Vegas, Nevada
September 24-26, 2017
2017 Credit Discussion Presented by:
Shahrokh Shah – MD/Group Head, Engineering & Construction – BMO Financial Group
Matthew Gibbons – MD/Group Head, Construction & Engineering – CIBC
Page 1 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Agenda
Loan Market Update
Interest Rate Market Update
Other Observations
BMO and CIBC
Page 2 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
A Leading Commercial & Investment Bank
BMO Financial Group
Organization
Key
Metrics1
A Leading Global Financial Institution
Global Banking Operations
Strong, Stable Partner
Moody’s
Institution Senior Debt Rating Credit Rating Outlook
Bank of Montreal A1 Negative
US Bank A1 Stable
Wells Fargo A2 Stable
JP Morgan Chase A3 Stable
PNC A3 Stable
Bank of America Baa1 Stable
Citigroup Inc. Baa1 Stable
Huntington Bank Baa1 Stable
Capital One Baa1 Stable
Fifth Third Bank Baa1 Stable
Key Bank Baa1 Stable
8th Largest North American Financial Institution
• Commercial, Retail and Private
Bank services
• Leveraging industry, business, and
wealth expertise
• Strong Midwest footprint with
offices in 25 states
• Leading full-service investment and
corporate bank
• Focused on large and mid-size
companies
• Deep industry knowledge across all
major sectors
• Canada's first bank established in 1817
• Offers broad range of retail banking, wealth management
and investment banking services
• One of the largest diversified financial services providers
in North America
Market Capitalization $49.2 billion
Total Assets $569.03 billion
LTM Revenue $16.9 billion
Employees 46,173
Tier 1 Capital Ratio 12.9%
1. Figures in $USD, 07/31/2017
BMO is a leading global investment & corporate bank backed by one of the world’s largest and most
1-month LIBOR and 5 Year Swap Rate (last 20 years)
5 year swap rate
1m LIBOR
Source: Bloomberg
Page 20 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Volatility (Normalization) Shows Signs of Returning
► Historically, short-term index rates, such as LIBOR, change frequently. From 1991 to 2011, the
average change in 1-month LIBOR during a 3 year period was 365 bps.
0
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Average Change in 1-month LIBOR During 3 Year Period
3y Range of 1m LIBOR
Avg Range from 1990-2011
Source: Bloomberg
Page 21 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
LIBOR Hits Highest Level Since 2008
► Money market rates have climbed to the highest level since the financial crisis
in response to recent rate hikes by the Federal Reserve.
1.23%
1.32%
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
2012 2013 2014 2015 2016
Ra
te (
%)
1-month & 3-month LIBOR
1-month LIBOR
3-month LIBOR
Source: Bloomberg
Page 22 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Fed has Nearly Achieved its Dual Mandate
► Eight years after emerging from the financial crisis, the Federal Reserve has
nearly achieved its dual mandate of full employment and stable inflation
4.0
4.5
5.0
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7.0
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2012 2013 2014 2014 2015 2016 2016 2017
Un
em
plo
yme
nt
Ra
te
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w J
obs A
dde
d
Labor Market Below “Full Employment” Inflation Near Target
Source: Bloomberg
Page 23 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
FOMC Projections
► Federal Reserve forecasts continue to show a gradual pace of rate hikes.
Source: Economic Projections of Federal Reserve Board, Sep 20, 2017
3 year path to normal “normal” rates
around 3%
Page 24 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Market Now Supports an Additional Hike in 2017
► The futures market currently implies a 71.4% probability of a third rate hike this year.
Current Target Rate Probabilities (Dec 13 2017 Fed Meeting)
Source: CME Fed Watch
Page 25 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
The Future of LIBOR
► Primary benchmark for short-term interest rates around the world -
tied to $350 trillion worth of financial derivative contracts, mortgages,
bonds and retail and commercial loans.
► Post financial crisis regulation has resulted in a lower volume of
transactions for banks to base LIBOR submissions.
► Expert judgement versus real transactions now make up a majority of
LIBOR submissions.
► Increased liability resulting from this approach has led the regulatory
agency that oversees LIBOR to recommended an expiration date for
LIBOR at the end of 2021.
Page 26 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
The Future of LIBOR
► The Federal Reserve has assigned the Alternative Reference Rate
Committee (ARRC) to manage the transition from U.S. Dollar LIBOR
to a new benchmark rate.
► Leading replacement rate is an index called the Broad Treasury
Financing Rate (BTFR). The BTFR rate contains a broad set of U.S.
treasury market based financing transactions.
► BTFR index rates are expected to be published by The Fed starting in
2018.
► The new benchmark will gradually be transitioned into credit
documents. In the event LIBOR becomes unavailable prior to this
happening credit documents will generally default to the Prime rate.
Page 27 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Agenda
Loan Market Update
Interest Rate Market Update
Other Observations
BMO and CIBC
Page 28 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Ideal Client
Character Market Position
Bonding
Quality of Cash Flow
Leverage / Capital Position
Reputation
Backlog / Margin
Liquidity
Revenue Diversity
Quality Mgmt
Team & Culture
Systems & Controls
Claims Mgmt
Return & Ancillary Business
Project Selection Criteria
What Does a Bank Look for in a Contractor?
Page 29 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Client Underwriting Keys
Area of Focus Credit Underwriting
• Ensuring that covenants are appropriate, and structures are
appropriately tight, to adequately monitor financial
performance, without hindering growth
• Detailed Review of surety agreements and terms
• Bonded work as a percentage of total revenue/backlog also
considered when evaluating risk and collateral
• Focus on bidding procedures to determine if appropriate
oversight is applied / proper approval systems are in place
• Analysis of historical and current work in progress reports to
asses profit fade and project execution risk
• Review of dependencies on major contracts/customers to
identify potential catalysts for financial performance
degradation without impacting potential areas of growth
• Monitor percentage of revenue associated with government
contracts, which are vulnerable to changes in policy and can
carry low margins
Capital Structure
Industry Outlook &
Customer Concentration
Bonded Work / Surety
Agreements
Bidding Procedures/Project
Execution
Page 30 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
General Observations
Theme Drivers
• Significant capital on the sidelines
• Multiples seem reasonable when compared to other
industries
• Recent history of growth in revenue and earnings and
improved margin profile are intriguing
• “Visibility” and perception there is longer term demand
• Balance sheets continue to carry the burden of projects
substantially completed
• Multi-year resolution processes ahead
• Stress on capital and liquidity positions
• Balance sheets improved and businesses well positioned
• Aging ownership demographic
• Visibility in backlog
• Favorable financing conditions
• Beneficiary of improved market conditions
• Strategic advantages within given markets
• Less burdened by problematic multi-year contracts
Increased Sponsor Interest
Formidable Regional Contractor
Continued Exit Strategy Evaluation
Hangover Continues
Reliance on Unproven Subs
• Strong market has created opportunity, particularly amongst
the trade.
• Aggressive expansion and quickly going up market
• Adequacy of capital position, supervision, controls, systems
Page 31 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Scarcity in Skilled Labor Force
An increase in construction projects around the
world has increased demand for skilled
laborers since the 2008 recession
Companies that are unable to secure laborers
face significant opportunity costs and
decreased growth prospects
As labor becomes more scarce, filling positions
becomes more expensive
Contributing Factors Mitigants
► Growth in construction projects
► Decreased unemployment rate
► Aging workforce
► Hours of training required for new labor force members
► Immigration costs
► Investment in internal training and promotion programs, as well as local training programs
► Increases in pay and benefits to retain current laborers
► Use of technology to replace positions
► Recruiting efforts outside of immediate construction area
Source: Navigant “Skilled-Labor Shortage: Myth or Reality?” 2017
Source: Bureau of Labor Statistics - Job openings - Workforce Statistics for NAICS: 236,237,238
The risk and expense associated with labor shortages can be mitigated through effective planning and
investment in both internal and external labor development
Page 32 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Interest Rate Increases Rate Risk Management – Best Practices Within the context of a broader risk management policy, managing interest rate risk usually involves the examination of
three key areas:
What is the ‘optimal’ mix of fixed and floating rate debt for our company?
Every company faces a unique mix of internal and external factors that influence the decision on ‘optimal’ debt
capital structure
Key quantitative objectives: lowest average cost of debt, lowest volatility of funding, and duration matching
– For intermediate tenors, a roughly balanced liability profile is the mathematically optimal blend
Any framework developed to analyze a company’s debt capital structure must consider historical data as well as
forward looking factors and their inter-relationships
Our observations indicate that most N. American corporations maintain fixed rate debt between 50% and 75% of
total debt
What are the potential risks/rewards of various hedging strategies?
Understand the quantum of risk and how a properly structured hedging program will perform under a variety of future
scenarios
Many companies will ladder the maturities of hedges and/or stagger the execution in order to reduce near-term and
longer-term pricing (repricing) risk
How do current market conditions help or hinder our objectives?
Current term rates remain near historical lows, favoring an increase in fixed rate liabilities (either via swapped bank
debt or bond issuance)
The yield curve is historically flat, reducing the cost to extend duration as well as the cost to hedge on a forward
basis
Interest rate risk management is a dynamic process that incorporates market conditions,
company specific factors and hedge performance as drivers of the decision
Page 33 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Interest Rate Increases (Cont.) Hedging Product Overview Interest rate derivatives are widely used by many different types of institutions as a part of regular prudent risk
management programs
Corporate entities use interest rate derivatives to manage fixed / float mix, hedge anticipated debt issuance and / or manage the currency mismatches between revenue streams and debt service
Other entities (e.g. hedge funds, pension funds, asset managers) use OTC derivatives both to hedge risk and / or take a position on the market
Although both exchange traded and OTC derivatives can be used for the same purposes, OTC derivatives provide a higher degree of customization, allowing for protection more closely tailored to a hedger’s specific risk profile
These are common contract features that can be customized:
Tenor The time between the start date and the maturity date of the instrument
Notional size /
amortization The amount of notional outstanding can remain flat, amortize or accrete
Forward start A contract entered into today that has an effective date that is weeks, months or years in the future
Floating rate index Specify both the index type (e.g. LIBOR, SIFMA , Prime) and the tenor (e.g. 1-month, 3-month, 6-month)
Payment frequency The frequency of settlements under the contract (e.g. monthly, quarterly). Can be the same or different for
fixed and floating legs
Swaps are flexible instruments that can be tailored to your specific situation
Page 34 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Interest Rate Hedging Strategies
Strategy Description Upfront Fee
Protects Against
Rising Rates
Benefits from
Falling Rates
Potential Early
Termination Values
Rate
Compared
to Swap
Plain
Vanilla
Swap
Fixed rate No Yes No Positive, flat or
negative N/A
Forward
Starting
Swap
Floating rate
initially, followed
by fixed rate
No Yes – after initial
floating period
Yes – during
initial floating
period
Positive, flat or
negative Higher
Cancellable
Swap
Fixed rate with
option to cancel
trade before
maturity
No Yes Yes – after call
period
Before call period:
Positive, flat or
negative
After call period:
Positive or flat
Higher
Swaption
Option to enter
into a swap
agreement at
future date
Yes Yes Yes
Before call period:
Positive or flat
After call period:
Positive or flat
Higher
Page 35 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Ownership/Liquidity Transition
Status
Quo
Debt
Recapitalization
Minority
Recapitalization ESOP
Majority
Recapitalization
Strategic
Sale
Liquidity
Ownership
Be
ne
fits
C
on
sid
era
tio
ns
• Grow revenue and
earnings in an effort to
increase future
valuation
• Maintain control and
maximize upside
• Provides rapid access
to capital and
opportunity for
Shareholder liquidity
• Enables Shareholders
to maintain economic
control
• Establishes lending
relationship that
Shareholders can
utilize for additional
capital requirements in
near-term
• Provides rapid access
to capital and
opportunity for
Shareholder liquidity
• Enables Shareholders
to maintain economic
control
• Establishes lending
relationship that
Shareholders can
utilize for additional
capital requirements in
near-term
• Creates liquidity and asset
diversification
• Competitive valuation to
majority recap
• Shareholders determine
process and criteria
• Ownership incentives for
employees
• Limited organizational
change – stocks stay in
friendly hands
• Lower valuation typical
• Creates liquidity and
source of future
growth capital
• Opportunity to benefit
from prevailing
industry trends
• Minimizes future
business risk
• Can be pursued in
conjunction with
acquisition growth
strategy
• Maximizes current
payout
• Eliminates business
risk
• Capitalizes on
potential synergies
and product
expansion
opportunities
• Valuation not solely a
result of capital
markets environment
• Risk associated with
execution of growth
strategy
• No near-term liquidity
or capital for growth
• Tighter leverage
standards and overall
lending criteria
• Liquidity will be limited
in an “un-sponsored”
transaction
• Debt service
requirements
• May reduce
Shareholders’
potential to realize
upside
• Expectation that
senior management
remains with the
Company
• Potential valuation
discount for
investment
• Tighter leverage standards
and overall lending criteria
• ESOP administration costs
• Potentially greater risk for
employee retirement funds
• Corporate obligation to
repurchase shares
• May reduce Shareholders’
upside
• Tighter leverage
standards and overall
lending criteria
• Optimal timing
• May reduce
Shareholders’ potential
to realize upside
• Ability to facilitate due
diligence
• Expectation that senior
management remains
with the Company
• Industry performance
and timing
• Company positioning
• Uncertainty of
Shareholders’ and
management’s future
roles
• Integration and
cultural issues
A desired balance of liquidity and ownership can be reached through a number of different actions
Page 36 23rd Annual CFO Roundtable and Tax Director Workshop
September 24-26, 2017
Increased Project Size and Complexity
• Large projects likely to be more capital intensive
• Multi-year construction timeline increases likelihood of unexpected events occurring
• Cost overruns and change orders are amplified by the scale of a given project
• New building designs call for a wider array of building techniques and building materials
• Industry importance of safety vs. customer request for rapid completion
Size Complexity
Ch
all
en
ge
s
So
luti
on
s
• Capital risk can be mitigated by entering into joint ventures or private-public partnerships
• Modern machines can speed up project completion by accelerating data collection and analysis
• Investment in project modeling and bidding software can help reduce errors and improve cost estimates
• Availability of high-grade materials (ex: glass/concrete-based products), and Building Information Modeling (“BIM”) software allows for more complex structure construction
• Use of prefabricated structures or modular building materials can shorten project completion time without increasing risk of injury
Source: IBISWorld Industry Report – Commercial Building Construction in the U.S. (December 2016)
Project size and complexity can be managed through a combination of proper structure,
and adoption of modern technology/building techniques
Page 37 23rd Annual CFO Roundtable and Tax Director Workshop