Assessing the Impact of Financial Industry Reform

Carolinas Cash Adventure

Jeff Avers

Treasury & Payment Solutions

Liquidity Strategy & Consulting

May 22, 2012

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Overview of Today‟s Financial Reform Discussion

Financial Reform is complicated, widespread and painful

It will have a financial impact on both banks and their clients

It will have (and already has had) an impact on corporate and

institutional liquidity management practices

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Regulatory Reform: “Strengthened but not Simplified”

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Regulatory Impact – A Sampling Dodd-Frank – 400 new rules, requires banks to do 92 new studies and issue 44 periodic reports

Only 33% of rules due by May 1, 2012 were finalized

- Regulation Q repealed – banks can begin to pay interest on

commercial checking deposits

- FDIC mandates unlimited deposit insurance on all

checking/transaction accounts

- FDIC insurance coverage permanently raised from

$100,000 to $250,000

• Should increase the number and total balances of CD‟s

between $100,000 and $250,000

- FDIC deposit assessment changed from being based on

quarterly ledger deposits to being based on consolidated assets

minus average tangible equity

SEC Money Market Fund Rule 2a-7 changed to reduce

shareholder/investor investment risk

• Shortened WAM, increased credit quality and overnight liquidity

• Will likely lower the relative yield on a permanent basis

• Possible requirement that money market funds

1. Maintain a capital buffer in order to serve as the first point of loss

absorption to the extent required,

2. Convert from $1.00 NAV to a Variable NAV, and

3. Restrict redemptions so that up to 10% of a redemption is held

back for up to 30-days

Published by Wall Street Journal ; December 5, 2011

0%

20%

40%

60%

80%

100%

Require Capital Buffers

Eliminate $1 NAV Restrict Redemptions

Percent of Corporate Treasurers that would Reduce or Eliminate Their Money Fund

Investments Based on Proposed SEC Changes

Source: Treasury Strategies 2012 Survey of Corporate Treasurers

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Regulatory Impact – A Sampling Basel III:

• Requires new standards for Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio

• LCR will only consider “free” or “unencumbered” securities” to be liquid

• Repo collateral and government deposit collateral are not unencumbered

• Deposit runoff assumptions exceed those realized in 2008-9

• Consumer vs. Wholesale and single-product vs. multi-product relationships have differing runoff

assumptions

• New capital requirements will likely increase loan pricing and may limit banks ability to lend to certain clients

• Total Capital remains at 8% with discussion about raising it to 10%*

• Tier 1 Capital is raised from 4% under Basel II to 6% by 2015 under Basel III*

• Minimum common equity raised from 2% under Basel II to 4.5% by 2015 under Basel III*

• Increased capital requirements plus basing FDIC on assets will drive some lending to „non-banks‟

Basel III Capital Framework All numbers are percentages

Common

Equity Tier 1

Capital Total

Capital

Minimum 4.5 6 8

Conservation Buffer 2.5 2.5 2.5

Minimum Plus Buffer 7 8.5 10.5

* The Basel III capital minimums include an additional 2.5% “buffer.”. A bank must meet the minimum plus the

buffer in order to be fully eligible to pay shareholder dividends, as well as pay discretionary bonuses to employees.

Capital Requirement Milestones

2013 Minimum capital requirements: Start of the gradual phasing-in of the higher minimum capital requirements.

2015 Minimum capital requirements: Higher minimum capital requirements are fully implemented.

2016 Conservation buffer: Start of the gradual phasing-in of the conservation buffer.

2019 Conservation buffer: The conservation buffer is fully implemented.

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Financial Impact – A Sampling

Higher interest expense on deposits

Reduced Revenue Streams

Volcker Rule

Potential divestitures

Reduced Fee Income

NSF/Overdrafts (Regulation E)

Debit Interchange (Durbin Amendment)

Revamped marketing collateral

Increased Fees

Uncollateralized daylight overdrafts

FDIC

Client communication costs

Development costs for new products

Employee training

Reduced value of deposits (“FTP”)

Increased cost of compliance & oversight

Human, Systems, tracking and reporting

Increased emphasis on eliminating marginally

profitable and unprofitable relationships

Increased Bank Expenses Increased Customer Expenses

Discontinuation of „Free Checking‟

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Summary: New Regulations Could Drive $1.5T

onto Bank Balance Sheets

When interest rates rise, we could see an additional $1.5 trillion flow back onto bank balance sheets.

• In other post and non-Reg Q countries, companies can hold as much as 50 - 70% of total liquidity in bank

deposits.

• Two current regulations could potentially drive even more liquidity back into the banking system - changes to

2a-7 regulations and collateral requirements for derivatives trading.

Unless loan demand also increases, bank balance sheets will be further constrained to accommodate these deposits.

• Interesting note: Barclays Capital estimates that banks are short $1.7 trillion in core stable funding under the

proposed new Basel III requirements.

In U.S., 25% of

Corporate

Liquidity = $1.3T

0%

10%

20%

30%

40%

50%

60%

70%

80%

U.S. France UK

Reg Q Post Reg Q No Reg Q

Percentage of Total Corporate Liquidity Held in Bank Deposits

Source: Treasury Strategies‟

proprietary research; Commercial

Deposit/Sweep Study & Global

Corporate Liquidity Research

Bank Deposits Defined as:

• DDA/Current Accounts

• Offshore Deposits

• Time Deposits/CDs

• Savings/MMDAs

• Sweep Accounts

This is a positive

outcome for U.S.

banks only if loan

demand catches up

to deposit growth

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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 September 30, 2011

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

contracted dramatically

since July 2010

• Versus July 2010: overnight,

30-day and 90-day yields are

down across the board

• 1-month and 3-month

Treasuries are yielding 0.08%

and 0.095% respectively

• Money Market Mutual Fund

yields continue to be anemic

• Most money market

instruments are currently in the

top half of their 52 week High-

Low range

Short-term Investment Instrument Rate as of

7/19/2010*

Rate as of

2/14/2011*

Rates as of

5/4/2012*

52-Week*

Overnight Instruments Low High

Fed Funds 20 bps 15 bps 18 bps 5bps 18 bps

Repo 25 bps 14 bps 18 bps 2 bps 33 bps

SunTrust ECR (Analyzed Business Checking) 35 bps 35 bps 25 bps 25 bps 35 bps

SunTrust ECR/Rate Paid (Analyzed Interest Checking) 25/5 bps 25/5 bps 25/5 bps

30-Day Instruments 5/4/2012* Low High

Treasuries 15 bps 13.5 bps 8 bps 0 bps 11 bps

Commercial Paper 29 bps 25 bps 11 bps 3 bps 13 bps

Eurodollars 25 bps 25 bps 12 bps 14 bps 30 bps

Libor 33.8 bps 26.5 bps 24 bps 18.5 bps 29.6 bps

SunTrust Money Market Account Rate 25 bps 25 bps 15 bps

90-Day Instruments 7/19/2010 2/14/2011 5/4/2012* Low High

Treasuries 15 bps 13 bps 9.5 bps 0.5 bps 11.5 bps

Commercial Paper 42 bps 30 bps 15 bps 12 bps 20 bps

Libor 51.25 bps 31.4 bps 47 bps 24 bps 58 bps

Eurodollars 45 bps 30 bps 20 bps 20 bps 38 bps

AAA-Rated Taxable Money Funds: 7-day Yield as of 6/30/2010 1/31/2011 4/30/2012 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 10 bps 9 bps 7 bps 10 bps

Local Government Investment Pools: Monthly Yield as of: July 31 Feb 28 April 30 Low High

Georgia Fund 1 LGIP (Monthly yield) 21 bps 17 bps 14 bps 9 bps 14 bps

Florida Prime LGIP (Monthly yield) 39 bps 27 bps 33 bps 21 bps 33 bps

9 Data Source: Treasury Strategies Corporate Liquidity Study www.TreasuryStrategies.com

January Fed Funds Rate 1999 - 2006

5%

5%

1%

2%1999

Corporate Liquidity

by Instrument

Notes/ Bonds

13%

CP/ Repo/ CD

45%

Other

32%

MM Mut Funds

10%

2005

Corporate Liquidity

by Instrument

MM Mut Funds

21%

Notes/ Bonds

29%CP/ Repo/ CD

24%

Other

26%

2006

Corporate Liquidity

by Instrument

MM Mut Funds

27%

Notes/ Bonds

23%

CP/ Repo/ CD

25%

Other

25%

Market Overview

Investment Instruments Change with Interest Rates

As interest rates fluctuate throughout the economic cycle, the specific types of

investment instruments used by corporate cash investors also changes.

2004

Corporate Liquidity

by Instrument

Notes/ Bonds

21%

CP/ Repo/ CD

15%

Other

28%

MM Mut Funds

36%

2005:

The last rising rate 2-3%

Fed Funds market

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Percent of Cash Portfolio Held in Various Products

Products 2005 (The last rising rate 2-3% FF

Market)

Current

Portfolio

2014 (FF expected to

reach 2% by

year-end)

2015 (The next rising

rate 2-3% FF

Market)

Market Large Client Large Client Large Client Large Client

Non-interest Analyzed DDA (ECR)-

New Interest bearing Checking

4% 15.0% 15.0%

Sweep 4% 14.6% 8.3% 5.0% 5.0%

Interest Bearing DDA --

Hybrid DDA (Pays ECR + Interest) --

Money Market Mutual Funds 21% 20.0% 20.0% 20.0%

Bank Money Market/Savings Products 2%

Commercial Paper/Repo/CD 24% 46.3% 20.0% 10.0% 10.0%

Commercial Paper

Repo

Bank CD

Notes/Bonds 29%

US Treasuries

US Government Agencies 0.7%

Corporate/FI/Muni Notes & Bonds

Short-term Fixed-Income/Bond Funds 3% 11.3% 40.0% 40.0% 40.0%

Asset/Mortgage Backed Securities 2%

Other Investment Instruments

(Eurodollar Deposits, Auction Rates,

Foreign Securities, Derivatives, etc.)

11% 27.8% 11.0% 10.0% 10.0%

Total 100% 100.0% 100.0% 100.0% 100.0%

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Percent of Cash Portfolio Held in Various Products

Products 2005 (The last rising rate 2-3% FF

Market)

Current

Portfolio

2014 (FF expected to

reach 2% by

year-end)

2015 (The next rising

rate 2-3% FF

Market)

Market Large NFP Large NFP Large NFP Large NFP

Non-interest Analyzed DDA (ECR) 4%

Sweep 4% 10% 10% 11% 11%

Interest Bearing DDA --

Hybrid DDA (Pays ECR + Interest) -- 4% 4%

Money Market Mutual Funds 21% 20% 20% 15% 15%

Bank Money Market/Savings Products 2%

Commercial Paper/Repo/CD 24%

Commercial Paper

Repo

Bank CD

Notes/Bonds 29% 60% 60%

US Treasuries 35% 25%

US Government Agencies 35% 25%

Corporate/FI/Muni Notes & Bonds 20%

Short-term Fixed-Income/Bond Funds 3% 10% 10%

Asset/Mortgage Backed Securities 2%

Other Investment Instruments

(Eurodollar Deposits, Auction Rates,

Foreign Securities, Derivatives, etc.)

11%

Total 100% 100% 100% 100% 100%

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Percent of Cash Portfolio Held in Various Products

Products 2005 (The last rising rate 2-3% FF

Market)

Current

Portfolio

2014 (FF expected to

reach 2% by

year-end)

2015 (The next rising

rate 2-3% FF

Market)

Market Mid-Size

Client

Mid-Size

Client

Mid-Size

Client

Mid-Size

Client

Non-interest Analyzed DDA (ECR) 4% 48% 10%

Sweep 4% 100%

Interest Bearing DDA -- 10% 10%

Hybrid DDA (Pays ECR + Interest) --

Money Market Mutual Funds 21% 30% 80% 90%

Bank Money Market/Savings Products 2%

Commercial Paper/Repo/CD 24%

Commercial Paper

Repo

Bank CD

Notes/Bonds 29%

US Treasuries 22%

US Government Agencies

Corporate/FI/Muni Notes & Bonds

Short-term Fixed-Income/Bond Funds 3%

Asset/Mortgage Backed Securities 2%

Other Investment Instruments

(Eurodollar Deposits, Auction Rates,

Foreign Securities, Derivatives, etc.)

11%

Total 100% 100% 100% 100% 100%

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Summary of Today‟s Discussions

1. Financial reform is complicated, widespread and painful

2. It will have a financial impact on both banks and their clients

3. Financial reform will have an impact on corporate and

institutional liquidity management practices