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Vanguard Municipal Market Outlook Philadelphia FPA

Vanguard Municipal Market Outlook Philadelphia FPA. May 17, 2011. Mike Kobs Senior Portfolio Manager Muni Bond Group. Municipal Bond Market Presentation. General Overview of the Municipal Market Review of Current Market Conditions

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Vanguard Municipal Market Outlook Philadelphia FPA

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  1. Vanguard Municipal Market OutlookPhiladelphia FPA May 17, 2011 Mike KobsSenior Portfolio Manager Muni Bond Group

  2. Municipal Bond Market Presentation • General Overview of the Municipal Market • Review of Current Market Conditions • Vanguard’s position on default risk and public pension underfunding • Municipal Bond Market Outlook • Q&A

  3. Unique Characteristics of theU.S. Municipal Securities Market • Issuers are typically state and local governments and not-for-profit entities • Most municipal debt provides a tax-advantage for investors • Borrowing cost advantage for issuers • Relatively high credit quality • Large number of independent issuers/credits • Municipal securities are exempt from registration with the SEC

  4. How are U.S. Municipal Borrowings Secured? • “General Obligation” Notes and Bonds • Backed by the full faith and credit of a state or local government • All sources of revenue, unless specifically limited, will be used to pay debt service on the bonds • “Revenue” Notes and Bonds • Issued to finance specific revenue-generating projects or utility systems • Secured solely by the revenues from the financed project or system

  5. How big is the Municipal Bond Market? • $2.925 Trillion outstanding • 50,000+ Issuers • 1.18 million cusips Source: MSRB 2010 FactBook

  6. Municipal Bond Market- Credit Quality and Sectors Core Inflation Momentum Factors

  7. Municipal Bond Market- New Issuance Supply Source: The Bond Buyer

  8. Municipal Bond Market- Holders of Municipal Debt Source: Federal Reserve Board, Flow of Fund Accounts

  9. Municipal rates have risen from historical low levels Core Inflation Momentum Factors

  10. Credit Quality Spreads Core Inflation Momentum Factors

  11. Municipals look attractive versus high quality alternatives Core Inflation Momentum Factors

  12. Historical Municipal Default Statistics Core Inflation Momentum Factors .89% [238 defaults (1999-2009)] .04% [10 defaults (1999-2009)] 1.54% [1,604 defaults (1986-2008)] .02% [10 defaults (1986-2008)] 1.57% [1,707 defaults (1970-2009)] .01% [54 defaults (1970-2009)] Moody’s Investors Services, U.S. Municipal Bond Defaults and Recoversies, 1970-2009 (February 2010); Moody’s Investors Service Corporate Default ad Recovery Rates, 1920-2009 (February 2010). Percentags based upon average one year default rate. Standard & Poors, 2009 Global Corporate Default Study and Ratings Transitions (March 17,2010); Standard & Poor’s; U.S. Municipal Ratings Transitions and Defaults, 1976-2009 (March 17,2010); Standard & Poor’s; U.S. Fitch Ratings Inc. U.S. Public Finance Transition and Default Study (1999-2009), March 25,2010; Fitch Ratings Global Corporate Finance 2009 Transition and Default Study.

  13. Municipal Market Trading Conventions • Over the Counter Market • 100’s of dealers • 1.2% of securities outstanding trade daily on average, most of these trades are in denominations of less than $100,000 par value • Evaluations are done daily by two pricing services: Thompson/JJ Kenny and IDC Muller • Pricing convention is on a Yield to Worst basis

  14. Current Market Conditions • Steep Yield Curve • Cheap relative to Treasuries • Wider Credit Spreads • Headline Risk • Regulatory Rhetoric

  15. Steep Yield Curve

  16. Cheap relative to Treasuries

  17. State and Local Government Challenges Core Inflation Momentum Factors • Pensions – the biggest long term challenge due to constitutional and statutory protections (estimates up to $3 trillion unfunded liability depending on discount rates selected) • OPEB – huge promise to retirees with estimates up to $700 billion unfunded liability, generally pay-as-you-go; can be altered by legislature • Medicaid – on the way to becoming largest line item in state budgets • Education – continuing to be squeezed, particularly with the loss of ARRA funding • Debt – much discussion of default, but debt burden remains within historical norms

  18. Source: Rockefeller Institute

  19. Source: Rockefeller Institute

  20. Source: Rockefeller Institute

  21. Source: Rockefeller Institute

  22. Municipal interest cost is manageable Core Inflation Momentum Factors

  23. Unfunded Actuarial Liabilities from Pensions and OPEBs Core Inflation Momentum Factors

  24. Debt levels have risen but are within historical norms Core Inflation Momentum Factors

  25. Municipal Market Outlook Core Inflation Momentum Factors • Yield Curve – Flattening as Fed Tightens • Credit Spreads – Wider than historical averages, differentiation in credit • Headline Risk – As the budget process moves forward, difficult decisions about cutting services and raising revenues will be played out in the press • Legislation Risk – Many initiatives to replace the tax-exemption in Munis will play out in the media and generate volatility depending on what form gains traction

  26. Q&A Core Inflation Momentum Factors • What concerns your clients about the Municipal Market?

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