Confidential Vanguard Municipal Market Outlook Philadelphia FPA May 17, 2011 Mike Kobs Senior Portfolio Manager Muni Bond Group
> 2 Confidential General Overview of the Municipal Market Review of Current Market Conditions Vanguard’s position on default risk and public pension underfunding Municipal Bond Market Outlook Q&A Municipal Bond Market Presentation
> 3 Confidential Issuers are typically state and local governments and not- for-profit entities Most municipal debt provides a tax-advantage for investors Borrowing cost advantage for issuers Relatively high credit quality Large number of independent issuers/credits Municipal securities are exempt from registration with the SEC Unique Characteristics of the U.S. Municipal Securities Market
> 4 Confidential “General Obligation” Notes and Bonds – Backed by the full faith and credit of a state or local government – All sources of revenue, unless specifically limited, will be used to pay debt service on the bonds “Revenue” Notes and Bonds – Issued to finance specific revenue-generating projects or utility systems – Secured solely by the revenues from the financed project or system How are U.S. Municipal Borrowings Secured?
> 5 Confidential $2.925 Trillion outstanding 50,000+ Issuers 1.18 million cusips How big is the Municipal Bond Market? Source: MSRB 2010 FactBook
> 6 Confidential Core Inflation Momentum Factors Municipal Bond Market- Credit Quality and Sectors
> 7 Confidential Municipal Bond Market- New Issuance Supply The Bond Buyer Source: The Bond Buyer
> 8 Confidential Municipal Bond Market- Holders of Municipal Debt Federal Reserve Board, Flow of Fund Accounts Source: Federal Reserve Board, Flow of Fund Accounts
> 9 Confidential Core Inflation Momentum Factors Municipal rates have risen from historical low levels
> 10 Confidential Core Inflation Momentum Factors Credit Quality Spreads
> 11 Confidential Core Inflation Momentum Factors Municipals look attractive versus high quality alternatives 10-Year Comparison 5/6/2011 MuniCorporate Quality Credit SpreadAAA (MMD)Yield Tax Eq Yield* Credit SpreadUSTYieldVs CorpVs Tsy AAA AA A BBB *35% Federal Tax Bracket
> 12 Confidential Core Inflation Momentum Factors Historical Municipal Default Statistics.89% [238 defaults ( )].04% [10 defaults ( )] 1.54% [1,604 defaults ( )].02% [10 defaults ( )] 1.57% [1,707 defaults ( )].01% [54 defaults ( )] 1.Moody’s Investors Services, U.S. Municipal Bond Defaults and Recoversies, (February 2010); Moody’s Investors Service Corporate Default ad Recovery Rates, (February 2010). Percentags based upon average one year default rate. 2.Standard & Poors, 2009 Global Corporate Default Study and Ratings Transitions (March 17,2010); Standard & Poor’s; U.S. Municipal Ratings Transitions and Defaults, (March 17,2010); Standard & Poor’s; U.S. 3.Fitch Ratings Inc. U.S. Public Finance Transition and Default Study ( ), March 25,2010; Fitch Ratings Global Corporate Finance 2009 Transition and Default Study.
> 13 Confidential Over the Counter Market 100’s of dealers 1.2% of securities outstanding trade daily on average, most of these trades are in denominations of less than $100,000 par value Evaluations are done daily by two pricing services: Thompson/JJ Kenny and IDC Muller Pricing convention is on a Yield to Worst basis Municipal Market Trading Conventions
> 14 Confidential Steep Yield Curve Cheap relative to Treasuries Wider Credit Spreads Headline Risk Regulatory Rhetoric Current Market Conditions
> 15 Confidential Steep Yield Curve
> 16 Confidential Cheap relative to Treasuries
> 17 Confidential Core Inflation Momentum Factors State and Local Government Challenges Pensions – the biggest long term challenge due to constitutional and statutory protections (estimates up to $3 trillion unfunded liability depending on discount rates selected) OPEB – huge promise to retirees with estimates up to $700 billion unfunded liability, generally pay-as-you-go; can be altered by legislature Medicaid – on the way to becoming largest line item in state budgets Education – continuing to be squeezed, particularly with the loss of ARRA funding Debt – much discussion of default, but debt burden remains within historical norms
> 18 Confidential Source: Rockefeller Institute
> 19 Confidential Source: Rockefeller Institute
> 20 Confidential Source: Rockefeller Institute
> 21 Confidential Source: Rockefeller Institute
> 22 Confidential Core Inflation Momentum Factors Municipal interest cost is manageable
> 23 Confidential Core Inflation Momentum Factors Unfunded Actuarial Liabilities from Pensions and OPEBs
> 24 Confidential Core Inflation Momentum Factors Debt levels have risen but are within historical norms
> 25 Confidential Core Inflation Momentum Factors Municipal Market Outlook Yield Curve – Flattening as Fed Tightens Credit Spreads – Wider than historical averages, differentiation in credit Headline Risk – As the budget process moves forward, difficult decisions about cutting services and raising revenues will be played out in the press Legislation Risk – Many initiatives to replace the tax-exemption in Munis will play out in the media and generate volatility depending on what form gains traction
> 26 Confidential Core Inflation Momentum Factors Q&A What concerns your clients about the Municipal Market?