INTEREST RATE RESEARCH March 2012 Joseph Abate 1

INTEREST RATE RESEARCH March 2012 Joseph Abate +1 212 412 6810 joseph. abate@barcap. com Money markets monthly update PLEASE SEE ANALYST CERTIFICATION(S) AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 37

Summary Monetary policy outlook Where does Libor go next? – Ratings decisions cloud the outlook – But unsecured funding rates are declining Positive signs in the CP market Tri-party repo and intra-day credit concerns Bank deposit funding trends – Unlimited bank deposit insurance Money market fund trends – Regional exposures – Pending reform 2 6/15/2021

Monetary policy outlook for 2012 Monetary policy is expected to hold steady throughout 2012 – FOMC’s enhanced guidance: Fed funds target expected to stay exceptionally low until late 2014 » Although the FOMC’s published funds forecasts reveal a fairly wide dispersion of views – Bernanke noted the improved tone of recent data at his Semi-Annual Congressional testimony – But “persistent downside risks to the outlook” remain – He did not signal the FOMC was considering additional asset purchases (QE) Operation Twist – Operation Twist Treasury bill and short coupon sales continue • The Fed plans to sell all its holdings of 3 m-3 y Treasury debt • And replace it with longer duration paper to lengthen the average maturity of its portfolio 3 6/15/2021

Operation Twist has boosted dealer positions Dealer positions, under 3 y TSYs ($bn) Operation Twist sales has caused a pile up of short-dated paper on dealer balance sheets – Dealer inventories of <3 y paper have surged to near $100 bn – And are expected to increase further as Twist continues With more to finance and reduced balance sheet capacity, collateral rates have moved higher – Pushing other short-rates higher Should the Fed sterilize its balance sheet operations? ______________ Source: Federal Reserve 4 6/15/2021

Twist sales and extra bill supply have pushed rates higher Bill rates (bp) Treasury repo rates (bp) ______________ Source: Federal Reserve and Barclays 5 6/15/2021

Where does Libor go next?

Libor rates have fallen since January Spot Libor (%) LOIS 1 y ahead (bp) Spot Libor rates have fallen since the start of the year. The declines have led to a contraction in forward LOIS. ______________ Source: Bloomberg 7 6/15/2021

LOIS deconstruction 3 m LOIS (bp) The decline in spot LOIS is driven by an improvement in bank credit – The credit component of the LOIS spread has fallen 13 bp since January 1 Market sentiment around bank earnings and European sovereign debt exposures has improved – Helped by the ECB’s 2 extremely large 3 y € liquidity injections ______________ Source: Bloomberg and Barclays Capital 8 6/15/2021

Bank ratings cloud the outlook for Libor On February 15, Moody’s placed the short-term ratings of a number of banks with capital markets businesses on downgrade watch – This creates two related issues: » How do money funds replace any potentially downgraded bank paper? » How do banks replace any funding lost from money funds? To the extent that this makes it harder for these banks (some of which are dollar Libor panel members) to raise dollar funding, Libor rates could rise Moreover, Libor has increasingly become a barometer of market confidence. Worries about bank financing could also cause Libor rates to rise But so far, the Moody’s announcement has had virtually no affect on 3 m Libor 9 6/15/2021

How much paper? Taxable MMF holdings of bank paper* ($bn) The banks on review for downgrade raise over $370 bn in shortterm funding from money funds – However, most of this is repo funding against government collateral » Moody’s rated money funds can generally “look through” to the underlying collateral – Excluding government repo, these banks raise $150 bn across deposits, CP (unsecured and secured) as well as non-traditional repo » Non-traditional repo and CP are the biggest shares ______________ *Across the institutions whose short-term ratings were on review as noted by Moody’s. Source: Moody’s, imoney. net, and Barclays Capital 10 6/15/2021

Bank reaction Large bank wholesale liability share (% total) In the event of a potential downgrade, banks’ ability to face money funds would decline Encouragingly, these banks are finding it easier to raise nonmoney market funding – Large US banks, for instance, have reduced their reliance on wholesale funding markets – And deposit growth has been very strong » Domestic bank deposits have risen 25% in the past year ______________ Note: Wholesale funding includes market borrowings and large time deposits. Source: Federal Reserve and Barclays Capital 11 6/15/2021

Money market reaction Money market funds might struggle to replace any downgraded bank paper – The SEC limits money fund exposure to any single Tier 2 issuer to just 0. 5% of portfolio assets – And 3% cumulatively across all Tier 2 exposures – Some of the banks on the downgrade watchlist are individually over the 0. 5% SEC threshold We expect money funds would: – Shorten their WAMs – Increase their government repo and bill holdings – And boost – to the extent their counterparty limits allow it – exposures to banks not on downgrade watch However, the speed of any adjustment would depend on the behavior of their investors – If institutional redemptions pick up in response to a downgrade, money fund managers might shorten their WAM faster and purchase more government repo and bills. Since the mid-February Moody’s announcement there has not been any change in money fund behavior – Prime fund allocations are unchanged – And balances are rising 12 6/15/2021

Could 3 m Libor go back to 25 bp? Before the recent financial market flare-up, 3 m LOIS was around 15 bp – Thus, if confidence returns to pre-crisis levels, then 3 m Libor should be 25 bp – Although financing conditions have improved since last fall, they are still far from pre-crisis levels – And the impact of the Moody’s ratings downgrade announcement could cloud the outlook for Libor – Moreover, LOIS is vulnerable to unpredictable “headline risk” We reckon there is sufficient momentum to take 3 m Libor toward 45 bp by mid-March If everything works out perfectly, we expect 3 m Libor to be at 25 -35 bp by year-end – The market remains somewhat skeptical – December ED points to 3 m Libor over 50 bp 13 6/15/2021

Other unsecured bank funding rates are moving lower 3 m transacted funding rates (%) 3 m surveyed funding rates (%) ______________ Source: Bloomberg, Federal Reserve 14 6/15/2021

Positive signs in the CP market

Outstanding financial CP is rising Financial CP outstanding ($bn) Financial CP outstanding (January 2011 = 100) Total financial CP outstanding is up 6% since the end of 2011. The pickup in outstandings is sharpest for non-US banks and branches ______________ Source: Federal Reserve 16 6/15/2021

Money fund eligible CP outstanding Tier 2 CP outstanding (% MMF eligible paper) Prime MMF Tier 1 CP (% total Tier 1 outstanding) The announced downgrade from Moody’s caused a sharp increase in the reported Tier 2 paper outstanding – even though there have been no downgrades yet. This is the result of how the Fed treats ‘downgrade watch’ in its data ______________ Source: Federal Reserve 17 6/15/2021

Daily CP issuance is light but lengthening Daily financial CP issuance ($mn/d) Issuance longer than 80 d (% total, 15 d mavg) Average tenors of newly issued financial CP have lengthened. These longer tenors have reduced the need for issuers to return to the market frequently so daily issuance has declined ______________ Source: Federal Reserve 18 6/15/2021

Outstanding maturities are lengthening Average maturity total CP outstanding (days) After shortening last fall and again heading into year-end, the average maturity on all outstanding CP has lengthened back above 42 d ______________ Note: These data include non-financial paper as well as financial paper. Source: Federal Reserve 19 6/15/2021

Tri-party repo risk

Regulators remain concerned Tri-party repo outstanding ($bn) The Federal Reserve remains concerned about the amount of intraday credit used in the tri-party repo market – Which exposes the clearing banks to significant systemic risk – The 3. 30 unwind auto-substitution have shortened the “window” but not eliminated the use of intraday credit Structured finance paper – ABS, CMO, money market and CP – account for just a small portion of tri-party repo outstanding (about 7%) – This has been fairly steady since the Fed began publishing tri-party repo figures in May 2010 ______________ Source: Federal Reserve 21 6/15/2021

Bank deposits & FDIC coverage

Flows into checking account balances remain robust Bank deposits (Jan 2011 = 100) Balances continue to flow into bank deposits – primarily checking accounts – In response to unlimited deposit insurance from the FDIC on non-interest bearing transaction accounts But money has also flowed into commercial bank savings deposits where the insurance coverage is capped at $250, 000 ______________ Source: Federal Reserve 23 6/15/2021

Non-interest bearing checking accounts are surging Bank deposits (2007 = 100) Non-interest bearing checking account balances have increased by almost $600 bn (34%) in the past year – We suspect that most of these balances were drawn from money market funds The expiration of unlimited deposit insurance at year end might shift some of these funds back into money funds – Although there is considerable regulatory uncertainty about the future structure of money funds ______________ Source: FDIC 24 6/15/2021

Account balances over $250, 000 “Super-sized” checking accounts ($bn) Balances in “super-sized” checking accounts total $1. 4 trn – 76% of this amount is held at the 19 largest banks with assets exceeding $100 bn Community banks are eager to see full deposit insurance coverage extended – Large banks – with access to financial markets – are more divided ______________ Source: FDIC 25 6/15/2021

FDIC unlimited deposit insurance: Here to stay? Is unlimited deposit insurance coverage still necessary? – Financing markets have opened up – And bank deposits are rising sharply – even outside of fully covered transaction accounts – Most of the deposits are held at the largest banks, so the program hasn’t leveled the playing field for community banks But ending the program abruptly in December 2012 might cause significant financial market volatility – Lobbying to extend the program has begun We expect unlimited coverage will be extended – But on a voluntary basis – that is, banks will decide to ‘opt-in’ or ‘opt-out’ – Those banks opting in will pay an explicit coverage fee in addition to their regular insurance premium – The largest banks may decide to opt out given their ability to access market funding and attract large deposits 26 6/15/2021

Money fund trends

Institutional money fund balances Institutional balances (Dec 2010 = 100) Investor anxiety appears to be fading Institutional government-only balances have fallen 5% or $35 bn since their late-November peak – At the same time, institutional balances in prime funds have been rising steadily – Prime fund balances are up 3% since mid. December or $30 bn ______________ Source: imoney. net 28 6/15/2021

Prime funds WAMs and buffers WAM (days) 7 d liquidity buffer (% total assets) ______________ Source: imoney. net 29 6/15/2021

Taxable money fund holdings by country Holdings by country (% of total taxable assets) ______________ Source: imoney. net 30 6/15/2021

Regional bank funding WAMs French bank money market funding WAM (days) Other bank money market funding WAM (days) ______________ Source: imoney. net 31 6/15/2021

Money fund regulatory paths The SEC is preparing to publish guidelines for money fund reform – perhaps as early as this month The proposals seem to take two paths: – Capital buffers with redemption limits – Or the establishment of mandatory floating NAVs 32 6/15/2021

Money fund regulatory paths, cont’d Capital buffer with redemption limits – Capital buffers of 1 to 3% of AUM – The capital buffer might more closely align fund manager incentives with portfolio riskiness – The capital buffer could be structured as a first-loss security – enabling the NAV effectively to float while maintaining a stable NAV for the money fund depositor – But the cost would be expensive – especially given the difficult earnings environment for fund sponsors – And it is unclear how deep investor appetite would be for these securities – Regulators are also focused on institutional investors’ proclivity to run in times of stress » The discussion seems focused on 3% gates that are held for 30 d » Would replacing “same-day liquidity” with daily withdrawal limits slow runs? » Unclear if a structure could be created that applies only in times of stress – which is precisely when investors are most keen to have “same-day liquidity” » This creates “trigger effects” – Redemption limits would effectively act like a negative interest rate » Would investors be happy to leave extra cash (above their daily needs) in money funds? » Like a minimum deposit requirement? 33 6/15/2021

Money fund regulatory paths, cont’d Floating NAVs – Replace the stable NAV and amortized accounting with floating NAVs and mark-to-market portfolio accounting – However, money funds and their institutional investors are keenly opposed to floating the NAV on their funds – After all, the primary reason for their holdings is “safety” and to outsource their cash management activities – As a result, it is unclear how much of the institutional money held in money funds ($1. 6 trn) would “go elsewhere” – “Elsewhere” • Bank deposits • Direct government-guaranteed paper 34 6/15/2021

Miscellaneous

A Treasury FRN? The Treasury seems set to announce plans to issue floating-rate notes, with a decision perhaps at the May refunding – It is unclear what the final structure might look like » Reference rate: OIS or bills, although a GCF repo index is an intriguing alternative » Reset frequency: TBAC recommended a daily reset, although weekly is possible » Final maturity: Given the reduction in competing (non-Treasury) FRN supply, we suspect anything under a 5 y maturity could attract strong demand – We do not believe money fund appetite for a Treasury FRN will be especially vibrant » Spread WAM capacity limits would limit appetite if the final maturity was 2 y » Although a 10 -15 bp spread over bills might attract strong interest from this community – Will a Treasury FRN crowd out bill issuance? 36 6/15/2021

Demand for “safe assets” is curiously steady Financial assets (ratio to GDP) “Safe assets” (% all financial assets) Despite the rapid expansion in financial assets – to 10 x GDP – the proportion of “safe assets” has been pretty steady around 32% for nearly 60 years. “Safe assets” is roughly the sum of Treasury, short- and long-term corporate debt, and securitized paper ______________ Source: Federal Reserve and Barclays Capital See: “The Safe Asset Share, ” G. Gorton, S. Lewellen, and A. Metrick (2012), American Economic Association Annual Meeting 37 6/15/2021

Analyst Certifications and Important Disclosures Analyst Certification(s) I, Joseph Abate, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17 th Floor, New York, NY 10019 or refer to http: // publicresearch. barcap. com or call 212 -526 -1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise. In order to access Barclays Capital's Statement regarding Research Dissemination Policies and Procedures, please refer to https: //live. barcap. com/publiccp/RSR/nyfipubs/disclaimer-research-dissemination. html. 38 6/15/2021

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