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Liquidity Management in the New Era Tampa AFP Jeff Avers Treasury & Payment Solutions Liquidity Strategy & Consulting June 2013.

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Presentation on theme: "Liquidity Management in the New Era Tampa AFP Jeff Avers Treasury & Payment Solutions Liquidity Strategy & Consulting June 2013."— Presentation transcript:

1 Liquidity Management in the New Era Tampa AFP Jeff Avers Treasury & Payment Solutions Liquidity Strategy & Consulting June 2013

2 2 Liquidity Deposits/Receipts Payments Corporate Cash Management Short-Term Investments Short-Term Borrowing Lockbox – Branch – Card Wire – ACH – Cash Concentration Wire – ACH – Card Checks/Controlled Disbursement

3 3 Higher bank interest expense on depositsReduced Revenue Streams  Volcker Rule  Potential divestitures Reduced Fee Income  NSF/Overdrafts (Regulation E)  Debit Interchange (Durbin Amendment) Increased Balance Sheet Costs  Basel III Capital Ratios  Basel III Liquidity Coverage Ratio Increased Fees  Uncollateralized daylight overdrafts  FDIC Client communication costs Development costs for new productsEmployee training Reduced value of deposits  Reg Q repeal  Basel III - Higher liquidity levels needed to support the commercial business Increased cost of compliance & oversight  Human, Systems, tracking and reporting Increased emphasis on minimizing marginally profitable and unprofitable relationships  Discontinuation of “Free Checking”  Collateralized Deposits  Syndicated Credit Facilities Increased Bank Expenses Increased Customer Expenses Regulatory Reform – A Sampling

4 4 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 25 Year Trend in Corporate Cash 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:

5 5 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:

6 6 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.”  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 Local Government Investment Pools (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 Risk & Return – Past, Present & Future of Short-Term Investing RISK % RETURN %

7 7 Risk & Return – AAA Rated LGIPs Source: State Treasurer’s Website for each State 2.9 bp 3.3 bp bp Fees

8 8 The upward sloped curve (BCD), 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 — B is the efficient portfolio for Return Level 1  From the portfolios that have the same risk level, an investor will prefer the portfolio with higher rate of return — C is the efficient portfolio for Risk Level 2 The upward sloped curve (BCD), 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 — B is the efficient portfolio for Return Level 1  From the portfolios that have the same risk level, an investor will prefer the portfolio with higher rate of return — C is the efficient portfolio for Risk Level 2 A D C B Risk Return * Developed by Harry Markowitz, a Nobel Prize winning economist, as a component of Modern Portfolio Theory Return 1 Return 2 Risk 1 Risk 2 Risk & Return - The Efficient Frontier*

9 9 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 May 7, 2013 Today’s Investing Opportunity: The Yield Curve

10 10 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 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 or 2015, we should continue to expect this to be “the new normal”  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 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 or 2015, we should continue to expect this to be “the new normal” Source: WSJ Money Rates as of May 7, 2013 Today’s Investing Opportunity: Reward for Credit Risk “Risk Free”Corporate RiskRisk Reward TreasuriesYieldCorporatesYieldCredit Spread 3-month T-Bill0.04%90-day CP0.11%0.07% 6-month T-Bill0.08%180-day CP0.23%0.15% 2-year T-Note0.22%2-year AA Corporate 0.46%0.24%

11 11 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 May 2013 Master Note30/20 bps Repo3 bps Eurodollar10 bps Federated Prime Fund 4 bps Federated Treasury Fund 1 bps Market rate movements have been mixed As of the end of May overnight rates have contracted slightly, while 30 and 90-day rates have shown mixed movement versus December 2012 One-month and three- month Libor are at their 52-week lows This implies the market has both lowered its perception of bank risk, and implies demand for bank borrowing has declined… confirming that banks are long on deposits Short-term Investment Instrument Rate as of 7/13/2011* Rates 11/26/2012 Rates 12/18/2012* Rates 5/31/2013* 52-Week* Overnight InstrumentsLowHigh Fed Funds 6 bps 16 bps 19 bps12 bps 10 bps 19 bps Repo 2 bps 29 bps 22 bps14 bps 6 bps 45 bps SunTrust ECR (Analyzed Business Checking)35 bps 25 bps 35 bps SunTrust ECR/Rate Pd (Analyzed Interest Checking) 25/5 bps 30-Day Instruments 11/26/201212/18/20125/31//2013 LowHigh Treasuries 2 bps 15.5 bps 1.5 bps 3 bps 1.5 bps17.5 bps Commercial Paper12 bps 14 bps 5 bps 8 bps 3 bps15 bps Eurodollars12 bps 23 bps Libor18.7 bps 20.9 bps 21 bps 19 bps 29.6 bps SunTrust Money Market Account Rate25 bps 15 bps 25 bps 90-Day Instruments 7/13/201111/26/201211/30/20125/31/2013LowHigh Treasuries 3 bps 10 bps 4 bps 4.5 bps 4 bps12.5 bps Commercial Paper15 bps 16 bps 12 bps 8 bps10 bps 20 bps Libor24.9 bps 31.2 bps 30.9 bps 27.5 bps bps Eurodollars15 bps 20 bps 28 bps AAA-Rated Taxable Money Funds: 7-day Yield as of 6/30/201110/30/201211/30/20124/30/2013 LowHigh Crane Treasury Institutional MF Index 1 bps Crane AAA Prime Institutional MF Index 4 bps 9 bps 8 bps 5 bps 10 bps Local Government Investment Pools: Monthly Yield as of: June 2011 Oct 2012Nov 2012*April ‘13LowHigh Georgia Fund 1 LGIP (Monthly yield)13 bps 18 bps 15 bps 9 bps 18 bps Florida Prime LGIP (Monthly yield) 23 bps 31bps 28 bps 22 bps 21 bps33 bps

12 12 Past, Present & Future of Short-Term Investing 12 Key Findings Among InvestorsComments / Implications 98% 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 were held in bank deposits, with 65% of investors allowing more than a 50% portfolio allocation Investors view this as a relatively safe haven and have consolidated the majority of their liquidity into bank deposits 19.2% of aggregate balances are allocated to money market funds (12.7% to prime money funds and 6.5% to treasury money funds), 4.8% to CP, 4.2% to UST’s, 3.6% to Government Agencies and 3.2% to repo Investors 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… with 86% of investors expect their average maturity to remain the same or 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 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 1 Companies are exposing themselves to risks that could be easily avoided and/or contained 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

13 13 Corporate Cash Has Been Increasing Grew from $500 Billion in 1988 to more than $2 Trillion at the end of 2012 Checkable deposits as a percent of Corporate Cash have increased steadily since 2008 Relative Value of ECR Unlimited FDIC through 12/31/2012 January Fed data indicates no significant change since December 2012 Trends In Corporate Cash

14 14 16%14.1% 13.1% 13.2% Recession 2001 Recession Recession Corporate Cash Percent Has Been Declining Corporate Cash Pct. Long-term Trend Declining over time Declined from 20% to 13% over 25 year period Increases during and after a recession Five-Year Trend Slight uptick in 2009 in response to the recession, but seems to be stabilizing

15 15 The Perfect Storm  Expiration of Unlimited FDIC  Economic Recovery  Rising Rates  Repeal of Reg Q  2A-7 Money Fund Reform  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 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

16 16 When Interest Rates Rise, The Repeal of Reg Q 1 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 1930s 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

17 17 A Likely Unintended Consequence of Reg Q Repeal For the typical treasury management bank, 60-70% of the revenue and 80-90% of profit comes from the spread on non-interest- bearing deposit Reg Q Banks are eligible to pay interest on corporate checking deposits Reg Q Repealed The Banking Industry will likely need to revise the pricing structure of the Treasury Management business in order to reflect the impact on revenue and profitability of the Repeal of Reg Q… and the associated reduction or elimination of non-interest-bearing deposits Post-Reg Q Environment Impact of Reg Q Repeal

18 18 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

19 19 Post Reg Q Repeal, the Primary Purpose of Sweep Has Changed Primary Purpose of Sweep Old ParadigmPost-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

20 20 Deposit Investment Allocations May Return to Pre-2008 Levels 20  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 1 Source: 2012 AFP Liquidity Survey

21 21 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 SunTrust Bank, Member FDIC. SunTrust is a federally registered service mark of SunTrust Banks, Inc. 04/13


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