Muni FinanceTuesday, May 3, 2011; 2:30 PM - 3:45 PM

Moderator:

Jeff Werbalowsky, Co-CEO, Houlihan Lokey

Speakers:

Orin Kramer, General Partner, Boston Provident LP

Marc Levinson, Partner, Orrick, Herrington & Sutcliffe LLP

Bill Lockyer, Treasurer, State of California

William Roberti, Managing Director, Municipal Restructuring, Alvarez & Marsal

Mark Ryan, Managing Director, Municipal Securities Division, Citigroup

1

Jeff Werbalowsky’s slides

Municipal Finance

Causes for Concern

2

The fantasy reality divide

State – $1.3 TN

Municipality – $2.1 TN(1)

Federal Government – $9.4 TN(2)

Household – $13.4 TN

State & Local Government – $3.4 TN(3)

Reality – Sisyphus

Fantasy – Atlas

Underfunded Pensions – $3.0 TN

Retiree Healthcare – $0.5 TN +

Note: Reflects total notional amount of debt outstanding as of Q4 2010

(1) Total state and municipal funded debt obligations equate to $10,927 for every person in the U.S., or $43,708 for a family of four

(2) In addition, other federal debt-like obligations include $7.9 trillion in unfunded social security, $22.8 trillion in unfunded medicare and $35.5 trillion in unfunded medicaid obligations; a total of $66.2

trillion in unfunded entitlement obligations

(3) Total federal, state and local funded debt obligations equate to $41,137 for every person in the U.S., or $164,546 for a family of four

3

Distress at the state levelLargest state budget shortfalls on record

*Reported to date

Source: CBPP Survey, revised September 2010

Note: Total state budget shortfalls in each fiscal year

($40)

($75)($80)

($45)

($79)

($123)

($71)

($119)

($31)

($68)

($59)

($6)

($200)

($150)

($100)

($50)

$0

2002 2003 2004 2005 2009 2010 2011 2012

Last Recession

Remaining Budget Gaps After Recovery Act & Extension

Budget Gaps Offset by Recovery Act & Extension

Last Recession

Remaining Budget Gaps After Recovery Act & Extension

Budget Gaps Offset by Recovery Act & Extension

4

($110)

($191)

($130)*($125)*

Distress at the broader municipal level

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

Percentage of GDP

Surplus

(Positive Balance)

Deficit

(Negative Balance)

State and Local Operating Balance Measure (% of GDP)

GAO Operating Balance Estimates as of March 2010Source: GAO simulations, updated March 2010

Note: The operating balance is a measure of the state and local government’s ability to cover their current expenditures out of current receipts. Historical data is from the

Bureau of Economic Analysis’s NIPA accounts from 1980 to 2008. GAO simulations are from 2010 to 2060, using Congressional Budget Office projections and

assumptions, particularly for the next 10 years. Simulations are based on current policy as enacted

State and Local Operating Balance Measure (% of GDP)

5

The pain for local governments is not over

Year Over Year Change in Local Government Property Tax Receipts

-4%

-2%

0%

2%

4%

6%

8%

10%

Source: Census Bureau and National League of Cities

Note: This chart estimates local government property tax revenues in fiscal 2011 as posting the first year-over-year decline since fiscal 1979

6

Sweeping it under the rug

Significant Decline in State Reserve Balances ($ in billions)

40%

60%

80%

100%

State and Local Pension Funding Status

Source: Pew Center on the StatesNote: Center for Retirement Research at Boston College

0%

3%

6%

9%

12%

$20

$40

$60

$80

Total Dollar Amount of State

Reserve “Rainy Day” Funds

Total State Reserve Fund

Balance as a Percentage of Total State Expenditures

Source: National Association of State Budget Officers

7

A tangled web

Federal Government

State Government Local Government

Transfers to State

Government: $423 Billion

(26.1% of State Government

Total Revenue)

Transfers to Local

Government: $58 Billion (3.8%

of Local Government Total

Revenue)

Net Transfers to Local

Government: $444 Billion

(29.0% of Local Government

Total Revenue)

Source: U.S. Census Bureau, 2008

Note: Duplicative intergovernmental transactions are excluded

8

Marc Levinson’s slidesDid Vallejo choose Chapter 9 as a strategic option?

9

Leading to bankruptcy

Expenditures$71.92

Expenditures$84.32

Expenditures$86.68

Expenditures$87.34

Revenues$73.30

Revenues$81.11

Revenues$82.51

Revenues$83.63

70

72

74

76

78

80

82

84

86

88

90

FY 04/05 FY 05/06 FY 06/07 FY07/08

US$ millions

10

Revenue and expenditure trends

Expenditures$71.92

Expenditures$84.32

Expenditures$86.68

Expenditures$87.34

Expenditures$76.12

Expenditures$67.92

Expenditures$63.42

Revenues$73.30

Revenues$81.11

Revenues$82.51

Revenues$83.63

Revenues$76.67

Revenues$67.69

Revenues$63.42

60626466687072747678808284868890

FY 04/05 FY 05/06 FY 06/07 FY07/08 FY08/09 FY09/10 FY10/11

US$ millions

11

General Fund FTEsChange over time FY03/04-FY10/11

DEPARTMENT FY2003/04 FY2010/11

Legislative 8 8

Administration 46 32

Community Development 23 22

Police Sworn 155 90

Police Non-Sworn 73 31

Fire 122 71

Public Works 68 58

TOTAL 495 312 12

Discretionary programs

City no longer provides funding

Other Governmental Agencies

• Solano County Library

• Greater Vallejo Recreation District

Community Based Organizations

• Police Athletic League

• Convention & Visitors Bureau

• Vallejo Symphony

• Youth & Family Services

• Naval & Historical Museum

• Florence Douglas Senior Center

• Boys & Girls Club

• Community Arts Foundation

$800,000 no longer being provided13

TOTAL STAFFING – NON SWORNFY 2003/04 FY 2010/11

58% DECREASE

73 31

Example: Communications Center Staffing

decreased from 27 to 16

Police departmentStaffing reductions over time

14

TOTAL STAFFING – SWORN OFFICERSFY 2003/04 FY 2010/11

42% DECREASE

155 90

Example: Traffic Enforcement

decreased from 13 to 6

Example: Patrol Officers

decreased from 90 to 55

Police departmentStaffing reductions over time

15

City comparisonsViolent crimes

Violent Crimes Violent Crimes/Officer

Richmond 1,095 6.1

Berkeley 615 3.4

Hayward 741 4.0

Fairfield 437 3.6

Vacaville 278 2.6

Vallejo 998 11.1

16

Police departmentImpacts of staffing reductions

• Most crime prevention activities eliminated

• All youth services activities eliminated

• Participation in FBI Joint Terrorism Task Force eliminated

• Four of five canine teams eliminated

• Insufficient staff to investigate solvable crimes

17

FIRE DEPARTMENT SERVICE CALLSFY 2003/04 FY 2010/11

30% INCREASE

10,361 13,500

Fire departmentService calls

18

FIRE DEPARTMENT STAFFINGFY 2003/04 FY 2010/11

42% DECREASE

122 70.5

Fire department staffing

19

FIRE STATIONSFY 2003/04 FY 2010/11

3 STATIONS CLOSED---

38% DECREASE

8 5

Stations

City comparisonsFirefighters per 1,000 population

Palo Alto 1.91

Alameda 1.48

Santa Clara 1.47

Richmond 0.86

Berkeley 1.27

Mountain View 1.04

Benicia 1.25

Contra Costa Fire 0.76

San Mateo 0.94

Santa Rosa 0.91

Vacaville 0.82

Vallejo 0.5421

Pavement condition Index (PCI) Rating

Backlog of $268 million to attain PCI Goal of 83

Backlog of $135 million to attain PCI Goal of 70

22

Pavement Condition Index (PCI) Rating

Arterials72

Collectors50 Residential

Local42

0

10

20

30

40

50

60

70

80

90

100

FY2009/10

Rating

Funding Source Arterials & Collectors: Federal and State grant funding

Funding Source: Gas Tax and Local Funding

PCI Goal = 83

138 miles

102 miles419 miles

PCI Goal = 70

23

Public WorksGrounds Infrastructure Maintenance

1,449

150

0

200

400

600

800

1,000

1,200

1,400

1,600

FY2010/11

Required Funding

Current Funding

US$ thousands

24

Public WorksBuildings Infrastructure Maintenance

491

49

0

100

200

300

400

500

600

FY2010/11

Required Funding

Current Funding

US$ thousands

Backlog of VehiclesNeeding Replacement

113

127

112104 107

19 23 20 2317

0

20

40

60

80

100

120

140

FY2010/11 FY2011/12 FY2012/13 FY2013/14 FY2014/15

Vehicles Backlog Replacement Scheduled

26

Marc Levinson’s slidesComparison of Chapter 9 to Chapter 11

27

Commencement of the case

• Municipalities cannot be put into chapter 9

involuntarily.

– Only a municipality can initiate a chapter 9

case. Section 303 of the Bankruptcy Code,

which provides for the commencement of

involuntary cases, is not applicable in

chapter 9.

– A chapter 9 case cannot be converted to

one under another chapter.

• Chapter 9 debtors are not required to file

schedules or statement of financial affairs.

– Pursuant to section 924, a chapter 9 debtor

is required to file a list of creditors.

– Under section 925, any claim listed on the

list of creditors is a proof of claim deemed

filed under section 501, unless listed as

contingent, disputed or unliquidated.

– No reporting requirements.

• Involuntary cases permitted.

– A chapter 11 case can be converted to

one under chapter 7

• Debtor required to file schedules and

statement of affairs

– Under section 1111(a), no proof of claim

required unless debt is listed in schedules

as contingent, disputed or unliquidated.

– Debtor must submit quarterly statements

of disbursements and make other

disclosures. (Rule 2015).28

Commencement of the case (cont)

• Publication of the notice of

commencement of the case.

– Section 923 requires publication of a

Notice of Commencement for three

consecutive weeks in a local newspaper

and in a newspaper having general

circulation among bond dealers and

bond holders.

– The notice must provide a date by

which objections to eligibility must be

filed.

• Bankruptcy judge is assigned by the

Chief Judge of the Circuit rather than

by the clerk of the bankruptcy court.

11 U.S.C. § 921(b).

• Not required.

• Judge selected at random.

29

Eligibility requirements

• Must be a municipality (political

subdivision or public agency or

instrumentality of a State). 11 U.S.C.

§ 109(c)(1).

• Legislative Authority.

– Municipality must be specifically

authorized under state law to be a chapter

9 debtor. 11 U.S.C. § 109(c)(2).

– Approximately one-half of states currently

have legislation providing some form of

authorization.

– Certain of these statutes contain

limitations as to the type of entity that may

file, and some require further approval

from the state or a state official prior to any

filing.

• Sole eligibility requirement relates to

nature of the debtor (i.e., railroads

and persons eligible to be chapter 7

debtors). 11 U.S.C. § 109(d).

30

Eligibility requirements (cont)

• Insolvency.

– Debtor bears a burden of proving that it is insolvent

as of the petition date. 11 U.S.C. 109(c)(3).

– A municipality is insolvent if it is (i) generally not

paying its debts as they become due unless such

debts are the subject of a bona fide dispute, or (ii)

unable to pay its debts as they become due. 11

U.S.C. § 101(32)(C).

• The “generally not paying its debts as they become due”

test requires a factual analysis of what payments have

been missed and their relation to the municipality’s overall

financial position.

• In determining whether the municipality is unable to pay its

debts as they become due, courts look at the cash flow of

the municipality rather than using a balance sheet test.

• The court will look to the municipality’s fiscal condition in

the near future, as opposed to two or more years down

the road.

• There is no insolvency requirement

for chapter 11 debtors.

31

Eligibility requirements (cont)

• Must desire to effect a plan to adjust its debts. 11

U.S.C. 109(c)(4).

• Good faith requirements.

– A municipality must show that it either:

• Has obtained the agreement of creditors holding at

least a majority in amount of the claims of each class

that the municipality intends to impair under a plan,

• Has negotiated in good faith with creditors but failed

to reach an agreement,

• Is unable to negotiate with creditors because

negotiations are impracticable, or

• Reasonably believes that a creditor may attempt to

obtain an avoidable preference. 11 U.S.C. §109(c)(5).

– A bankruptcy judge also may dismiss a chapter 9

petition if the debtor did not file the petition in good

faith. 11 U.S.C. 921(c).

• In the event of an appeal from the entry of an order

for relief, the bankruptcy court may not delay any

proceeding in the chapter 9 case, nor may any court

issue a stay. 11 U.S.C. § 921(e).

• No good-faith filing requirement.

• No chapter 11 equivalent.

32

Limitations on the power of the court

• Because of limitations imposed by the Tenth Amendment to the

U.S. Constitution on Congress’ power over the states, the

Bankruptcy Code provisions with respect to municipality debtors

place significant restraints on the powers of a federal bankruptcy

court to interfere with the operations of a municipality.

• State maintains its powers to control municipalities, subject to

specific Bankruptcy Code provisions (such as the power to reject

contracts). 11 U.S.C. § 903.

• Absent consent by the debtor, the court may not interfere with (1)

any of the political or governmental powers of the debtor, (ii) any

of the property or revenues of the debtor, (iii) the debtor’s use or

enjoyment of any income-producing property. 11 U.S.C. § 904.

– A chapter 9 debtor does not need court approval to use, sell or

lease property, including cash collateral (section 363 is not

incorporated into chapter 9).

– The debtor maintains complete control of most of its financial

affairs and operations (in bankruptcy, a municipality will still need

freedom to operate and provide services to citizens).

• Court cannot appoint an examiner of a trustee (except for certain

limited purposes relating to the recovery of avoidable transfers).

• Chapter 11 debtors subject to § 363.

• Trustee or examiner may be appointed.

33

Limited role of U.S. trustee

• The U.S. Trustee has no general

supervisory authority in a chapter 9 case

(reason being that it would be an improper

interference with the political and financial

affairs of the municipality debtor).

– Does not examine the debtor at a meeting

of creditors -- there is no meeting of

creditors.

– Does not have the authority to move for

appointment of a trustee or examiner or for

conversion of the case.

– Does not monitor the financial operations of

the debtor or review the fees of

professionals retained in the case.

• The U.S. Trustee’s most important role in

chapter 9 cases is to appoint a creditors

committee or other committee(s).

• The U.S. Trustee plays an active role in

overseeing the bankruptcy case.

• Conducts first meeting of creditors.

• Appoints members of official committees.

• May move for appointment of a trustee or

examiner.

• May move to convert the case.

• Monitors financial operations and fee

requests from estate professionals.

34

Case administration

• Chapter 9 does not create an estate.

– Section 541 is not incorporated.

– Section 902(1) defines “property of the estate” to

mean “property of the debtor.”

• Retention of Professionals.

– Sections 327 through 331 of the Bankruptcy Code

are not applicable in a chapter 9 case. Therefore,

the debtor does not need court approval to retain

professionals, and any professionals retained by the

debtor need not satisfy the requirements that they

be disinterested or not hold or represent an interest

adverse to the estate.

– The debtor does not need court authorization to pay

professionals during the course of the bankruptcy

case. The only provision of chapter 9 governing the

compensation of professionals provides as a

confirmation requirement that all amounts to be paid

by the debtor or by any person for services or

expenses in the case or incident to the plan have

been fully disclosed and are reasonable. 11 U.S.C.

§ 943(b)(3).

• Commencement of the case creates an estate.

• Section 327 through 331 apply.

35

Case administration (cont)

• Automatic stay.

– The Bankruptcy Code automatic stay provisions

apply in chapter 9.

– Section 922(a) adds automatic stay provisions that

prohibit actions against officers and inhabitants of

the debtor if the action seeks to enforce a claim

against the debtor.

• Prohibits a creditor from bringing a mandamus

action against an officer of a municipality on

account of a prepetition debt.

• Prohibits a creditor from bringing an action against

an inhabitant of the debtor to enforce a lien on or

arising out of taxes or assessments owed to the

debtor.

– Section 922(d) limits the applicability of the stay.

• Chapter 9 petition does not operate to stay

application of pledged special revenues to payment

of indebtedness secured by such revenues.

• An indenture trustee or other paying agent may

apply pledged funds to payments coming due or

distribute the pledged funds to bondholders without

violating the automatic stay.

• Automatic stay applies only to the debtor and its

property.

36

Case administration (cont)

• Committees.

– Creditors committee has powers and duties

similar to those of a committee in a chapter 11

case.

– Cannot be appointed until after the entry of the

order for relief, which may take months in a

chapter 9 case in which eligibility is challenged.

– Debtor cannot be ordered to pay the

professionals employed by a committee, but

generally, an agreement is reached.

• Right to be heard more expansive in chapter 9.

– Section 1109 applies

– Fed. R. Bankr. P. 2018(c) provides that:

• The Secretary of the Treasury of the United

States may, or if requested by the court shall,

intervene in a chapter 9 case.

• Representatives of the state in which the debtor

is located may intervene in a chapter 9 case with

respect to matters specified by the court.

– Order for relief occurs on the petition date in

a voluntary chapter 11.

– Committee’s retained professionals paid

pari passu with debtors’ professionals.

37

Case administration (cont)

• Dismissal.

– Court may dismiss a chapter 9 petition if it

concludes the debtor did not file the

petition in good faith or if the petition does

not meet the requirements of chapter 9.

– Court also may dismiss the petition for

cause, including:

• Lack of prosecution

• Unreasonable delay by the debtor that is

prejudicial to creditors

• Failure to propose or confirm a plan within

the time fixed by the court

• Material default by the debtor under a

confirmed plan or

• Termination of a confirmed plan by

reason of the occurrence of a condition

specified in the plan.

11 U.S.C. § 930.

• Court may convert to chapter 7 or

dismiss as specified in 11 U.S.C.

§ 1112.

38

Avoidable transfers

• Bankruptcy Code avoidance powers

are applicable.

• In chapter 9 cases, however, a

transfer of property by a municipality

to or for the benefit of a bondholder

on account of such bond may not be

avoided as a preference. 11 U.S.C.

§ 926(b).

• Bankruptcy Code avoidance powers

are applicable.

39

Assumption or rejection of executory

contracts and unexpired leases

• Section 365 applies in chapter 9 cases

• Collective bargaining agreements

– Section 1113 does not apply in chapter 9

cases.

• A municipality debtor thus enjoys

greater latitude than a chapter 11 debtor

with respect to modification or rejection

of labor agreements.

• The bankruptcy court should permit

rejection if the debtor demonstrates that

the CBA burdens the debtor, that, after

careful scrutiny, the equities balance in

favor of rejection, and that the prospects

of reaching a deal in the near future are

not good.

• Section 1114 does not apply in

chapter 9 cases.

• A chapter 11 debtor cannot

unilaterally abrogate a CBA.

– Section 1113 requires a chapter 11

debtor to negotiate proposed

modifications of a collective bargaining

agreement with the authorized

representative of the employees

covered by such agreement.

– During this process, many steps are

required of the debtor and court

approval is necessary for debtor

rejection or modification of a collective

bargaining agreement.

• Section 1114 enumerates the

stringent ground rules for treatment of

retiree benefits. 40

Special revenues

• Obligations secured by a lien on

special revenues retain such lien

post-petition in chapter 9. However,

the security interest is subject to the

necessary operating expenses of the

project involved. 11 U.S.C. §928(b).

• The holder of a claim payable solely

from special revenues does not have

recourse against the debtor.

11 U.S.C. § 927. This prevents the

conversion of revenue bonds into

general obligation bonds.

• A debtor with a nonrecourse claim

may, under certain circumstances, be

treated as having recourse against

the debtor. 11 U.S.C. § 1111(b).

41

Plan of adjustment

• Only the debtor may file a plan for

adjustment of debts -- creditors may

not propose and file competing plans.

• The Bankruptcy Code does not fix a

specific deadline by which the debtor

must file a plan. If a plan is not filed

with the petition, the debtor shall file

such plan at such later time as the

court fixes. 11 U.S.C. § 941.

• Creditors may file a plan after

termination of exclusivity.

• A trustee may file a plan because

such appointment terminates

exclusivity.

42

Plan of adjustment (cont)

• Plan content and confirmation requirements in chapter 9 cases are similar to

those applicable in chapter 11 cases.

– One class of impaired claims must vote to accept the plan.

– A class accepts a plan if the plan is accepted by holders of at least two-thirds in

amount and a majority in number of claims within that class actually voting.

– Each class of claims that is impaired under the plan must accept it. However, if

all requirements for confirmation are satisfied except that acceptance has not

been received by all impaired classes, the court nevertheless shall confirm the

plan if it does not discriminate unfairly and is fair and equitable with respect to

each impaired class that has not accepted the plan -- i.e., cramdown.

– Plan must be feasible and in the best interests of creditors, and the debtor must

have obtained any regulatory or electoral approval necessary under applicable

nonbankruptcy law to carry out any provision of the plan. 11 U.S.C. 943(b).43

Discharge

• A municipality debtor receives a discharge of

all debts as of the time when: (1) the plan is

confirmed; (2) the debtor deposits any

consideration to be distributed under the plan

with the disbursing agent appointed by the

court; and (3) the court determines that

securities deposited with the disbursing agent

will constitute valid legal obligations of the

debtor and that any provision made to pay or

secure payment of such obligations is valid.

11 U.S.C. § 944(b).

• A municipality debtor is not discharged from

any debt (i) excepted from discharge by the

plan or the order confirming the plan, or (ii)

owed to an entity that, before confirmation of

the plan, had neither notice nor actual

knowledge of the case.

11 U.S.C. § 944(c).

• Confirmation of a plan discharges a debtor

from any debt that arose before the date of

confirmation. 11 U.S.C. § 1141(d). After

confirmation, the debtor is required to make

plan payments and is bound by the

provisions of the plan.

OHSWEST:261097276

44

William Roberti’s slides

45

The Key Tool for Municipal Restructuring

• First point of entry and key tool

• Not a GAAP statement of cash flows- GAAP can obscure reality

• Summary of organization’s sources and uses of cash

Treasury Cash Flow

• Major cash sources & uses

• Operational structure

• Primary assets

• Variable & fixed expenses

• Core vs. non-core activities

• Major cost drivers

Gain Understanding of…

• Is there an immediate or imminent cash crisis?

• Will cut-backs be needed in the foreseeable future?

• What areas of the entity use the most capital?

• Are working capital decisions undermining operations and the ability to function?

• Is spending in particular areas too high?

• Is there a need for interim financing and if so, what future revenue stream may be available as collateral?

To Answer These Questions

46

Points of Conflict in Municipal Restructuring

Labor

Cost takeout from CBAs and Labor

Contracts is always more difficult,

takes longer than planned and

generally is a negotiation

Outsourcing

The separating of core and non-core

operations, and the analyzing of

potential outsourcing of the non-core

is always contentious. It is not difficult

to indentify non-core operations- it is

difficult to convince people that

moving jobs from public to private is

a beneficial move

Assets

Selling assets is difficult as the

community can never totally agree on

how and when to monetize land,

buildings or other capital assets

47

What to expect in a distressed municipal

environment

“this is the way it has always been done”

Insufficient Human Resources Systems

Lack of sufficiently-detailed and reliable

historical data

No monthly closings of the books –

irregular accounting practicesAbsence of monitoring

functions in finance

Difficulty forecasting mandated services

Sensitivity around review of roles and

responsibilities

Culture adverse to change

48

Mark Ryan’s slides

49

The 2011 municipal market paradox

Bearish Muni themes flood the headlines...

… yet CDS and BAB spreads have tightened ???

1Source: Bloomberg, Data through April 18th, 2011

Limited buyer baseExtraordinary selling pressure is absorbed by fewer alternative buyers

Retail Dominated: Approximately 70% of municipal debt is owned by direct retail

investors and retail proxies such as bond funds

Lack of Institutional Buyers: Major fixed income market participants such as

endowments, pension funds, life insurance companies, international investors, hedge

funds, and private equity funds have generally been absent from the tax-exempt

market due to their inability to use the tax-exemption. In addition, the 1986 Tax Act

limited the ability of banks and US corporations to purchase municipal bonds while

also diminishing the tax benefit to P&C insurers and broker dealers

2008 Crisis: Several broker dealers went out of business and others have reduced

their capital commitments to the market. Municipal hedge funds which previously

provided ~$50 billion liquidity have virtually ceased to exist

Liquidity Providers

Municipal Hedge Fund Holdings2

Municipal Bond Ownership2

1Source: Citi Estimates 2Source: Federal Flow of Funds Data

Property & casualty company sellingP&C buying has not provided its traditional support for the market

Municipal Portfolio ($bn)

2010 10k 2009 10k ∆1y Quotes from recent Earning Call

46.6 54.1 -14.5%“We have reduced the Chartis municipal bond portfolio to approximately $36.3 billion net of the prefunded municipal bonds. Current

portfolio is high quality… and the majority of the portfolio is in revenue bonds”

39.5 41.3 -4.4%"That state and local finances were stressed has been known to every serious institutional participant for years…It has lead state and local

officials to confront these problems…we're encouraged by what we read"

20.0 19.8 +1.0%“We believe as many others have commented, that [recent headline] concerns are largely overblown…We remain comfortable with the

credit quality of our tax exempt portfolio”

16.0 21.3 -24.9% “We continue to focus on strategic risk mitigation. As a result, in 2010 we reduced our municipal bond exposure by $5.5b”

12.1 12.1 unch“The investment portfolio is in good shape...Municipal bond holdings have been top of mind recently…Going forward, we expect to see some

volatility in munis, some price volatility in munis, and we’ll continue to dynamically manage”

6.0 6.9 -13.0%"Sold municipal bonds in the quarter $602 million over the last half of the year. Year end municipal bonds represent 46.5% of our

investment portfolio"

5.5 5.8 -5.2% “We were pretty happy with the municipal bond portfolio. Other than [NJ, NY, IL], nothing particularly gives us concern”

2.9 3.9 -25.6%We had the muni world being a bit unstable and that certainly colored our thinking as well in doing a bit less there, but we remain bullish

on buyback

2.8 2.1 +33.3%If there were a severe problem in [GOs / essential service], you would not be looking at a zero [recovery]. You would be looking at a

restructuring...it's a very high cents-on-the-dollar recovery. There is a growing sense of reality within the world of government that they

have to live within the means that they have, the credit markets"

2.5 2.3 +8.7%With respect to municipal bonds, in our portfolio, we've got an average credit quality of AA. It's very well diversified among states, both

general obligation and special revenue bonds. It only represents about 5% of the portfolio… so we are very comfortable

1Source: SEC Filings, Call transcripts sourced from FactSet

Supply and demand imbalanceTax-exempts suffer from demand inelasticity due to lack of institutional buyers

Predominantly a Retail Market1

BABs Kept Tax-Exempt Market in Check2

CA State GO BABs / Tax-Exempt Yield Curve as of 10/8/09

Retail Dominated Market: Approximately 70% of municipal debt is

owned by direct retail investors and retail proxies such as bond funds

Lack of Institutional Buyers: Major fixed income market participants

such as endowments, pension funds, life insurance companies,

international investors, hedge funds, and private equity funds have

generally been absent from the tax-exempt market due to their inability to

use the tax-exemption. In addition, the 1986 Tax Act limited the ability of

banks and US corporations to purchase municipal bonds while also

diminishing the tax benefit to P&C insurers and broker dealers

2008 Crisis: Several broker dealers went out of business and others

have reduced their capital commitments to the market. Municipal hedge

funds which previously provided ~$50 billion liquidity have virtually

ceased to exist

No BABs Release Valve: The BABs program provided a release valve

for the tax-exempt market, allowing municipal issuers to expand beyond

retail and access the full universe of fixed income investors

1Source: Federal Flow of Funds Data 2Source: Citi Estimates

Buyer base in transitionContinued market pressure until new institutional buyers emerge

Retail Selling Pressure: When mutual fund managers receive redemptions

requests, they raise cash by selling positions to broker dealers through "Bid

Wanteds." Bid Wanteds have reached the 2008 credit crisis highs

Positive Feedback Loop: The selling pressure from retail fund redemptions has

driven tax-exempt yields higher. This increase in yield has further depressed NAVs

and led to a continuing cycle of fund redemptions, forced selling, and further NAV

declines

New Buyers Needed: As credit concerns cause retail investors to reduce their

portfolio allocations to tax-exempt municipals, new institutional buyers with the

capabilities to understand municipal credit fundamentals must emerge before the

market can stabilize

Muni Bid Wanted & MMD2

-1,200

-1,000

-800

-600

-400

-200

0

200

400

600

800

-12

-10

-8

-6

-4

-2

0

2

4

6

8

Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11

Da

ily F

low

($

mill

ion

s)

NA

V %

Cu

mu

lative

Daily Flow

NAV % Cum

Mutual Fund Outflows vs. NAV of 10 Largest Muni Funds1

Yield Ratio of AAA Muni's vs AAA Corporates3

60%

70%

80%

90%

100%

110%

120%

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Sept 11 & 30YR Tsy

End

Dec '08 Post-

Lehman

Bear

Stearns

BABs supplant

tax-exempt supply

Fund outflows

& BABs end

3%

4%

5%

6%

300

400

500

600

700

800

900

2006 2007 2008 2009 2010 2011

MBWD 4 Week Average

30yr MMD

1Source: EPFR, Data through April 8th, 2011 2Source: Bloomberg through March 16th, 2011 3Source: The Bond Buyer, and Bloomberg, Data through March 18th, 2011

No longer a rates marketA difficult transition from an interest rate market to a credit market is underway

Percent of Insured New Issuance & Average Monoline Rating1

Correlation of 30 year MMD to Treasuries3Spread of Key GO & Revenue Names to MMD2

Growing Credit Concerns: Persistent negative headlines and media coverage of

the municipal market have led to anxiety among retail investors who historically

viewed municipals as a safe haven

End of Credit Homogenization: Downgrades have virtually eliminated monoline

bond insurance from the municipal market

Emergence of Muni Credit Spreads: Yields on high grade municipal GOs and

essential service revenue bonds have begun to trade with significant variability based

upon underlying credit quality

Market Adjustment: Market is adjusting to yield changes & the opportunities a credit

market generates

-

50

100

150

200

2007 2008 2009 2010 2011

CA GO IL GO MD GO TX GO BATA Rev PortAuth Rev

Pre-Crisis Post Crisis

0%

10%

20%

30%

40%

50%

60%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

% of New Issuance Insured Bond Insurer Average Credit Rating

AAA

BBB+

BB-BB-

-

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

1Source: The Bond Buyer, Bloomberg 2Source: Thompson Municipal Market Data, Citi Estimates 3Source: Thompson Municipal Market Data, Bloomberg

Market transition creates opportunityMarket volatility has abated, but pending issuance creates uncertainty

Credit Pressures Continue: The municipal market will continue to suffer from negative headlines

as municipalities grapple with budget deficits, especially at the local level

Bank Facility Renewals: With an unprecedented $135 billion of bank facility expirations in 2011,

municipal issuers will face significant pressure to refinance variable debt or arrange for replacement

facilities

Increased tax-exempt supply: First Quarter issuance hit an 11 year low

No BABs "release valve": The expiration of the BABs program eliminates the ability for municipal

issuers to efficiently access institutional demand in the taxable market

Reversion to Historical CAGR: With fund flow redemptions of $46 billion since November 10th,

the municipal market total net assets have effectively reverted to the historical 4.95% CAGR

calculated from 2000-2008 $150

$200

$250

$300

$350

$400

$450

$500

$550

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Total Net Assets

Projected Net Assets

Municipal Market Fund Assets1

Bank Facility Renewals2 ($ billions)$138

$75

$53

$14

$23

$5 $6

$28

2011 2012 2013 2014 2015 2016 2017 2018

Balance of LC Renewals

Historical Municipal Issuance3 ($ billions)

1Source: ICI Monthly Fund Flow Data through Feb 2011, Projection based on 4.97% CAGR from Jan 2000-Sep 2008 2Source: Bloomberg and JJ Kenny Drake 3Source: The Bond Buyer, 2011P based on Citi Estimate

Buyer’s marketCredit selectivity and cross-over buyers on the rise

Municipal Issuance by Type1 ($ in billions)

0

50

100

150

200

250

300

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

GO Revenue

-80bps

-60bps

-40bps

-20bps

0bps

20bps

40bps

60bps

80bps

Sep05 Mar06 Sep06 Mar07 Sep07 Mar08 Sep08 Mar09 Sep09 Mar10 Sep10 Mar11

GO Bond Index Spread Over Yale

GO Index Spread to Yale Bonds

-1,200

-1,000

-800

-600

-400

-200

0

200

400

600

800

-12

-10

-8

-6

-4

-2

0

2

4

6

8

Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11

Da

ily F

low

($

mill

ion

s)

NA

V %

Cu

mu

lativ

e

Mutual Fund Outflows vs. NAV of 10 Largest Muni Funds1

With mutual fund withdrawls, credit selectivity is rising

Buyers are much more aware of risks with general obligation bonds and we are

starting to see greater interest in revenue names

As tax exempt municipals remain cheap, we are seeing taxable buyers

participating in tax-exempt bonds at attractive spreads… essentially getting the

tax exemption for free

Rising NAV during

fund outflows

1Source: EPFR, Data through April 8th, 2011

Municipal default historyMunis have had modest default rates even during extreme financial stress

Civil War Reconstruction: The period of 1873-1879 witnessed the worst credit loss rates on US

municipal debt. During this period, several states were in default and loss rates, net of recovery,

equaled 15% of debt outstanding

Great Depression: During the Depression, approximately 16.2% of municipal debt was in default.

However, Arkansas was the only US state to default during this period, and the total loss of principal

on all municipal debt during the period was only 0.5%

Moody’s Default Study2: Issuers have very limited default experience compared to corporates. For

the period 1970 – 2009, the 10-year cumulative default rates for Aa/AA and Baa/BBB municipalities

were 0.03% and 0.16% respectively compared to 0.54% and 4.85% for corporates with the same

credit rating2

Period

Average Debt

Outstanding % of Defaults % Loss

1837-43 $245,000 51.0% 6.1%

1873-79 1,000,000 24.5% 15.0%

1893-99 1,300,000 10.0% 1.9%

1929-37 18,500,000 15.4% 0.5%

Defaults by State and Local Units in Major Default Periods1

Incidence of Defaults by Type of Governmental Unit, 1929 – 37 ($M)1

Governmental Unit

Total

Number

% of Units in

Default

Net Debt of All

Units, 1932

% of Debt in

Default

States 48 2.1% 2,361 6.8%

Counties 3,053 13.7% 2,391 15.1%

Incorporated

municipalities 16,366 8.8% 8,842 19.9%

Towns & townships 20,262 0.4% 344 2.9%

School districts 127,108 1.0% 2,040 7.8%

Reclamation, levee,

irrigation and drainage

districts 3,351 28.2% 1,599 25.0%

Other special districts 5,229 12.4%

Total 175,417 2.7% 17,577 16.2%

Chapter 9 Characteristics

US States cannot seek bankruptcy protection

Local governments can file bankruptcy with state approval

No provision for liquidation and distribution of assets to creditors

Municipalities must voluntarily file

Recent Cases

Vallejo California filed primarily due to high labor costs in order to utilize Chapter 9 to renegotiate union contracts. Vallejo proposes a plan that impairs bond holders, while leaving vested pension benefits unchanged

San Diego threatened bankruptcy to renegotiate union benefits

Valley Health and Sierra Kings Health filed to adjust debt and potentially sell hospitals. Sale of hospital subject to voter approval. Voted GO statutory lien was enforceable1Source: Based on George H. Hempel, “The Postwar Quality of Municipal Bonds” unpublished dissertation

2Source: Moody’s Investor Service, Special Comment “U.S. Municipal Bond Defaults and Recoveries 1970 – 2009”, February 2010 3Source: Advisory Commission on Intergovernmental Relations, City Fiscal Emergencies, July 1973

State & local revenue trendsLocal governments will experience greater problems than States

State revenue trends reflect the severity and duration of the recession, however, over the past 5 quarters YoY increases in revenues

States are cutting budgets, drawing down reserves and raising taxes to maintain fiscal stability– There have been spending decreases in both fiscal years 2009 and 2010 with small

increase projected for 2011 & cuts for 2012

States have successfully closed large gaps but we expect on-going challenges as $43 billion of ARRA funding ends in 2011

States have implemented the easy solutions including raising $40 billion in fee and tax increases and drawing on reserves. Barring strong growth, 2012 budget year will be difficult continuing the string of negative headlines in the municipal market

CA and IL, two of the most troubled states, appear to be making meaningful progress towards more sustainable revenue and expenditure plans

Income & sales taxes continue to grow YoY with personal income taxes increasing strongly

State Local Cities are responding to budget gaps more slowly than states and appear behind the curve

Aggregate property taxes have been meaningfully revised indicating a jump in 2008-2010

Local governments, especially in economically challenged areas are experiencing significant

assessed value declines that are not yet evident in the aggregate numbers

Local governments in California, Nevada, Florida, Michigan and to a lesser extent New Jersey are

worth watching. California Redevelopment and assessment deals are especially exposed

Recent soft property tax collection is likely to continue as assessed value declines impact tax levies

Revenue Mix – Trends in Three Largest Tax Sources1

Year-Over-Year % Real Change in Major Taxes Percent Change of 4-Quarter Average

-20%

-16%

-12%

-8%

-4%

0%

4%

8%

12%

2004Q

1

2004Q

3

2005Q

1

2005Q

3

2006Q

1

2006Q

3

2007Q

1

2007Q

3

2008Q

1

2008Q

3

2009Q

1

2009Q

3

2010Q

1

2010Q

3

Income tax

Sales tax

Property tax

City General Fund Revenue and Expenditures1

Year to Year Change Constant Dollars

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Change in Constant Dollar Revenue (General Fund)

Change in Constant Dollar Expenditure (General Fund)

1Source: U.S. Census Bureau (tax revenue) and Bureau of Economic Analysis (GDP price Index) 2Source: National League of Cities, October 2010, US Census Bureau

Additional slides

60

200 years of municipal finance

Development of the U.S. municipal bond markets

Quarterly: 1952Q1 – 2010Q4

Source: Federal Reserve.

$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

19

52

19

54

19

56

19

58

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

US$ trillions

Other

Banking institutions

Insurance companies

Mutual funds

Individuals

Amount outstanding of U.S. municipal securities

62

Who are the largest holders of $2.9 trillion

U.S. municipal bond debt?

Source: Federal Reserve. 63

Individuals37.5%

Mutual funds32.6%

Banking institutions

10.2%

Insurance companies

15.3%

Other4.5%

Holders of U.S. municipal securitiesTotal = $2.9 trillion (2010)

Poor performance of municipal bonds

in recent months

Source: Bloomberg.64

100

105

110

115

120

125

Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11

Index Merrill Lynch municipal master price return index

Shaded area indicates recession

Annualized return = - 4.5% in Q4 2010

Returns on municipal bonds in recent months

Merrill Lynch Municipal Master Index

Total return Price return

Periodic Annualized Periodic Annualized

1-month return -0.36 -4.13 -0.77 -8.66

3-month return 0.29 1.20 -0.93 -3.73

6-month return -4.24 -8.32 -6.53 -12.67

1 year return 1.27 1.27 -3.46 -3.46

YTD return 0.29 1.20 -0.93 -3.73

Note: YTD is as of April 6, 2011.

Source: Bloomberg.65

2010: tax-exempt municipal securities index

underperformed vs. major U.S. bond indices

Source: Bank of America Merrill Lynch Bond Indices.

15.2%

12.5%

9.5%8.5%

7.3%6.3% 5.9% 5.7% 5.6%

4.6%

2.3%0%

2%

4%

6%

8%

10%

12%

14%

16%2010 pre-tax full year rates of return

66

A drop in investor demand for municipal bonds

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan Feb

US$ billions Monthly U.S. municipal bond issuance, Jan 2010-February 2011

2010 2011

Sources: Thomson Reuters, SIFMA.67

Investors have pulled $40 billion from tax-free

municipal bond mutual funds in recent months

Source: Investment Company Institute.

-15

-10

-5

0

5

10

15

Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11

US$ billions Municipal bond mutual funds (monthly net new cash flows)

$40 billion outflows of

municipal bond funds(11/2010-03/2011)

Shade area indicates recession

68

Municipal downgrades now exceed upgrades

Source: Moody’s Investors Service, “US Public Finance Third Quarter 2010 Ratings Revisions” (November 4, 2010).

*through third quarter

0

100

200

300

400

500

600

700

800

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 *10

Rating changes

Year

Upgrades

Downgrades

69

Great Recession hit state and local tax

receipts harder than prior recessionsQuarterly: 1989Q1 – 2010Q4

Sources: U.S. Census Bureau, NBER.

-15%

-10%

-5%

0%

5%

10%

15%

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

YoY % change

Year

Total state and local tax revenue

Jul. 90 - Mar. 91

recession Mar. 01 - Nov. 01

recession

Dec. 07 - Jun. 09

Great Recession

70

Municipality bankruptcy filings are quite rare

There were five bankruptcy filings for munis in 2010

Source: Chapman and Cutler LLP.

12 3

5 56

11

20

9 911

19

1311

13

10

5 4

2

4

10

86 6 6

9

5 5 4

10

5

0

5

10

15

20

25

FilingsChapter 9 municipality filings by year

71