U.S. State & Local Government Debt Markets

©Copyright 2012 Cumberland Advisors

®. Further distribution prohibited without prior permission.

U.S. State & Local Government Debt Markets

Global Interdependence Center March 25-27, 2012

Florida Office New Jersey Office (800) 257-7013 One Sarasota Tower 614 E. Landis Avenue 2 N. Tamiami Trail, Suite 303 Vineland, NJ 08360 Sarasota, FL 34236

Peter Demirali Managing Director & Portfolio Manager

John Mousseau, CFA Managing Director & Portfolio Manager

David R. Kotok Chairman & Chief Investment Officer




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• $3.8 Trillion in U.S. Dollars

• State and local general obligations, state and local agencies (housing, public utilities, water, education, economic development, others)

• Build America Bonds Revisited

• Historical Default Rates

• Meredith Whitney Whiplash

• State of the States

U.S. State & Local Government

(Sub-Sovereign) Debt Market




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• It is a bond issued by a state, state or local agency, or local government (city or town) 2 types of Municipal Bonds

• General Obligation (G.O.) The bond is secured by the issuer’s full faith, credit, and taxing power

• Revenue Bond The bond is secured by revenue from tolls, user charges, or rents derived

from the facility financed. Examples include turnpikes/toll roads, water and electric authorities, education and dormitory authorities, housing authorities, economic development authorities, port authorities and others.

• Historically, most municipal debt issued is exempt from federal income taxes. Recently, the Build America Bond (BAB) has significantly increased the amount taxable municipal supply and attracted substantial interest internationally.

What is a Municipal Bond?




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CDL4

Quarterly Data 3/31/1952 - 12/31/2011

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95Total Marketable and Nonmarketable Federal Government Debt as % of GDP ( ) 12/31/2011=99.36

Components of US Government Debt as Percentage of GDP

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44Government-Sponsored Enterprises (GSE) Debt as % of GDP ( ) 12/31/2011=40.69

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21State and Local Government Debt as % of GDP ( ) 12/31/2011=19.63

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Copyright 2012 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.

. www.ndr.com/vendorinfo/ . For data vendor disclaimers refer to www.ndr.com/copyright.htmlSee NDR Disclaimer at




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• Build America Bonds (BABs) were created by the America Recovery

Reinvestment Act of 2009 (“ARRA” or “Stimulus Act”) in February

• Permits state and local governments to sell taxable bonds instead of

tax-exempt bonds and receive periodic payments from the US

Treasury equal to 35% of the interest on the bonds for the life of the

debt

• Congress created BABs to broaden the market for municipal debt

and to provide a more efficient subsidy than tax exemption

Build America Bonds

Federally Subsidized Taxable Municipal Bonds




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• BABs program expired December 31, 2010

• There were no limits on the amount of debt that may be sold as

BABs and no restrictions on their structure or maturity beyond the

rules applicable to tax-exempt bonds

• From an investor’s perspective, BABs are simply taxable municipal

bonds. The Federal interest subsidies are paid directly to the

issuers, not to investors, and are generally not material in the

analysis of the creditworthiness of BABs.

Build America Bonds - Continued -

Federally Subsidized Taxable Municipal Bonds




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• No! Historically, investment grade municipal

bonds have had exceptionally low default rates.

Does Sub-Sovereign = Subprime?




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Default Rates: Muni vs. Corporates

Average Cumulative Default Rates, 1970-2011, Municipal vs. Corporates All Municipals

Rating 1 2 3 4 5 6 7 8 9 10

Aaa 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Aa 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01%

A 0.00% 0.00% 0.01% 0.01% 0.02% 0.02% 0.02% 0.03% 0.04% 0.04%

Baa 0.01% 0.04% 0.07% 0.11% 0.14% 0.19% 0.24% 0.28% 0.33% 0.37%

Ba 0.28% 0.80% 1.32% 1.83% 2.29% 2.76% 3.26% 3.60% 3.82% 3.92%

B 3.21% 6.27% 9.18% 12.21% 15.20% 17.12% 18.19% 19.06% 20.15% 21.85%

Caa_C 9.17% 13.01% 15.39% 16.65% 17.58% 18.72% 20.15% 21.97% 23.68% 23.68%

Investment-Grade 0.00% 0.01% 0.02% 0.02% 0.03% 0.04% 0.05% 0.06% 0.07% 0.08%

Speculative-Grade 1.33% 2.47% 3.49% 4.45% 5.35% 6.08% 6.71% 7.19% 7.59% 7.94%

All Rated 0.01% 0.03% 0.04% 0.05% 0.07% 0.08% 0.09% 0.10% 0.12% 0.13%

Global Corporates

Rating 1 2 3 4 5 6 7 8 9 10

Aaa 0.00% 0.01% 0.01% 0.04% 0.10% 0.17% 0.24% 0.31% 0.39% 0.48%

Aa 0.02% 0.06% 0.13% 0.24% 0.35% 0.46% 0.57% 0.67% 0.76% 0.86%

A 0.06% 0.19% 0.39% 0.58% 0.80% 1.04% 1.30% 1.61% 1.93% 2.22%

Baa 0.18% 0.50% 0.91% 1.38% 1.89% 2.42% 2.92% 3.44% 4.03% 4.71%

Ba 1.12% 3.10% 5.44% 7.91% 10.15% 12.21% 14.02% 15.83% 17.67% 19.54%

B 4.25% 10.01% 15.73% 20.74% 25.27% 29.51% 33.50% 36.97% 40.16% 43.00%

Caa_C 17.32% 28.95% 38.27% 45.67% 51.97% 56.23% 59.21% 62.60% 66.22% 70.24%

Investment-Grade 0.09% 0.26% 0.49% 0.74% 1.02% 1.32% 1.61% 1.92% 2.26% 2.61%

Speculative-Grade 4.56% 9.35% 13.89% 17.87% 21.34% 24.35% 26.99% 29.37% 31.60% 33.69%

All Rated 1.61% 3.27% 4.82% 6.14% 7.26% 8.22% 9.04% 9.79% 10.50% 11.17%

Source: Moody’s




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Default Rates: GO and Non-GO

Average Cumulative Default Rates, 1970-2011, GO and Non-GO

Non-General Obligation

Rating 1 2 3 4 5 6 7 8 9 10

Aaa 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Aa 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.02% 0.02% 0.03% 0.03%

A 0.00% 0.01% 0.02% 0.02% 0.03% 0.04% 0.05% 0.06% 0.08% 0.09%

Baa 0.02% 0.07% 0.14% 0.22% 0.29% 0.38% 0.48% 0.58% 0.68% 0.77%

Ba 0.38% 1.16% 1.96% 2.75% 3.50% 4.29% 5.15% 5.76% 6.15% 6.36%

B 3.95% 7.74% 11.38% 15.25% 19.18% 21.78% 23.30% 24.59% 26.33% 29.24%

Caa_C 9.43% 13.36% 15.79% 17.06% 18.00% 19.17% 20.63% 22.51% 24.29% 24.29%

Investment-Grade

0.00% 0.02% 0.03% 0.05% 0.06% 0.09% 0.11% 0.13% 0.16% 0.18%

Speculative-Grade

1.83% 3.44% 4.92% 6.33% 7.69% 8.85% 9.86% 10.67% 11.36% 12.01%

All Rated 0.03% 0.06% 0.09% 0.12% 0.15% 0.18% 0.21% 0.24% 0.27% 0.30%

General Obligation

Rating 1 2 3 4 5 6 7 8 9 10

Aaa 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Aa 0.00% 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.01%

A 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.01%

Baa 0.00% 0.01% 0.01% 0.02% 0.02% 0.03% 0.03% 0.03% 0.04% 0.04%

Ba 0.08% 0.08% 0.08% 0.08% 0.08% 0.08% 0.08% 0.08% 0.08% 0.08%

B 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Caa_C 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Investment-Grade

0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01%

Speculative-Grade

0.07% 0.07% 0.07% 0.07% 0.07% 0.07% 0.07% 0.07% 0.07% 0.07%

All Rated 0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01%

Notes: 1. The first cohort considered is the one-year cohort starting on January 1, 1970. The last cohort considered is the one-year cohort starting on January 1, 2011. 2. Transition rates are averaged over cohorts spaced one month apart.




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Credit Default Swaps (CDS): MI




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Credit Default Swaps (CDS): CA




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Credit Default Swaps (CDS): IL




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Credit Default Swaps (CDS): MD




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Credit Default Swaps (CDS): TX




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Meredith Whitney Whiplash




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State & Local Gov’t Employment Declining




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State & Local Gov’t Employment Far Worse




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Local Gov’t Education Employment




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State Tax Revenue




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Muni’s & Treasuries: January 1, 2007

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Municipal Market Advisors AAA

U.S. Treasury

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Source: Bloomberg and Cumberland Advisors.




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Muni’s & Treasuries: December 29, 2008

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Years Source: Bloomberg and Cumberland Advisors.




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Muni’s & Treasuries: April 20, 2009 In

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U.S. Treasury

Build America Bonds




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Muni’s & Treasuries: October 20, 2009 In

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Build America Bonds




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Muni’s & Treasuries: April 20, 2010 In

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U.S. Treasury

Build America Bonds



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U.S. Treasury

Build America Bonds


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Muni’s & Treasuries: November 2, 2011 In

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Muni’s & Treasuries: March 19, 2012

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Build America Bonds

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About Cumberland Advisors

Cumberland Advisors supervises over 1.9 billion dollars in separate account assets for individuals, institutions, retirement plans, government entities, and cash management portfolios. Cumberland manages portfolios for clients in 49 states, the District of Columbia, and in countries outside the U.S. Cumberland Advisors is an SEC-registered investment adviser.

Munis, Taxables, ETFs

Cumberland’s portfolio management efforts emphasize long-lasting relationships and continuous dialogue among clients, their consultants, tax advisors, accountants, estate planners, and their assigned portfolio management contact at Cumberland. Cumberland offers several different investment portfolio management styles. Our investment strategy is described in detail on our website. Fixed Income

All of our fixed-income offerings are total return strategies, but can take the client’s current income needs into consideration. Our fixed income styles are Tax-Free Municipal Bonds, Taxable Bonds, and Short-Term Investment Program

Stocks

Cumberland uses Exchange-Traded Funds to manage global equities. Exchange-Traded Funds (ETFs) are securities that mimic the price performance and dividend yield of an index, or a basket, of securities. Cumberland uses ETFs as building blocks in crafting a portfolio, investing in attractive equity sectors, industries, market capitalization strata, styles, and regions. Our equity portfolios are U.S. Exchange-Traded Funds (ETF) Equity, International Exchange-Traded Funds (ETF) Equity, Emerging Markets Exchange-Traded Funds, and Global Multi-Asset Class Exchange-Traded Funds. Balanced Accounts

Cumberland can blend the strategies presented above to create a balanced mix of stocks and bonds.

For further information about Cumberland Advisors, please visit our website at www.cumber.com.

http://www.cumber.com/

Documents

U.S. State & Local Government Debt Markets