October 19, 2010Pierpont Securities LLCTHE CASE FOR BUILDING AGOVERNMENT SECURITIES

Pierpont Securities LLCwww.pierpontsecurities.com

DEALERGrant’s Fall Conference 2010

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The Business Case

Barriers to Entry

Regulatory Reform

Fiscal Forecast

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Broker Dealer EconomicPrimaryO

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Dealer Opportunity

Economic Outlook

Primary Dealers

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Section 1

Primary Dealers

Section 1

Primary Dealers

Primary Dealers: Definition

A Primary dealer is a bank or securities broker-dealer that may trade directly with the Federal

Reserve System of the United States. Such firms are required to make bids or offers when they q

Federal Reserve conducts open market operations, provide information to the Federal

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Reserve’s open market trading desk, and to participate actively in the U.S. Treasury securities

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auctions. They consult with both the U.S. Treasury and the Federal Reserve about funding the

budget deficit and implementing monetary policy.R Y

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g p g y p y

Source: The Federal Reserve Bank of New York

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Primary Dealers

The number of Primary Dealers has come full circle over the last 50 years to 18 from a peak of 46 in 1988

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Prim

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Source: The Federal Reserve Bank of New York

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01960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

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Primary Dealers

September 1988 (46)Aubrey G. Lanston & Co., Inc. Dean Witter Reynolds Inc. Kidder, Peabody & Co., Inc. Salomon Brothers Inc.

Kleinworth Benson GovernmentBank of America NT & SA Dillon, Read & Co. Inc. Kleinworth Benson Government Securities, Inc. Sanwa-BGK Securities Co., L.P.

Bankers Trust Company Discount Corporation of New York Lloyds Government Securities Corporation Security Pacific National Bank

B St & C I Donaldson, Lufkin & Jenrette L F R th hild & C Shearson Lehman Government

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Bear, Stearns & Co., Inc. , &Securities Corporation L.F. Rothschild & Co. Securities, Inc.

Carroll McEntee & McGinley Incorporated

Drexel Burnham Lambert Government Securities Inc.

Manufacturers Hanover Securities Corporation

Smith Barney, Harris Upham & Co., Inc.

Chase Manhattan Capital Markets The First Boston Corporation Merrill Lynch Government Securities S G Warburg & Co Inc

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TIA Corporation The First Boston Corporation Inc. S.G. Warburg & Co., Inc.

Chemical Bank First National Bank of Chicago Midland Montagu Securities Inc. Thomson McKinnon Securities Inc.

Citibank, N.A. Goldman, Sachs & Co. Morgan Stanley & Co. Incorporated Wertheim Schroder & Co. Incorporated

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Continental Illinois National Bank and Trust Company of Chicago Greenwich Capital Markets Inc. The Nikko Securities Co.

International, Inc.Westpac Pollock Government Securities, Inc.

County NatWest Government Securities, Inc. Harris Government Securities Nomura Securities International, Inc. Yamaichio International (America),

Inc.

Source: The Federal Reserve Bank of New York website

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CRT Government Securities, Ltd. Irving Securities, Inc. Paine Webber Incorporated

Daiwa Securities America Inc. J.P. Morgan Securities, Inc. Prudential-Bache Securities, Inc.

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Conclusion: US Treasury Needs More Counterparties

August 2010 (18)Aubrey G. Lanston & Co., Inc. Dean Witter Reynolds Inc. Kidder, Peabody & Co., Inc. Salomon Brothers Inc. Cantor Fitzgerald & Co.

GBank of America NT & SA Dillon, Read & Co. Inc. Kleinworth Benson Government Securities, Inc. Sanwa-BGK Securities Co., L.P. Credit Suisse USA LLC

Bankers Trust Company Discount Corporation of New York Lloyds Government Securities Corporation Security Pacific National Bank Deutsche Bank Securities Inc.

Donaldson Lufkin & Jenrette Shearson Lehman Government

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Bear, Stearns & Co., Inc. Donaldson, Lufkin & Jenrette Securities Corporation L.F. Rothschild & Co. Shearson Lehman Government

Securities, Inc. HSBC Securities USA Inc.

Carroll McEntee & McGinley Incorporated

Drexel Burnham Lambert Government Securities Inc.

Manufacturers Hanover Securities Corporation

Smith Barney, Harris Upham & Co., Inc. Jefferies & Company inc.

Chase Manhattan Capital Markets Merrill Lynch Government

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Corporation The First Boston Corporation Merrill Lynch Government Securities Inc. S.G. Warburg & Co., Inc. Mizuho Securities USA Inc.

Chemical Bank First National Bank of Chicago Midland Montagu Securities Inc. Thomson McKinnon Securities Inc. RBC Capital Markets Corp.

Citibank, N.A. (Citigroup Global Markets Inc.) Goldman, Sachs & Co. Morgan Stanley & Co.

IncorporatedWertheim Schroder & Co. Incorporated RBS Securities Inc.

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Continental Illinois National Bank and Trust Company of Chicago Greenwich Capital Markets Inc. The Nikko Securities Co.

International, Inc.Westpac Pollock Government Securities, Inc. UBS Securities LLC

County NatWest Government Securities, Inc. Harris Government Securities Nomura Securities International,

Inc.Yamaichio International (America), Inc.

Source: The Federal Reserve Bank of New York website

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CRT Government Securities, Ltd. Irving Securities, Inc. Paine Webber Incorporated BNP Paribas Securities Corp.

Daiwa Securities America Inc. J.P. Morgan Securities, Inc. Prudential-Bache Securities, Inc. Barclays Capital Inc.

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Section 2

Fiscal Forecast

Section 2

Fiscal Forecast

Cumulative Net Financing Flows Have Been Increasing Since FY 2007 A

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3 mo Average Gross Issuance vs. Weighted Average bid to Cover

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Spending Has Radically Increased and is Becoming More “Mandatory”

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Federal Revenues and Expenditures as a % of GDP Expenditures Revenues

14%

18%

22%

1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008

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Source: Historical information from Treasury and CBO, 2010 is Pierpont estimate, 2020 projections from CBO.

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Supply Drivers Are Not Expected to Change Any Time Soon

Entitlement ReformLong-term budget outlook is dismal. Reform will ultimately happen, but is not on the immediate horizon. Budget headwinds (and thus heavy supply) will persist for years to come.

GSE LiabilitiesThere has been very little change enacted here. Will multi-trillion dollar liabilities be brought on to the balance sheet?A

L balance sheet?

Foreign Central BanksCentral banks have accumulated massive amounts of dollar reserves most of which have been invested inO

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Central banks have accumulated massive amounts of dollar reserves, most of which have been invested in Treasury and Federal Agency paper. Will they diversify either across currencies or asset classes?

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Section 3

Lower Barriers to Entry

Section 3

Lower Barriers to Entry

Barriers to Entry Have Decreased for Firms Like Pierpont Securities

A convergence of favorable tailwinds supports our venture

Regulators (FRB NY) are acutely aware of the low number of underwriters

Treasury supply is abundant going out several years

Risk capital is available and being attracted to this space

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Technology and infrastructure costs have become commoditized

Talent has become readily available post the financial crisis

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Section 4

Recent Regulatory Reform

Section 4

Recent Regulatory Reform

Regulatory Reform

Regulatory reform is viewed as net positive for smaller more narrowly focused firms like Pierpont Securities

BASEL III Increased Bank capital levels will ultimately drive the cost for balance sheet and leverage higherp y g g

Dodd-Frank Bill Ultimately allows additional market participants to enter the swaps trading arenaA

L Ultimately allows additional market participants to enter the swaps trading arena

Regional derivatives dealers and broker-dealers will have an opportunity to compete with the large dealers that currently warehouse 93% of the outstanding US$ derivative contracts.

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Encourages new trading arrangements and solutions e.g. International Derivatives Clearing Group (ICDG) to compete with the LCH and CME

*The Dodd-Frank Act remains a work in progress It will require no fewer than 243 rulemakings and 67 studies or reportsR Y

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The Dodd-Frank Act remains a work in progress. It will require no fewer than 243 rulemakings and 67 studies or reports from 11 financial regulatory agencies

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Regulatory Reform

"The Wall Street reform bill will - for the first time - bring comprehensive regulation to the swaps

marketplace. Swap dealers will be subject to robust oversight. Standardized derivatives will be required to

trade on open platforms and be submitted for clearing to central counterparties. The Commission looks

forward to implementing the Dodd-Frank bill to lower risk promote transparency and protect the American

public.”

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-CFTC Chairman Gary Gensler

“The top 5 derivative dealers hold 93% of total notionals More than 86% of these dealer’s holdings areON

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The top 5 derivative dealers hold 93% of total notionals. More than 86% of these dealer s holdings are

interest rate contracts. Therefore, in terms of the derivatives risk matrix, a vast majority of commercial bank

derivatives activities is in interest rate contracts at a few dealer banks ”R Y

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derivatives activities is in interest rate contracts at a few dealer banks.

-FDIC Allen C. Puwalski (analyst)

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Section 5

Economic Outlook

Section 5

Economic Outlook

U.S. is not Headed for Japan Style Malaise

Economic growth has proven sensitive to stimulus (2009) and restraint (2010)

Inflation expectations are still significantly positive (gold, US$, UST curve, TIPS)p g y p (g , , , )

Activity should pick up in 2011 even if the soft patch continues for a while

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Thus, interest rates will be volatile, providing an active trading environment for a government securities dealer.

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Households are Making Progress on Deleveraging and the Savings Rate has Soared

DEBT SERVICE BURDENS PERSONAL SAVINGS RATE

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1090q1 93q1 96q1 99q1 02q1 05q1 08q1

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Debt Service Ratio Financial Obligations Ratio

Source: Federal Reserve Source: BEA

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Corporate Profitability Means the Gun is Loaded and Credit While Tight, is Thawing

CORPORATE PROFITS (USD BN)FED SR. LOAN OFFICER SURVEY

NET % OF BANKS TIGHTENING C&I LOAN STANDARDS

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Source: Department of Commerce Source: Federal Reserve Board

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But Household Balance Sheets Have Only Begun to Recover and Housing is Still a Mess

HOUSEHOLD NET WORTH AS % OF DISPOSABLEPERSONAL INCOME

COMBINED NEW AND EXISTING HOME SALESANNUALIZED THOUSANDS OF UNITS

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475 5000

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40002007 2008 2009 2010

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Source: Census Bureau, Natl. Association of Realtors.

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Housing Continues to Lag the Rest of the EconomyA

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Source: Bloomberg

Forecast: Mediocre But No Malaise

2010 2011 2012

Real GDP Pierpont 2.8 3.3 4.4

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BloombergSurvey 2.7 2.5 3.1

CPI I fl ti Pi t 1 7 2 2 3 2

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Bloomberg Survey 1.6 1.5 2.0

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10 yr TreasuryYields (Year End)

Pierpont 2.50 4.30 5.20

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Bloomberg Survey 2.56 3.48 N/A

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How Will Policy Affect Treasury Financing and Interest Rates?

Any further fiscal “stimulus” likely to be limited and would add to debt concerns

Further monetary stimulus is on the way. QE2 will increase the amplitude of the rate cycle

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An aggressive FRB (zero interest rate policy?) means more rate volatility, not less

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Economic Recovery Interrupted

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MONTHLY CHANGE IN PAYROLLS

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-1000

Monthly Change in Private Payrolls Monthly Change in Nonfarm Payrolls

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Economic Recovery Interrupted

Why has the economic recovery stalled?

Uncertainty has led businesses and households to temporarily flee to the sidelines. Government policies have people concerned.

Obamacare. Tremendous uncertainty for businesses around labor costs, plus new taxes.

FinReg Reform. Financial firms don’t know the rules of the road yet.

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Energy. Cap and trade? Offshore drilling ban.

Taxes. Where are taxes going to be in 2011?

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Fiscal policy. Still waiting for a plan to attack the deficit.

Populism. President and Congress vilify industries that oppose their policies (health insurers, banks, oil companies etc ) Who is next?R

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companies, etc.). Who is next?

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