the case for building a government securities …
TRANSCRIPT
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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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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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”
26%
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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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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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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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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bt S
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1090q1 93q1 96q1 99q1 02q1 05q1 08q1
Deb
01985 1990 1995 2000 2005 2010
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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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2000
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500 0
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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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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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600
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Jan-09 Jul-09 Jan-10 Jul-10
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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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