gurtin fixed income presentation_tbp conference_10.4.12

7/31/2019 Gurtin Fixed Income Presentation_TBP Conference_10.4.12

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TBP Conference2012 Municipal Market Overview


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No part of this presentation may be copied, reproduced, stored in a retrieval system, or transmitted in any form or by any means electronic, mechanical, photocopying, recording, or otherwise without thewritten permission of Gurtin Fixed Income Management, LLC. This presentation is incomplete without the accompanying oral commentary and discussion.

Copyright 2012 by Gurtin Fixed Income Management, LLC

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The Municipal Market in 2012

Dont believe everything you read (or hear).

Whats going on in California and is it a precursor for the restof the country?

(A Case Study)


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Municipal debt has many self proclaimed experts.

Our View: there are few seasoned and skilled professionalstrained in true fundamental municipal credit analysis.

The Municipal Market in 2012: Thesis


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The Municipal Market in 2012: Summary

Dont Believe Everything You Read (Or Hear)

1) Individuals are the largest holders of outstanding municipal debt

2) Individuals are insecure about municipal credit, mostly because few people

fundamentally understand municipal credit analysis

3) Generally, individuals confuse sustainable income for total return

4) There is a dearth of properly trained municipal credit analysts and an overreliance onratings agencies as arbiters of credit risk assessment

Many analysts incorrectly attempt to apply corporate fundamental analysis tomunicipal obligors

Conclusion: The lack of understanding and knowledge of municipal creditquality creates confusion, misperception, and volatility.


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The Municipal Market in 2012: Summary

Whats Going on in California?

(A case study on why you should never believe everything you read or hear)

1) Widely reported credit stress, some of which is real

2) Concerns are warranted, but are overblown by lack of market knowledge and ratingsagencies unwillingness to focus on forward looking research

3) Somewhat a precursor for national trend, but manageable

This creates opportunity for seasoned professionals with strong research


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No part of this confidential presentation may be copied, reproduced, stored in a retrieval system, or transmitted in any form or by any means electronic, mechanical, photocopying, recording, or otherwise without the written permission of Gurtin Fixed Income Management, LLC. This presentation is incomplete without the accompanying oral commentary and discussion.


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Households directly and indirectly hold roughly 74% of outstanding municipal debt.

49%

16%

9%

7%

9%

3% 2%5%

Owners of Municipal Debt

Households

Mutual Funds

Property/CasualtyInsurance Co.

Money Market

FundsCommercial Banks

Life Insurance Co.

Closed-End Funds

Other

Source: Federal Reserve Board, June 2012

Individuals buy and holdmany bonds directly

Many bonds arepurchased and held

with little to no creditanalysis

Insecurity stems from alack of credit analysis


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Market confusion and bond holder insecurity regarding credit quality is due to not only ageneral lack of sophisticated buyers, but years of insurance dominance in the market untilthe 2008 credit crisis:

0

100

200

300

400

500

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 YTD

MUNICIPAL DEBT ($ BILLIONS)

Insured Issued

Insurance in the municipal market is akin to giving a person an umbrella when itssunny, and taking it away when it rains.


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The combination of AAA insurance and reported historical infinitesimal municipal defaultrates left markets with a dearth of independent analysts trained in credit research.

Source: Moodys Investors Service, January 2009.

Security Rating 1 2 3 4 5 6 7 8 9 10

MunicipalInvestment Grade

0.00% 0.01% 0.01% 0.02% 0.03% 0.03% 0.04% 0.05% 0.05% 0.06%

MunicipalAll Rated

0.01% 0.02% 0.03% 0.04% 0.05% 0.06% 0.07% 0.07% 0.08% 0.09%

CorporateInvestment Grade

0.08% 0.24% 0.46% 0.71% 0.97% 1.26% 1.54% 1.84% 2.16% 2.50%

CorporateAll Rated

1.57% 3.22% 4.73% 6.03% 7.14% 8.10% 8.92% 9.67% 10.38% 11.06%

Moodys Average 10 Year Cumulative Default Rates of Rated Bonds (1970-2009)Municipals vs. Corporates


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In a world without insurance, the low default rate for rated bonds may be deceiving; sectormatters.

Source: Gurtin Fixed Income proprietary study.

Gurtin Fixed Income Municipal Default Study (1970 2010)

Sector Incident Rate

State General Obligation 0.00%

State Lease 0.00%

Local Government 0.20%

Essential Revenue 0.49%

Higher Education 0.85%

Non-Essential Revenue 2.56%

Health Care 4.76%

Corporate 5.26%

Special Assessment 7.69%

Do individuals know what they own?

What do bond funds own?


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Are things getting worse?

RatingsAgency Risk

MunicipalDerivative Risk

IndirectDebt Risk

MunicipalPension Risk

Obligor City ofSan Bernardino, CA

JeffersonCounty, AL

City ofHarrisburg, PA

City ofCentral Falls, RI

CreditEvent Type

City approvedbankruptcy filing

County filed forChapter 9bankruptcy

City defaulted onguaranteepayments

City went into receivership(later filed for Chapter 9bankruptcy)

Date of Credit Event July 2012 November 2011 September 2009 May 2010

Investment GradeRating at Time of

Credit Event

BBB+(S&P)

A3(Moodys)

Baa2(Moodys)

Baa1(Moodys)

Current External RatingCC(S&P)

Caa3(Moodys)

Withdrawn(Moodys)

Caa1(Moodys)

In a world with a dearth of research and an unsophisticated buyer base, are thecredit ratings agencies good arbiters for forward looking credit risk assessment?

This leaves the market vulnerable to Armageddon-like prognostication by market pundits,untrained in municipal research, such as Meredith Whitney predicting hundreds of billionsof imminent defaults in late 2012.


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Individuals tend to confuse total return for sustainable income, and when rates rise andprices fall many assume that falling prices are due to credit deterioration.

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00(15,000)

(10,000)

(5,000)

-

5,000

10,000

15,000

Y

ield(%)

M

illions($)

Muni Bond Fund 10 YR AAA GO

Net Municipal Bond Fund Flows vs. 10-Year Municipal Yields

Source: Thompson Reuters and Investment Company Institute


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Whats going on in California?

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(A case study on why you should never believe everything you read or hear)

1) California shares the distinction with Illinois of being the lowest rated state by Moodysand S&P

2) Multiple local government bankruptcy filings (Vallejo, Stockton, San Bernardino, &Mammoth)

3) Moodys downgrades of all redevelopment agency debt in California to belowinvestment grade

4) Media misreporting about the danger of capital appreciation (zero coupon) bonds

- Is it safe to invest in California municipal debt?

- Are there misperceptions?

- Are there opportunities arising from misperceptions?

- Is the real or perceived weakness in California a precursor to Credit stressnationally?


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Misperceptions: California vs. Illinois

Conclusion: The State of California as a sovereign entity is actually a solid creditsafe for investment.

Statistics CA IL

General Obligation Ratings A1/A- A2/A

Personal Income $1,677M $568M

Debt/Personal Income 0.4% 6.0%

Debt/Capita $155 $2,654

Debt/Total Expenditures 9% 10%+

Pension (% Funded) 80% 43%

Annual Pension Payments/Budget 3% 15%

Debt Service Constitutional Preference After Prop. 98 Payments None

Pension Reform Measures Recent Savings $42B-$55B over 30 years None



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1) Potential Moodys downgrade of all cities in California due to speculation of continuedbankruptcies Does little to solve problem of lack of forward looking analysis of individual credits

by ratings agencies, should create opportunities Pockets of very weak cities

2) Moodys downgrade of Redevelopment Agencies to below investment grade due todissolution of agencies by the governor Should not come as a surprise

3) Headlines regarding Poways $1 billion of Capital appreciation bonds $1 billion due in roughly $50 million increments over 19 years from 2033 2051 Not one bullet maturity

Notable Issues

Real Long-Term Issues

Pensions Entitlements Dysfunction of Legislation Many defaults from credits already experiencing credit distress


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Opportunities Arising from Misperceptions

Conclusion: The City of Stocktons bankruptcy created contagion across all creditswith Stockton in the issuer name.

Ratings Detail City of Stockton Stockton Water Enterprise Stockton-East Water System

S&P ratingprior to bankruptcy

A+ A+ A

S&P ratingafter bankruptcy

D BBB+ BBB+

Gurtin ratingprior to bankruptcy

Do Not Buy Do Not Buy N/A

Gurtin ratingafter bankruptcy

Do Not Buy Do Not Buy Buy

Gurtin RatingRationale

The rating is based on thecontinued weak local

economic with persistent highunemployment, a sizable but

weak tax base with well aboveaverage foreclosure rates and

a continued weak financialposition.

The rating is based on theweak service area givenhigh unemployment andforeclosure trends. Debt

service coverage hasdeclined markedly in

recent years and the debtprofile includes significantexposure to derivatives.

The rating is based on theUtility's large service area, itsrole as a wholesale waterprovider to four differentmunicipal utilities, anadequate financial positionand relatively modest debtlevels with reserves greaterthan outstanding debt.



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Are the perceived and real problems in California a precursor to an increase incredit stress nationally?

Yes and No.

Yes The number of weak obligors experiencing credit stress is increasing.

No Some issues are distinct to California (i.e., redevelopment agencies).

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