oregon short-term fund overview and update

Oregon Short-Term FundOregon Short-Term FundOverview and UpdateOverview and Update

2009 OMFOA/OACTFO Annual Spring ConferenceSalishan Spa & Golf Resort Spring Conference – Gleneden Beach, OregonMarch 10, 2009

Perrin Lim - Sr. Fixed Income Investment OfficerTom Lofton – Investment Officer & Sr. Credit Analyst

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Part 1: Oregon Short-term Fund (OSTF) Oversight, Management, and Investment Guidelines.

Part 2: Changes in the OSTF Portfolio and Performance.

Part 3: Recent market events

Part 4: Thoughts on Credit Risk Evaluation.

Today’s PresentationToday’s Presentation

Oversight and Management StructureOversight and Management Structure

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Portfolio ConstructionPortfolio Construction

• The OSTF is actively managed – does not passively follow an index.

• Management team seeks to add value while adhering to a disciplined risk control process.

• Utilizes team approach – investment decisions are openly debated.

• Investment Objectives: (in order of importance)1. Principal preservation2. Liquidity3. Outperform 91-DayTreasury Bill.

• Portfolio adheres to comprehensive set of investment guidelines approved by OIC and OSTF Board.

• Management Strategy:• Incorporates a top-down or macro-economic approach to position

portfolio sector and interest rate exposures.• Utilizes a fundamental (bottom-up) risk assessment to determine

individual investment positions.

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Investment Outlook

Investment Outlook

OSTF Portfolio

Rules

OSTF Portfolio

Rules

Sector Allocation

Sector Allocation OSTFOSTF

ImplementationImplementation

Monitoring & ControlsMonitoring & Controls

Interest Rate

Exposure

Interest Rate

Exposure

Issue Selection

Issue Selection

External Manager Resources

External Manager Resources

Internal ResearchInternal Research

Third Party Research

Third Party Research Ratings Agencies

Ratings AgenciesStreet Research

Street Research


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Generic security types – no structured investments or derivatives.

•Fixed Income Debt Instruments only -

•U.S. Treasury Securities

•U.S. Government Agency Securities

•Corporate Indebtedness

•Negotiable Certificates of Deposit.

•All investments denominated in US$ only.


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Portfolio Construction

Short Term to Maturity

•Maturity Guidelines:

•50% of the portfolio must mature within 93 days.

•A maximum of 25% of the portfolio may mature over one year.

•No investment may mature in over 3 years as measured from settlement date.

•OSTF Maturity Distribution as of March 4, 2009

•81% matures within 6 months

•OSTF Maturity Distribution as of March 4, 2009

•81% matures within 6 months


Diversified with heavy bias towards US government-backed obligations

Diversification guidelines -

•100% of the portfolio may be in U.S. Treasury securities.

•100% of the portfolio may be in U.S. Government Agency securities.

•50% maximum of portfolio per FDIC issuer•33% maximum of portfolio per agency issuer.

•50% maximum exposure to corporate obligations.

•5% maximum to corporate debt of any single issuer.

OSTF diversification as of March 4, 2009•Largest exposure to any corporate issuer = 3.92%•Government-backed 51%•Banking/Financial 30%•Industrial/Manufacturing/Chemical 6% •Utility 4% •Consumer 3% •Energy 1% •Aerospace/Defense 1% •Import/Export 1% •TCD 1%•Medical/Pharmaceutical 1%

OSTF diversification as of March 4, 2009•Largest exposure to any corporate issuer = 3.92%•Government-backed 51%•Banking/Financial 30%•Industrial/Manufacturing/Chemical 6% •Utility 4% •Consumer 3% •Energy 1% •Aerospace/Defense 1% •Import/Export 1% •TCD 1%•Medical/Pharmaceutical 1%

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Composed of high quality securities

•Total weighted average credit quality of the portfolio shall be a minimum of Aa2 by Moody’s and AA by S&P.

•Minimum corporate indebtedness credit ratings at time of purchase must be Aa2 by Moody’s and AA by S&P.

•If investment is downgraded below Aa2/AA after purchase, it can remain in the portfolio to protect against forced selling into a potentially weakened marketplace.


S&P Ratings Moody's RatingsAAA AaaAA+ Aa1AA Aa2AA- Aa3A+ A1A A2A- A3

BBB+ Baa1BBB Baa2BBB- Baa3BB+ Ba1BB Ba2BB- Ba3B+ B1B B2B- B3

CCC+ Caa1CCC Caa2CCC- Caa3CC CaC C

Highest

Lowest

OSTF as of March 4, 2009:

•Average credit quality of Aa2/AA•91% of portfolio rated at least Aa3 or AA- or higher

OSTF as of March 4, 2009:

•Average credit quality of Aa2/AA•91% of portfolio rated at least Aa3 or AA- or higher

Investment Grade

High Yield

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Active management value can be added through three main areas:

1. Sector Allocation: Ongoing research, analysis, and evaluation of market sectors with respect to current market prices, i.e. spread or risk premium

2. Issue Selection: Primarily a bottom-up process to uncover mispriced or undervalued credits and/or securities

3. Term to Maturity:1. macro-economic factors as well as the general political environment2. Staff weighs its views vs. market expectations.3. Goal is to add value based on the longer term trend and positioning

the fund accordingly, not timing the market

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Current State of Fixed Income MarketsCurrent State of Fixed Income Markets

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The Cost of Credit Risk Has Increased DramaticallyThe Cost of Credit Risk Has Increased Dramatically

TARP I Passes

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Fear Driving Flight To SafetyFear Driving Flight To Safety

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Federal Reserve

Federal Reserve

The US Government Is Responding…..MassivelyThe US Government Is Responding…..Massively

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Difference between Investment grade and high yield spreads seeks capture price of credit risk in corporate term funding markets.

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Induced Liquidity Showing Induced Liquidity Showing TenuousTenuous signs of Success signs of Success

The TED spread (originally: Treasury vs. Eurodollar Futures but now is difference between T-bill rate and LIBOR) captures difference in risk premium between unsecured interbank borrowing (LIBOR) and risk-free gov't borrowing (T-bill) rates. Similar to LIBOR - OIS differential, it seeks to capture credit risk and cash hoarding, and can be highly driven by the flight to quality trade where the T-bill rate moving down dominates the change in the TED spread.

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Significant OSTF Developments.Significant OSTF Developments.

• New class of investments : Government-backed corporate obligation.

• Added dedicated credit analyst position.

• Allows for better monitoring of credit risk.• Increases capacity to improve diversification within the portfolio.

• Building “Reserve Fund”

• Offsets short-term effects of potential future credit events.• Targeting about 1% of OSTF as a reserve fund balance.

• Providing an excess of approximately 58 basis points versus historical default rates for the current credits in the OSTF.

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•FDIC’s Temporary Liquidity Guarantee Program (TLGP)•Creates a new class of government-backed senior corporate debt

•Explicit full faith and credit guarantee by FDIC regarding timely payment of principal and interest.

•In the event of a default, each of the FDIC members would be charged a special assessment to cure the default.

•Triple-A or (P1/A+/F1+: Money Market) rated by all three rating agencies (Moody's, S&P; Fitch).

•TLGP issuance is over $200 billion and continues to grow.

•TLGP securities improve diversification versus other federal agency exposures.

•TLGP Debt has outperformed agency debt.

FDIC-backed TGLP SecuritiesFDIC-backed TGLP Securities

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Lehman Brothers Bankruptcy UpdateLehman Brothers Bankruptcy Update

•On September 15, 2008, Lehman Brothers, Inc. filed for bankruptcy.

•The OSTF held 2 positions in Lehman’s senior unsecured debt (rated A2/ A) with a combined cost of $187.5 million or 1.98% of total fund.

•Lehman Brothers was one of the largest bankruptcies in history with significant complexity given geographic dispersion of assets and liabilities.

•Significant events since bankruptcy:•Eight operating divisions (mostly trading, sales, money management) sold for approximately $2.7B in cash and securities.•Resolved most of derivative counterparty contracts.•Operated by Alvarez & Marsal, a turnaround law firm, to manage restructuring.

•Alvarez & Marsal’s objective is to position LBHI to exit from bankruptcy in 18 to 24 months or late 2010.

•Current OPERF mangers average recovery estimate is 35% with 3 to 4 year time horizon.

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OSTF Portfolio ChangesOSTF Portfolio Changes

Change in ExposureGuideline Policy Percent Par Value Percent Par Value Percent

Portfolio maturities less than 93 days > 50% 77.45% 8,883,471,000 74.69% 7,807,641,000 (2.76%)Portfolio maturities between 94 days & 1 year -- 6.80% 779,945,000 8.32% 869,998,000 1.52%Portfolio maturities greater than 1 year < 25% 15.75% 1,806,344,000 16.99% 1,775,930,000 1.24%Maturities greater than 3 years 0% 0.00% 0 0.00% 0 0.00%Total 100.00% 11,469,760,000 100.00% 10,453,569,000 0.00%

Treasury and/or Agency Securities 0-100% 53.76% 6,165,751,000 46.23% 4,832,450,000 (7.53%)Gov't Guaranteed Corporates 6.59% 689,000,000 6.59%

Commercial Paper (minimum A-1/P-1) < 50% 19.88% 2,280,050,000 21.41% 2,238,278,000 1.53%Corporate Bonds < 25% 25.28% 2,899,909,000 24.49% 2,560,391,000 (0.79%)

Total Corporate Indebtedness < 50% 45.16% 5,179,959,000 45.90% 4,798,669,000 0.74%

Repurchase Agreements 0-100% 0.00% 0 0.00% 0 0.00%Reverse Repurchase Agreements 0-100% 0.00% 0 0.00% 0 0.00%Time Certificates of Deposits < 20% 1.08% 124,050,000 1.28% 133,450,000 0.20%Total 100.00% 11,469,760,000 100.00% 10,453,569,000 0.00%

Agency Securities, Largest Holdings by Single Issuer < 33% 18.38% 2,108,141,888 16.81% 1,757,244,949 (1.57%)Corporate Indebtedness, Largest Holdings By a Single Issuer < 5% 3.19% 365,885,344 3.94% 411,870,619 0.75%Corporate Exposure including Ltr of Credit < 10% 3.19% 365,885,344 3.94% 411,870,619 0.75%

Moody's or Standard & Poor'sMinimum Aa2 / AA < 3.5

2.31 (Aa1) / 2.38 (AA+) < 3.5

2.91 (Aa2) / 3.05 (AA) 26% / 28%

WAM, exposure in days -- -- 156.4 -- 146.8 (6.17%)

Fixed Rate -- 80.66% 9,251,967,000 72.35% 8,068,403,983 (8.31%)Variable Rate -- 19.34% 2,217,793,000 27.65% 3,083,483,000 8.31%

Feb. 27, 2009

Maturity Distribution

Diversification

Total Average Credit Quality

Interest Rate Exposure (adjusted for variable rate securities)

Fixed versus Variable Weight

OSTF Statistics & ComplianceFeb. 29, 2008

OSTF Portfolio ChangesOSTF Portfolio Changes

Percent Par Value Percent Par Value Difference

Diversification By SectorGovernment-backed 53.8% 6,165,751,000 52.8% 5,521,450,000 (0.9%)Banking/Financial 41.4% 4,754,109,000 30.6% 3,193,921,000 (10.9%)Industrial/Manufacturing/Chemical 2.0% 225,000,000 5.5% 573,823,000 3.5%Utility 1.7% 195,850,000 3.3% 340,159,000 1.5%Consumer 0.0% 5,000,000 2.4% 250,000,000 2.3%Energy 0.0% - 0.5% 50,000,000 0.5%Aerospace/Defense 0.0% - 1.4% 145,383,000 1.4%Import/Export 0.0% - 1.7% 182,383,000 1.7%TCD 1.1% 124,050,000 1.3% 133,450,000 0.2%Medical/Pharmeceutical 0.0% - 0.6% 63,000,000 0.6%Total 100.0% 11,469,760,000 100.0% 10,453,569,000 0.0%

Feb. 29, 2008 Feb. 27, 2009

OSTF Statistics & Compliance

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OSTF Portfolio PerformanceOSTF Portfolio Performance

Total Return Performance

1 2 3 4 5As of: 1/31/2008 1 MONTH 3 MOS. YTD YEAR YEARS YEARS YEARS YEARSOREGON SHORT TERM FUND** 0.57 1.36 0.57 5.55 5.35 4.66 3.87 3.35

91 Day T-Bill 0.50 1.26 0.50 5.10 5.03 4.42 3.66 3.15


91 Day T-Bill 0.01 0.22 2.06 2.06 3.52 3.96 3.74 3.25


91 Day T-Bill -0.01 0.10 -0.01 1.54 3.30 3.85 3.69 3.23

**Includes cash balances reported for PERS, SAIF, CSF, VARIABLE, and HIED.

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OSTF Portfolio PerformanceOSTF Portfolio Performance

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OSTF Investment EnvironmentOSTF Investment Environment

•The number of corporate credits with long-term ratings of at least Aa2/AA has shrunk significantly. Investments beyond 270 days will likely be heavily weighted towards government-backed investments – (a good thing in the current economic environment?).

•Corporate debt that was non-financial and not commercial paper (i.e. original issue > 270 days) comprises less than 1% of OSTF.

•Regardless of your economic outlook, interest rates have little room to decline further. However, significantly higher levels of government debt create uncertainty regarding market expectations for inflation.

•Given the renewed interest in risk control (regulation, leverage, underwriting) it is difficult to envision robust economic growth in the near future.

•In the shorter-term maturity part of the yield curve, where the OSTF invests, debt issued by financials comprises that vast majority of available non-government related investments.

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Credit Risk AssessmentCredit Risk Assessment

•Relative Value in Credit

Why not buy all issues that fit portfolio guidelines?

» Cash Generation – Stability? Sources? Uses?» Income stability and diversification» Leverage trends» Liquidity» Refinancing risk» S.W.A.T. – Position of Core businesses.» Filings; Management Presentations; Earnings Calls» Event Risk: LBO’s, Share Repurchases, Break-up value.» Covenants. » Market value of related public credit and equity instruments are an

important indicator.» Investment alternatives:

» Fixed vs. float » 2 yr vs. 5yr

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•We try to avoid the rush of looking at investments “when-offered” by the street, instead, we have built a “pre-approved/pre-sorted” set of issuers that we monitor continuously.

•Despite a strong focus on fundamentals for security selection, subjective considerations are a significant part of the credit evaluation process.

•In the prior cycle, debt investors needed to be aware of a business’ breakup value for potential LBO risk, now we need to be cognizant of recovery value of the parts.

•Free cash flow : positive? stable?•Are the assets fungible? There are few well-funded buyers in this market; do I really want an exotic or niche business exposure?

•Maintain a healthy degree of cynicism and suspicion of management.•Do they really have a clue about what is going to happen six months ahead? Management’s job is to improve the perceived value of the company.•How easy is it to cook the books?

•Examples: •Frequency of non-recurring charges. What about add-backs?•Revenue & expense recognition characteristics in growth vs. decline phase.


Investment Annuity Level 2+3 5EBT Contribution / Liabilities / Assets / Debt / Debt / Market / Report Year

Company Moody's Assets Revenue Margin Revenues Equity Equity Capital EBIT Book Period CDSPrimary Equity Exchange & Symbol S&P Seq. Change Seq. Change Prior Prior Prior Prior Prior Prior Prior Fiscal 30d ChgInternal Rating Fitch YoY Change YoY Change Year Ago Year Ago Year Ago Year Ago Year Ago Year Ago Year Ago As of 90d ChgLife and Health InsuranceMetLife, Inc. A2/NEG $501,678 $13,962 10.3% 41.4% 631.2% 984% 47.3% 4.2x 1.2x 2008 Q4 707 NYSE:MET A-/NEG (4%) 4% 14% 36% 510% 910% 42.8% 3.1x 1.4x 12/31/2008 175 1 A+/NEG (10%) (1%) 14% 36% 514% NA 37.0% 2.9x 1.3x 1 Sector Average $250,512 $5,224 (5.1%) 31.8% 637.2% 1730% 46.7% (6.5x) 1.3x 767

(5%) (3%) 7% 32% 538% 1109% 39.8% 7.7x 1.6x 209(11%) (11%) 11% 31% 375% NC 35.7% 3.4x 1.7x (96)

•Placed MetLife on hold on 11/3/08 for commercial paper investments.

In context to market and economic developments, what were Met’s risks?•MET was profitable – double-digit margin before taxes!•Seemingly well capitalized with Debt/Capital at < 50%.

•Worries:•Given the convulsions going on in the market, Level II and Level III (hard to value assets) posed significant risk if the auditors decided these assets were permanently impaired. (Compare to BAC at 610% or USB at 208%)•Earnings from the investments portfolio drove a significant portion of overall revenues.•Debt/EBIT was already 3.1x. In other words I would need to have faith in the next three year’s profit to repay outstanding debt.•Annuity sales, long an earnings driver, had become an albatross. Annuity liabilities were huge overhang given the declining value of the underlying investments.

•MET’s short-term and money market ratings were lowered by S&P from A-1 to A-2 on 2/26/09.

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Summary: Take AwaysSummary: Take Aways

• Investment Policy dictates investment of assets

• Mistakes happen…Goal is to learn and minimize in the future

• Know what one buys…Form own opinion and evaluate relative to all outside resources.

• Always consider Worst Case Scenario/Reaching for Yield – Sleep Factor

• If 2-year US Treasuries bought and 2-year Treasuries increase 200 b.p.?

• If credit bought and issuer experiences negative headlines

oregon short-term fund overview and update

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