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t t t
ede al ese ve Bu ld
T E C d i B d M k T d
Framing Presentations on Tax-Exempt Conduit Bond Market Trends:
Credit Enhancement TrendsCredit Enhancement Trends
California Debt and Investment Advisory Commission California Private Activity Bonds Workshop
Federal Reserve Building
PRESENTATION3
g Los Angeles, California 90015
September 7, 2011
g
Speaker
Nikolai J. Sklaroff, Director Wells Fargo Securities
o Public Finance Investment Banker
o Published “California’s Credit Crisis: Financing Credit Facilities After the Financial Storm” in Debt Line in December 2009*
o Much has changed, even since 2009
* While at Loop Capital
H i it ti i t h ?
Outline of Topics
How has the credit enhancement market changed and what How has the credit enhancement market changed and what does it look like today?
How is it continuing to change?
What new options are available?
What does the future hold?
P
- - - - - - - - - - -
30 Y "A " MMD 30 Y "B " MMD- -
Impact of Credit Ratings – After the Crisis
900
Interest Rates by Credit Ratings Today
700
800
500
600
oint
s
260 bps
176 bps
300
400 Basi
s P
Credit spreads were widest in 2009 and
100
200
Credit spreads were widest in 2009 and have since narrowed but are still wider
than pre-crisis
0
Jan 07 Jun 07 Nov 07 Apr 08 Sep 08 Feb 09 Jul-09 Dec 09 May 10 Oct 10 Mar 11 Aug 11
Year
30 Year "Aaa" MMD 30 Year "Baa" MMD
Source: Municipal Market Data. As of August 25, 2011.
“i d ” 2 0% ”
Impact of Credit Ratings – Today’s Yields
Interest Rates by Credit Ratings Today
6.0%
"AAA" INSURED "AA" "A" "Baa"
4.0%
5.0%
Now 1.76% separates the top and bottom
3.0%
Rate
“investment grade bonds today
1.0%
2.0%
0.0%
2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
Year
Source: Municipal Market Data. As of August 25, 2011
N t R t dAssurance Corporation
Bond Insurers Lose Their Triple-A Ratings
Insurer Moody’s S&P Fitch
Aa1 AA+ Stable Negative Not Rated
Aa3 Negative Outlook
AA+ Negative Outlook Withdrawn
Aa3 AA+
Assurance Corporation
Aa3 Negative Outlook
AA+ Negative Outlook Withdrawn
Withdrawn Withdrawn Withdrawn
Baa1 Outlook Developing BBB
Outlook Developing Withdrawn
Withdrawn Withdrawn Withdrawn Withdrawn Withdrawn Withdrawn
Withdrawn Withdrawn Withdrawn
Withdrawn Withdrawn Withdrawn
Ca Outlook Developing Withdrawn Withdrawn
Source: Bloomberg. As of August 25, 2011
30%
The Rise and Fall of Municipal Bond Insurance
90%
100%
70%
80%
50%
60%
Unenhanced
Other Guarantees
40%
50% Standby Purchase Agreements
Letters of Credit
Bond Insurance
20%
30%
0%
10%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Bond Buyer. As of August 25, 2011
4
T t l M k t C it li ti
January 1, 2007 June 15, 2011
Changes in the Bank Industry
Total Market Capitalization
January 1, 2007 August 25, 2011
274 Citigroup 139 JPMorgan (AA-)
120
120
125
168
240
Wells Fargo
UBS
RBS
JPMorgan
Bank of America
53
58
78
87
131
UBS (A+)
Goldman Sachs(A)
Bank of America (A+)
Citigroup (A+)
Wells Fargo (AA)
85
90
93
115
120
Morgan Stanley
Goldman Sachs
Barclays
Wachovia
Wells Fargo
33
36
41
43
53
Credit Suisse (A+)
Deutsche Bank (A+)
RBS (A-)
US Bank (AA-)
UBS (A+)
64
67
75
82
W M
US Bank
Deutsche Bank
Credit Suisse
Merrill Lynch
14
25
31
32
S T t (BBB )
BB&T (A+)
PNC (A+)
Barclays (AA-)
Morgan Stanley (A)
24
24
30
42
43
Bear Stearns
BB&T
SunTrust
Lehman Brothers
WaMu
6
10
KeyBank (A-)
SunTrust (BBB+)
15
22
23
- 50 100 150 200 250 300
KeyBank
PNC
National City
- 50 100 150 200 250 300
Source: Bloomberg. Company websites. As of August 25, 2011
sse
Changes in the Letter of Credit Industry
Top 20 LOC Banks in 1991 Top 20 LOC Banks in 2001 Top 20 LOC Banks in 2011 YTD(1)
Rank Bank Principal Amount
Mkt. Share
National Flag Rank Bank Principal
Amount Mkt. Share
National Flag Rank Bank Principal
Amount Mkt. Share
National Flag
1 Mitsubishi Bank 738.2 7.8 1 Bank of America NT&SA 1268.5 9.8 1 JPM Chase 1019.1 23.7
2 Sumitomo Bank 701.7 7.4 2 SunTrust Bank 906.3 7.0 2 Wells Fargo Bank 787.2 18.3
3 Societe Generale 576.2 6.1 3 US Bank National Association 525.9 4.1 3 Bank of America NT&SA 500.8 11.6
4 Industrial Bk of Japan Tr Co. 574.9 6.0 4 Allied Irish Banks 491.6 3.8 4 AGM formerly FSA Inc 396.1 9.2
5 Morgan Guaranty 542.6 5.7 5 Bank One, NA 486.1 3.8 5 US Bank National Association 298.6 6.9
6 Swiss Bank Corporation 516.4 5.4 6 Wachovia Bank 465.2 3.6 6 Citibank NA 295.0 6.9
7 AMBAC 493.2 5.2 7 Landesbank Hessen-Thuringen 436.0 3.4 7 Northern Trust Company 228.4 5.3
8 National Westminster Bank PLC 427.0 4.5 8 Bayerische Hypo Vereinsbank AG 413.0 3.2 8 Royal Bank of Canada 200.0 4.7
9 FGIC 423.0 4.5 9 The Chase Manhattan Bank, N.A. 379.0 2.9 9* National Australia Bank 112.5 2.6
10 Citibank NA 320.4 3.4 10 Fleet Bank NA 337.0 2.6 9* Australia & New Zealand Bk Gp 112.5 2.6
11 Student Loan Marketing Asoc 313.3 3.3 11 Firstar Trust Company 320.9 2.5 11 PNC Bank NA 107.2 2.5
12 Union Bank of Switzerland 305.2 3.2 12 The Bank of New York Mellon 310.9 2.4 12 Morgan Stanley Bank 100.0 2.3
13 Sumitomo Trust & Banking 299.6 3.2 13 Bayerische Landesbank 296.4 2.3 13 Union Bank NA 77.6 1.8
14 The Fuji Bank, Limited 287.4 3.0 14 First Union Natl Bk of Georgia 233.1 1.8 14 TD Bank NA 72.3 1.7
15 Bank of Tokyo 253.0 2.7 15 Barclays Bank PLC 224.6 1.7 15 The Bank of New York Mellon 64.2 1.5
16 Credit S i 187 6 2 0 16 PNC Bank NA 208 3 1 6 16 US Bank 60 3 1 416 Credit Suisse 187.6 2.0 16 PNC Bank NA 208.3 1.6 16 US Bank 60.3 1.4
17 Toronto-Dominion Bk & Tr Co. 165.9 1.7 17 US Bank 202.2 1.6 17 Union Bank of Switzerland 55.0 1.3
18 The Sanwa Bank, Limited 164.1 1.7 18 HypoVereinsbank Luxembourg SA 200.0 1.5 18 Bank of Scotland 53.3 1.2
19 Barclays Bank PLC 152.1 1.6 19 AmSouth Bank NA 199.0 1.5 19 Bank of Tokyo-Mitsubishi UFJ 45.0 1.1
Source: Thomson Financial and company websites; True Economics Rankings. As of August 25, 2011
20 The Tokai Bank, Ltd. 134.9 1.4 20 Branch Banking & Trust Co 191.1 1.5 20 Federal Home Loan Mtg Corp 32.1 .8
Industry Total 9,510.5 100.0 Industry Total 12,946.0 100.0 Industry Total 4,302.8 100.0
Select Credit Bank Ratings and Trading Relationships
Long-Term Credit Support and Counterparty Ratings and Trading Values(1)
Bank Moody's S&P Fitch
Wells Fargo Bank
J.P. Morgan
U.S. Bank
Aa2
Aa1
Aa2
AA
AA-
AA-
AA-
AA-
AA-
Northern Trust
Bank of America
Aa3
Aa3
AA
A+
AA-
A+
BB&T
Citibank
PNC Bank
Goldman Sachs
A1
A1
A2
A1
A
A+
A+
A
A+
A+
A+
A+
CompassCompass
Keybank
Morgan Stanley
Fifth Third
SunTrust
Regions
A3A3
A3
A2
Baa1
Baa1
Baa1
AA
A-
A
BBB
BBB
BBB-
A+A+
A-
A
A-
BBB+
BBB-
Source: Bloomberg as of 8/15/2011
LOC/Liquidity Support Volume
Bank Exposures LOC/Liquidity
> $30B BofA JPM
$29B - $20B Wells Fargo Citibank
$19B - $10B Dexia US Bank
$9B - $6B Barclays BB&T Helaba PNC State Street
< $5B Allied Irish BBVA BLB BMA/Harris BNP BoNY Depfa KBC LBBW Lloyds RBC Regions
Source: Bloomberg. As of August 25, 2011.
Scotia Soc Gen Sumitomo SunTrust Union Bank
T th b k t d f 54% f l
General Trends in Credit Enhancement
Bond Insurance Option, Going, Going…
Variable rate issuance declining and current volume Variable rate issuance declining and current volume dominated by replacement facilities
Banks retaining capacity for existing clientso Banks retaining capacity for existing clients
o Pricing remains competitive
o Greater attention to documentation
(1) o Top three banks accounted for 54% of volume(1)
o Number of banks providing enhancement has declined since 2008, with little activity from foreign banks
(1) Thomson Financial; True Economics Rankings. As of August 25, 2011
Variable rate growth and dramatic changes
HiHisttoriical Vl Variiablble RRatte IIssuance
120.0
BBilli
ons
100.0
80.0
60.0
40.0
20.0
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
VRDO ARS
Source: Thomson Financial. As of August 25, 2011
0.0
Changes in the Letter of Credit Volume
Hi t l LOC I Historiical LOC Issuance
80.0
BBilli
ons
70.0
60.0
50.0
40.0
30.0
20 0 20.0
10.0
0.0
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
National California
Source: Thomson Financial. As of August 25, 2011
But the Stats are misleading…
While the decline in variable rate and LOC issuance is genuine, it is also vastly overstated
Significant movement to on-balance sheet enhancement alternatives: Direct Purchase by Banks
Different banks are doing the product differently and the generic term really describes multiple products
Volume significant
o Some banks buying as securities, some as loans
o Some show up in market data, much does not
O S d l S ll i h S
Three Basic Models
Issuer Bonds*
SIFMA +/-Spread
VRDO Structure Index Floater Structure Wells Fargo Direct Purchase Structure
SIFMA +/-Spread
SIFMA +/-Spread
LOC Provider Remarketing Agent
Fee Fee Tender Option
Issuer Bonds* Spread
Issuer Securities** Spread
Comparison of Risks
* Bonds purchased by Investors * Bonds purchased by Investors ** Bonds purchased by WFS
Remarketing remarketing agent’s capital strength and performance
Spread over index is locked in for the entire Index Floater period
Systemic Put Investors refuse to hold VRDOs or Index Notes as an asset class
Bank does not have a right to tender
the Index Floater to the borrower prior to the expiration of the Index p p
Floater Period‡
Bank Renewal Facility is not renewed or pricing increases dramatically upon renewal
If bank does not negotiate a new
Index Floater term or will not write an LOC upon expiration, issuer faces
term out
Interest Rate Variable rates may rise unexpectedly resulting in higher debt service
Rates are variable and may rise resulting in increased costs
‡ Under certain credit events, the Bank may accelerate repayment of the securities
VRDO Index Floater Wells Fargo Direct Purchase
Spread over index increases due to Bank Risk Spread over index is locked in for the investor discomfort with bank credit entire Index Floater period
Spread over index is a function of a
Variable rates are extraordinarily low
Hi t i l SIFMA
9.0%
High: 7.96% Low: 0 07%
Historical SIFMA
7.0%
8.0% Low: 0.07% Average: 2.72% Current: 0.20%
5.0%
6.0%
3.0%
4.0%
Average = 2.72%
1.0%
2.0%
0.0%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Period of extraordinarily low ratesPeriod of extraordinarily low rates
Source: Thomson Financial. SIFMA as of August 25, 2011.
Economist Outlook on the 30-Yr US Treasury (as of August 12, 2011)
Economist Outlook on the Federal Funds (as of August 12, 2011)
Outlook for Variable rates looks to remain low
1.50% 7.00%
Economist Outlook on the 30-Yr US Treasury (as of August 12, 2011)
Economist Outlook on the Federal Funds (as of August 12, 2011)
Citi
0.75%
1.00%
1.25% BofA Merrill
Moody's
Citi
Wells Fargo
3 00%
4.00%
5.00%
6.00%
BofA Merrill
Moody's Economy
Wells Fargo
0.00%
0.25%
0.50%
Economy
0.00%
1.00%
2.00%
3.00%
Unique clarity from the Fed’s recent outlook for rates
Current 3Q 2011 4Q 2011 1Q 2012 2Q 2012 3Q 2012 4Q 2012 Current 3Q 2011 4Q 2011 1Q 2012 2Q 2012 3Q 2012 4Q 2012
Rates are expected to remain low through 2013
Source: Bloomberg. As of August 12, 2011.
g
Future Issues for Variable Rate Financing and Credit
Bank ratings and balance sheets
Shifting business models
Evolution of new products
o DP is continuing to evolve in response to competitive pressures and investor demand
On balance sheet alternatives
Term / Renewal Term / Renewal
Cost
Basel III
Interest rates Interest rates
- -
Questions and Follow up
Nikolai J. Sklaroff Public Finance Investment Banker
Wells Fargo Securities 550 California Street, 10th Floor MAC A0112-108 San Francisco, CA 94104 415-222-6825 Direct 415-608-5467 Cell 415-975-7537 Fax415 975 7537 Fax [email protected]
Wells Fargo Securities is the trade name for certain capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including Wells Fargo Bank, National Association and Wells Fargo Securities, LLC, member NYSE, FINRA and SIPC.
“
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