Updates From the Equities Desk

Equity markets had a good quarter with most ending higher. Best performers included the U.S., Japan, Hong Kong and Germany. The S&P 500 rose above 1,400 for the first time since 2008 and the Nikkei recovered losses it incurred after the earthquake last year. The global economy received some positive news; with the successful Greek debt swap and bailout and the effects of the ECB Long Term Refinancing Operation (LTRO) drove down peripheral bond yields. A notable exception was the Spanish market which finished lower as concern grew about its ability to fund itself.

Unfortunately the market rally wasn't necessarily positive for the lending business. Markets such as the U.S. and Hong Kong have experienced reduced short selling and weaker loan demand as shorts have been squeezed by rising equity prices. This has resulted in increased refinancing by borrowers (trying to reprice loan fees down) and high portfolio turnover as borrowers returned high fee loans to reborrow at lower levels. Market analysis in the U.S. indicates that hedge funds have reduced bearish bets (shorts) as the market rally has caused their performance to trail the underlying index. Big short positions have been squeezed as share prices have recovered. In addition to lower levels of short selling, increased hedge fund long positions at prime brokers created inventory that prime brokers can use to cover client shorts, reducing their need to borrow from agent lenders.

The main driver of borrower demand continued to be directional shorts. Across the lending book the sectors in demand haven't changed materially from previous quarters and include:

• Asia-Pacific – real estate and construction, consumer goods, technology, financials, materials, retail and shipping -demand is broad based
• Europe, Middle East and Africa – financial, alternative and technology
• U.S. – retail, technology, shipping, education and alternative energy

Although M&A activity was weak, there has been corporate activity in the form of capital raisings. This was responsible for most of the new borrowing demand, with an obvious sector being financial.

The European dividend season started in earnest. Markets traded included Austria, Denmark, Finland, Germany, Italy, France and Sweden. Levels on loans were strong, and were generally as good or better than 2011. One market of concern was France, where borrower uncertainty about changes to French stamp tax caused levels to fall.

Balances in Japan increased significantly towards the end of the quarter as borrowers swapped high dividend, locally held stock into lower dividend international shares. The trades were over the March month end dividend record date, but will come off quickly as April continues. U.S. overnight cash rates started to increase, which helped spreads on the U.S. equity book. Short selling bans on financial shares were lifted in Belgium, France, Italy and Spain. Good borrowing demand was seen in both Italy and Spain as hedge funds returned to shorting this popular sector. During the ban, funds expressed a negative view by shorting corporate bonds. With the equities now available to short, corporate bond demand weakened. The short selling ban in Greece was extended until July 25, 2012.

This publication by J.P. Morgan Worldwide Securities Services is intended to inform our clients and friends of developments in the industry and to provide information of general interest. It is not intended to constitute accounting, legal or tax advice and should not be relied upon as such.