svb asset management economic book q3 2013

Quarterly Economic Report 2013SVB Asset Management

Q3

http://www.svb.com/assetmanagement/

Table of Contents

Thoughts from our CIO 03

Overview 04

Domestic Economy 06

Federal Reserve 16

Markets & Performance 21

Global Economy 31

Regulatory 37

2 SVB Asset Management | Quarterly Economic Report Q3 2013

Thoughts from our CIO 03

Overview 04

Domestic Economy 06

Federal Reserve 16

Markets & Performance 21

Global Economy 31

Regulatory 37

There is no doubting the fact today’s economy is growing, but it is also clear that the quality of growth is subpar.

Consumption, representing about 70 percent of the economy, has been growing – albeit at a slower pace – and has received some surprising help from the auto industry. Consumer outlooks, however, are shaky compared to the past two decades in light of uncertain fiscal and monetary policies.

Employment growth is slowing and we remain far from “recovered” in this all-important measure of economic health. Lower participation in the workforce is not the ideal way to lower the unemployment rate and there is some sense the Fed will look deeper into the data to assess any potential improvement in the labor markets.

The housing market has shown some heady price increases and rising housing starts are filtering through the economy to provide growth in many sectors. On the other hand, higher mortgage rates in the coming months will provide a solid headwind in fourth quarter.

Our special topic this quarter looks at the changing make-up of the Federal Reserve where we’ll likely see a few more “hawks” but not enough to affect the decisions. We are hopeful the 2014 FOMC voters will have something to be hawkish about!

The much discussed “great rotation” from bonds into equities took a pit stop in cash during the quarter, but our analysis of flow of funds data reveals that September inflows helped drive markets to new highs.

On the regulatory front, we’ll be watching the SEC for further insight into money fund reform. I don’t expect any significant change to the industry given the outpouring of comment letters against such change. Should a move to floating NAV occur, I would anticipate a very long implementation period allowing investors to reevaluate and adjust their cash management tools.

Looking ahead, I would expect a relatively calm quarter of activity with the Fed largely on the sidelines. The only wild card at press time is the debt ceiling debate. Compared to our experience in 2011, I would expect this to be only a moderate speed bump.

Joe Morgan, Chief Investment Officer

3

Thoughts from our CIO

A Bit of a Head Fake

SVB Asset Management | Quarterly Economic Report Q3 2013

4

Economic growth is slowly picking up despite headwinds stemming from fiscal policy.

The consumer has started to pull back on spending showing that higher taxes and interest rates are having an effect.

Improvement in employment has slowed with job growth struggling and labor force participation at 30+- year lows.

Inflation has been running below the 2 percent objective, although this is expected to normalize in the medium term.

Monthly housing data has been mixed showing that the market is trying to balance higher mortgage rates with tight home supply.

Domestic Economy It has been an interesting quarter for the Fed. Not only has there been a lot of chatter on the course of monetary policy, but the FOMC voting members will face significant turnover next year including a new chairman.

With the potential changes, the Fed regime is shaping up to look less dovish, which may have implications for future monetary policy.

Last quarter speculation regarding when the Fed would start to taper lead to volatility in the markets.

The Fed’s September 18 announcement to hold off on tapering surprised markets, causing a rally across the curve.

The question remains whether or not quantitative easing has been effective, especially for the broader economy.

Special Topic: The Fed

Overview


Overview

5

The Fed’s decision not to taper led stocks and bonds higher and all sectors posting positive returns.

Equities have become the asset class of choice among investors given the recent fund inflows. This has led to a significant outperformance of stocks versus bonds.

Investors have tempered their appetite for bonds; however, with spreads range bound, credit still offers protection against higher future interest rates due to higher income.

Global tensions in Syria and a slowdown in EM economies could lead to some short-term volatility in commodity prices.

Markets/Performance Global Economy Irrespective of who is in office, debate on the debt ceiling continues, but we expect legislators to continue to raise the debt ceiling.

The Comment period has ended for SEC MMF reform in the last quarter. Implementation is not expected within the year.

European regulators introduced their version of MMF reform. Acceptance by various legislators is still required.

Regulatory Europe: Expansion germinates, starting a discontinuous path to medium-term sustainability.

China: Slowing exports underlie a downshift in overall growth; domestic retail consumption is increasingly imperative .

Japan: Entrenching BOJ monetary easing and planned economic reforms are steadying the yen.

U.S.: Dollar volatility to increase amid improving prospects in some G20 economies and pending Fed action.


Domestic Economy SVB Asset Management

Domestic Economy

GDP Struggling to Pick Up Momentum GDP

Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter annualized.

GDP and Components GDP Y-o-Y Growth 4Q Average – Long View

Since the recovery started the U.S. has averaged just over 2 percent growth.

Sequestration has caused growth to slow, especially given recent tax hikes and spending cuts.

Consumption is helping offset the reductions in government spending and driving the economy forward despite recent headwinds.

The second half of the year is projected to have better growth as the effects of sequestration have subsided and the Fed holds off on tapering for the time being.


-1.0%

1.0%

3.0%

5.0%

Government Net Exports Res Investment Bus Fixed Investment Inventories Personal consumption exp GDP

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

U.S. GDP Q-o-Q Trailing 4-Quarter Average

Consumption Restrained Growth Consumer Sentiment – University of Michigan

Source: U.S. Bureau of Economic Analysis (BEA), Census.gov, University of Michigan / Thomson Reuters - Survey of Consumers, SVB Asset Management.

Retail & Food Services Sales Personal Consumption – % Change

Consumer sentiment as shown by the University of Michigan survey steadily declined in the third quarter with the latest reading at 76.8, a five-month low. This is below the 30-year average of 87, but still above the five-year average of 71.

Retail sales have been tested in recent months with signs of slower growth. Purchases rose only 0.2 percent in August, below expectations and the smallest gain in four months.

Higher mortgage rates, higher payroll taxes, and limited wage growth are some of the factors which seem to be limiting the consumer’s spending power.


40.0

60.0

80.0

100.0

120.0

Average

$5.0

$10.0

$15.0

$20.0

$25.0

$250.0

$300.0

$350.0

$400.0

$450.0

Vehi

cle

Sal

es (M

illio

ns)

Ret

ail &

Foo

d S

ervi

ces

Sal

es (B

illio

ns)

Ex Autos Vehicle Sales

-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%

Consumption Restrained Growth Personal Income

Source: U.S. Bureau of Economic Analysis (BEA), Federal Reserve, SVB Asset Management.

Personal Savings as a % of Disposable Income

Household Net Worth Personal incomes have been fairly muted in recent months, averaging just over 0.2 percent growth, while savings rates have been very steady for the majority of the year, hovering right around 4.5 percent.

Although the consumer may have wavered a bit in terms of sentiment, household net worth continues to be on the rise supported by gains in the housing and equity markets. The last reading in Q2 showed that net worth rose $1.3 trillion during the quarter to $74.8 trillion.

9

$0.0

$20.0

$40.0

$60.0

$80.0

Bill

ions


0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

Mon

thly

Per

cent

age

Cha

nge

Employment Slowing Down Employment Landscape

Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months.

Full-Time Employment

Long Term Unemployment The unemployment rate has dropped to 7.3 percent, although the drop is partially due to less people participating in the work force.

Despite all the monetary support by way of quantitative easing, the pace of hiring has yet to accelerate.

The pace of hiring has slowed since the beginning of the year and the quality of jobs is weak with more part-time than full-time jobs being added.

The number of long-term unemployed has declined since the peak, but is still at an unhealthy high level.


-15.0%

-5.0%

5.0%

15.0%

-1,000.0

-500.0

0.0

500.0

1,000.0

Thou

sand

s

Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

Recession Period Unemployed 27 Weeks and Over

0.0 2,000.0 4,000.0 6,000.0 8,000.0 10,000.0

100,000.0 105,000.0 110,000.0 115,000.0 120,000.0 125,000.0

Thou

sand

s

Thou

sand

s

Full Time Employment (LHS) Part Time for Economic Reasons (RHS)

Employment Slowing Down Fewer Workers Supporting Greater Population

Source: U.S. Bureau of Labor Statistics (BLS), SVB Asset Management.

Will the Recent Spike in Earnings Hold Up?

Hires and Quits Remain Depressed Workers as a percentage of the total population remain depressed.

The labor force participation rate is at 35-year low, causing some of the drop in the unemployment rate to be driven by fewer participants rather than more jobs.

Turnover, as measured by job hires and quits, remains depressed vs. recent growth trends.


57.0%

59.0%

61.0%

63.0%

65.0%

3.0%

5.0%

7.0%

9.0%

11.0%

Unemployment Rate (LHS) Employment to Population Rate (RHS)

1.0%

2.0%

3.0%

4.0%

5.0%

Job Hire Rate Job Quit Rate

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

60.0%

62.0%

64.0%

66.0%

68.0%

Labour Force Participation Rate (LHS)

Avg Hourly Earnings Growth (RHS)

U.S. Housing Market On the Fence Home Sales & Supply

Source: National Association of Home Builders (NAHB), Census.gov, S&P, and SVB Asset Management.

Housing Starts Home Prices – Indexed to 100

Housing indices have been more volatile in recent months as the market has been balancing higher mortgage rates with continued tight home supply.

Sales of existing homes have continued to rise in the third quarter; however, new home sales have experienced more of a slowdown.

Home prices reflect the same trend with double-digit, one-year increases, but levels remain below their prior peak reached in 2006.


0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0

3.0 4.0 5.0 6.0 7.0 8.0 9.0

Hom

e S

uppl

y (m

onth

s)

Hom

e S

ales

(Mill

ions

)

Total Sales (new & existing) Existing Home Supply

90

140

190

240

Case Schiller 20 City FHFA Purchase Median Home Price

0.0

70.0

140.0

210.0

280.0

350.0

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

Pop

ulat

ion

(Mill

ions

)

Hou

sing

Sta

rts

(Tho

usan

ds)

Housing Starts U.S. Population

U.S. Housing Market On the Fence Homeownership Rate

Source: Census.gov, National Association of Realtors and SVB Asset Management.

Housing Affordability Composite Index

Home Foreclosures - % of Total Loans Homeownership has held at 65 percent for the past two quarters. The sustained drop during the past decade indicates that this may reflect positive data in the future.

Foreclosures appear to have turned the corner which implies some relief for the typical consumer.

Home affordability has started to reverse the upward trend showing that the rise in mortgage costs is a significant factor. In the latest Fed announcement, policymakers cited a tightening of financial conditions as being one of the reasons for keeping the pace of monthly bond purchases.


0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%

0.0

50.0

100.0

150.0

200.0

250.0

Affo

rdab

ility

Inde

x

Housing Affordability 30 Year Fixed Mortgage Rates

62.0%

64.0%

66.0%

68.0%

70.0%

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0%

Inflation Below the Line Component Distribution August 2013

Source: U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS) and SVB Asset Management.

Core PCE

Consumer Price Index Producer Price Index


-5.0%

0.0%

5.0%

10.0%

15.0%

% c

hang

e fro

m p

rior y

ear

CPI Ex Food & Energy CPI

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

% c

hang

e fro

m p

rior y

ear

PPI Ex Food & Energy PPI

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

% c

hang

e fro

m p

rior y

ear

Core PCE Fed Target Monetary Policy Threshold

CPI Components 12-month ChangeFood & Bev. 1.4%

Housing 2.2%

Apparel less Footw ea 1.6%

Transportation 0.0%

Medical Care 2.3%

Recreation 0.4%

Educ. & Comm. 1.6%

Other 1.6%

Headline CPI 1.5%Less:

Energy -10.0%

Food 1.4%

Core CPI 1.8%

41.1%

17.2%

14.2%

7.1%

6.7%

5.9%

2.8% 5.0%

Housing Transportation Food & Bev. Medical Care Educ. & Comm. Recreation Apparel less footwear Other

Inflation Below the Line Wage Growth: Average Hourly Earnings

Source: U.S. Bureau of Labor Statistics (BLS), U.S. Energy Information Administration (EIA), University of Michigan / Thomson Reuters - Survey of Consumers and SVB Asset Management.

Crude Oil – Spot & Futures

Univ. of Michigan Survey of Inflation Expectations At the recent Fed meeting, the Committee acknowledged that inflation has been persistently running below its 2 percent objective, but they expect this will revert over the medium term.

Inflationary measures such as CPI and PPI have both been coming in very close to expectations and inflation continues to be a very low concern to many.

We are still not seeing significant wage growth, which is needed in order to drive inflation. Furthermore, emerging markets demand has subsided which has stabilized commodity prices.


1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Ann

ual %

cha

nge

1.5%

2.5%

3.5%

4.5%

5.5%

1 Year Ahead 5-10 Year Ahead

$0.0

$50.0

$100.0

$150.0

Pric

e pe

r bar

rel

Crude Oil Crude Oil Futures

The Federal Reserve SVB Asset Management

The Federal Reserve

http://www.svb.com

Federal Reserve A New Fed Regime


Talk of a new Fed chair was persistent throughout the third quarter until Larry Summers made the surprise announcement that he was withdrawing from consideration.

At the time of print, Janet Yellen appears to be the lead candidate to succeed Mr. Bernanke when his term expires at the end of January 2014. An announcement from the Obama administration is expected in the coming weeks.

With 18 Fed policymakers, each with divergent viewpoints, arriving to a policy consensus is difficult. To the right is a breakdown of the current assembly and how that may change. The bottom line is that it looks like the regime may be less dovish next year.

Current Camp

Voting (2013)

Voting (2014)

Ben Bernanke (Chair) Dove Yes No – term ends at the end of January Janet Yellen (Vice Chair) Dove Yes Likely dependent on Fed Chair decision Daniel Tarullo Dove Yes Yes Sarah Bloom Rakin Dove Yes No – leaving the board of governors Jeremy Stein Dove Yes Yes Jerome Powell Dove Yes No – term ends at the end of January Eric Rosengren Dove Yes No William Dudley Dove Yes Yes Charles Evans Dove Yes No James Bullard Dove Yes No Sandra Pianalto Dove No No – announced retirement Dennis Lockhart Dove No No Narayana Kocherlakota Dove No Yes John Williams Dove No No Esther George Hawk Yes No Charles Plosser Hawk No Yes Jeffrey Lacker Hawk No No Richard Fisher Hawk No Yes

Federal Reserve Is Q.E. Working? Are Record Low Mortgage Rates Helping?

Source: Bloomberg and SVB Asset Management

Will the Wealth Effect be Sustainable?

The question that many are asking, including the Fed, is whether quantitative easing is helping the broader economy.

Mortgage rates are at record lows; however, mortgages outstanding have been on the decline for the last five years.

Home prices have finally stabilized and are rising in many areas. Meanwhile, equities are rising with the S&P 500 hitting an all-time high in September. However, the fundamentals are not supporting the increase, an indication sustainability will be difficult.

The unemployment rate, which is a Fed target, has been dropping but largely due to a drop in the participation rate. There is also concern that the quality of the jobs added is weakening.


0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0%

$9.0

$9.5

$10.0

$10.5

$11.0

$11.5

Bill

ions

Mortgages Outstanding (LHS) 10 YR Treasury (RHS) 30 YR Treasury (RHS)

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%

61.0% 62.0% 63.0% 64.0% 65.0% 66.0% 67.0%

Labor Force Participation Rate (LHS) Unemployment Rate (RHS)

600 800 1,000 1,200 1,400 1,600 1,800

150

170

190

210

230

250

S&P 500 (RHS) Home Prices (LHS)

Low Participation Rate Impacts the Unemployment Rate

Federal Reserve Still Growing, For Now The third quarter was a volatile one as investors tried to predict the pace of tapering that was hinted at back in May. The big surprise was on September 18 when the Fed announced it would hold off on tapering and gave no clear indication of when tapering would take place.

The sell-off triggered by the anticipation of tapering created a lot of volatility in markets and significant increases to interest rates. The rise in interest rates might have unnerved the Fed given the fragile state of the U.S. recovery.

In the last FOMC meeting of the quarter the Fed stated that there has been “growing underlying strength in the broader economy” but wants to “await more evidence that progress will be sustained before adjusting the pace of its purchases.”

Source: Federal Reserve and SVB Asset Management.

Recent Balance Sheet Trends


$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

$3.5

$4.0

Trill

ions

Other Fed Reserve Assets

Central Liquidity Swaps

Other

Aurora

Maiden Lane III

Maiden Lane II

Maiden Lane I

TALF

AIG

Seasonal Credit

Secondary Credit

Primary Credit

Other Loans

Treasury Currency Outstanding

Special Drawing

Gold Stock

MBS

Federal Agency Debt Securities

U.S. Treasury Securities

Federal Reserve Mixed Signals The Fed continues to monitor economic data and is using the unemployment rate and inflation rate as metrics to monitor the need for monetary policy.

The unemployment target is set at 6.5 percent and looser monetary policy will continue as long as inflation remains below 2.5 percent.

However, in June Bernanke mentioned that an unemployment rate of 7 percent could warrant the end of quantitative easing. While the unemployment rate is headed in that direction, it is propelled by a very low labor force participation rate. In the last meeting, Bernanke said the unemployment rate is not necessarily a great measure of the state of the labor market.

Source: U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS) and SVB Asset Management.

Targeting Unemployment and Monitoring Inflation


0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

0.0%

1.0%

2.0%

3.0%

Core PCE (LHS) Core PCE Thresholds (LHS)

U.S. Unemployment Rate (RHS) U.S. Unemployment Thresholds (RHS)

U.S. Unemployment Target 6.5%

Core PCE Threshold 2.5%

Markets & Performance SVB Asset Management

Markets & Performance

http://www.svb.com

Funds Flow Injecting Fuel Into Equities

Source: Bloomberg , Investment Company Institute, MSCI, and SVB Asset Management.

Equity Flows & Stock Performance

Net New Fund Flows Money Market Fund Flows

There were large flows out of bond funds during the month of June and large flows into equity funds in September.

Flows into equity funds have recently exceeded performance driven by a dovish fed and lackluster top-line revenue growth.

With the decision to continue Quantitative Easing, the recent trends in equity and bond flows could persist.

Money market funds have started to normalize in anticipation of the SEC decision regarding the recent proposals.


-$80.0

-$40.0

$0.0

$40.0

$80.0

Bill

ions

Total Equity Total Bond

-25.0%

-15.0%

-5.0%

5.0%

15.0%

-$40.0

-$20.0

$0.0

$20.0

Mill

ions

Net New Cash Flow (LHS) Total Return on Equities (RHS)

$2.4 $2.5 $2.5 $2.6 $2.6 $2.7

Trill

ions

MMF AUM

Bond Sector Spreads Stuck in a Range?

SVB Asset Management | Quarterly Economic Report Q3 2013 23

Source: Bloomberg, BoAML , Barcap Live, Citigroup and SVB Asset Management.

Spread Performance by Asset Class

-200

300

800

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Uncertainty at the Fed and in Congress has contributed to the recent volatility in the market.

Despite the recent chatter, credit spreads have been resilient and will likely trade within their respective ranges for the near term.

Corporate bond performance was boosted by increased demand for new issues, characterized by a flurry of new deals this year.

In addition, the Fed's decision not to taper has boosted demand for riskier assets which should help credit spreads.

0

50

100

150

200

250

Spr

ead

(bps

)

Inv. Grade Corporates U.S. Agency MBS ABS

Bond Market Where’s the Alpha? The Fed’s decision to delay tapering led the majority of the U.S. bond sectors to post positive excess returns.

Year-to-date, high grade corporate sectors, such as Insurance and Financial Services, led the way posting 3.3 percent and 2.0 percent in excess returns. The Verizon downgrade to BBB is part of the reason for Telecom underperformance YTD.

Meanwhile, CMBS and ABS sectors have provided the alpha in the securitized space.

Source: Bloomberg, BoAML and SVB Asset Management.


0.4

-0.3

0.6

3.3

1.9

1.9

1.7

1.1

0.9

0.7

0.6

0.5

0.3

0.1

0.1

-0.3

-0.9

-1.1

-1.2

-2.0 -1.0 0.0 1.0 2.0 3.0 4.0

ABS

MBS

CMBS

SECURITIZED SECTOR

Insurance

Financial Services

Automotive

Banking

Services

Technology & Electronics

Consumer Cyclical

Capital Goods

Healthcare

Consumer Non-Cyclical

US TREASURY

Energy

US AGENCY

Media

Basic Industry

Telecommunications

GOVERNMENT & CORPORATE SECTOR

Excess Return % YTD

Equity Markets Directional Indicators Strength in S&P 500 Co. Fundamentals Reduce Risk & Improve Performance


VIX is the Directional Indicator for Equities (VIX - inverse scale)



Index

Index 10

12

14

16

18

20

22

24 1350

1400

1450

1500

1550

1600

1650

1700

1750

S&P 500 (LHS) VIX (RHS)

Commodities U.S. Politics Driving Price Crude Futures – Per Barrel

Source: Bloomberg and SVB Asset Management.

Gold Prices – An Ounce Iron Ore Futures – Per Ton

Commodities, such as crude oil, have been tied to combat potential in the Middle East, the value of the U.S. dollar and expectations of the economy.

Oil prices had been rising because of the Syria crisis, yet recently dipped again on news of easing tension and a U.S.-Russia deal in Geneva.

The lack of tapering has given other commodity inflation hedges, like gold, an added pop. The weakening of the U.S. dollar will strengthen those investments.


$80.0

$90.0

$100.0

$110.0

$1,200.0

$1,400.0

$1,600.0

$1,800.0

$90.0

$115.0

$140.0

$165.0

Benchmark Performance

Investment Performance Where’s the Horsepower?

Ticker 3Q 2013 2013 YTD 2012 2011 2010 2009 2008 2007

Short Benchmarks 3-Month Treasury Bill G0O1 0.018 0.058 0.111 0.103 0.126 0.207 2.057 5.004 3-Month Citi/Salomon CD SBMMCD3 0.051 0.153 0.307 0.289 0.310 0.822 3.442 5.448 6-Month Treasury Bill G0O2 0.063 0.154 0.171 0.268 0.365 0.579 3.582 5.607 6-Month Cit/Salomon CD SBMMCD6 0.067 0.203 0.488 0.389 0.437 1.611 3.756 5.459 1-yr Treasury Bill G0O3 0.126 0.227 0.204 0.496 0.792 0.813 4.746 5.948 Treasury 1-3 yr Treasury G1O2 0.294 0.298 0.434 1.554 2.348 0.785 6.609 7.317 3-5 yr Treasury G2O2 0.683 -0.567 1.577 6.229 5.695 -0.672 12.153 9.836 Corporate/Govt (A Rated and Above) 1-3 yr Corp/Govt B110 0.376 0.414 1.188 1.527 2.641 2.766 5.184 6.981 3-5 yr Corp/Govt B210 0.891 -0.376 3.077 5.479 5.925 2.958 6.174 8.324 Agencies 1-3 yr Agencies G1P0 0.304 0.270 0.847 1.536 2.338 2.189 7.034 6.735 3-5 yr Agencies G2P0 0.832 -0.585 2.588 5.290 4.900 3.223 8.971 8.261 Municipals - Tax Exempt 1-3 yr Pre-refunded U1AF 0.409 0.577 0.520 1.800 0.923 3.189 5.875 4.710 3-7 yr Pre-refunded U2AF 0.987 0.095 1.539 4.951 2.087 5.345 7.992 5.390 Auto Asset Backed Securities ABS, Autos, Fixed Rate, (1.45yrs) R0U0 0.460 0.407 2.291 1.689 3.077 14.845 -0.682 5.723 Other Indices Dow Jones Industrial Average INDU 1.033 15.484 7.257 5.544 11.023 3.116 -33.762 6.432 S&P 500 SPX 4.123 18.769 13.405 2.110 12.783 23.454 -38.486 3.530 NASD CCMP 9.810 26.350 15.906 -1.799 16.910 43.888 -40.541 9.812 MSCI World Index MXWO 6.878 16.064 13.184 -7.615 9.262 27.283 -42.081 7.093 CRB Index (Commodities) CRY 2.749 -2.904 -3.372 -8.264 15.430 23.563 -39.450 16.679


Source: Bloomberg, BoAML, Morgan Stanley.

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0%

10 YR BBB Yield - 10 YR Treasury Yield

August 2013 2.7%

Loan Market Fundamentals The New Normal?

Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group

Credit Spreads Less than Half of 2009 Peak

Fundamentals Remain Steady 3-Month LIBOR Remains at Historic Lows

Credit spreads have fallen since the 5.6 percent peak during the financial crisis in January 2009, but remain higher than the sub-2.0 percent levels seen pre-crisis. In August 2013, spreads fell further to 2.7 percent.

LIBOR continues to remain at historic lows as the Fed continues its accommodative bond-purchasing policy. While inflation is expected to rise over the coming quarters, the tapering has been deferred until more solid evidence of an economic recovery is presented.

Since the trough in loan pricing in April 2009, prices have largely recovered and are ending 3Q 2013 above par after reaching peak levels in June 2013.


January 2009 5.6%

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0%

August 2013 0.28%

65

75

85

95

105 LPC LCDX (Secondary Loan Price Index - Par = 100)

High Yield Market Fundamentals Catching Up High Yield Funds Dip Notably in June

Source: Thomson Reuters Loan Pricing Corp., Lipper FMI and SVB Financial Group

High-yield issuance volume dropped dramatically this summer due to issuer worries over higher interest rates and a lack of demand for the fixed rate asset class.

There was a notable pick up in the fall as September priced over $22 billion of U.S. corporate high yield bonds in just 19 deals, surpassing issuance volumes of the last three months and making it the third busiest September on record. In comparison, June priced nearly $14 billion over 30 deals, July $20 billion over 47 deals, and August $13 billion over 35 deals.

Sprint Corp. was the first to come to the market after Labor Day with its $6.5 billion high yield deal for general corporate purposes. Since then, five more billion-plus deals have hit the high yield bond market, including Tenet Healthcare’s $4.6 billion two-part deal to finance the acquisition of Vanguard Health Systems.

In comparison to September, the first two months of 3Q 2013 priced 82 deals with a much smaller average deal size of just $410 million versus September’s average of over $1 billion.

Companies are likely to take advantage of the breather provided by the Fed to go into the market prior to the holiday season.

High Yield Take-Outs of Bank Debt


$0.0

$5.0

$10.0

$15.0

Volu

me

(Bill

ions

)

Bank-Loan Paydown

$0

$100

$200

$300

$400

Net

Ass

ets

($ in

Bill

ions

)

Loan Funds HY Bond Funds

Overall Loan Market Overview Powering Through Historical Syndicated Loan Volumes

Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group

The overall loan market held steady for the third quarter of 2013 on loans to back mergers and acquisitions, but was absent of notable movements given the traditionally slow summer season.

This trend is a turnaround from a year marked mostly by repricings and refinancings.

The leveraged loan market added another $61 billion of issuance in August, bringing August year-to-date issuance to $736 billion, up from $387 billion in the same period last year, as market participants reported continued strong demand for floating-rate products.

Banks have remained disciplined in their approach in 3Q 2013, but have been receptive to lending both up and down the grade. Leveraged loan issuances through mid-September have already nearly matched 2012 volume (614 deals compared to 664 in 2012).

Over $20 billion of institutional loans came to market the week of September 9, continuing the heavy flow of new money issuance following the Labor Day holiday.

The proportion of loans related to M&A or LBO issuance rose to roughly 54 percent as of September 13, versus about 19 percent YTD.

Investors cautiously awaited the outcome of the September 18 Fed meeting on the tapering after recent mixed economic data left questions about the magnitude of the Fed’s program.

Institutional Lending Exceeded Pro Rata Loans


$0

$500

$1,000

$1,500

$2,000

Issu

ance

(Bill

ions

)

Leverage I-Grade Other

$0.0 $20.0 $40.0 $60.0 $80.0

$100.0 $120.0 $140.0 $160.0

Leve

rage

d lo

an v

olum

e (B

illio

ns)

Pro rata Institutional

Global Economy SVB Asset Management

Global Economy

http://www.svb.com

Manufacturing PMI

Source: MarkIt, Bloomberg and SVB Asset Management.

Growth is germinating within the eurozone, though fluctuation will continue over the next year before it takes root. Supporting the recovery will be a moderation of tight credit standards for retail and enterprise borrowers.

Manufacturing activity is improving. Germany and Italy are leading growth, while France is lagging. Expansion occurred for the first time in two years in Spain. Exports were key in lifting manufacturing in the eurozone, as well as in the U.K.

While trailing manufacturing activity growth, eurozone services are trending upwards, with recent expansion strongest in Ireland. Stabilization of new services business orders suggests services will begin to contribute positively in the near future.

As fiscal and regulatory reforms continue, expect growth to be inconsistent over the next year. The ECB will likely intervene when necessary, but will not introduce additional extraordinary programs to boost growth. We don’t anticipate a rate cut near-term, absent financial market stress.

Services PMI


Europe Discontinuous Growth

30

40

50

60

Man

ufac

turin

g P

MI

Eurozone Germany France Italy

30

40

50

60

Ser

vice

s P

MI (

>50

Exp

ansi

on)

Eurozone Germany France Italy

Europe Euro & Pound Rebound Currency Performance

Source: Eurostat, Bloomberg and SVB Asset Management.

Recent indications of strong growth in the U.K. and emerging signs of

expansion in the eurozone have lifted the GBP and EUR.

An acceleration in U.K. manufacturing and services growth, as well as

a strengthening housing market and falling jobless claims propelled

recent gains in the GBP. With the U.K. unemployment rate at 7.7

percent, above the 7 percent threshold set by the BOE for initiating a

change in monetary policy, further gains will not hasten.

Eurozone trade balance has declined after reaching a record high in

March 2013, as weak domestic demand reduced imports. A solidly

positive trade balance is proving support for the EUR. With the

eurozone seeking to export its way to growth, trade balances will

remain positive.

The eurozone experienced its first quarterly expansion in the second

quarter in almost two years. While the majority of national budgets

have improved year over year, further fiscal and regulatory reform

remain ahead. On the balance, this will contribute to a range-bound

euro.

Eurozone Trade Balance


$1.1

$1.2

$1.3

$1.4

$1.5

$1.6

$1.7

$1.4

$1.5

$1.5

$1.6

$1.6

$1.7

EU

R /

US

D

GB

P/U

SD

GBP EUR

-€ 100.0

-€ 50.0

€ 0.0

€ 50.0

€ 100.0

€ 150.0

Billions

China Balancing Act

Source: National Bureau of Statistics of China, Bloomberg and SVB Asset Management.

Aggregate Financing

Export Activity Retail Sales

Despite efforts by the authorities to control credit growth, the trend remains robust with non-bank financing channels complicating policy and presenting downside risk to the economy.

Macroeconomic policies continue to focus on rebalancing from investment led consumption towards household consumption.

Though trade surpluses and currency reserve accumulation persist, slowing exports increases the importance of retail sales to maintain growth.


-30.0% -20.0% -10.0%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0%

% C

hang

e Ye

ar -o

ver -

Year

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

% C

hang

e Ye

ar- o

ver -

Year

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

¥ B

Illio

ns

Asia Battling Inflation & Deflation Yen & Rupee Weaken

Source: Ministry of Health, Labor, and Welfare, Bloomberg and SVB Asset Management.

India Inflation Uncontained

Japan Labor Market Improving Japan: The BOJ upgraded its assessment of the economy to “recovering moderately”, as public spending, home sales, and the labor market have improved since the start of its ‘Quantitative-Qualitative Easing’ (QQE) program. Increased political stability and comfort with expansionary policies will keep JPY/USD range-bound, with weakening bias in the medium to long term.

India: Incoming RBI Governor Rajan raised the repo rate 25bps while simultaneously reducing the Marginal Standing Facility by 75 basis points at his first RBI meeting in September. The dual moves reflect the dilemma in fighting inflation without impairing growth. Continued INR weakness is possible in the medium term, as the limits to Rajan’s resolve to contain inflation is undetermined.


70.0

80.0

90.0

100.0

40.0

50.0

60.0

70.0

JPY

/US

D

INR

/US

D

INR JPY

100.0

110.0

120.0

130.0

CPI Combined (2010 = 100)

U.S. Dollar Short-Term Uncertainty Ahead U.S. Treasury Curve

Source: Bloomberg and SVB Asset Management.

The Federal Reserve’s September decision to maintain the pace of its bond purchase program flattened the strength of the USD. Emerging market currencies, as well as high-yielding G-10 currencies, benefitted. USD weakness may continue in the near-term before modestly strengthening.

The U.S. economy continues to grow faster than most developed countries, though recent higher interest rates and near-term political uncertainty may temporarily slow the growth pace. Manufacturing is recovering from a second quarter slowdown, while service activity is showing robust growth.

Longer-term interest rates continued to trend higher through the third quarter, though a protraction of the Fed’s QE program has put a temporary lid on rates. With the possibility the Fed may not alter its current bond purchase program until the beginning of 2014, expect medium and long-term rates to remain steady.

Volatility should increase near term due to ambiguous Federal Reserve policy direction and be range-bound medium term as growth re-emerges outside the U.S.. The USD may modestly move higher over the long-term on fiscal and political resolutions and normalization of interest rate policies in late 2015.

DXY USD Index


0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Rat

e %

Sept 20 2013 Jan 2013 Jan 2008 Jan 2005 Jan 2003

70.0

75.0

80.0

85.0

90.0

Inde

x Le

vel

Regulatory SVB Asset Management

Regulatory

http://www.svb.com

U.S. Debt Navigating the Grapevine

The U.S. debt burden has

increased irrespective of who is in

office. This may be due to

macroeconomic conditions which

have required a higher reliance on

debt funding in recent years.

Treasury has been using

extraordinary measures to avoid a

default since the last increase in

debt ceiling to $16.7 trillion in May

2013.#

Recent payments from Fannie and

Freddie together with the

sequester and other tax measures

have eased pressures on the debt

ceiling but the extraordinary

measures are predicted to last

until mid-October by the Treasury.

Expect further rhetoric debates in

Congress to continue but the

market believes the debt ceiling

will be raised eventually due to

budget deficiencies.

# As of press time Source: Bloomberg, SVB Asset Management

Outstanding Treasury Securities and U.S. Statutory Debt Limit

38

$0.0

$2.0

$4.0

$6.0

$8.0

$10.0

$12.0

$14.0

$16.0

$18.0

Trill

ions

Outstanding Treasury Securities Democrat Republican US Statutory Debt Limit


U.S. Regulatory Environment When Will We Cross The Finish Line?

39

Amendments to SEC 2a-7 rule have been in place since February 2010. Key changes included more restrictive maturity limits, higher credit quality standards, the establishment of new daily and weekly liquidity requirements as well as thorough stress testing and additional disclosures.

As of June 2013, two additional SEC proposals have been put forward. The 90-day comment period on those proposals ended September 23, and the industry is waiting for the SEC to deliberate.

Should the SEC decide to proceed with one of the proposals, the implementation period is estimated to span a timeframe of one to two years from the announcement.

Opt

ion

One

Floating NAV (Prime Institutional Funds Only)

Mark-to-market NAV valuation similar to other mutual funds with a NAV price rounded to the nearest 1/100th of a penny

Exemption for Government and Retail Funds. Government funds defined as those holding 80 percent or more in cash, government securities or repurchase agreements collateralized by government securities. Retail funds are defined as having a $1 million limit on daily redemptions

Pro: Daily pricing would reflect gains and losses fostering greater transparency

Con: Causes a “first-mover advantage”

Opt

ion

Two Liquidity Fees and

Redemption Gates (Optional for Government Funds)

If weekly liquidity drops below 15 percent of total assets, a two percent liquidity fee for redemptions could be imposed

If weekly liquidity drops below 15 percent of total assets, a maximum 30-day suspension of redemptions could be imposed for any 90-day period

Pro: The investor keeps the stability of a stable $1.00 NAV

Con: In times of stress, when cash is crucial, access to funds could be delayed or subject to a fees

Potential reforms could be a combination of the above proposals by the SEC

Potential Reform Proposals by the SEC as of June 2013

Source: SVB Asset Management.


European Money Markets The EU Speedbump


On September 4, 2013 the European Union released their own proposals to control the massive money market fund industry.

Rule implementation would require acceptance by all EU member states and pass Parliament. Parliamentary elections are scheduled for next Spring, which will have an impact on, not only the outcome, but the implementation timetable.

The new proposals were released in conjunction with added regulation on the so-called shadow banking sector. The rules would apply to money market funds domiciled in Europe.

Capital Buffer Money market funds that maintain a constant net asset value (CNAV) would require a 3 percent capital buffer to absorb potential losses and stabilize the fund during periods of high redemptions and decreasing asset values

Liquidity Requirements MMMFs must have at least 10 percent of their portfolio maturing within one day and 20 percent within one week to protect investors from potential runs (Similar to SEC requirements of 10 percent/ 30 percent)

Concentration Limits Issuer concentration would be kept at 5 percent limit to prevent large undue weight on any particular issuer (similar to SEC requirements)

Our Team

41

Managing Director

Jeff Schnitz [email protected]

Chief Investment Officer

Joe Morgan, CFA [email protected]

Head of Credit Research

Melina Hadiwono, CFA [email protected]

Portfolio Managers

Eric Souza [email protected] Paula Solanes [email protected] Renuka Kumar, CFA [email protected] Jose Sevilla [email protected]

Credit and Risk

Sook Kuan Loh, CFA [email protected] Tim Lee, CFA [email protected] Kyle Balough [email protected]

Silicon Valley Bank Partners

Susan Winters Dave Bhagat Kelly Caviglia Priyanka Raju Girish Mallya Sudhakar Pattabiraman

Head of Portfolio Management

Ninh Chung [email protected]


This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.

All material presented, unless specifically indicated otherwise, is under copyright to SVB Asset Management and its affiliates and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of SVB Asset Management. All trademarks, service marks and logos used in this material are trademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities.

©2013 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal Reserve System. SVB>, SVB>Find a way, SVB Financial Group, and Silicon Valley Bank are registered trademarks. SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value. B_SAM-13-13087 Rev. 10-11-2013 0413-0042


SVB Asset Management


555 Mission Street, Suite 900 San Francisco, CA 94105

555 Mission Street, Suite 900San Francisco, CA 94105

SVB Asset Management


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