Liquidity Management in the New Era

Discussion with the Richmond AFP

Jeff Avers

Treasury & Payment Solutions

Liquidity Strategy & Consulting

November 15, 2012

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Liquidity Management in the New Era

 Past, Present & Future of Short-Term Investing

Risk and Return

Efficient Frontier

Today’s Investing Opportunity

Treasury Yield Curve

The Reward for Credit Risk

Market Rates

Key Insights from 2012 AFP Liquidity Survey

The Perfect Storm

Unlimited FDIC and the DDA Bubble

The Impact of Reg Q Repeal

Past and Future Role of Sweep

The New Role of Liquidity

Change in Allocation of Investments

Agenda:

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“These new regulations will fundamentally change the way we get around them.”

Regulatory Reform

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Objective of Today’s Discussion

The basic principals of liquidity investing are no different today than in the past

The dynamics of today’s short-term investment environment should lead you to construct a portfolio whose composition is different than pre-2008

Financial Regulatory Reform has already had an impact on liquidity management practices, and will continue to do so going forward

Make These Three Key Points:

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Risk & Return Past, Present & Future of Short-Term Investing

As investment risk increases, so does the expected return As investment risk increases, so does the expected return

Investopedia defines the risk-return tradeoff as “the principle that potential return rises with an increase in risk. Low levels of risk are associated with low potential returns, whereas high levels of risk are associated with high potential returns. According to the risk-return tradeoff, invested money can render higher profits only if it is subject to the possibility of being lost. Because of the risk-return tradeoff, you must be aware of your risk tolerance when choosing investments for your portfolio.”

Investopedia defines the risk-return tradeoff as “the principle that potential return rises with an increase in risk. Low levels of risk are associated with low potential returns, whereas high levels of risk are associated with high potential returns. According to the risk-return tradeoff, invested money can render higher profits only if it is subject to the possibility of being lost. Because of the risk-return tradeoff, you must be aware of your risk tolerance when choosing investments for your portfolio.”

Investors should consider the risk-return tradeoff as they view the yields associated with each investment option

For investment products that involve an underlying portfolio of securities, such as money market mutual funds and/or LGIPs, investors should review the portfolio holdings before investing to make sure they are comfortable with the portfolio’s (1) issuers and (2) asset classes for all of the securities held in the portfolio

–Some investors may not be comfortable with foreign issuers, broker-dealers or finance companies, while others may not be comfortable with asset-backed securities (ABS) or commercial paper

–A review of the portfolio’s holdings will reveal any discrepancies with the investor’s risk tolerances

Investors should consider the risk-return tradeoff as they view the yields associated with each investment option

For investment products that involve an underlying portfolio of securities, such as money market mutual funds and/or LGIPs, investors should review the portfolio holdings before investing to make sure they are comfortable with the portfolio’s (1) issuers and (2) asset classes for all of the securities held in the portfolio

–Some investors may not be comfortable with foreign issuers, broker-dealers or finance companies, while others may not be comfortable with asset-backed securities (ABS) or commercial paper

–A review of the portfolio’s holdings will reveal any discrepancies with the investor’s risk tolerances

Cash investors should strive to understand the concept of risk-return when managing their short-term cash portfolio. The risk-return tradeoff implies that higher yielding investments carry a higher level of risk, with US Treasuries (UST) generally being considered to offer the ‘risk-free’ rate. All other short-term investments are considered to carry a higher degree of risk than UST’s, and should therefore offer a higher rate of return

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The Efficient Frontier*

The shaded area represents all possible portfolios one could invest

in The upward sloped curve (PQVW), called the efficient frontier, is the optimal set of portfolios for every given level of risk and expected return

• From the portfolios that have the same return, the investor will prefer the portfolio with lower risk, and

• From the portfolios that have the same risk level, an investor will prefer the portfolio with higher rate of return

• S is the efficient portfolio for risk level X2

• T, U and R do not offer the optimal return for their given level of risk

* Developed by Harry Markowitz, a Nobel Prize winning economist, as a component of Modern Portfolio Theory

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Today’s Investing Opportunity: The Yield Curve  

The 0-24 month portion of the fixed-income yield curve is extremely flat, offering very little incentive to extend investment maturities or portfolio duration

The World Isn’t Flat… But Yields Sure Are

Liquidity investors have

historically focused on the

0-24 month segment

Source: NYT Treasury Yield Curve as of October 30, 2012

•Yield Curve

•Key Rates

                                                         

•Yield Curve

•Key Rates

                                                         

•Yield Curve

•Key Rates

                                                         

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Today’s Investing Opportunity: Reward for Credit Risk  

The Market is not offering much return for taking on additional credit risk

Investor reward for taking on credit risk is minimal, providing very little incentive to do so

Today’s liquidity investors are focused on principal preservation and liquidity, with very little emphasis on yield

Liquidity Investors have taken advantage of the FDIC unlimited guarantee and the generous ECR offered by the banking industry

Bank deposits have replaced money market mutual funds as the primary liquidity investment vehicle

Considering the Fed expects rates to remain at similar levels until late 2014, we should continue to expect this to be “the new normal”

Risk-Reward

Treasuries Yield Corporates Yield Credit Spread

3-month T-Bill 0.10% 90-Day CP 0.16% 0.06%

6-month T-Bill 0.14% 180-Day CP 0.31% 0.17%

2-year T-Note 0.24%2-Year AA Corporate 0.48% 0.24%

"Risk Free" Corporate Risk

Source: WSJ Money Rates as of J uly 17, 2012

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Market Rates for Cash Investment Instruments

Alternative Cash Investment Options

• Rates obtained from (1) WSJ Money Rates, (2) Crane Data (money funds) and (3) State-specific LGIPs

SunTrust Sweep Yields

As of August 31, 2012

Master Note 35/20 bps

Repo 3 bps

Eurodollar 10 bps

Federated Prime Fund 4 bps

Federated Treasury

Fund

1 bps

Overall market rates have been cyclical over the last 2

years

• Most money market instruments are currently in the top half of their 52 week High-Low range

• While overnight rates are similar to those in the summer of 2010, with the exception of Libor, 30-day and 90-day rates bare more similarity to the summer of 2011

• The “Greek situation” has caused a flight to safety, suppressing the yield on US Treasuries

• Money Market Mutual Fund yields continue to be anemic

Overall market rates have been cyclical over the last 2

years

• Most money market instruments are currently in the top half of their 52 week High-Low range

• While overnight rates are similar to those in the summer of 2010, with the exception of Libor, 30-day and 90-day rates bare more similarity to the summer of 2011

• The “Greek situation” has caused a flight to safety, suppressing the yield on US Treasuries

• Money Market Mutual Fund yields continue to be anemic

Short-term Investment Instrument Rate as of 7/19/2010*

Rate as of 7/13/2011*

Rates as of 10/26/2012*

52-Week*

Overnight Instruments Low High

Fed Funds 20 bps 6 bps 17 bps 7 bps 19 bps

Repo 25 bps 2 bps 23 bps 4 bps 33 bps

SunTrust ECR (Analyzed Business Checking)Ask Your SunTrust Banker or Treasury Management Officer

SunTrust ECR/Rate Paid (Analyzed Interest Checking)

30-Day Instruments 10/26/2012* Low High

Treasuries 15 bps 2 bps 12.5 bps 0 bps 12.5 bps

Commercial Paper 29 bps 12 bps 15 bps 3 bps 15 bps

Eurodollars 25 bps 12 bps 12 bps 12 bps 23 bps

Libor 33.8 bps 18.7 bps 21.2 bps 20.5 bps 29.6 bps

SunTrust Money Market Account Rate Ask Your SunTrust Banker or Treasury Management Officer

90-Day Instruments 7/19/2010 7/13/2011 10/26/2012* Low High

Treasuries 15 bps 3 bps 10 bps 0.5 bps 11.5 bps

Commercial Paper 42 bps 15 bps 16 bps 12 bps 20 bps

Libor 51.25 bps 24.9 bps 31.3 bps 35 bps 58.25 bp

Eurodollars 45 bps 15 bps 20 bps 20 bps 28 bps

AAA-Rated Taxable Money Funds: 7-day Yield as of 6/30/2010 6/30/2011 9/30/2012 Low High

Crane Treasury Institutional MF Index 1 bps 1 bps 1 bps 1 bps 1 bps

Crane AAA Prime Institutional MF Index 12 bps 4 bps 9 bps 7 bps 10 bps

Local Government Investment Pools: Monthly Yield as of:

July 2010 June 2011 Sep 2012 Low High

Georgia Fund 1 LGIP (Monthly yield) 21 bps 13 bps 17 bps 9 bps 15 bps

Florida Prime LGIP (Monthly yield) 39 bps 23 bps 301bps 21 bps 33 bps• Rates obtained from (1) WSJ Money

Rates, (2) Crane Data (money funds) and (3) State-specific LGIPs

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Past, Present & Future of Short-Term Investing

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Key Findings Among Investors Comments / Implications98% of institutional investors consider safety of principal (77%) and/or liquidity (21%) to be their primary objective

Yield has always been a tertiary objective … however, investors are actually treating it as such today

51% of aggregate portfolio balances held in bank deposits, with 65% of investors allowing more than a 50% portfolio allocation

Investors view this as a relatively safe haven

Only 12.7% of aggregate balances are allocated to prime money funds, 6.5% to treasury money funds, 4.8% to CP, 4.2% to UST’s, 3.6% to Gov’t Agencies and 3.2% to repo

• Investors have consolidated the majority of their liquidity into bank deposits

• They are no longer diversifying their portfolio across as many asset classes as has been the case in the past

• Money Funds have lost almost 50% of their allocation versus 2004 (19.2% vs. 36%), when Fed Funds were 1% at the bottom of the 1999 to 2006 rate cycle

72% of instruments have maturities of 30-days or less with 11% at 91+ days… and 86% of investors expect their average maturity to remain the same of shorten further going forward

There is very little incentive to move out the yield curve, with investors unwilling to take the associated liquidity and/or interest rate risk

61% of those experiencing portfolio growth attribute it to higher operating cash generation, while only 28% of those experiencing portfolio diminishment attribute it to a decline in cash generation with fully 72% attributing it to redeployment of cash for strategic purposes (CapEx, acquisitions and/or debt repayment)

This is a positive statement on the direction of the economy and possibly the stock market, although the increased cash flow is likely heavily attributable to extensive cost cutting across Corporate America

Only 78% of organizations overall, 86% with sales over $1B, 65% with sales under $1B and 80% of net investors have a written investment policy

Companies are exposing themselves to risks that could be easily avoided and/or contained

Investors allowing Treasuries and/or Treasury MMF’s declined from 82% and 67% in 2011 to 68% and 56% respectively in 2012

This may reflect the downgrade in UST’s, as well as the associated principal volatility

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1.

1. Refer to Whitepaper published by SunTrust entitled “Why Businesses Need to Reassess Their Investment Policies Now”

Findings from 2012 Association of Financial Professionals (AFP) Liquidity Survey

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The Perfect Storm Expiration of Unlimited FDIC Economic Recovery Rising Rates Repeal of Reg Q Redeployment of Corporate Cash

There is a potential “Perfect Storm” brewing

Each event individually is likely to reduce the portion of corporate cash held in bank deposits. This combination of events, slated to happen within a 12-24 month period of one another ,will serve to reduce and redistribute bank deposits in favor of the following destinations:

Bank Deposits

Alternative Cash Investment Options Money Market Funds Investment Sweep US Treasuries and Government Agencies Commercial Paper and other cash investment

Instruments Non-interest-bearing DDA will convert to interest-

bearing DDA and/or investment sweep Cash will be used to fund Capital Expenditures,

Acquisitions, and for other strategic purposes The percent of corporate cash maintained in bank

deposits will likely begin to revert to pre-2008 levels 2007 – 27% of corporate cash held in bank deposits 2012 – 51% of corporate cash held in bank deposits

Likely Future Destinations of Corporate Cash Likely Future Destinations of Corporate Cash

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Unlimited FDIC and the DDA Bubble

Destination* AllRev

< $1BRev > $1B

Net Borrower

Net Investor

No Significant Change to DDA

59% 61% 58% 64% 53%

Prime MMF 17 11 24 20 16

Treasury MMF 16 14 19 16 17

Treasury/Agencies 14 21 10 9 23

Repo 6 9 4 7 5

Other 8 5 10 4 11

* Source: 2012 AFP Liquidity Survey

Possible Destinations of Non-Interest-Bearing DDA at End of 2012:

• We have seen an unprecedented buildup of non-interest -bearing deposits, with fully 30% of balance sheet liquidity held in DDA

• This has been driven by a combination of the FDIC unlimited guarantee and the relative return that is being offered by ECR

At $2+ trillion, Non-Interest-Bearing Deposits are at an All Time High

The majority of Corporate and Institutional Treasuries appear to be planning to maintain their position in DDA should the FDIC unlimited guarantee expire in December 2012

→ This is likely attributable to the relative stability offered by bank deposits, in combination with the relative yield offered by ECR

→ ECR is considered among the best risk-return tradeoffs, even if the unlimited guarantee expires

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When Interest Rates Rise, The Repeal of Reg Q plus Money Fund Reform Could Drive $1T+ onto Bank Balance Sheets… Provided the Banks Want the Liquidity

Percent of Total Corporate Liquidity Held in Bank Deposits*

This is a positive outcome for U.S. banks only if loan demand and deposit growth are in synch

*Source: 2010 AFP Liquidity Survey and Treasury Strategies’ Global Liquidity Research

¹ Repealed in 2011, Regulation Q was a 1930’s Depression Era regulation that disallowed banks from paying interest on commercial checking accounts

¹

In countries allowed to pay interest on checking, corporates maintain 60-70% of their liquidity in the banking system

Impact of Reg Q Repeal

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A Likely Unintended Consequence of Reg Q Repeal

Impact of Reg Q Repeal

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The Economic Recovery May be Funded by Cash

Percent of Companies Self-Funding their 2010 and 2011 Capital Expenditures and Planning to Self-Fund in 2012

Redeploying Cash vs. Borrowing to Fund Capital Expenditures

Given the build-up of cash over the last 3-4 years, companies have been self-funding a major portion of their capital expenditures… and are likely to do so going forward

Banks usually benefit from an economic recovery through the expansion of their lending and/or underwriting activity… which may be slow in coming this time

Source: Greenwich Market Pulse, January 2012

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Post Reg Q Repeal, the Primary Purpose of Sweep Has Changed

Primary Purpose of Sweep

Old Paradigm Post-Reg Q Obtain yield on idle cash balances Diversify away from bank risk

Obtain yield in excess of interest-bearing DDA

Predominant Sweep Vehicles Money Funds Eurodollar Deposits Repo Bank Parent Commercial Paper

Repo (eliminate credit risk) Money Funds (diversify away from bank risk) Bank Parent CP (yield enhancement) Alternative ‘off balance sheet’ products

The Future of Sweep

Source: Treasury Strategies’ proprietary research; Commercial Deposit/Sweep Study & Global Corporate Liquidity Research

$-

$100

$200

$300

$400

$500

$600

$700

$800

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 YTD

Total U.S. Sweep Balances ($B)

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Deposit Investment Allocations May Return to Pre-2008 Levels

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Cash investors have been increasing their allocation to bank deposits over the last six years, while simultaneously decreasing their allocation to money market mutual funds

If there is more certainty around the future of money market funds, when rates begin to rise cash investors might reallocate their portfolios to be weighted no more than 25-35% in bank deposits, which is consistent with pre-2009 levels

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Source: 2012 AFP Liquidity Survey

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Summary of Today’s Discussion

The basic principals of liquidity investing are no different today than in the past

The dynamics of today’s short-term investment environment should lead you to construct a portfolio whose composition is different than pre-2008

Financial Regulatory Reform has already had an impact on liquidity management practices, and will continue to do so going forward