Global Securities Lending and Commission Management Update
The City of Fresno Fire and Police and Employees Retirement System
August 24, 2010
Christopher Doell, CFA, CIMA®
Senior Vice President
Head of Client Relations—North America
Global Securities Lending
[email protected]
312-444-7177
© 2010 Northern Trust Corporation
Antwon McGruder
Vice President
Senior Institutional Sales
Northern Trust Securities, Inc.
[email protected]
312-557-3545
northerntrust.com
Table of Contents


2
Securities Lending Update
Commission Management Update
The City of Fresno Fire and Police and Employees Retirement System
Service
Expertise
Integrity
Securities Lending Update


3
Background and Summary of the Lending
Process
Securities Lending and Collateral Management
Market Update

Historical Earnings

Financial Market Crisis Responses

Portfolio Detail

Reporting

Summary

Appendix
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Securities Lending Update
Background of the Lending Process
It promotes market efficiency and liquidity

Securities Lending Defined:
A common market practice
whereby securities are
transferred on a temporary basis
from a lender to a borrower with
the latter obliged to return the
securities either on demand or at
the end of a specified period
Integral component of developed securities market for both domestic and international investors

Allows price discovery and the arbitrage of pricing inefficiencies

Supports the development of the capital markets by facilitating various investment
strategies

Important part of risk management

Used for fail coverage to ensure smooth settlement cycles
Who lends securities and why?

Long-Term, Institutional Investors

An investment tool to enhance portfolio returns

To offset or eliminate costs of custody and administration

Does not interfere with portfolio strategy – investment manager should continue regardless
of securities lending
Who borrows securities and why?

4
Investment banks (Prime Brokers), investment funds, prop traders, market makers and other
intermediaries

Hedging

Short sell

Arbitrage strategies

Settlement obligations
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Summary of Securities Lending Process and Associated Risks
1. Initiate Loan
2. Negotiate Terms
Revenue
Split
City of
Fresno
3. Receive Collateral
Northern
Trust as
Lending
Agent
Security
Availability
Loan
Allocations
(e.g. Cash, U.S. Gov’t.
Securities, certain equities,
sovereigns)
4. Move Security
Borrower
(e.g. prime
brokers
such as
Goldman Sachs,
Deutsche Bank)
End User/
Borrower
(e.g. Hedge
Funds such as
Citadel or
Bridgewater)
5. Daily Mark to Market
Collateral
6. Return Security
Cash
Collateral
Non-Cash
Collateral
7. Return Collateral
Core USA
Borrower Risk
Simultaneous borrower default and insufficient collateral to buy-in the security
Trade Settlement Risk
Investment manager sells an on-loan security and borrower is unable to return the security to the custodian to
settle the trade
Collateral Investment Risk
Investment in collateral option becomes impaired or decreases in value
Interest Rate Risk
Rebate rate on a loan exceeds the earnings rate on cash collateral investments in a collateral option
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Northern Trust Program Overview as of June 30, 2010
Lendable
Base
Distribution Network
Collateral Structure

467 participating clients

49 worldwide markets


$626.7 billion lendable
securities

24-hour trading Chicago, Toronto,
London, Hong Kong
$110.1 billion cash and
non-cash collateral

Cash managed jointly
with $220.3 billion in
Northern Trust’s Short
Duration Fixed Income
Division

Array of pooled
Collateral Sections and
custom fund collateral
options

$105.9 billion loans
outstanding


primary source for
borrowers

40 approved
counterparties

Electronic links
effective loan
allocation system
Scale of a leader
Primary source for borrowers
Strong distribution network
Collateral expertise
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Securities Lending Update
Current Borrower Profile as of June 30, 2010
40 Approved
Counterparties
35% “AA-” long-term S&P rating or better
97.5% “A” long-term S&P rating or better
2.5% does has a long-term ratings of BBB+
Top 10 all have “A” or better long-term S&P rating
Morgan Stanley
Top 10
Borrowers
Goldman Sachs
Royal Bank of Scotland
*Top 10 have 82% of total
loan volume
Barclays Plc
JP Morgan Chase
Citigroup Inc
Credit Suisse Group
HSBC Holdings PLC
Deutsche Bank
Bank of America
Borrowers approve or restrict borrowing from clients based on their
Agency Lender
Disclosure
credit and capital considerations
Clients may look to restrict borrowers in our lending program
Customization
7
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Securities Lending Update
Historical Net Earnings & Lendable Base—City of Fresno
Cumulative Net Earnings
since 2004 = $7,681,806
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Securities
Annual
9
Lending Update
Scorecard, 7/2009 thru 6/2010—City of Fresno
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Securities Lending Update
Earnings Performance Comparison, 2009 vs. 2010—City of Fresno
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Securities Lending Update
Top Ten Earnings—City of Fresno
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Securities Lending Update
Review of 2008/2009 Market Crisis Actions





Determination of Collateral Deficiency

In September 2008, Northern Trust posted a collateral deficiency in certain constant-dollar NAV pools equal to the shortfall in the market-to-book ratio below 100.
This action helped ensure that the risk of loss was allocated equitably across all pool participants at a time of extreme market disruption.

Northern Trust did not immediately require clients to provide payment to their respective collateral pool. In fact, we stated that the remaining liabilities, after
accounting for realized losses, would be subject to potential future reversal, if improving conditions allowed.
Northern Trust’s Support to Clients

In October 2008, Northern Trust made a voluntary, one-time cash contribution of approximately $150 million to affected client accounts.

Beginning in October 2008, Northern Trust also voluntarily reduced its share of the securities lending fee split by 20% for a period of twelve months.

With these voluntary actions taken by Northern Trust, all clients in the impacted pools will find that their exposure to realized losses in their pool to date have been
largely or more than offset by the capital support and fee reduction measures offered by Northern Trust.
Flexible Risk Mitigation

Northern Trust introduced the staged withdrawal program to direct lending clients in September 2008. Clients electing the staged withdrawal were able to gradually
reduce their loan caps to limit the value of securities on loan and ultimately exit the pool without taking an interest in collateral. Upon exit, clients paid to their
respective collateral pool their full amount of collateral deficiency liabilities outstanding.

For indirect lending clients, Northern Trust Global Investments implemented a Twice-Monthly Program providing an opportunity for investors to reduce their
exposure to lending Common & Collective Funds
Enhanced Client Reporting Tools

Northern Trust launched the Securities Lending Reporting Block on Passport®, providing transparent, targeted and timely information to clients in an easy-to-use
dashboard format .

Client communications were expanded to include the Securities Lending Market Intelligence newsletter and periodic Market Update Call webcasts
Changes to Collateral Reinvestment Guidelines

In November 2008, Northern Trust outlined temporary, more conservative investment practices for all of the pools subject to the September 2008 collateral
deficiency determination.

In October 2009, Northern Trust formally implemented updated investment guidelines for all the Collateral Sections subject to a collateral deficiency determination

In general, the new guidelines are largely aligned with those governing money market funds subject to SEC Rule 2a-7 and designed to reflect an even more
conservative investment profile across multiple parameters
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Securities Lending Update
Collateral Deficiency Summary—City of Fresno
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Securities Lending Update—July 2010
Generating Spread: Lending vs. Investment 2001- 2010 YTD (Core USA)
*Fed
14
Funds Effective Rate used 2001-2004, Fed Funds Open used 2005-present
The City of Fresno Fire and Police and Employees Retirement System
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Securities Lending Update
General Recent Observations and Trends
 Demand from the Borrower Community

Loan balances have remained relatively stable despite the general market sell-off related to industry-wide concerns over recent European sovereign debt issues.

Hedge fund outlook has grown more cautious due to ongoing market volatility and questions around the final form of financial regulation legislation.

Equity Markets
 Recent increase in market volatility has resulted in a short-term decline in trading activity.
 Coming to the close of the yield enhancement season. Trading activity has been robust with pricing levels slightly higher than in 2009.

Fixed Income Markets
 Strong demand and spreads for exposures in Greece, Italy, Portugal, and Spain due to price volatility, plus strong borrowing demand for German government
bonds as flight to quality affects liquidity in the market.
 Uncertainty of the Fed’s liquidity exit approach, EU sovereign debt issues, and regulatory environment make forecasting future demand challenging.

Evolving Regulatory Environment
 Recent expansion in short selling regulations across the Eurozone.
 The marketplace still awaits details of the form of US financial regulation legislation coming out of Washington.
 Market Drivers

Equity markets declined significantly in May and have since shown elevated volatility due to Eurozone issues and ongoing uncertainty about global financial
regulation.

The VIX (CBOE Volatility Index) rose 90%, resulting in increased short coverings as investors wish to be shielded from elevated levels of volatility.

General decline in hedge fund trading activity on the back of this uncertainty suggests a lack of conviction in the market.
 Spread Environment

Wide spreads remain for the most in-demand equity securities, particularly for yield enhancement trades and specials opportunities.

Recent increase in short-covering activities has led to reduced overall spread levels.

US Government debt spreads remain under pressure as interest rates remain low, while European Government debt spreads have widened as demand has recently
increased.
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Securities Lending Update
Collateral Reinvestment: General Current Observations & Trends




Short-term Fixed Income Markets

Trading environment has generally deteriorated  Short-term fixed income markets are not as liquid as they were a few months ago. Investors are reluctant to
lend money to European banks and are keeping exposure to banks domiciled in Greece, Italy, Ireland, Portugal, and Spain very short-term.

Short LIBOR rates have risen relative to Fed Funds in the past few months. As reflected by LIBOR changes, banks are more reluctant to lend to each other due
to concerns about industry-wide exposure to sovereign debt of European countries. Rise in LIBOR rates has caused interest rates on investments with credit
risk such as certificates of deposit, commercial paper, and floating rate notes to rise.
Liquidity

Liquidity premium Liquidity remains an expensive insurance policy to purchase with rates still low and Federal Reserve policy on hold.

Preserving Short-Term Liquidity Targeting enhanced overnight liquidity levels and maintaining high-quality, liquid positions. Short-term fixed income markets
are subject to volatility as events unfold in Europe.
Credit Quality

Monitoring all securities  Portfolio and risk management teams remain alert for opportunities to restructure, divest, or otherwise reduce exposure to securities
and issuers where appropriate.

Downgrades Observing fewer downgrades across corporate and asset-backed holdings as the economy improves.

Consumer strength High unemployment and the uncertain housing market remain negatives for legacy holdings across the Securities Lending program with
exposure to real estate.
Government Support

Initiatives to date appear to have successfully addressed some of the major liquidity/capital concerns.

Global government support remains in effect and provides a constructive backdrop for the overall market, even though some facilities have expired and others
are being utilized less than they were six months ago.

The exit strategy for government intervention programs is generally expected to be an orderly and lengthy process.
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Securities Lending Update
Investment Profile: Core USA Cash Collateral Fund as of June 30, 2010
* Based upon traded basis from holdings reports
NOTE: This information was created using the best unaudited data available to us and may not be completely reliable, accurate, or timely. Data is prepared on a
settled basis, which may differ from traded basis data on the Cash Collateral Holdings report. “Traded Basis” reflects pending trades.
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Securities Lending Update
Comparison of Legacy Assets for Core USA Collateral Section June 30, 2010
Core USA - Legacy Assets vs New Assets
$35,000,000,000.00
$30,000,000,000.00
$25,000,000,000.00
$20,000,000,000.00
$15,000,000,000.00
$10,000,000,000.00
$5,000,000,000.00
$-
9/18/2008
6/30/2010

Comparison of Legacy Assets vs New
Assets - Core USA
Collateral Section - 6/30/2010
% Legacy Assets
14%
% New Assets
86%
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The City of Fresno Fire and Police and Employees Retirement System

Legacy Assets (as defined as
assets that were in Core USA
collateral section as of
9/18/2008) totaled
$4,835,070,491.95 as of
6/30/2010
Legacy Assets comprised 14%
of the cash collateral for Core
USA collateral section as of
6/30/2010
Service
Expertise
Integrity
Securities Lending Update
Core USA Supplemental Characteristics Report - June 30, 2010
Note:
This report has been created using the best available data and may contain information provided by third parties, derived by third parties or derived
from third party data and/ or data that may have been categorized or otherwise reported based upon client direction. This report is for the exclusive use of
clients and is not intended to be used for any other purpose. The information contained in the report is unaudited (and therefore may not be completely
reliable). Portfolio holdings are subject to change at any time without notice. The report is provided for informational purposes only. Northern Trust
assumes no responsibility for the accuracy, timeliness or completeness of any such information. This is not intended as a recommendation, offer or
solicitation to buy, hold or sell any of the listed securities.
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Securities Lending Update
Core USA Market to Book History - June 30, 2010
CORE USA FUND
20
Date
Market to Book Without Receivable
9/18/2008
0.9881
9/30/2008
0.9853
10/31/2008
0.9734
11/28/2008
0.9672
12/31/2008
0.9613
1/30/2009
0.9691
2/27/2009
0.9689
3/31/2009
0.9639
4/30/2009
0.9730
5/29/2009
0.9787
6/30/2009
0.9839
7/31/2009
0.9866
8/31/2009
0.9891
9/30/2009
0.9915
10/30/2009
0.9953
11/30/2009
0.9963
12/31/2009
0.9978
1/31/2010
0.9989
2/28/2010
0.9991
3/31/2010
0.9994
4/30/2010
0.9996
5/28/2010
0.9994
6/30/2010
0.9995
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Securities Lending Update
Credit Risk Management Structure
Security Approval Group (SAG):


Northern Trust has supplemented its credit risk management structure by establishing this independent risk management group with
a new risk manager to identify changes within the credit landscape.
Consists of four professionals from Credit Risk, Fixed Income Research and Credit Policy which must unanimously approve all new
issuers and limits.

Prior to the purchase of a new security into the portfolio, a credit analyst will present the asset to SAG for approval.

This provides an additional layer of credit review.
Credit Risk Management Committee (CRMC):



Primary group for setting credit policy and procedure in Northern Trust Global Investments (NTGI).
9 committee members: 7 from outside Fixed Income Research, 4 from outside NTGI. Risk management and credit policy both have
representatives.
CRMC sets overall policy governing short term funds, including reducing fund and day limits.
Risk Management of the Collateral Pools



21
In prior market updates, the Northern Trust team has addressed the apparent deteriorating performance of a small segment of assetbacked holdings, specifically residential mortgage-backed securities backed by subprime and Alt-A mortgages.
While the majority of assets in the collateral pools have benefited over the past several months from improving market conditions,
these subprime and Alt-A mortgage-backed securities have faced challenges as economic difficulties persist and homeowner
delinquencies rise. These positions represent less than 1% of the overall holdings of each of the cash collateral pools.
Our portfolio management and risk management professionals constantly look for opportunities to restructure, divest or otherwise
reduce exposure to certain portfolio holdings, where appropriate.
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Securities Lending Update
Keeping our Clients Informed—Outreach Efforts

Securities Lending data block on Northern Trust Passport®
 Facilitates the online distribution of tailored information on each client’s portfolio holdings, characteristics,
investment performance and commentary
 Future versions will enable clients to access predefined, dynamic reporting output
 Initial rollout took place in January 2009

Securities Lending Market Intelligence Newsletter
 Periodic newsletter featuring news, insight, and portfolio commentary
 Watch for future editions featuring thought-leadership articles on the evolving state of the industry

Client Conference Calls
 Market Update Calls being conducted on a monthly basis
 Special client calls to be held as events warrant

Notices from Senior Management
 Securities Lending senior managers continue to issue market update letters to clients
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Risk and Performance Reporting
Flexible reporting to help monitor program risk and performance delivered
electronically
Daily
We
can build a customized
reporting package to fit
your needs

Borrower Utilization - Summary by Borrower

Account Utilization - Loan Detail, Summary by Account

Securities Loaned - Detail

Collateral
 Issuer Summary Report – two day data lag
 Cash Collateral Holdings Report – two day data lag
 Market to Book Report – two day data lag
 Collateral Characteristics
Monthly

Performance Scorecard :
Total Client, vs. Pool, Account Performance
Date Range Comparison
Security Level Breakdown
23

Earnings Statement – Summary & Detail

Securities Lending Collateral and Earnings Summary
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Securities Lending Update
Securities Lending Data Block on Passport®
Facilitates the online
distribution of
vital, tailored information
on each client’s portfolio
holdings, characteristics,
investment performance
and commentary
Enables clients to access dynamic
reporting output
24
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Securities Lending Update
Summary

Throughout the financial market crisis, a key goal for Northern
Trust has been to treat its clients equitably

Voluntary support provided by Northern Trust has substantially
offset realized losses for clients in the affected Collateral
Sections

Service
Expertise
Integrity
Program modifications designed to adjust to the changing
needs of our clients include a focus on enhanced client
reporting tools and the implementation of new collateral
reinvestment guidelines

Northern Trust remains firmly dedicated to the Securities Lending
business and meeting the needs of clients

Our global leadership position enables us the flexibility to create
and support new program options in the future
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Commission Management Update
Contents



26
Review of the program
Network of Brokers
Reports
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Commission Management Update
Commission Management Review – Rolling 12 Months

July 1, 2009 through June 30, 2010

Program Commission
$1,094,906.92

Rebate basis
$38,482.83

Rebate
$30,648.47

Rebate %
80 – Domestic
70 – International
27

% CM trades of total

Effective commission rate
6.01%
 Before rebate
1.26 cps (cents per share)
 After rebate
1.23 cps
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Commission Management Update
Effective Commission Rates – Rolling 12 Months
28
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Commission Management Update
Summary

Current Environment

Commissions have been falling for the last few years
 Providers excluding trades having commissions under a specified level, usually 3cps

Many CM providers and participating brokers left the space
 Program economics tough in the lower commission environment

Northern’s Commission Management, a smarter approach

Northern Trust Securities restructured its Commission Management program
 Economics work for all parties
 All trades are eligible
 Rebate basis is 80% commission in excess of the executing brokers cost of trade processing

Economics work for City of Fresno Retirement Systems
 Recaptured amount lowers effective commission
 Benefit to plan until there is no rebate available
― No rebate available means plan is trading at broker’s cost.
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Commission Management Update
Network of Brokers

Domestic
BNY ConvergEX
Blaylock Robert Van, LLC
CF Global

International
CF Global
CIBC World Market - Canadian Markets Only – Canadian Money Managers only
Commission Direct - Canadian Markets Only - Canadian Money Managers Only.
Cowen and Company, LLC
Cowen and Company, LLC
Fidelity
Eden Financial
Floor Broker Network
Floor Broker Network
G-Trade
G-Trade
Heflin & Co. LLC
Heflin & Co. LLC
HSBC
HSBC
Instinet
Imperial Capital
ITG
Instinet
Knight Equity Markets
ITG
Mischler Financial
Jackson Securities
NTSI
Knight Equity Markets
Pershing
Loop Capital
Melvin Securities
Redi Markets LLC
Societe Generale
Merrill Lynch
Mischler Financial
M.R. Beal
NTSI (Northern Trust Securities
Inc)
Pershing
Piper Jaffray
Ramirez & Company
Redi Markets LLC
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Commission Management Update
Trade Execution Report—City of Fresno
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NORTHERN TRUST
Appendix:
Biography
Biography
Christopher Doell, CFA
Senior Vice President
Northern Trust Global Investments
Head of Client Relations - North America
Northern Trust-Chicago
Professional Experience
Chris is responsible for all of Northern Trust's securities lending client relationships in North America. He leads a
team of experienced Relationship Managers and Account Managers to ensure high quality service and
unrivaled satisfaction is provided to all clients. He also leads the sales efforts for new business development
for Northern Trust's global securities lending practice.
Prior to his current position, Chris served as leader of the middle-market institutional sales/servicing team for
Northern Trust Global Investments. In that role, Chris coordinated the new business development and client
servicing responsibilities for a team of Relationship Managers and institutional sales partners.
Chris has also served as a Relationship Manager and Account Manager for Large Corporate clients in
Northern Trust's Corporate & Institutional Services unit.
Year Started at Northern Trust 1996
Year Started in Industry
1992
Credentials and Affiliations
 Chartered Financial Analyst (CFA) Charterholder
 Certified Investment Management Analyst (CIMA)
 M.B.A. degree with concentrations in marketing, finance, and management strategy from
Kellogg School of Management, Northwestern University
 B.S. degree in finance with an accounting emphasis from Marquette University
 Earned Certified Cash Manager designation in 1997
 Holds Series 7 & 63 Securities Licenses
 Member, CFA Society of Chicago
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Biography
Antwon McGruder
Vice President
Northern Trust Securities, Inc.
Senior Institutional Sales
Northern Trust-Chicago
Professional Experience
Mr. McGruder joined the NTSI team in February 2009 as Vice President, Senior Institutional Sales. Prior
to joining NTSI, Mr. McGruder worked for 4 years at the Bank of Montreal / BMO Capital Markets, with
primary responsibility of the strategic development and growth of BMO’s U.S. Credit Business. Prior to
BMO, Mr. McGruder worked for 5 years at J.P. Morgan Chase & Co. (Legacy Bank One), including a
just under 1 year stint in London, working for their Structured Investment Vehicle. Mr. McGruder has a
background of being exclusively responsible for the marketing and distribution of credit derivative
products, single name credit default swaps, and other structured related products (Indices,
Collateralized Debt Obligation’s, etc.). Mr. McGruder has presented at several conferences,
including one Keynote Speaker Engagement. Given market synergies and mechanics,
Mr. McGruder also distributed fixed and floating rate corporate bonds, Asset Backed Securities, and
other Fixed Income Products. Mr. McGruder brings expertise in both transactional and structured
trading with institutional accounts of all types; Banks, Insurance Companies, Hedge Funds,
Money/Asset Managers, Corporations, and others.
Year Started at Northern Trust 2009
Year Started in Industry
2001
Credentials and Affiliations
 M.B.A. from the Kellogg School of Management at Northwestern University
 B.S. in Finance from the University of Illinois at Urbana-Champaign
 Series 7 and 63 Licenses
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NORTHERN TRUST
CONFIDENTIALITY NOTICE: This communication is confidential, may be privileged and is meant
only for the intended recipient. If you are not the intended recipient, please notify the sender ASAP
and delete this message from your system.
IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax
matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding
penalties that may be imposed by law. For more information about this notice, see
http://www.northerntrust.com/circular230.
Evaluations are based on the asset allocation, actual historical spread and on-loan figures provided to
Northern Trust. Consequently, as changes in these factors occur and as trading patterns of the
portfolio managers’ shift, actual earnings generated in securities lending may be impacted. Even with
these limitations, this evaluation is a useful indicator of the earnings potential of your portfolio.
This presentation has been created using the best data available to us and may contain information provided by third parties, derived
by third parties or derived from third party data. Please consider this presentation as containing confidential information. The
information contained in the presentation is unaudited. Portfolio holdings are subject to change at any time without notice. The report
is provided for informational purposes only. Northern Trust assumes no responsibility for the accuracy, timeliness or completeness of
any such information. Any list of portfolio holdings is not intended as any advice or recommendation, offer or solicitation to buy, hold or
sell any of the securities listed. Execution prices may differ from current market prices and market values depending upon market
conditions at time of execution.