DEMIRALI, PETER June 1610

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U.S. State & Local Government Debt Markets

Peter DemiraliManaging DirectorPortfolio Manager


©Copyright 2010 Cumberland AdvisorsSM. Further distribution prohibited without prior permission.

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U.S. STATE & LOCAL GOVERNMENT (SUB-SOVEREIGN) DEBT MARKET

• $2.3 Trillion in U.S. Dollars• State and Local General Obligations, State and

Local Agencies (Housing, Public Utilities, Water, Education, Economic Development, others)

• Does Sub-Sovereign = Subprime?• Historical Default Rates• Recent Developments (Build America Bonds,

Global Rating Changes, Bond Insurers)• Outlook



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What is a municipal bond?• 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 of taxable municipal supply and attracted substantial interest internationally.



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DOES SUB-SOVEREIGN = SUBPRIME?

• No! Historically, investment grade municipal bonds have had exceptionally low default rates.



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Source Moody’s



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Source Moody’s



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Build America Bonds Federally Subsidized Taxable Municipal Bonds

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



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• Under current law, BABs must be sold by December 31, 2010.

• There are 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.



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• On April 15th, triple-A rated University of Virginia sold $250 million of 30-year BABs at a yield of 6.22%, 250 basis points above 30-year US Treasury yields. UVA has an after subsidy interest cost of 4.04% (65% of 6.22%) and is saving approximately $2 million per year in interest cost (80 basis points) versus issuing tax-exempt bonds.

• As of the end of December, states and local governments across the country had sold over 600 bond issues of BABs aggregating to more than $64 billion in par in a large range of sizes and structures



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“Build America Bond Subsidy Shift May Fuel $130 Billion in Sales”

• By Ryan J. Donmoyer and Jeremy R. Cooke Dec. 29 (Bloomberg) -- Sales of Build America Bonds, the fastest-

growing part of the U.S. municipal debt market, may double to $130 billion in 2010 as states and cities rush to borrow before Congress can change federal subsidies. Lawmakers might retool the program to treat transportation debt more generously than other issues, Ron Wyden, the Oregon Democratic senator who proposed the bonds as an “experiment” six years ago, said in an interview. The U.S. government pays 35 percent of interest costs on taxable borrowing for local public works.

“There’s going to be some discussion of whether there ought to be different flavors of Build America Bonds,” said Wyden, who originally estimated the measure, authorized this year as part of President Barack Obama’s economic-stimulus program, would create $4 billion to $5 billion in securities. “There will inevitably be a debate about cost.”

After reaching $64.3 billion since offerings began in April, new issues of Build America Bonds will more than double to $130 billion in 2010, equivalent to 30 percent of next year’s total sales of municipal debt, according to Loop Capital Markets, a Chicago-based investment bank and municipal underwriter.

The surge may be fueled by state and local governments racing to borrow “if it seems likely that the level of the BAB subsidy will be reduced” after the current program expires on Dec. 31, 2010, George Friedlander, a Morgan Stanley Smith Barney strategist, said in a research note Dec. 18.



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“Build America Bond Plan Gains Obama Backing With Lower Subsidy”

• “Repairing Market” Build America Bonds “were successful in helping to repair a

severely damaged municipal finance market, making much needed credit available at lower borrowing costs for infrastructure projects that create jobs,” Treasury Secretary Timothy Geithner said in an e-mailed statement last week. “By making Build America Bonds a permanent and expanded financing tool for state and local governments, we’re investing in our country’s long- term economic growth in a cost-effective way.”



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About Cumberland AdvisorsCumberland Advisors supervises over one billion dollars in separate account assets for individuals, institutions, retirement plans, government entities, and cash management portfolios. Cumberland manages portfolios for clients in 47 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 IncomeAll of our fixed-income offerings are total return strategies, but can take the client’s current income needs into consideration. Our fixed income styles areTax-Free Municipal Bonds, Taxable Bonds, and Short-Term Investment Program

StocksCumberland 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 AccountsCumberland 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.

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DEMIRALI, PETER June 1610

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