Liquidity Management in the New Era

1. Liquidity Management in the New Era Discussion with the Richmond AFP Jeff Avers Treasury & Payment Solutions Liquidity Strategy & Consulting November 15, 2012

2. Liquidity Management in the New Era Agenda: •  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

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

4. Objective of Today’s Discussion Make These Three Key Points: • 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

5. Risk & Return Past, Present & Future of Short-Term Investing 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.” As investment risk increases, so does the expected return 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 • 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

6. 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

7. Yield Curve • Key Rates • Yield Curve • Key Rates • Yield Curve • Key Rates Today’s Investing Opportunity: The Yield Curve 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 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

8. 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”

9. Market Rates for Cash Investment InstrumentsAlternative Cash Investment Options • 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 • Rates obtained from (1) WSJ Money Rates, (2) Crane Data (money funds) and (3) State-specific LGIPs • Rates obtained from (1) WSJ Money Rates, (2) Crane Data (money funds) and (3) State-specific LGIPs

10. Past, Present & Future of Short-Term Investing 1 Findings from 2012 Association of Financial Professionals (AFP) Liquidity Survey 1. 1 1. Refer to Whitepaper published by SunTrust entitled “Why Businesses Need to Reassess Their Investment Policies Now”

11. 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: Likely Future Destinations of Corporate Cash Likely Future Destinations of Corporate Cash • 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 Bank Deposits

12. At $2+ trillion, Non-Interest-Bearing Deposits are at an All Time High Unlimited FDIC and the DDA Bubble 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 • 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

13. ¹ Impact of Reg Q Repeal 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 In countries allowed to pay interest on checking, corporates maintain 60-70% of their liquidity in the banking system 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 ¹ Repealed in 2011, Regulation Q was a 1930’s Depression Era regulation that disallowed banks from paying interest on commercial checking accounts

14. Impact of Reg Q Repeal A Likely Unintended Consequence of Reg Q Repeal

15. The Economic Recovery May be Funded by Cash Redeploying Cash vs. Borrowing to Fund Capital Expenditures Percent of Companies Self-Funding their 2010 and 2011 Capital Expenditures and Planning to Self-Fund in 2012 Source: Greenwich Market Pulse, January 2012 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

16. The Future of Sweep Post Reg Q Repeal, the Primary Purpose of Sweep Has Changed

17. Deposit Investment Allocations May Return to Pre-2008 Levels 1 Source: 2012 AFP Liquidity Survey • 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

18. 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