View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

I
CONFIDENTIAL

BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM

Board of Governors

R&S 100-179
February 20,

Henry H. Edmiston

Trip to Chicago

General market outlook
The bankers in Chicago feel that the decline in the Government
security market since the first of the year has gone a long ;vay in correcting
the artificial level of rates which resulted from the rapid rise in prices
after the election. In general, they feel that forces tending to push prices
lower outweigh on balance those tending to increase prices. There is a considerable difference of opinion, however, as to the extent to which prices
are likely to decline. Some bankers feel that the tremendous volume of
Treasury financing over the near future combined with increased demands for
loans and for new capital by corporations will produce a substantial rise in
interest rates. The rise in rates would, of course, be more pronounced if
the Federal Reserve System obtains authority to increase reserve requirements
and uses it. On the other hand, some of the bankers feel that the rise in
interest rates will be slow and believe that the longest bone outstanding,
the 1960-65, may stabilize at somewhere around 2 l/2 per cent as compared
with the current yield of about 2o^0 per cent.
Recent market operations
The Chicago banks ordinarily do little in the market during the
early part of the year except to acquire Treasury "bills for the purpose of
supplying their customers with tax-exempt securities for the April 1 tax
date. This year is no exception to the general rule. The Continental Illinois, however, has started on a buying program of Treasury bonds on a scale
down. During the last two weeks they have acquired $5*000,000 of bonds under
this program. The entire program CB.11S for purchases of $25,000,000 with
$5*000,000 to bo bought on each l/2 point decline in the market. The Continental also holds its full allotment of about $10,000,000 on the last issue
of defense notes. The increase of 17,000,000 in its holdings of guaranteeds
represents purchases of H. 0. L. C. notes maturing May 15 whioh can be used
for April 1 tax avoidance.
The First National Bank has recently sold $5,000,000 of its Marchnote rights and purchased an equal amount of the 2 1/L\.s of 1951-53. Thus
the bank is, in effect, doing its own refunding as its tax position does not
permit buying taxable securities unless they can obtain the full tax equivalent yield. The bank now has only $2,000,000 of note rights left and, no
doubt, these will be refunded in the market in a similar fashion. The Northern
Trust Company has hold its full allotment of the new defense notes and purchased about &5>000#0Q0 additional in the market, partly against sales of



To:

R&S 100-179
February 20, I9I4.I

Board of Governors

CONFIDENTIAL
rights. The City National Bank also held their allotments of the two taxable
notes and purchased enough in the market to bring their holdings up to a total
of $7*000,000. The Karris Trust sold its allotments of defense notes in the
market end has made fey,- changes in its other holdings. The accompanying table
shows recent changes in the portfolios of leading Chicago basks*
GOVERNMENT SECURITY HOLDINGS OF CHICAGO 1JA27KS
I In millions of dollars)
Northern
Harris
First
Continental
Trust
National
Illinois
Trust
Dec. Feb. Dec. Feb. Dec. Feb. Dec. ?eb.
12
12
12
12
31
31
31
31

189

Bonds:
Up to 5 years....
5 to 10 years...•
10 to 20 years,.•
Over 20 years..• «
Total bonds...

c

1

128

he

232

k5

51
12

65
15

6

ME

U07

12
*
106
170
1/
31&

321

h

11

22

36

U2

675

653

I402

530

111

3
39

300
100

Total direct and

6

22
38

k

9

2?

18

0
y0

li

1

21

21

79

31

58

0
6

2
8

Hi

u

0

l

City
national
Dec. Feb.
12
31

17

60

Less than $500,000.
yiov/s on Treasury Finar.cing
General
The Chicago banks feel that the Treasury should take no chances on
the first issues of taxable bonds because of general market conditions, because of the continued tense international situation, and because of the unfavorable reaction to the re-cent issues of defense notes. They believe that
the Treasury should give holders of the bond and note rights an option of
converting into at least two and possibly three new taxable securities with
premiums adequate to assure complete conversions. Any cash offerings should
also be generously priced. Even though the premiums may seem unnecessarily
high, it is desirable to have investors well pleased in order that the market
will be more receptive to subsequent cash financings. Although the Chicago
banks may tend to exaggerate the picture somewhat, their vievrs carry added
weight because of their large correspondent; accounts. At the time of each
Treasury financing country banks throughout the area call up these banks to
ask what they think about the particular offerings and it is helpful for the
Chicago banks to give the offerings good publicity.




To:

Board of Governors

- 3 "

R&S 100-179
February 20, 19Ul

CONFIDEMTIAL
Specific issues and taxable differential
The bankers generally mentioned a 354 P er cent short note, a 2 1/2
/-per cent bond of around a 10-year maturity, and a long 2 3 l , per cent bond as
/j
issues which would be favorably received by various classes of investors. In
Chicago the Harris Trust and the City National banks would only be interested
in the note, while the Northern Trust would probably be interested in an intermediate-term bond. The Continental would subscribe to any bonds offered for
cash and would be buyers in the secondary raarket both on cash and refunding
issues unless prices advanced too sharply. The First National Bank, viiich now
pays Federal income taxes, would not be interested in any taxable securities
unless they showed the full tax equivalent yield.
The Chicago people do not have much confidence in their judgment as
to the proper differential between a taxable and nontaxable Treasury bond.
The lowest differential mentioned was about 0.30 per cent, whila the highest
way about the full tax equivalent. They feel that there are a .Large number of
potential purchasers for taxable bonds that were not in the market for taxable
defense notes at the existing low rates. The insurance companies, the savings
banks, banks not subject to Federal normal income taxes (a group in which a
large number of country banks fall), nonprofit-making institutions, and trust
funds cf individuals wore iaentionod aa the inora important investors cf this
type.
In this connection, the views of people close to the corporate market,
such as investment bankers and bank trust officers, were quite in contrast to
those expressed by the commercial bankers. One investment banker, for example,
expressed the opinion that the Treasury could sell a large volume of 10-year
bonds for 2 l/U per cent, a rate which would be above the current market on
high-grade corporate bonds and railroad equipment trusts of this general maturity range. The principal trust officer of a large Chicago bank mentioned
that he had a large number of trusts which would be delighted to obtain taxable
intermediate Treasury bonds at 2 l/?. per cent or long Treasury bonds at 2 3 ^
/1
per cent, as both rates would be out of line with current quotations on highgrade corporate bonds.
Some bankers expressed concern about the secondary raarket on the
issue or issues offered for conversion on the ground that potential investors
will hold off awaiting the cash offerings expected shortly. Although there
is a largo volume of excess funds in the hands of these investors, they do
not know how much may be absorbed by allotments on their subscriptions to new
taxable securities issued for cash and consequently they will not be inclined
to buy the new refunding issues in the market unless prices decline substantially after trading begins. According to the Dow-Jones ticker Tuesday morning
the Secretary announced he would do the refunding next week and raise now cash
the first week in March. The banks* views on this subject may change, therefore, when they learn that the new cash will be raised through increasing
Treasury bill issues.




c

• y
To: Jjoard of Governors

- k -

R&S 100-179
February 20, 1 1 1 1
9--

CONFIDENTIAL
Most of the bankers in discussing the differential between taxable
and nontaxable Treasury bonds consider that a normal tax rate of 30 P e r cent
applying to 19Ul incomes is almost certain and think that in making calculations perhaps an oven higher rate should be used. The question also arises
as to the effect on the market as a result of the fact that many potential
investors who do not pay corporate income taxes at present may soon be in
that position. For example, a number of banks will soon have to pay income
taxes because of increased income from loans, and because of refundings of
their large holdings of nearby maturities of Government securities which now
provide them with tax-exempt income. One banker also mentioned the fact that
he was talking with an executive of a large insurance company recently who
expressed concern over the future tax status of insurance companies. Although
insurance companies now have a considerable margin before they would have
Federal income taxes to pay, it is possible that the tax laws will be changed
so that they will not obtain the present high deductions for tax purposes.
To the extent that insurance companies anticipate such changes in t - x laws,
r.
they will be inclined to hold on to their present nont&rjcable Government
securities rather thai: switch to taxable issues when a spread d.^velops.
Miscellaneous comments

c

Several Chicago bankers expressed the opinion that there is a large
market for certain possible new typos of taxable savings bondt.. This is
particularly true if the bonds pay a current return cf 2 l/2 per cent or
better. Many accounts in the banks' trust departments need current income,
especially where there arc different beneficiaries for the income and the
principal of the trust. In this connection, it is important that permission
be given so that the nev; savings bonds may be transferred directly to beneficiaries without having to be redeemed at a penalty. One banker also mentioned that, in order to reduce the demand liability to the Treasury, savings
bonds paying an annual income might, in the future, be redeemed either in
cash or in some specified outstanding market bond at the option of the Treasury,
The Chicago banks continue to show an increase in loans, particularly
term loans. The First National Bank, which is a leader in the term loan field,
shows an increase of about Clj.0,000,000 since a year ago. While many recent
new loans may be attributed to the increase in general business activity resulting from the national defense program, Chicago banks do not have such a
large amount of direct defense loans. For example, the First National Bank
has made commitments for about $18,000,000 of direct defense loans, on which
about $12,000,000 has been disbursed. About ^J^OOjOOO of this amount represents plant facilities loans and the remainder loans on supply contracts.




To:

Board of Governors

- ? -

R&S 100-179
February 20, 19Ul

CONFIDENTIAL
List of Persons Interviewed
Continental Illinois — Mr, Knight, Vice President
Mr. Drew, Vice President (Trust Lepartment)
Mr, Bennett, 2nd Vice President (Trust Departraent)
First National —

Mr, McCloud, Vice President
Mr, Grier, Assistant Vice President

Harris Trust -r Mr, Brinkman, Vice President
Mr, Elliot, Vice President
Mr, Wayne
Northern Trust —
City National —

Mr. Spaulding, Vice President
Mr,, ITigoland, Assistant Vice President
Mrc Daniel

Harris, Hall, & Company — Mr. Hall, President

c

Federal Reserve Bank — Mr. Schaller
Mr, Sihler
Mr* Dawes