PFM Asset Management LLC 300 S. Orange Avenue, Ste. 1170 Orlando, FL 32801 (407) 648-2208 800 Yes-2-PFM www.pfm.com

1. Traditional Investment Choices and Emerging Alternatives GFOA National Conference San Antonio, Texas May 22, 2011 Presented by: Steven Alexander, CTP, CGFO, Managing Director PFM Asset Management LLC 300 S. Orange Avenue, Ste. 1170 Orlando, FL 32801 (407) 648-2208800 Yes-2-PFM www.pfm.com

2. Introduction • Managing Director, with 25 years industry experience, responsible for the administration of PFM’s investment advisory and consulting services in the Southeast • Previously served as Treasury Manager for Orange County. Responsible for management of the County’s $800 million cash and investment portfolio. • Deputy Director of Accounting for Orange County, Florida. • A securities and investment Fraud Examiner for the State of Florida. • Authored Florida’s Investment Policy Statute. • Serves on the Association of Public Treasurer Investment Policy Certification Committee. • Worked for the Governor’s Emergency Financial Oversight Board for City of Miami. • Serves as an instructor for the Florida GFOA’s School of Governmental Finance. • Mr. Alexander holds Series 6 and 63 licenses with the FINRA.

3. Agenda • Current Economic Landscape • Future of GSEs and Implications for Investors in Agency Debt • Changing Corporate Debt Landscape and Investing in Corporate Obligations • Update on Banking Sector & Investing in Bank Products

4. Current Economic Landscape

5. The Economy Is Subject To Regular Cycles Gross Domestic Product (Quarter on Quarter) First Quarter 1995 through First Quarter 2011 Source: Bloomberg

6. Current Economic Conditions and the Business Cycle Peak Interest rates high Full employment High inflation Contraction Production slows Corporate profits fall Stock market losses Unemployment rises Interest rates decline Inflation falls Expansion Corporate profits rise Stock market gains Consumer confidence improves Production increases Interest rates rise Unemployment falls Construction rebounds Inflation increases We are here Trough Interest rates low High unemployment Low inflation

7. Most Indicators Point To Growth S&P 500 Dec 2008 – May 2011 ISM Manufacturing Dec 2008 – Apr 2011 Oil Dec 2008 – May 2011 Personal Income Dec 2008 – Mar 2011 Change in Non-Farm Payrolls Dec 2008 – Mar 2011 CPI Jan 2008 – Mar 2011 Source: Bloomberg

8. Uncertainty Remains Political Turmoil in the Middle East Japanese Nuclear Disaster Internal Debate at the Fed Budget Battles/Government Shutdown?

9. Market Risks Biggest Risks in 2011 European sovereign debt crisis China tightening rates, trigger economic slowdown Turmoil in the Arab world, rising oil prices Threat of Japanese Recession

10. Long-Term Rate History 10-Year Treasury Yields Longest Bull Market in History 3.11% Source: Bloomberg

11. Yields Remain Low Across The Curve U.S. Treasury Yield Curve 10-Year Range as of May 5, 2011 Source: Bloomberg

12. Future of GSEs and Implications for Investors in Agency Debt

13. U.S. Federal Agencies • A Federal Agency security is a term used to describe two types of bonds: Bonds guaranteed by U.S. Federal Government Agencies and bonds issued by Government Sponsored Enterprises (GSEs) – corporations created by Congress to foster a public purpose, such as affordable housing. • Federal Agency security types: • Discount notes - Similar to T-bills, discount securities that mature from 1 day to 1 year. • Notes/Debentures - Uncollateralized coupon-bearing securities with a stated maturity and coupon rate. • Callable notes - Identical to notes/debentures except for specified call provision which grants option to issuer to redeem prior to maturity. • U.S. Federal Government Agency securities are backed by the full faith and credit of the United States Government while GSE securities are considered to be implicitly backed by the government. • Therefore, GSEs typically offer slightly higher yields over treasuries. • Credit quality of federal agency securities is AAA. • Frequent issuers include FNMA, GNMA, FHLB, FHLMC and FFCB.

14. Stronger Regulatory Environment • July 2008: Congresses passes the Housing and Economic Recovery Act of 2008 • Created a new independent regulator for Fannie Mae, Freddie Mac, and the FHLBs by combining parts of three government agencies: • Powers granted to the FHFA: • Safety and soundness mandate; • Establish capital standards; • Authority to remove officers and directors; • Restrict asset growth and capital distributions; • Review and approve new product offerings, and • Put a regulated entity into receivership. • Established Treasury emergency authority: • Authority for Treasury to purchase debt and common stock of GSEs; • Goal to provide stability to the financial markets; and, • Prevent disruptions in the availability of mortgages.

15. Mission Extended Through Conservatorship • Sept 2008: FHFA placed FNMA and FHLMC into conservatorship. • Goals of conservatorship: • Conserve the enterprises’ assets, and • Mitigate systematic risk. • FHFA assumed the power of the board and management: • No longer managed to maximize shareholder value • Reconstituted the boards and executive management • Eliminated common and preferred dividends (saving $2B/yr) • Halted all political and lobbying activities • Implemented enterprise risk oversight system including Governance, Solvency, Earnings, Credit/market/operational risk • Designed to protect GSE debt and MBS securities; does not protect preferred and common shareholders • Allows the GSEs to issue MBS, provide guarantees and to grow their retained portfolio • Note: FHFA cannot dissolve the enterprises. This can only be done by an act of Congress

16. U.S. Treasury Providing Unlimited Support • Sept 2008: Treasury and FHFA established Preferred Stock Purchase Agreements: • Contractual agreements between the Treasury and the conserved entities; • Treasury will ensure that each company maintains a positive net worth through periodic capital infusions. • “These agreements support market stability by providing additional security and clarity to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities. This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations.” • “Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe.” • U.S. Treasury statement: www.treas.gov/press/releases/hp1129.htm • “… we [the U.S. Treasury] have essentially guaranteed Fannie Mae and Freddie Mac securities.” • U.S. Treasury statement: www.treas.gov/press/releases/hp1301.htm

17. U.S. Treasury Providing Unlimited Support September 2008 : Treasury agrees to commit up to $100 billion each to FNMA and FHLMC February 2009: Raised to $200 billion each December 2009: Raised to unlimited amount for next 3 years, after which remaining portion of the original $200B commitment to each GSE will be reinstated www.treas.gov/press/releases/2009122415345924543.htm This significant, and currently unlimited, support indicates that the U.S. government continues to stand behind the obligations of the GSEs. Collectively, these measures restored confidence, reduced yield spreads, and repaired the basic functioning of the U.S. mortgage market. Significant improvement Cumulative Draws of Treasury Senior Preferred Stock by Fannie Mae and Freddie Mac (in billions) Sep 2008 – December 2010 Source: FHFA: Quarterly Draws on Treasury Commitments to Fannie Mae and Freddie Mac per the Senior Preferred Stock Purchase Agreements

18. FNMA & FHLMC Critical to U.S. Mortgage Finance Enterprises’ Market Share – MBS Issuance Volume Source: FHFA Conservator’s Report on the Enterprise’s Financial Performance 4th Quarter 2010

19. FNMA & FHLMC Remain the “Big Fish” Enterprise Share of Residential Mortgage Debt Outstanding As of 2010 47% Represents >$5 trillion Source: FHFA; http://www.fhfa.gov/Default.aspx?Page=70

20. Agency Debt Remain Highly Liquid • Billions in Agency discount notes are issued and sold every day. • The Agency market remains active and viable, including rolling over maturing and called debt. Federal Agency Average Daily Trading Volume 1997 - 2010 Source: SIFMA

21. Agency Sr. Debt Retains Top Ratings Source: Credit Ratings from Fannie Mae and Freddie Mac Second Quarter 10-Q as of March 31, 2011

22. Agency Debt Remains Widely Accepted Spread of 30-year FNMA Current Coupon to 10-year Treasury April 2001 - April 2011 Mortgage Master Index Par Weighted Price April 2001 - April 2011 Record high prices Record narrow spreads Source: Bloomberg; Merrill Lynch Index data

23. Agency Debt Remains Widely Accepted Agency spreads are narrower than historical averages and below pre-crisis levels. Yield Spread Between 2-year Federal Agency and 2-year U.S. Treasury Note May 2006 - May 2011 10 yr avg.= 0.33% Source: Bloomberg; Merrill Lynch Index data

24. Agency Debt is a Major Asset Class Barclays Aggregate U.S. Bond Index Composition Source: Barclays Aggregate US Bond Index; as of 1Q2011

25. Agency Debt is Widely Held • Agency debt is one of the most widely held asset classes – held by mutual funds, banks, state and local governments, insurance companies, pension funds, and foreign central banks. Freddie Mac Debt Holders Distribution Source: Freddie Mac Quarter Earnings Report http://www.freddiemac.com/debt/html/sactivitymain.html

26. Agency Debt is Widely Held • In addition to the U.S. Treasury’s direct $154 billion capital injections, the U.S. Federal Reserve owns over $1.1 trillion in agency MBS and agency debt as a result of its asset purchase programs and Quantitative Easing I. Federal Reserve Balance Sheet Holdings January 2007 – May 2011 Fed Agency Debt Mortgage-Backed Security Purchases $1.1 trillion Source: http://www.clevelandfed.org/research/data/credit_easing/index.cfm -- Cleveland Federal Reserve: Credit Easing Policy Tools

27. Challenges Remain • Housing market remains weak, but may be bottoming. Serious problems remain in certain geographic regions (NV, CA, AZ, FL). • Delinquencies and foreclosures remain at troubling levels, the highest in recent history. • Real Estate Owned (REO): Collectively GSEs own over 100K properties. • High unemployment and slow recovery pose significant headwinds. • Their huge retained portfolios expose them to significant market risk should rates move up sharply. • Continued reliance on front loaded short-term funding. • Staffing: attracting and retaining high quality staff. • Ultimate future: to be determined by Congress. For the foreseeable future, there is no alternative. The private-label securitization market is virtually dead, and will never return in its prior form. Delinquencies Foreclosures Source: Bloomberg

28. The Future – Treasury White Paper Options • 3 options for the future of FNMA and FHLMC: • Privatized system with the government insurance role limited to FHA, USDA and Dept. of Veterans’ Affairs’ assistance for narrowly targeted groups of borrowers; • Option 1 plus a guarantee mechanism to scale up during times of crisis; • Option 2 plus catastrophic reinsurance behind significant private capital. • Under any currently viable option, Agency MBS and debt holders would be protected.

29. Treasury Restates Support • “The government is committed to ensuring that Fannie Mae and Freddie Mac have sufficient capital to perform under any guarantees issued now or in the future and the ability to meet any of their debt obligations. The Administration will not pursue policies or reforms in a way that would impair the ability of Fannie Mae and Freddie Mac to honor their obligations.” • Reforming America’s Housing Finance Market, A Report to Congress, February 2011, Pg. 24

30. Conclusion • Fannie Mae & Freddie Mac remain critical to mortgage finance in the U.S. There is currently no viable alternative. • GSEs remain vastly important to the U.S. economy. • U.S. Treasury is providing unlimited capital support. • There are many indications of market acceptance for agency debt. • Future of GSEs is uncertain, but a default is unthinkable. • All currently viable outcomes will support debt-holders and owners of Agency MBS (SLMA model of privatization provides a historical guideline, as existing debt was grandfathered as GSE debt).

31. Agency Returns Are Driven By Spreads Source: Bloomberg

32. Callables May Underperform With Big Interest Rate Moves Yield Time Time As rates drop, a callable security will likely be called after its lockout period. You will then have to reinvest at lower rates. In a rising rate environment, a callable security is unlikely to be called and will have a similar duration to a bulleted security.

33. Agency Floaters • Federal Agency securities with variable coupon payments based on an index • Typically Federal Funds or LIBOR • Floating rate note are defensive in rising interest rate environments • Daily and monthly resets will outperform quarterly resets if interest rates rise • Look for positive margins

34. Changing Corporate Debt Landscape and Investing in Corporate Obligations

35. Corporate Notes • Unsecured promissory notes issued by corporations and financial institutions • New issue corporate bonds are sold through a selling group similar to new issue Agency notes • Requires specialized research staff to analyze credit worthiness • Rated by national rating services such as Moody’s (Aaa, Aa1, Aa2, Aa3, etc.) and Standard & Poor’s (AAA, AA+, AA, AA-, etc.) • Active secondary market • Traded at higher yields and wider bid/ask spreads (usually 2-5 basis points) than U.S. Treasuries or Federal Agencies

36. Definition of Credit Ratings S&PMoody’sExplanation of Rating AAA Aaa High quality. Smallest degree of investment risk AA Aa High quality. Differs only slightly from highest-rated issues A A Adequate capacity to pay interest and repay principal BBB Baa More susceptible to adverse effects of changes in economic conditions BB Ba Has speculative elements; future not considered to be well-assured B B Generally lack characteristics of desirable investment CCC Caa Poor standing. Vulnerability to default C C Extremely poor prospect D D in default

37. Composition of the Credit Universe Credit Rating Distribution of Merrill Lynch Investment Grade Corporate Indexas of April 2011

38. Short-Term Credit Universe is Constrained Credit Rating Distribution of Merrill Lynch 1-5 Year Corporate Indexas of April 2011

39. Overall Credit Environment is Improving Standard and Poor’s Rating Actions 2001 through 2Q 2011

40. Corporate Spreads Over Treasuries Have Narrowed 2-Year Corporate/Treasury Spread January 1, 2008 – May 10, 2011 10 yr avg.= 1.07% Source: Bloomberg

41. Corporate Returns Are Driven By Spreads Source: Bloomberg

42. Commercial Paper • Unsecured promissory notes issued by corporations and financial institutions • Maturity ranges from 1 day to 270 days • Investment grade is rated A-1+ / A-1 by S&P or P-1 by Moody’s • Requires specialized research staff to analyze credit worthiness • Active secondary market • Most CP programs are placed through dealers • Some CP can be purchased directly from certain issuers (e.g., General Electric Capital Corp., Toyota Motor Credit Corp., American Express Credit Corp.) • Bid/ask spread is roughly 2-4 basis points

43. Short Term Rates Have Collapsed

44. Creating Value in Commercial Paper Short-Term Rates December 2009 – May 2011 Source: Bloomberg

45. Implications For Investors • Corporate returns are more volatile than Treasury returns. • Part of the volatility of corporate securities comes from their sensitivity to business cycles. When Treasuries were producing 6.6% returns in 2008, corporate securities returned -2.4%. • A small allocation to corporate securities in a portfolio could increase long-term returns while adding minimal volatility.

46. Update on Banking Sector & Investing in Bank Products

47. Certificates of Deposit • A time deposit in a financial institution documented by a certificate that bears a specified dollar amount of the deposit, a maturity date and an interest rate • Negotiable CD’s • Traded in the security markets • Issued by large banks and savings and loans • Usually traded in lots of at least $1 million • Not collateralized • Non-Negotiable CD’s • Usually issued by local financial institutions • Premature redemption penalties • Not marketable

48. Bank Debt Obligations • Bankers’ Acceptances - Obligation issued by a domestic or international bank created to facilitate commercial trades. Traded on a discount basis with maturities of usually 6 months or less. Offered at yields higher than Treasuries and Agencies • Investor needs to differentiate “bank-level” debt from holding company debt • Securities purchased directly from certain issuers or in secondary market • Bid/ask spread is typically 2-5 basis points

49. Bank Balance Sheets Balloon • The Fed added unprecedented amounts of cash to the economy • However, the increased cash on bank balance sheets indicate unwillingness to lend Commercial Bank Cash Assets January 2000 – May 2011

50. Resolving Failed Institutions Source: FDIC website; 2010 Annual Report & Statistics at a Glance