Triple Whammy - stock market, banking, real estate

Now, the IMF has described this as the largest financial crisis since the Great Depression in 1929.
I think we would all agree.
A reasonable question to ask is why banks and dealers, as well as investors, never learn from previous financial crisis. If you look back over the past 150 years, booms and busts and financial crises occur with depressing regularity – almost like clockwork.
Ton Fell often said, if your country hasn’t had a banking or financial crisis in the past decade, just wait – one will be coming shortly.
There was a major banking crisis in the U.S. in the late 1870s following an incredible railroad boom. The U.S. Federal Reserve was created in 1913 following a series of bank crises and runs on deposits.
And then, of course, we had the stock market crash in 1929 and the Depression. This was followed in 1934 by the establishment of the Federal Deposit Insurance Corporation in the U.S. to protect depositors and the Securities and Exchange Commission to protect investors.
Crises over the last seventy-years have been less severe, although I can tell you they seemed, and were, very serious at the time.
The LDC banking crisis in 1982 – the Canadian Bank Stock Index fell by 42%.
The U.S. Savings & Loan crisis in the late 1980s when 2,000 S & Ls went out of business – U.S. bank shares fell by 45%.
Until now, the all time high water mark for massive market and business excesses in living memory was the breaking of the Japanese bubble in 1989. While this crisis was confined to Japan, it is the second largest economy in the world so it was big.
This was a triple whammy. A stock market bubble, a banking bubble and real estate bubble all wrapped up in one. When the bubble burst many banks and insurance companies were forced to merge, restructure or were bailed out by the government. The Japanese bank stock index topped out just after Christmas 1989 and dropped by 45% in just the first year but eventually declined by 91%.
(I call that a bear market)
It is of interest that, even now, the overall Japanese stock market, as measured by the Nikkei Dow, is 80% below where it was twenty years ago. The Japanese crisis lasted more than a decade and total losses were estimated at about $750 billion.
Finally, in the late 1990s we had the incredible telecom and internet bubble which broke in 2000. We can all remember this - you know, when Nortel had a market cap of over $350 billion.
The late 1990s was a period of wild investor hysteria.
It was a true feeding frenzy with the Nasdaq tripling in less than two years and IPOs doubling and tripling on the first day of trading.
As always, the bubble broke, the Nasdaq Stock Index declined by 77% over the next three years with the bankruptcy of Enron, Worldcom being two of the biggest in American history.
That crisis brought us Sarbanes-Oxley.
When you look back on all these cycles, a central question is “why do we have to go through constantly recurring market and business bubbles.
Kindleberger, the late MIT historian, is well known for his 1978 book “Manias, Panics and Crashes” which traces four centuries of booms and busts.
Cycle after cycle the similarities are striking. It all gets back to;
- over-optimism and herd mentality
- greed in the financial business
- excessive leverage
- borrowing short and lending long
- flawed financial innovation and
- regulatory failure
(usually all wrapped up with a good dollop of fraud and corruption)
Those who don’t learn from the mistakes of history are doomed to repeat them and that’s why we are here again – one more time.

5 Reasons Canada is Better Off than the USA

First, the Canadian economy and our financial institutions have benefited from certain elements of plain good public policy. For the past eleven years the Federal Government has been running surpluses aggregating over $100 billion. Accordingly, Canada’s economy and financial system are in a stronger position than most, going into this downturn.
Second, the national retail banking franchises of the Canadian banks provides them with a strong and stable funding base, less dependent on volatile wholesale funding. This is a huge asset in difficult times.
Third, we have benefited in Canada from a strong regulatory framework. Our banks are the most conservatively capitalized in the world.
Fourth, in Canada we have kept tighter control of our residential mortgage market.
Fifth and final, I believe Canada’s financial institutions have been inherently more risk averse than those in the U.S. and Europe.

Less cowboy capitalism and less bet the bank mentality. This more conservative approach over the years has served us well.

CVCA Portfolio Management

Critical to proactively manage portfolio company performance through a downturn - increased focus on dashboard reporting and managing expectations
- Cash flow "Quick Hits": Dial back growth; Focus on streamlining direct costs as opposed to SG&A; Aggressively manage working capital
- Very rarely are cuts too deep - need to react to current environment quickly and prepare for the worst - revisit downside case
Clearly, we are operating in very difficult and uncertain times. That being said, there was a general consensus that good deals will get done in 2009.

CVCA Valuation & Structuring

Valuation of Canadian PE deals never reached the heights of their US counterparts - many Canadian sponsors sat on the bench and leverage levels were relatively prudent
- For the most part, there is not widespread acceptance of the "new world" amongst sellers - deals getting done are when sellers are distressed
- Lack of transaction comps post Fall 2007, significantly deteriorating current trading and lack of visibility through 2009 make valuation incredibly difficult - greater emphasis on diligence
- To mitigate valuation concerns, recent transactions have seen a greater emphasis on earn outs and vendor take backs - trend will likely continue
- Most interesting opportunities have a restructuring angle - need to structure for the downside case.

CVCA Market Update

Fresh from the CVCA conference last week:
Market Update
PE deal activity has been crippled by significant expectation gaps between buyers and sellers and a lack of financing
- Current baseline LBO structure for a "middle of the fairway" business - EV: 5.0-6.0x EBITDA; Total debt: 2.0-2.5x EBITDA
- Shift towards smaller deals - Larger US sponsors are looking at equity tickets in the region of US$200m
- 2009 has seen positive inflows into leveraged loan and high yield funds marking a potential return to mainstream lending
- Increasing number of GP's are returning LP commitments and/or reworking terms - fundraising market is limited, although there is demand for distressed/turnaround funds
- Increasing number of mid market US sponsors looking North to Canadian carve outs and/or distressed situations
- 2007/2008 funds will make for some of the best vintages given unprecedented buying opportunities