St Petersburg Graduate School of Management
June 6, 2008
Michael Klein
Chairman of the Institutional Clients Group
Vice Chairman, Citi
The Headlines Tell The Story…
“The Collapse of Major Investment House: Symbol of Wall St. Era Is Dismantling”
“Facing Unfortunate Facts; It’s Time to Separate the Recession from the Euphemisms”
“Middle East Investor Buys Major Stake in U.S. Bank”
“Leveraged Buy-Out Funds Are High-Fliers No Longer”
“Anti-LBO Bill Introduced in Congress”
The Agency was Starting to Detect Problems in Bank Lending to Highly Leveraged Companies”
“The Market for Bank Debt is in Complete Disarray”
– New York Times, 1990
1990
– Washington Post, 1991
– The Associated Press, 1991
– Wall Street Journal, 1990
– Reuters, 1990
– OCC, 1989
– ML, 1990
1
The Markets Have Been Declared Dead
Total GDP Growth
Equity Market (DJIA)
M&A Activity
But some companies, firms and business models did not survive.
2000-2007
41%
319%
905%
3,194%
1990-2000
69%
240%
662%
1,383%
.. And Reborn Many Times
Leveraged Finance Issuance
2
How The Markets Have Changed
2H 07: Markets Seized
H1 08…? Drought
Credit Contraction RecessionIlliquidity
… Through Summer ’07:Liquidity Wave
3
A Decade of Financial Wealth
Per Capita Income Equities Real Estate
Commodities Derivatives Art
8000
9000
10000
11000
12000
2003 2004 2005 2006 2007
700
1000
1300
1600
2003 2004 2005 2006 2007
900
1300
1700
2100
2500
2900
2003 2004 2005 2006 2007
1500
2000
2500
3000
3500
4000
2003 2004 2005 2006 2007
100
270
450
516
0
100
200
300
400
500
600
2001 2005 2006 2007
Source: Factset, EIU, Reuters, Citi Research, ArtnetNote: Per Capita Income Global, Equities: S&P 500, Real Estate: FTSE EPRA/NAREIT Global, Commodities: Moody’s Commodity IndexDerivatives: Citi Wedge 2007 dollar amount in trillions.
50
60
70
80
90
2003 2004 2005 2006 2007
4
Globalization And Liquidity
The Three Waves Of Globalization
• Investment Grade Emerging Market Sovereigns
• Local / Global Bonds
• Local / Global Banks
• EM Equity Markets
Regulatory Technology Capital
• Personal Computers / Networks
• Internet
• Mobile Phones
• Wireless
• WTO
• NAFTA
• EU
• CAFTA
5
The Liquidity Cycle
Liquidity Cycle
Global Economic Transition
Robust Growth
New Capital Flows
Excess Liquidity
Reach for Yield
6
$81
$583
$3,935
$6,995
$0
$2,000
$4,000
$6,000
$8,000
1980 1990 2000 2007
Unprecedented Liquidity
Source: Dealogic & BIS.
$34
$95
$516
$0
$100
$200
$300
$400
$500
$600
1980 1990 2000 2007
US$ in Billions US$ in Trillions
Equity & Debt Issuance Value of Outstanding Derivatives
7
Three Main Drivers of Global Liquidity
GlobalLiquidity
Economic Industrial New Engines
Commodities-Driven Sovereign Reserves
Financial Entrants
8
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
2,200
2,400
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
Starts
Sales
Source: US Census Bureau.
(Units in 000s)
U.S. Housing
Mortgage market at $11T equals GDP.
Liquidity Evaporates Triggered by Housing and Leverage
Subprime Lower Grade Securities Pricing
Subprime is less than 10%.
3%
13%
23%
33%
43%
53%
63%
73%
83%
93%
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08
ABX BBB 07-1
9
-30%
-35%
-69%
-81%
Equity
M&A Ann.
Lev Loans
Corp HY5
10
15
20
25
30
35
40
Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08
Vix
Contagion Spread Through The Financial Markets
Source: Citi, Bloomberg, SDC
Asset-Backed Commercial PaperFixed Income Markets
Significant Market Volumes Decline Y-o-YEquity Volatility
400
500
600
700
800
900
1,000
1,100
$1,200
2005 2006 2007 2008
ABCP ($b, O/S)
2.00
2.50
3.00
3.50
4.00
4.50
5.00
5.50
6.00
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08
LIBOR - 3 Month
10
Impacted Many New Markets
Sub-Prime Mortgages
Leveraged/ Liquidity Loans
Commercial Paper
Bank Balance Sheets
Equities Decline
TBD…
SIVs
Subprime CDOs
Monoline Insurers
Auction Rate MarketConduits
Derivatives
11
Pre-Tax % of 2006Firm Total Losses TBV
IKB Deutsche $8.9 492.1%UBS 38.2 134.7%Merrill Lynch 31.7 94.8%Citigroup 40.9 58.9%CIBC 4.1 52.4%Washington Mutual 8.3 49.2%Morgan Stanley 12.6 40.9%Credit Suisse 9.6 36.5%Royal Bank of Scotland 15.2 29.2%Credit Agricole 6.4 27.6%Bank of America 14.9 27.4%Bear Stearns 3.2 27.2%Deutsche Bank 7.6 23.9%Wachovia 7.0 23.6%Lehman Brothers 3.3 22.4%ABN Amro 2.4 20.3%HSBC 12.4 17.5%JPMorgan Chase 9.7 17.4%HBOS 5.9 16.8%Fortis 3.7 15.3%Mizuho Financial Group 5.5 13.9%Societe Generale 4.0 13.2%Barclays 3.2 13.1%Goldman Sachs 3.0 11.1%Natixis 1.9 9.8%Dresdner 3.4 7.0%Others 56.3
Total $323.3
Enormous Capital has been Drained out of the System…
Source: Bloomberg (May 9, 2008).
Virtually all caused by mortgage exposure.
Cumulate Losses Since Beginning of 2007 to Date
12
Enormous Capital has been Drained out of the System
Banks & Brokers
U.S Commercial Paper Market
Structured Finance / ARS Market
Other
(~$1,000 Billion)
?
Source: Bloomberg, Federal Reserve, Dealogic, Citi estimates.
Post-TaxLosses Leverage Loss of Liqudity
Banks ($137) 15x ($2,048)
Brokers ($74) 30x ($2,209)
Total ($4,257)
July '07 Current Decrease
$2,187 $1,822 ($365)
~$5.6 trillion
13
Broker-Dealers and Banks’ Financing Costs Exploded5 Year CDS Spreads
January ’06 to December ‘06
5
105
205
305
405
505
605
705
805
Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08
GS BSC JPM MER C LEH MS
0
50
100
150
200
250
300
350
400
450
500
Jan-06 Apr-06 Jul-06 Oct-06
January ’07 to July ‘07
0
50
100
150
200
250
300
350
400
450
500
Jan-07 Apr-07 Jul-07
August ’07 to Current
0
50
100
150
200
250
300
350
400
450
500
Aug-07 Nov-07 Feb-08
14
Financing Markets are a Balance of Power
Central Banks
Universal Banks
Brokerage Firms
CapitalMarkets
Investors
In Times of Stress, the Power Moves to the Central Bank
•Substantial liquidity from Central Banks•3.25% cut to discount rate•Unique use of Fed discount window•Bear bailout•Mortgage commitments approaching $500B
15
Company Capital Raise
$17.0 Billion
$13.1 Billion
$10.5 Billion
$10.0 Billion
$9.7 Billion
Investors Have Essentially Replenished the Near Term Gap
Company Capital Raise
$44.1 Billion
$43.7 Billion
$23.3 Billion
$17.4 Billion
$17.9 Billion
Total Capital Raised of over $275 Billion /
Total Funding of $700 BillionSource: Bloomberg (May 9, 2008).16
$3.0
$12.0
2007 2015
Sovereign Wealth Funds: Competitors or Partners?
SWFs Are Projected to Grow Significantly(in Trillions)
SWFs are Big and Getting Bigger ($ T)
$48.1
$23.6
$5.4
$3.0
$1.9
$1.3
$7.5 - $12.0
Asset ManagementIndustry AUM
Retirement FundsAUM
ProjectedSovereign Wealth
Funds
Foreign ExchangeReserves
Sovereign WealthFunds
Hedge Funds AUM
Private Equity AUM
17
SWF Capital Can Reshape Global Economic Landscape
Source: Warnock and Warnock: “International Capital Flows and US Interest Rates,” NBER 12560, Oct 2006. McKinsey Global Institute: “The New Power Brokers: How Oil, Asia, Hedge Funds and Private Equity are Shaping Global Capital Markets,” Oct. 2007. Estimates of SWF capital inflow effects based on historical relationship between GDP growth and FDI, as estimated by Carkovic and Levine
(2005), “Does Foreign Direct Investment Accelerate Economic Growth?”.
Purchasing Power Reduces Cost of Treasuries by 130 bps
If SWFs Primarily Invest in US, Growth Increases by 1/3
At Oil Prices of $100/barrel, Incremental $2.5 bn Investment into World Markets per Day
18
MSCI EM
0
250
500
750
1,000
1,250
$1,500
2003 2004 2005 2006 2007 2008
The Four Dichotomies Since the Dislocation BeganUS vs. InternationalFinancial vs. Real Economy
Debt vs. Equity The Great Emerging Markets
US GDP Growth
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
2003 2004 2005 2006 2007
Source: Factset, Dealogic, IMFReports
All are Converging.
S&P 500
0
250
500
750
1,000
1,250
1,500
$1,750
2003 2004 2005 2006 2007 2008
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
2006 2007 2008E 2009E
US Euro Area Emerging Market
19
Trends that Matter
New Capital Flows
New Capital Flows &
Disintermediation
Regulatory Change
Energy/ Commodities
Emerging Markets
20
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