Bond Market Liquidity Stanford, CA March 20, 2015 Darryll Hendricks UBS Views expressed are those of the author and not necessarily those of UBS Intermediaries are shrinking… FICC Revenues (USD bn) 100 IB fixed income revenues down by about 20% relaQve to 2010 to 2012 period 80 60 40 20 0 2010 to 2012 average 2013 to 2014 average FICC Front Office Headcount (thousands) 30 IB front office headcount in fixed income down about 25% from 2010 to 2014 25 20 15 10 5 0 Beginning of 2010 End of 2014 Source: CoaliQon … with implicaQons for balance sheets and business strategies Broker-­‐Dealer Assets 450 400 350 300 250 200 150 100 50 0 Treasury and Agency assets Corporate bond assets Corporate equiQes assets 2010 2012 2014 Treasury and Agency assets down by 25% since 2010 Corporate bond assets down by 35% EquiQes up by 60% Repo liabiliQes (not shown) down by 25% Source: Flow of Funds McKinsey esQmates that increases in capital and other costs are reducing RoE for IB fixed income businesses from ~19% (2010) to 5~8%, depending on when new rules come into force, and prior to responses by firms Firms will conQnue to respond by selecQvely scaling back businesses and operaQng them differently Can we see an impact? •  Significant trend toward credit indices •  6σ move in UST markets (Oct 2015) •  ReducQons in inventories in face of higher volaQlity (e.g., TIPS, below IG credit) •  Reduced raQos of trading volumes to amounts outstanding (e.g., MBS) Corporate bond markets •  Investment grade –  Median daily turnover down from peak of $20 mm to $3-­‐4 mm –  Bid-­‐ask spreads back to pre-­‐crisis levels ~44bp •  High yield –  Median daily turnover down from peak of $7mm to $2.5 mm –  Bid-­‐ask spreads ~100bp (as of Q4 2014) •  But aggregate liquidity picture may mask pockets of illiquidity –  Energy sector bid-­‐ask spreads have decoupled since December, parQcularly in HY –  CCC vs other HY –  Corporate credit ETFs – discounts to NAV •  To what extent will alternaQve fund managers provide liquidity if market overshoots? Source: UBS Global Research