Municipal Market Update
December 4, 2008
Discussion Topics
Recent events in the capital markets
Impact on national and local municipal markets
Historical interest rates
Continued challenges with
 Bond insurers
 Commercial banks
 Investment banks
Summary
Contact information
1
Timeline of Capital Markets Developments
 US economy is healthy;
interest rates are low and
consumers feel confident
 This helped push up realestate values
 With values escalating, lenders
felt more confident about
making mortgages to
customers whose poor credit
histories had prevented them
from buying homes in the past
 Home ownership reaches
a record high of 69% in
2004
 Sub-prime loans
expanded to 20 percent of
the mortgage market in
2006, from 9 percent a
decade earlier
2000
 Skyrocketing housing
prices lured real-estate
speculators
 This created even more
demand and drove the
cycle further
Note: This timeline is highly simplified for discussion purposes
2006
 Defaults in the mortgage market began
to spill over into the asset-backed
security and CDO markets and seeped
into every area of the financial markets
 There is great concern about the
exposure of major investment banks,
and several banks were downgraded
 The rating agencies are concerned
about the exposure of bond insurance
companies, and a full review is initiated
2007
 The mortgage market began
seeing an increase in defaults
and delinquency to a level
that exceeded modeled
expectations
 Property values stopped
increasing or started to
decrease
 Adjustable Rate Mortgages
(ARM) began to reset higher
2008
 Uncertainty and volatile
markets continue as
investors seek liquidity
and safe credit structure
 Volatility expected to
continue
 Recession expected to
last until 2010
Sources: Ponder Investment Company research and NPR.org news articles
2
A Historic Quarter for Wall Street
Week of
Significant Events
September 15
•
•
•
Lehman files for bankruptcy; Bank of America announces buyout of Merrill Lynch
AIG downgraded; government “Invests” $85 billion
Reserve Primary Fund “breaks the buck”
•
Investor fears spurs flight to quality



September 22
Treasury and Fed bolster Money Market Funds (“MMF”) with a guaranty program; extended to municipal market late in the week
Investors pull nearly $80 billion from money market funds
The 3-month Treasury yield falls to near zero
•
•
Global central banks join to unfreeze credit markets; U.S. Treasury announces $700 billion bailout plan
Goldman Sachs and Morgan Stanley, the only two remaining investment banks, become bank holding companies
•
•
•
•
Morgan Stanley announces sale of up to $8.5 billion in stock to Japanese bank Mitsubishi
Warren Buffett’s Berkshire Hathaway announces a $5 billion investment in Goldman Sachs
FBI begins investigating Fannie Mae, Freddie Mac, Lehman Brothers and AIG for potential mortgage fraud
Washington Mutual is closed by the US government in the largest failure by far of a U.S. bank; the assets are sold to
JPMorgan Chase for $1.9 billion
EU government steps in with several major bailouts
•
•
Citigroup agrees to acquire Wachovia’s banking operations for $2.1 billion in stock; later in the week, Wells Fargo offers $15.6
billion
The House rejects the proposed bailout plan; the Senate approves the revised plan by a 74-25 vote; the House approved the
revised plan by a vote of 263-171
Commercial banks, investment banks and AIG borrowed a record $410 billion from the Federal Reserve
October 6
•
•
•
•
•
Passage of the bail-out plan doesn’t allay market fears; the Dow drops below 9,000 for the first time since 2003
Fed announced a plan to buy commercial paper in an effort to thaw short-term lending markets
The Fed and several other foreign central banks lowered interest rates in an unprecedented coordinated effort
AIG to receive an additional $37.8 billion loan from the Fed
Treasury announces plans to buy stakes in a wide range of banks
October 13
•
•
•
Volatile stock market continues
Report that housing starts fell to second lowest rate in 50 years
Hedge funds saw a record $210 billion drop in assets under management during the third quarter
September 29
•
•
Source: Various news reports; Citigroup market update presentation dated 10/23/08
3
A Historic Quarter for Wall Street (continued)
Week of
Significant Events
October 20
•
•
•
•
October 27
•
•
November 3
•
•
•
•
November 10
•
•
•
November 17
•
•
•
•
U.S. Government and N.Y. Attorney General open joint investigation into the $34.8 trillion credit-default swap market
Municipal bonds rally most in 26 years as the tax-exempt market thaws; yields drop 73 basis points in one week (nearly ¾ of
1%)
AMBAC and MBIA make bid for government help under rescue plan
Federal Reserve announces plans to shore up money market mutual funds
Commodities head for their worst month since 1956 on concerns that a slump in global economic growth will sap demand for
raw materials
Commerce Department says gross domestic product contracted in the third quarter at the fastest annual pace since 2001
U.S. Treasury announces its plans to sell $55 billion in long-term government debt this quarter as a slowing economy
balloons the budget deficit to a record level
U.S. Treasury announced major changes to its auction schedule, reflecting what is likely to be a record high $1 trillion-plus
budget deficit this year
JPMorgan Chase, UBS and Royal Bank of Scotland, three of the world’s biggest banks, say they expect further pain from
the global financial crisis
Financing arm of General Motors, GMAC, posted its 5 th straight quarterly loss and said its mortgage unit may not survive
Treasury Secretary Paulson announces plan to use the second half of the $700 billion financial rescue program to help
relieve pressure on consumer credit, scrapping an effort to buy devalued mortgage assets
General Motors stock drops 30% after an analyst cuts price target to zero
American Express gets Fed’s OK to become a bank holding company
Mortgage write downs and rising audit costs could push Freddie Mac’s 2009 losses into the range of $20-$40 billion,
according to an analyst
China takes over Japan’s spot as the biggest foreign holder of Treasury bills, notes and bonds
Standard & Poor’s drops AMBAC from AA to A
Fears about deflation push Dow Jones to close below 8,000 for the first time since March 2003
4
Impact on the Municipal Market
The immediate impact on the municipal market was high interest rates and a halt to new
bond issues coming to market
 Flight to quality generally meant investment in U.S. Treasuries which has pushed benchmark
treasury yields to 50-year lows with the 2-yr at 1.00% and the 10-yr at 2.93% as of 11/28/08
 Massive out-flows from municipal money market funds resulted in significantly higher rates
 SIFMA Index (1) resets
9/10
9/17
9/24
10/1
10/8
10/15
1.79%
5.15%
7.96%
5.74%
4.82%
3.45%
10/22
10/29
11/5
11/12
11/19
11/26
2.28%
1.82%
1.26%
1.14%
1.12%
1.03%
 Few new variable-rate demand bonds were issued
 Many commercial banks have been unwilling to provide LOC support for new issues during
this volatile time
 Investment banks have been reluctant to take on additional remarketing business when it
was so difficult to successfully remarket debt currently outstanding
 Daily Variable Rate Demand Bonds (“VRDBs”) have significantly out-performed weekly bonds
 No new fixed-rate bond issues came to market for several weeks
1) The Securities Industry Financial Market Association Index is a 7-day index comprised of tax-exempt variable rate demand bonds (“VRDBs). The Index represents a
cross section of national VRDB issues. The rate resets on every Wednesday afternoon and becomes effective on Thursday.
5
Short-term Variable Rates
Although the relationship between SIFMA and 67% 1M LIBOR has held over the long-term, the current
credit turmoil has caused a spike in short-term tax-exempt VRDO yields in late September.




The SIFMA index as of 11/19/08 was 1.12%, implying a short term ratio of SIFMA to 1M LIBOR of 79%.
The disruption in the tax-exempt market is attributable to several factors:
– Seasonal tax implications (September 15 tax payments and September 30 quarter end)
– Money Market Fund Assets down substantially in late September
– Flight to quality given credit and economic environment
– Failed remarketings that result in higher rates
– Widening demand gap between troubled and well-regarded Letter of Credit banks
Over the past month the market has responded positively
– MMFs have begun to experience net inflows
– Strong investor demand for new “untainted” VRDO issues
Significant concerns remain regarding concentration of exposure to relatively few bank names and
uncertainty surrounding practical impact of central bank guarantees
On September
24th, SIFMA
reset at 7.96%
8.0
67% of 1M LIBOR
SIFMA Index
6.0
4.0
2.0
0.0
(1) Based on market conditions as of November 21, 2008 and subject to change. SIFMA = 1.12% and 1M LIBOR = 1.39%
(2) Fixed spread quoted based on a Act/360 day count basis.
6
Impact on the Municipal Market
Tax-exempt market has begun to recover
 MMFs beginning to see net inflows; strong demand for short-term paper easing variable rate
borrowing costs
 Merrill Lynch brought a fixed-rate healthcare deal to market on October 23, the first in over six
weeks
 Providence Health and Services (Aa2/AA)
 Yield of 6.70% in 2038 which reflects a credit spread of 1.33% versus 0.50% one year ago
 In October and November strong AA and A rated credits begin coming to market, including
Trinity (St. Alphonsus) and St. Luke’s
 Credit spreads remain in the +1.50% to 1.80% for strong credits
 The first BBB+ transaction went to market in October
 Loma Linda, CA, with credit spread of 2.89%
 Forward looking supply is still substantial
 Transactions that can access retail distribution are benefiting with lower interest rates
 Conditions still very volatile from day to day
7
Recent Trend in Long-term Fixed Rates
Graph shows the relationship between indices over the past 18 months
7.00%
"A" Healthcare Revenue Bond
SIFMA Swap
67% LIBOR Swap
AAA MMD
6.00%
5.00%
4.00%
3.00%
2.00%
A pr-07
Jul-07
Oct -07
Jan-08
A pr-08
Jul-08
30 YR “A” Healthcare (2)
30 Yr SIFMA Swap (3)
30 Yr 67% LIBOR Swap (3)
As of 11/21/2008
7.15%
3.53%
2.22%
Average
5.44%
3.94%
3.41%
Min
4.51%
3.33%
2.12%
Max
7.44%
4.47%
4.09%
Std Dev
0.67%
0.22%
0.31%
Key Stats (1)
Oct -08
(1) Rate history provided from April 2007 through November 21, 2008
(2) Approximate “A” rated Healthcare traditional fixed rates. Rates are estimates and do not necessarily reflect actual traded levels.
(3) Swap rates are quoted at mid-market and do not include any ongoing costs
8
Trinity Pricing Summary
Highlights of the market included
 Strong retail demand in Idaho
 One of first 5 Healthcare transactions to come to market in six weeks due to credit crunch
 Significant institutional investor participation
The limited supply of Idaho municipal bonds was a plus with institutional investors
Idaho benefit of 12 to 30 basis points
Issue:
Bond
Ratings
Pricing
Par
Par call
Maturity
12/1/2014
12/1/2015
12/1/2016
12/1/2017
12/1/2018
12/1/2019
12/1/2023
12/1/2028
12/1/2034
MI Hosp Finance Auth- Trinity Health Credit Group
Aa2/AA
(Moody’s/S&P)
Bond
Ratings
10/28/2008
$192.795 million
12/1/2018
Amount
Coupon
5,905
6,205
6,535
6,895
7,290
5,000
34,515
22,825
97,625
192,795
Issue:
5.00%
5.25%
6.00%
5.75%
6.00%
6.25%
6.12%
6.25%
6.50%
Yield
5.25%
5.40%
5.60%
5.00%
5.90%
6.05%
6.25%
6.50%
6.65%
Spread
to AAA
1.58%
1.57%
1.60%
1.58%
1.55%
1.54%
1.40%
1.46%
1.40%
IDHealth Fac Auth- Trinity Health Credit Group
Aa2/AA
(Moody’s/S&P)
Pricing
10/28/2008
Par
$178.31 million
Par call
12/1/2018
Maturity
Amount
Coupon
Yield
12/1/2014
12/1/2015
12/1/2016
12/1/2017
12/1/2018
12/1/2019
12/1/2023
12/1/2028
12/1/2034
4.95%
5.11%
5.29%
5.45%
5.65%
5.80%
6.10%
6.35%
6.50%
5,110
4,040
4,610
4,505
7,155
4,550
41,260
45,415
61,665
4.75%
5.00%
5.25%
5.40%
5.63%
5.63%
6.00%
6.13%
6.25%
Spread
to AAA
1.28%
1.28%
1.29%
1.28%
1.30%
1.29%
1.25%
1.31%
1.28%
178,310
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Challenges for Healthcare Providers Accessing Capital Markets
Investment Banking Firms
 3 top underwriters exited the municipal business

Bear Stearns

UBS

Lehman
 Others, including Citigroup, under pressure and reluctant to commit capital
 Reduced headcount through mandatory reductions in force
 Significant decrease in available capital
 Product offerings have changed dramatically, and differ by firm
 Increased return on capital requirements, putting further pressure on fees
Monoline Bond Insurance Companies
 No consensus on long-term stability of any insurer
 Little perceived value of bond insurance
 Higher premiums and more restrictive covenants
 Requests for consent difficult and costly to secure
Credit Enhancement Providers (primarily commercial banks)
 Letters and lines of credit significantly more costly
 Covenants more restrictive
 Trading levels increased due to market capacity constraints
 Provision of credit tied to additional fee business
 Regional banks gaining business
10
Bond Insurer Ratings November 24, 2008
Moody’s
ACA
Not Rated
S&P
A to CCC Negative Dev
Fitch
Not Rated
12/19/2007
AMBAC
Baa1 Developing Outlook
A Negative Outlook
Rating Withdrawn
11/5/2008
11/19/2008
6/26/2008
Aa2 Stable
AAA Stable
AAA Affirmed Stable
Downgrade from Aaa on 11/21/2008
6/18/2008
12/12/2007
BHAC
Aaa Stable
AAA Stable
Not Rated
CIFG
B3 Under Review
B Watch Developing
Withdrawn
10/28/2008
8/22/2008
10/21/2008
B1 Negative Outlook
CCC Negative Watch
CCC Negative Outlook
6/23/2008
7/31/2008
7/31/2008
Aa3 Developing Outlook
AAA Negative Watch
AAA Negative Watch
Downgrade from Aaa on 11/21/2008
10/9/2008
10/10/2008
Baa1 Developing Outlook
AA Negative Outlook
Rating Withdrawn
11/7/2008
8/14/2008
6/26/2008
A3 Negative Outlook
BBB+ Negative Outlook
Rating Withdrawn
6/25/2008
8/26/2008
5/2/2008
Caa1 Under Review
B Watch Developing
Rating Withdrawn
10/24/2008
11/18/2008
9/05/2008
Assured Guaranty
FGIC
FSA
MBIA
Radian
XLCA (Note is
now Syncora)
Sources: Moody’s Investors Service; Standard & Poor’s; The Bond Buyer; UBS; Morgan Stanley; WSJ Online
11
Current Underwriting Experience
Variable Rate Debt
 For direct pay letters of credit deals, rates have returned to one to two percent and lower in some instances
 For standby letters of credit, insured transactions, and issues with other credit concerns, variable rates are as
high as 7%
Fixed Rate Debt
 Access to market remains very volatile even for highly rated issuers and has become more difficult in the last two
weeks
 Longer underwriting periods for negotiated transactions and shorter notices for competitive transactions are
becoming more common
 Underwriters are less willing to commit capital by taking down bonds without increased underwriting spreads
 Difficult to find buyers throughout the entire maturity structure
Mitigation Measures
 Be flexible with timing and structure
 Smaller issues are better because of strong but limited retail demand
12
Idaho Tax-Exempt Market
 Idaho Market for fixed rate, tax-exempt debt has performed relatively well:
 Low supply of bonds; likely to continue
 Retail demand is strong
 Conditions are still very volatile; similar transactions receive wildly varying reception only days apart
 What could change on a local basis
 If rates fall significantly, retail is less likely to be a major factor. Six percent appears to be threshold level
 If rates decline, issuance could rise as slated refundings reach market
 Issuance is likely to remain relatively low because decrease in housing development will mean fewer
school bonds
13
Summary
The relationship between SIFMA and 1-month LIBOR has normalized, at least for now
 Current VRDB programs should trade at or near SIFMA with the following qualifications

VRDBs with “tainted” credit support may continue to trade off significantly
– Involvement of bond insurers
– Credit quality of the supporting bank
– Expertise of the remarketing agent

Daily VRDBs may continue to out-perform weekly VRDBs in the near term (months?)
– Daily liquidity more valuable to investors than weekly liquidity
– Many remarketing agents will not agree to take on the risks of daily remarketing
 New bond issues are limited by access and cost of credit enhancement

Self-liquidity is a good option for strong (AA) borrowers
14
Summary, continued
The fixed-rate market appears to be opening up, particularly for highly rated credits, but there remains
significant supply of new bonds with limited investor demand
 The Bond Buyer’s 30-day visible supply as of December 2, 2008 was $21.3 billion, highest since October 2002
and 55% higher than the 12-month average
 In recent years, institutional demand has been driven by tender option bond programs (“TOBs”) and leveraged
buyers who have been under pressure from dislocated muni/Treasury ratios and margin calls

Many investors set up TOBs when the 30-year muni/Treasury ratio was 90% while recent levels were
134%, resulting in losses

Major broker-dealers have been imposing margin calls on customer TOBs

As VRDBs are put back to dealers, some are losing financing and therefore being forced to liquidate
assets

High short-term rates may cause TOB programs to unwind if the short-term funding cost exceeds the
coupon on the bonds
 Retail investors have become much more important than in the past, but institutional buyers are still a major
requirement for successful sale of a large issue
 Covenant and security packages are more restrictive now than in the past
15
Summary, continued
Developments that could improve the municipal debt market include the following
 Fear needs to subside and confidence needs to be restored
 Continued retail buyer interest is important for sale of fixed-rate bonds and to support municipal money market
funds
 New issue volume and/or secondary market portfolio unwinding needs to ease and be absorbed
 Crossover buyers need to return to the market, lured by relative upside and cheapness of municipals
 Broker-dealers need to re-commit capital to improve liquidity in the marketplace
Financial products have generally performed as expected
 With the possible exception of auction bonds, where investors significantly under-priced the value of liquidity
Market uncertainty increases cost, security requirements and investor scrutiny
“Flight to quality” behavior by investors tends to disproportionately affect the tax-exempt market
16
Contact Information
Michael Lewis, Vice President Public Finance
 Office phone: 208-344-8587
 Mobile phone: 206-330-7656
 Email: mlewis@snwsc.com
Michael Tym, Vice President
 Office phone: 219-531-2369
 Mobile phone: 312-961-0274
 Email: mtym@ponderco.com
17