Moody’s Asset Management
Conference: Will There Be A Great
Rotation?
April 26, 2013
Welcome
Moody’s Asset Management Conference: Will There Be A Great Rotation?
2
TODAY’S AGENDA
9:00 AM - 9:45 PM
Economic Outlook and Prospects for Capital Formation
John Lonski, Chief Capital Markets Economist, Moody's Analytics
9:45 AM - 10:30 AM
Panel Discussion: Debt Issuers Perspective
Sector Views: “Specter of rising rates, curse or a blessing?”
Daniel Serrao, Associate Managing Director, Managed Investments Group (Moderator)
Public Finance and Pensions - Timothy Blake, Managing Director
Leveraged Finance - Chris Padgett, Senior Vice President
REITs - Philip Kibel, Senior Vice President
10:30 AM - 10:45 AM
Break
10:45 AM - 11:15 PM
Liquidity Impact: Money Markets
New Directions for Cash Investors in a Changing Environment, Rates, Supply and Investor Behavior
Robert Callagy, Vice President and Senior Analyst, Managed Investments Group
11:15 AM - 11:45 AM
Asset Class Perspectives: Closed-End Funds
“Can the Carry Trade Carry-On?”
Income to growth and product innovation case studies; Perspectives on leverage
Neal Epstein, Vice President and Senior Credit Officer, Managed Investments Group
11:45 AM - 12:30 PM
Panel Discussion: Spotlight on Rotation Scenarios and Implications for Manager Credit
Profiles
Risks and Rewards Considered in “making the call”, Asset rebalancing in a time of transition, Achieving Investment
Objectives in Periods of Asset Migration, “Fixed Income to Equities”
Daniel Serrao, Associate Managing Director, Managed Investments Group (Moderator)
Michael F. Mazier, Senior Fixed Income Strategist, Van Eck Associates Corporation
William T. Meyers, Managing Director, Nuveen Investments, LLC
Leah Modigliani, Senior Vice President, Neuberger Berman Group, LLC
Moody’s Asset Management Conference: Will There Be A Great Rotation?
3
Rising Rates of Resource Utilization to
Lift Profits and Yields
John Lonski, Managing Director and Chief Capital Markets Economist, Capital Markets Research Group
1
Fiscal Austerity
Moody’s Capital Markets Research Group, April 2013
US Enters Into Uncharted Demographic Territory...Average Annual
Growth Rates During Next 10 Years Will Slow to 0.5% for Working Age
Population and 3.2% for Those 65 Years and Older
16 to 64 Years of Age
65 Years and older
3.5%
3.5%
3.0%
3.0%
2.5%
2.5%
2.0%
2.0%
1.5%
1.5%
1.0%
1.0%
0.5%
0.5%
0.0%
0.0%
73Q1 78Q1 83Q1 88Q1 93Q1 98Q1 03Q1 08Q1 13Q1 18Q1 23Q1
Average annualized growth rates of 10-year spans, actual & predicted
Moody’s Capital Markets Research Group, April 2013
6
Real Federal Government Spending Should Drop
Recessions are shaded
$1,150
Real Federal Government Spending: act & pred $ bil of 05$s
$1,050
$950
$850
$750
$650
$550
$450
67Q4 71Q1 74Q2 77Q3 80Q4 84Q1 87Q2 90Q3 93Q4 97Q1 00Q2 03Q3 06Q4 10Q1 13Q2
Moody’s Capital Markets Research Group, April 2013
7
Real State & Local Government Spending Should Decline
Recessions are shaded
Real St at e & Local Government Spending: act & pred $ bil of 05$s
$1,770
$1,570
$1,370
$1,170
$970
$770
$570
69Q1
73Q1
77Q1
81Q1
85Q1
89Q1
93Q1
97Q1
01Q1
05Q1
09Q1
13Q1
Moody’s Capital Markets Research Group, April 2013
8
Cost of Insuring State & Local Government Debt Sinks:
Cost of Insuring $10,000 of Debt
22-Apr-13
1
$128
YearEnd 2012
2
$181
YearEnd 2011
3
$285
Connecticut
California
O hio
M ichigan
$75
$71
$68
$67
$111
$173
$113
$117
$134
$234
$171
$154
N ew York City
N ew Jersey
Pennsylvania
$64
$61
$55
$113
$114
$85
$200
$176
$152
Florida
M aryland
N ew York State
Texas
W isconsin
$42
$36
$36
$35
$32
$80
$92
$88
$63
$81
$137
$90
$151
$91
$124
United States
$37
$40
Illinois
Moody’s Capital Markets Research Group, April 2013
9
2
Global Prospects
Moody’s Capital Markets Research Group, April 2013
Eurozone Is a Major, Disinflationary Drag on World Economic Activity:
Contraction < 50, Expansion > 50; source: Markit, JPMorgan, MCMRG
Global PMI Composit e: index
Eurozone Composit e PMI: index
62
62
60
60
58
58
56
56
54
54
52
52
50
50
48
48
46
46
44
44
42
42
40
40
38
38
36
36
34
Jun 04
34
Jul 05
Aug 06
Sep 07
Oct -08
Nov-09
Dec-10
Jan-12
Feb-13
Moody’s Capital Markets Research Group, April 2013
11
2013 Will Be 14th Straight Year In Which Emerging Markets Outrun
Advanced Economies ... A/A/G/Rs of 10-years-ended 2012 = 1.6% for
Developed Countries and 6.6% for Emerging Markets : yy % changes
ADVANCED ECONOMIES
EMERGING MARKET COUNTRIES
9.0
9.0
8.0
8.0
7.0
7.0
6.0
6.0
5.0
5.0
4.0
4.0
3.0
3.0
2.0
2.0
1.0
1.0
0.0
0.0
-1.0
-1.0
-2.0
-2.0
-3.0
-3.0
-4.0
-4.0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Moody’s Capital Markets Research Group, April 2013
12
Plunge by Net Exports as Percent of US GDP to 2005-2006's Record
Low Hints of Loss of Global Competitiveness
Recessions are shaded
Real Net Export s % Real GDP: act & pred $ bil of 05$s
0.8%
-0.2%
-1.2%
-2.2%
-3.2%
-4.2%
-5.2%
-6.2%
67Q4 71Q3 75Q2 79Q1 82Q4 86Q3 90Q2 94Q1 97Q4 01Q3 05Q2 09Q1 12Q4
Moody’s Capital Markets Research Group, April 2013
13
US Merchandise Exports Grew by 2.5% yearover-year During 3-months-ended February
2013 as …
1. Exports to Latin America grew by 6.9%
2. Exports to Emerging Market Asia grew by 7.3%
that included an 8.3% increase by sales to China.
3. Exports to the EU contracted by -6.8%.
4. Exports to Japan dipped by -1.6%.
Moody’s Capital Markets Research Group, April 2013
14
Composite Index of Export Orders Hints of Modest Growth
for US Exports
USExport s: yy % change of 3 mo avg ( L )
ISM Composit e Index of US Export Orders: 6 mont h avg ( R )
22%
17%
58.0
12%
55.5
7%
53.0
2%
50.5
-3%
48.0
-8%
45.5
-13%
43.0
-18%
40.5
-23%
Sep-97 Mar-99 Sep-00 Mar-02 Sep-03 Mar-05 Sep-06 Mar-08 Sep-09 Mar-11 Sep-12
38.0
Moody’s Capital Markets Research Group, April 2013
15
Revitalized Exports Would Improve Prospects for Core Business
Sales: yy % change of moving 3-month sums
Export s
Core Business Sales
22.0%
19.5%
17.0%
14.5%
12.0%
9.5%
7.0%
4.5%
2.0%
-0.5%
-3.0%
-5.5%
-8.0%
-10.5%
-13.0%
-15.5%
-18.0%
-20.5%
-23.0%
Mar93 Dec94 Sep96 Jun98 Mar00 Dec01 Sep03 Jun05 Mar07 Dec08 Sep10 Jun12
22.0%
19.5%
17.0%
14.5%
12.0%
9.5%
7.0%
4.5%
2.0%
-0.5%
-3.0%
-5.5%
-8.0%
-10.5%
-13.0%
-15.5%
-18.0%
-20.5%
-23.0%
Moody’s Capital Markets Research Group, April 2013
16
3
Capital Spending
Moody’s Capital Markets Research Group, April 2013
Q1-2013-to-date's Sales & Operating Profits Have Been
Sluggish…About 34% of S&P 500 Has Reported for Q1-2013
Income from Continuing
Income from
Sales: S&P 500
Operations: S&P 500
Sales: S&P 500
Continuing
excluding financial
excluding financial
Operations: S&P 500
companies
companies
1
2
3
4
10Q1
12.3
52.4
12.5
38.0
10Q2
8.9
48.5
11.4
39.6
10Q3
8.5
30.8
9.6
25.1
10Q4
8.4
33.2
8.5
18.3
11Q1
9.2
19.9
11.1
20.4
11Q2
11.1
16.2
12.9
18.9
11Q3
10.2
14.9
11.7
17.9
11Q4
6.9
4.9
8.1
7.1
12Q1
5.4
6.2
5.7
4.4
12Q2
-0.1
0.0
-0.6
-0.8
12Q3
1.0
4.6
0.5
-1.7
12Q4
3.3
8.0
2.7
4.0
1.5
3.5
1.9
1.1
13Q1 to date
Sources: Bloomberg News, MCMRG
Moody’s Capital Markets Research Group, April 2013
18
Modest Outlook for Nominal GDP Growth May Also Apply to the
Business Sales Proxy: yy % changes
Nominal GDP: act & proj ( L )
Gross Value Added: nonfin corp ( R )
7.8%
7.6%
5.6%
5.8%
3.6%
3.8%
1.6%
1.8%
-0.4%
-2.4%
-0.2%
-4.4%
-2.2%
-6.4%
-4.2%
86Q4 88Q4 90Q4 92Q4 94Q4 96Q4 98Q4 00Q4 02Q4 04Q4 06Q4 08Q4 10Q4 12Q4
-8.4%
Moody’s Capital Markets Research Group, April 2013
19
Deceleration by Business Sales Proxy Softens Outlook for
Business Spending on Capital Equipment: yy % changes
Business Spending on Capit al Goods ( L )
Gross Value Added of US Non-financial Corporat ions ( R )
12.5
7.5
7.5
5.5
3.5
2.5
1.5
-2.5
-0.5
-7.5
-2.5
-12.5
-4.5
-17.5
-6.5
-22.5
-8.5
93Q1
95Q1
97Q1
99Q1
01Q1
03Q1
05Q1
07Q1
09Q1
11Q1
13Q1
Moody’s Capital Markets Research Group, April 2013
20
Core Capital Goods Orders Shrink: yy% change, nsa
Q 1-13
1
Q 4-12
2
Q 1-12
3
2012
4
2011
5
2010
6
2009
7
2008
8
2007
9
2006
10
Durable GoodsTotal
-0.2%
2.0%
9.3%
4.1%
9.7%
27.1%
-30.3%
-6.0%
4.9%
7.7%
N ondefense CapitalGoods
-3.5%
-4.6%
15.4%
0.9%
13.2%
36.7%
-37.2%
-8.3%
7.7%
9.4%
-0.5%
-3.5%
9.5%
-0.3%
10.2%
17.0%
-24.6%
-0.8%
1.4%
10.3%
-24.7%
54.6%
-22.9%
-3.7%
-23.3%
37.6%
-17.6%
22.6%
0.8%
25.0%
9.7%
3.4%
2.8%
-0.1%
-3.1%
-11.1%
-21.4%
-24.3%
-44.5%
9.0%
-6.0%
0.6%
-1.2%
13.6%
-3.5%
-18.7%
3.4%
39.1%
9.4%
7.1%
8.9%
22.5%
17.2%
4.9%
3.4%
30.7%
0.2%
11.5%
-3.7%
3.3%
9.5%
9.2%
-0.2%
-10.2%
7.6%
8.5%
15.8%
17.1%
4.9%
28.4%
-27.8%
-7.9%
7.6%
19.2%
-12.1%
34.2%
31.8%
15.6%
46.9%
17.0%
11.1%
-31.6%
236.2%
27.8%
-26.9%
-31.9%
-25.4%
-40.3%
-12.0%
-18.6%
-23.6%
-76.4%
-21.6%
-17.7%
0.9%
1.9%
5.0%
-20.7%
-4.1%
1.8%
-23.3%
41.0%
-0.8%
5.2%
8.0%
9.7%
-9.3%
-1.9%
-2.0%
32.5%
8.4%
-0.1%
10.0%
8.7%
13.4%
22.0%
10.1%
3.9%
15.2%
22.3%
N ondefense CapitalGoodsEx Aircrft
Defense CapitalGoods
M otorVehiclesand Parts
M achinery
Fabricated M etalProducts
Prim ary M etals
Com m unicationsEquipm ent
Com puter& Electrnc Prdcts(HiTech)
Com puterProducts
Aircraftand Parts
Defense Aircraftand Parts
Moody’s Capital Markets Research Group, April 2013
21
4
Household Spending
Moody’s Capital Markets Research Group, April 2013
Very Strong Correlation of 0.86 Between the Yearly Percent
Changes of a Business Sales Proxy and Private-Sector Payrolls:
yy % changes
Privat e-sect or Payrolls ( L )
Gross Value Added: nonfin corp ( R )
3.8%
2.8%
7.6%
1.8%
5.6%
0.8%
3.6%
-0.2%
1.6%
-1.2%
-0.4%
-2.2%
-2.4%
-3.2%
-4.2%
-5.2%
-4.4%
-6.4%
-6.2%
-8.4%
86Q4 88Q4 90Q4 92Q4 94Q4 96Q4 98Q4 00Q4 02Q4 04Q4 06Q4 08Q4 10Q4 12Q4
Moody’s Capital Markets Research Group, April 2013
23
Nearly 4 Years into the Current Upturn, Payrolls Still Trail
Their Previous Cycle High of January 2008
Recessions are shaded
Jobs as a % of the Previous Cycle Peak
120.5%
118.0%
115.5%
113.0%
110.5%
108.0%
105.5%
103.0%
100.5%
98.0%
95.5%
93.0%
Aug-74 Aug-78 Aug-82 Aug-86 Aug-90 Aug-94 Aug-98 Aug-02 Aug-06 Aug-10
Moody’s Capital Markets Research Group, April 2013
24
Employment Growth has Been Skewed Toward
Workers Aged 55 Years and Older
Average annualized % changes:
Total Household
Employment: 16 to
Survey Employment
54 years of age
1
2
Employment: 55
years of age and
older
3
Number of Workers
Aged 55 years and
Older as % Total
Employment
4
1991-2000 Upturn
1.6%
1.4%
2.6%
12%
2002-2007 Upturn
1.2%
0.5%
5.3%
16%
Current Upturn
0.6%
-0.2%
3.8%
22%
Moody’s Capital Markets Research Group, April 2013
25
Consumers' Exceptionally Low Income Expectations
Weigh On Retail Sales
Consumers' Income Expectations Index: avg net % expecting income growth ( L )
Retail Sales: avg annualized % change ( R)
22.5
20.0
17.5
15.0
12.5
10.0
7.5
5.0
2.5
0.0
-2.5
-5.0
Dec82
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
Dec85
Dec- Dec-91 Dec-9 Dec-9 Dec88
4
7
00
Dec03
Dec06
Dec- Dec-12
09
Moving 5-year observations
Moody’s Capital Markets Research Group, April 2013
26
Employment Income's Subpar Pace Limits the Upside for
Retail Sales Growth: yearly % change of mov. 3 mo. avgs.
Ret ail Sales
Employment Income
10.0
10.0
7.5
7.5
5.0
5.0
2.5
2.5
0.0
0.0
-2.5
-2.5
-5.0
-5.0
-7.5
-7.5
-10.0
-10.0
-12.5
Jun-87 Dec-89 Jun-92 Dec-94 Jun-97 Dec-99 Jun-02 Dec-04 Jun-07 Dec-09 Jun-12
-12.5
Moody’s Capital Markets Research Group, April 2013
27
Number of New Car and Light Truck Sales Are Extraordinarily Low
Compared to Real Disposable Personal Income
Car and Light Truck Sales: millions of units, mov yr-long avg ( L )
Real Disposable Personal Income: annualized in $ bills ( R)
$10,500
17.5
16.5
$9,500
15.5
$8,500
14.5
$7,500
13.5
$6,500
12.5
$5,500
11.5
$4,500
10.5
$3,500
9.5
68Q4
$2,500
74Q4
80Q4
86Q4
92Q4
98Q4
04Q4
10Q4
Moody’s Capital Markets Research Group, April 2013
28
Number of Homes Sold Are Very Low Relative to Real Disposable
Personal Income
Total One-Family Home Sales: millions of annualized…
Real Disposable Personal Income: annualized in $ bills…
$10,500
7.5
$9,500
6.5
$8,500
5.5
$7,500
$6,500
4.5
$5,500
3.5
$4,500
2.5
1.5
68Q4
$3,500
$2,500
74Q4
80Q4
86Q4
92Q4
98Q4
04Q4
10Q4
Actual & projected
Moody’s Capital Markets Research Group, April 2013
29
Record Home Affordability, Yet Home Sales Are Back Where They Were
in 1997-1998
Home Affordability Index ( L)
Total Sales of 1 Family Homes: mills of units, annlzd ( R)
7.5
200
190
180
170
160
150
140
130
120
110
100
7.0
6.5
6.0
5.5
5.0
4.5
4.0
3.5
3.0
Jul- Apr- Jan- Oct- Jul- Apr- Jan- Oct- Jul- Apr- Jan- Oct- Jul-11 Apr90 92 94 95 97 99 01 02 04 06 08 09
13
Moving 3 month averages
Moody’s Capital Markets Research Group, April 2013
30
For Q1-2013, Only Sales of Autodealerships, Restaurants and NonStores Topped Core Retail Sales' 3.2% Annual Gain: yy % changes
Q 1-13
1
TotalRetailSales
2.8%
RetailSalesex GasStations(Core) 3.2%
Q 4-12
2
4.2%
4.2%
Q 1-12
3
8.1%
7.9%
2012
4
5.2%
5.4%
2011
5
7.9%
6.7%
2010
6
5.6%
4.7%
2009
7
-7.4%
-5.4%
2008
8
-0.9%
-2.3%
2007
9
3.4%
3.0%
2006
10
5.1%
4.5%
Autodealerships
GasStations
Food & Beverage Stores
5.5%
-0.2%
2.9%
6.7%
4.2%
2.8%
8.5%
10.2%
5.4%
7.9%
3.9%
3.3%
10.6%
17.9%
5.5%
10.9%
14.5%
2.3%
-14.4%
-22.5%
-0.2%
-13.5%
11.3%
4.0%
1.1%
7.1%
4.3%
1.3%
11.4%
3.3%
Housing Related
Building M aterialStores
Furniture & Appliance Stores
0.9%
1.4%
0.2%
3.1%
4.3%
1.5%
10.3%
13.8%
5.7%
4.6%
5.5%
3.2%
3.0%
4.1%
1.3%
0.7%
0.4%
1.2%
-12.1%
-12.4%
-11.6%
-5.5%
-5.1%
-6.1%
-2.2%
-4.0%
0.5%
4.5%
4.2%
4.9%
GeneralM erchandise Stores
"DiscountChain"Proxy
Departm entStores
ApparelStores
-4.0%
-3.5%
-5.4%
2.7%
-2.5%
-2.4%
-2.9%
4.1%
5.5%
6.8%
2.2%
9.7%
0.4%
1.1%
-1.2%
5.5%
3.5%
5.3%
-0.7%
6.1%
2.8%
4.4%
-0.7%
4.5%
-0.8%
1.6%
-5.6%
-5.2%
3.1%
7.7%
-5.1%
-2.5%
4.4%
8.2%
-1.8%
3.8%
4.9%
8.9%
-1.0%
6.1%
Drug Stores
-0.4%
0.0%
3.2%
0.9%
4.2%
3.2%
2.6%
4.1%
6.2%
6.3%
N on-Stores
12.8%
11.8%
10.8%
11.7%
15.4%
9.6%
-2.5%
3.4%
8.6%
11.3%
Restaurants
3.8%
6.1%
9.9%
7.3%
5.9%
3.3%
-1.1%
2.6%
5.1%
6.6%
Moody’s Capital Markets Research Group, April 2013
31
5
Interest Rate Outlook
Moody’s Capital Markets Research Group, April 2013
Blue Chip Consensus Expects 10-year Treasury Yield Will Top 20032007's Average During 2017 through 2024
Nominal GDP: yy % change
1
10-year Treasury Yield: %
2
10-year Treasury Yield less
Nominal GDP Growth: bp
3=2- 1
2003-2007
5.7%
4.40
-128
12Q2
12Q3
12Q4
13Q1
3.9%
4.3%
3.5%
3.6%
1.82
1.64
1.71
1.95
-206
-263
-184
-169
Blue Chip Consensus Forecasts as of early April 2013:
13Q2
13Q3
13Q4
14Q1
14Q2
14Q3
14Q4
3.8%
3.5%
4.2%
4.3%
4.6%
4.7%
4.9%
2.00
2.10
2.30
2.40
2.60
2.70
2.80
-185
-136
-194
-189
-200
-203
-208
2015
2016
2017
2018
2019
5.2%
5.0%
4.9%
4.8%
4.7%
3.40
4.10
4.50
4.70
4.70
-180
-90
-40
-10
0
2020-2024
4.6%
4.70
10
Moody’s Capital Markets Research Group, April 2013
33
Success at Cutting Federal Debt Vis-a-vis GDP Would Allow the 10-year
Treasury Yield to Trail Nominal GDP Growth by 1.5 to 2.0 Percentage Points, or
What Generally Occurred in 1954-1965: moving yearlong averages in %, actual
& Blue Chip projections
10-year Treasury Yield
Nominal GDP Growt h: yy % change
15.0%
15.0%
13.0%
13.0%
11.0%
11.0%
9.0%
9.0%
7.0%
7.0%
5.0%
5.0%
3.0%
3.0%
1.0%
1.0%
-1.0%
-1.0%
-3.0%
54Q1 59Q3
-3.0%
65Q1 70Q3
76Q1 81Q3
87Q1 92Q3
98Q1 03Q3 09Q1 14Q3
Moody’s Capital Markets Research Group, April 2013
34
Sluggish Unit Labor Costs Imply Persistently Rapid Price
Inflation Is Most Unlikely
PCEPrice Index: YoY% change ( L )
Unit Labor Costs: YoY% change of moving yearlong avg. ( R )
11.5
10.5
9.5
8.5
7.5
6.5
5.5
4.5
3.5
2.5
1.5
0.5
-0.5
-1.5
-2.5
65Q3 71Q3
77Q3 83Q3 89Q3 95Q3 01Q3 07Q3
11.5
10.5
9.5
8.5
7.5
6.5
5.5
4.5
3.5
2.5
1.5
0.5
-0.5
-1.5
-2.5
13Q3
Moody’s Capital Markets Research Group, April 2013
35
In Summary, Fiscal & Monetary Policies
Cannot Indefinitely Compensate for the
Primary Drivers of an Economy’s Long-Term
Performance, Which Include…
1. DEMOGRAPHY: population growth, age distribution of population
2. TECHNOLOGY & RESOURCES: labor productivity
3. PROPERTY RIGHTS: legal, regulatory & tax framework
4. GLOBAL COMPETITIVENESS
Moody’s Capital Markets Research Group, April 2013
36
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accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider
purchasing, holding, or selling.
Moody’s Capital Markets Research Group, April 2013
Panel Discussion
Debt Issuers Perspective: Sector Views –
“Specter of rising rates, curse or blessing?”
Panel Discussion
Debt Issuers Perspective: Sector Views –
“Specter of rising rates, curse or blessing?”
Timothy Blake
Financial Stress Continues Across Municipal Sectors
» Municipal market is broad and has diversity of credit risks
» States and local governments continue to be stressed through the weak recovery, and
some are exposed to risks from the federal budget situation
» Moody’s has maintained negative outlooks on state and local government sectors for
five years; outlooks also negative for hospitals, universities, and transportation credits
» Downgrades have outpaced upgrades for 16 consecutive quarters
Rating Changes by Number
300
Downgrades
Upgrades
250
200
150
100
50
0
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12
Source: Moody’s Investors Service
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Budget pressures persist due to weak tax revenue trend
Source: U.S. Census Bureau
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Municipal market issuance suppressed in past two years
Source: U.S. Census Bureau, Thomson Municipal Market Data
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Panel Discussion
Debt Issuers Perspective: Sector Views –
“Specter of rising rates, curse or blessing?”
Chris Padgett
Leveraged Finance Credit Environment
Current Market Activity
 Market access remains robust; strong demand evidenced by low yields across the
Leveraged Finance rating spectrum. Loan issuance is particularly strong, perhaps as
investors evaluate the risk of rising interest rates.
 Based on our Covenant Office’s most recent report, bond deals reflect the weakest
covenants of the past 2 years. Cov-lite loans are proliferating.
 Credit fundamentals remain mostly solid and liquidity remains a stabilizing factor as the
economy, while expected to grow modestly is vulnerable to a number of event risks.
 Current Credit Strengths:
 Strong Liquidity, Low interest costs, Modest economic growth
 Current Credit Weaknesses:
 Increasing leverage, Weak covenant protection, High degree of event risk
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Leveraged Finance Credit Environment
Liquidity, Covenant Stress Indexes Are Leading Indicators of
Changes in the Default Rate
Liquidity-Stress Index remains at all time low, well below historical average
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
Feb-06
Feb-07
Feb-08
Moody's Liquidity Stress Index
Feb-09
Feb-10
1-year US spec-grade default rate
Feb-11
Feb-12
Feb-13
Covenant Stress Index
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Leveraged Finance Credit Environment
Cov Lite Loans

Institutional cov-lite loan volume was significant at close to $80 billion for 1Q2013. This compares to just
over $80 billion for all of 2012.

Cov lite loans in complex capital structures are expected to disproportionately hurt bondholder recovery
because of significant debt cushion for secured lenders.
Bank Debt Cushion and Recovery
100.00%
90.00%
Instrument Discounted Recovery
80.00%
70.00%
60.00%
50.00%
Average
Std Dev
40.00%
30.00%
20.00%
10.00%
0.00%
<10%
10-20%
20-30%
30-40%
40-50%
50-60%
60-70%
70-80%
80-90%
>90%
Debt Cushion
Source: Moody’s Investors Service; Data from Moody’s Ultimate Recovery Database, which includes about 1,000 defaults of US nonfinancial companies dating back to 1988.
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Panel Discussion
Debt Issuers Perspective: Sector Views –
“Specter of rising rates, curse or blessing?”
Philip Kibel
Outlooks for Property Sectors
Ratings
Market
Fundamentals
Retail
Stable
Stable
Office
Stable
Stable
Industrial
Stable
Stable
Multifamily
Stable
Positive
Healthcare
Stable
Stable
Lodging
Stable
Stable
Sector
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Sector Strengths
» Platforms are stronger than ever: US REITs, particularly investment grade, continue to
expand in size, scope and diversity while culling older, less productive assets
» Many REITs have adopted a “back to basics” business strategy through simplified
business models, which provides increased transparency
» Liquidity is strong: manageable, near-term debt maturities, ample bank line capacity,
large unencumbered asset pools, and access to all capital market quadrants
» Financial flexibility due to balance sheet strength
» Operating fundamentals are tracking the U.S. economy as it continues to grow - despite
U.S. fiscal drama
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Sequestration and Rising Interest Rates
» Sequestration and other US fiscal drags
– Spending cuts
»
Effects will be felt most severely in 2Q and 3Q
– Tax increases
»
“strength” in consumer spending during Q1 driven by higher utilities spending; impact expected to become more
apparent in 2Q
– Affordable Care Act
»
Potential impediment for employment growth in retail, leisure, hospitality and professional services industries
– Debt Ceiling by August
» Rising Interest Rates
– Sufficiently low leverage and strong cash flows will buffer impact of refinancing debt at higher rates
– Rising interest rates generally follow improving economy which means strength in rental rate
growth
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Evolving Business Platforms and Growth
» Reducing non-strategic, domestic joint ventures
» Exiting non-core businesses
» Targeting narrower, more dominant markets
» REIT Investment Diversification and Empowerment Act of 2007 (RIDEA)
» (Re)Development
– Pipelines grew in multi-family, industrial and office during 2012; expect trend to continue
– Focus on size and associated business risk
» International Investment
– Often through JVs or funds, but seeing more whole investment
– Focus on earnings potential, platform expansion vs. transparency, business risk, control
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Panel Discussion
Debt Issuers Perspective: Sector Views –
“Specter of rising rates, curse or blessing?”
Al Remeza
US CLO Issuance Over Time
January 2012 – May 2013
# of Deals
Effective Date Par (millions)
30
$14,000
25
$12,000
$10,000
20
$8,000
15
$6,000
10
$4,000
5
$2,000
0
$0
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Date
Source: Moody's Investors Service
Effective Date Target Par ($Mil)
GLOBAL CLO
# of Deals
Historical Average Impairment Rate
Aaa CLO Spreads Over Time
Impairment Rate
January 2012 - February 2013
ALL TRANCHES
bps
200
180
160
140
120
100
80
60
40
20
0
1/31/2013
3/1/2013
6/12/2012
8/11/2012
Date
11/10/2012
9/13/2012
8/16/2012
7/19/2012
6/21/2012
5/24/2012
4/26/2012
3/29/2012
1/3/2012
Source: JP Morgan
ONE YEAR
0.25%
FIVE YEAR
1.90%
INVESTMENT
GRADE
ONE YEAR
0.08%
FIVE YEAR
0.78%
* Total of 4267 tranches since 1993.
Source: Moody's Investors Service
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Key Metrics Show CLOs Are Stronger
US CLO Average WARF and Senior OC Level by Year
WARF
Senior OC
WARF
Senior OC (Median)
3000
130.00
2900
128.00
2800
126.00
2700
124.00
2600
122.00
2500
120.00
2400
118.00
2300
116.00
2200
114.00
2100
112.00
2000
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12
110.00
Source: Moody's Investors Service
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Fundamentals Drive Loan Performance
U.S. Trailing 12-Month Speculative-Grade Default Rate Over Time
10%
Actual
8%
Baseline Forecast
Pessimistic Forecast
Optimistic Forecast
6%
4%
2%
Jan-14
Dec-13
Nov-13
Oct-13
Sep-13
Aug-13
Jul-13
Jun-13
May-13
Apr-13
Mar-13
Feb-13
Jan-13
Dec-12
Nov-12
Oct-12
Sep-12
Aug-12
Jul-12
Jun-12
May-12
Apr-12
Mar-12
Feb-12
Jan-12
0%
Source: Moody's Investors Service
In Billions of USD
Historical Refunding Needs Profile By Maturity
$300
$200
$100
$0
2007 Study
2008 Study
2007
2008
2009
$17
$24
$41
$13
$29
$45
$26
$44
$120
$21
$79
$155
$212
$338
$26
$67
$136
$280
2009 Study
2010 Study
2011 Study
2010
2011
2012
2013
2014
2015
2016
2017
Totals
$82
$86
$190
$805
$184
$693
Source: Moody's Investors Service
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Moody’s Investors Service is the source for all numbers, facts, and figures presented in this report,
unless otherwise noted.
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Panel: Debt Issuers Perspective:
Sector Views – “Specter of
rising rates, curse or blessing?”
Daniel Serrao, Associate Managing Director, Managed Investments (Moderator)
Timothy Blake, Managing Director, Public Finance Group
Philip Kibel, Senior Vice President, REIT’s
Chris Padgett, Senior Vice President, Leverage Finance
Al Remeza, Senior Vice President, CLO’s
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Break
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Liquidity Impact: New Directions for
Cash Investors in a Changing
Environment
Robert Callagy, Vice President and Senior Analyst - Managed Investments
MMFs: Rates, Supply, New Directions for Cash Investors
1.
Rising Rates, When?
2.
Impact of Rising Rates on MMFs
3.
Supply/Demand Dynamics
4.
Regulatory Developments
5.
New Directions for Cash Investors
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1
Rising Rates, When?
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Low Interest Rates Environment to Persist through
End of 2014
United States (Fed funds rate)
Euro Zone (Refi rate)
United Kingdom (Discount Rate)
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Source: Moody’s Analytics
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FOMC’s Participants Assessment of Appropriate Monetary
Policy
Number…
Appropriate timing of
policy firming
16
15
14
12
10
8
6
4
1
4
2
1
0
2016
2015
2014
2013
Source: Moody’s Investors Service
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Fed’s Exit Will be Unprecedented
Steps outlined in June 2011 FOMC Minutes
»
Stop purchasing new SOMA assets via LSAPs;
»
Cease reinvesting some or all payments of principal on the
securities holdings in SOMA;
»
Modify forward guidance on the path of federal funds rate and
initiate temporary reserve-draining operation
»
Raise the target federal funds rate
»
Sell agency securities from SOMA over period of 3-5 years
Source: Minutes of the Federal Open Market Committee, June 2011
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MMF Assets Have Shown Great Resiliency
Prime
Government
Treasury
Tax-Exempt
2,500
($) Billions
2,000
1,500
1,000
500
0
Source: iMoneyNet
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Despite Low Yields, Investors Continue to Hold Cash
Corporate Cash Balances at U.S. non-financial companies
Source: Moody’s Investors Service
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Sustained Trend Towards the Allocation of Cash to Safety
Products
90%
80%
70%
60%
78%
73%
74%
60%
56%
51%
50%
37%
40%
30%
78%
74%
23%
27%
42%
42%
25%
20%
10%
0%
2006
2007
2008
2009
2010
2011
2012
% of short-term investments in bank deposits, MMFs and Treasury Bills
% of short-term investments in bank deposits
Source: Association for Financial Professionals Global Liquidity Survey, July 2012
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2
Impact of Rising Rates
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Changes in Interest Rates and Cash Flows Influence MtM NAV
Source: Investment Company Institute
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2010 Reforms – Reduced MMFs Exposure to Interest Rate Risk?
Interest Risk Profile Benefited from 2010 Reforms
»
Reduced WAMs to 60 days
»
Increased Liquidity Levels
»
Imposed Stress Testing Requirements
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What Happens When MMFs Meet Rising Rates?
Prime MMF Assets
Fed Funds Rate
2,000
7%
1,800
6%
1,600
5%
($) Billions
1,400
1,200
4%
1,000
3%
800
600
2%
400
1%
200
0
0%
Source: Federal Reserve, iMoneyNet
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How Do Managers Insulate Funds from Interest Rate Risk
»
Roll back WAMs
»
Increase investment in floaters, Fed Funds- or Libor-based
»
New daily MtM NAV disclosures likely to increase managers
vigilance around interest rate risk management
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Rising Rates Will Provide Relief to MMF Sponsors
Source: Investment Company Institute
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2
Supply/Demand Dynamics
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Supply and Demand Imbalance in the Short-End
A reduction in supply of assets to investors
»
Reduced short dated bank issuance
»
Limited issuance from highly rated corporates
»
Reduction in eligible issuers
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MMFs Challenged to Find Supply of Eligible High-Quality
Short-Term Debt
Source: SIFMA, 4Q large time deposits not available
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Supply and Demand Imbalance in the Short-End
Changing demand factors…..
»
Reduction in the number of approved issuers
»
Changes to MMF regulation
»
Increase in collateralized lending by MMFs
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3
Regulatory Reform
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Timeline of Key Money Market Fund Reforms
Initiative
Region
Institutional Money Market Fund Association (IMMFA) Code of Practice Amended
US Securities and Exchange Commission (SEC) Money Market Fund (MMF) Reform Rules Effective
Committee of European Securities Regulators (CESR) Proposes Definitions for MMFs
President’s Working Group on Financial Markets Releases Paper on MMF Reform
French Autorité des Marchés Financiers favours ban on CNAV
Financial Stability Board (FSB) publishes initial recommendations for MMF reform
SEC cancels its vote on MMF Reform Proposals due to majority opposition
Tim Geithner urges Financial Stability Oversight Council (FSOC) to consider less onerous MMF reform
alternatives
International Organization of Securities Commissions (IOSCO) issues its MMF reform recommendations
SEC publishes study analyzing effectiveness of its 2010 reforms
FSOC Publishes Proposed Consultation for MMF reform
FSB endorses IOSCO recommendations
SEC commissioners publicly state additional reforms necessary
FSOC Extends Comment Period on MMF Reform Proposal
Federal Reserve Presidents Support FSOC proposal
FSOC Comment Period Ends
SEC Expected to Publish Proposed Rules
European Commission (EC) requested to deliver interim report on first stage implementation of proposals
FSB Final Recommendations on Shadow Banking due
EC requested to deliver interim report on second stage implementation of proposals
Timeframe
Europe
Dec-09
US
Europe
US
Europe
International
US
May-10
May-10
Oct-10
May-11
Oct-11
Aug-12
US
Sep-12
International
US
US
International
US
US
US
US
US
Europe
International
Europe
Oct-12
Nov-12
Nov-12
Nov-12
Nov-12 - Jan-13
Jan-13
Feb-13
Feb-13
1H 2013?
Jun-13
Sep-13
Jun-14
Source: Moody’s Investors Service
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Broad Resistance to VNAV, Capital and Holdback
Proposed Reforms (Nov 2012)
»
Convert to Floating NAV, exception – Treasury MMFs
OR
»
Maintain Constant NAV, BUT
–
Hold Capital Reserves
–
Require Redemption Holdback
Responses to FSCO MMF Proposals
Response
Yes
No
Total
Floating NAV
14
75
89
Capital + Holdback Capital + Other
9
13
55
47
64
60
Source: Financial Stability Oversight Committee (FSOC)
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What Fund Types Would Be Most Impacted?
Likely Excluded
»
Treasury MMFs
Jury Still Out
»
Government MMFs
»
Tax-Exempt MMFs
»
Retail Prime MMFs
Expected to be Included
»
Institutional Prime MMFs
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Value Proposition of MMF Could be Changing
Likely Response to Holdback
Likely Response to VNAV
No bearing on
33%
23%
20%
organizations
organizations
43%
willingness to
invest
Monitor and sell
14%
No bearing on
7%
funds if/when NAV
willingness to
invest
Stop Investing but
maintain holdings
falls below $1
23%
30%
7%
No bearing on
organizations
Likely Response to Capital
Requirements
30%
34%
willingness
to invest
Stop Investing
but
maintain holdings
Stop investing and
reduce but not
25%
Source: Association of Financial Professionals
eliminate
holdings
Stop investing
and
11%
divest of all holdings
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Cash Flow Impact of MMF Regulatory Reform
Likely to affect investor behavior but hard to speculate….
»
Uncertainty around accounting and tax
»
Greatest cash flow sensitivity in prime fund segment
»
Likely to see balances move from prime mmfs to govt funds
»
?
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4
New Directions for Cash Investors
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New Directions for Cash Investors
»
Go Direct
»
Separately managed accounts
»
Low Duration/ Ultra Short Bond Funds
»
Bank Deposit Products
»
ETFs
Moody’s Asset Management Conference: Will There Be A Great Rotation?
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Rory Callagy
+1 212 553-4374
robert.callagy@moodys.com
Managed Investments Group’s Website
www.moodys.com/managedinvestments
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Asset Class Perspectives: Closed
End Funds – Can The Carry Trade
Carry On?
Neal Epstein, Vice President and Senior Credit Officer - Managed Investments
CEFs: Can the Carry Trade Carry On?
1.
Recent Performance
2.
Product Activity
3.
Leverage
4.
Financial Management
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1
Recent Performance
Moody’s Asset Management Conference: Will There Be A Great Rotation?
89
What fuels leveraged CEF performance?
»
Performance of underlying asset classes –boosts NAV
»
Scarcity of portfolio assets – sustains premium pricing
»
Investors’ desire to hold higher-yielding securities – reduces trading
discounts
»
Slope of yield curve – fuels carry trade, augments fund income.
All these impacts are “credit positive” for investors in CEF leverage…
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What fuels leveraged CEF performance?
»
But what if monetary policy is the source of these “benefits“?
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Performance of CEF equities year to date
»
Quantitative easing supports
markets, keeping interest rates
low.
»
Demand for relatively-higher
yielding investments, including
speculative-grade fixed income
and dividend-paying equities
»
Inflation hedges, including real
estate, energy; metals are in
decline.
Source: CEFA, Moody’s. Weighted average returns of underlying Lipper categories to 17 April,
comprising 625 funds and $245 billion of net assets. .
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Closed End Fund “Flows”: Looking for Rotation
Source: Bloomberg. Millions of dollars.
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2
Product Activity
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Product Activity: Fund Launches and Mergers
»
Current IPO activity concentrated in taxable fixed income area (eg.,
PCI)
»
Mergers prominent among muni CEFs – cost savings a positive
»
Some drivers:
–
Demand for underlying asset class => yield, “exotic” diversification
–
CEF “census” – first mover advantages
–
Need to overcome short-term performance drag of IPO: underwriters’
spread impacts NAV, market discounting further affects price.
–
Leverageable returns available, but market appears crowded.
–
Munis: declining portfolio income, as older bonds are called
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CEF IPO Activity – Last Six Months’ Total = $10.1 billion
IPO sby Date
10/26/2012
Babson Cap Glb SD HY (BGH)
StoneHarborEM TotInc(EDI)
11/28/2012
AresDynam icCrdtAlloc(ARDC)
FirstTrustM LP Ener& Inc(FEI)
12/6/2012
N uveen IntDurM un Term (N ID)
12/21/2012
PrudentialGlShtDurHY (GHY)
1/29/2013
PIM CO Dynam icCreditInc(PCI)
2/7/2013
N uveen IntDurQ lty M uni(N IQ )
2/16/2013
Apollo TacticalIncom e (AIF)
BlackRock M lt-SctrInc(BIT)
3/26/2013
Brookfield M tge O pp Inc(BO I)
Cohen & SteersM LP Inc& E (M IE)
Eaton Vance M uniIncTrm (ETX)
N eubergerM LP Incom e (N M L)
Grand Total
Fixed Incom e -Taxable
Fixed Incom e -TaxExem pt
GeneralEquity
463
290
320
830
725
740
3,431
188
280
720
420
480
205
6,663
1,117
1,005
2,315
Source: CEFA, CEFConnect
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Municipal CEF Fund Mergers – Leverage Consolidation
Month
Funds
Surviving Fund
Security
Type
$ Amount
Apr
NUO, NXI, Nuveen Ohio Quality Income
NBJ, NVJ Municipal Fund, Inc. (NUO)
MTP
$74.00
Apr
NAZ, NFZ, Nuveen Arizona Premium
NKR, NXE Income Municipal Fund (NAZ)
MTP
$51.00
Jan
NUM,
NMP,
NZW
Nuveen Michigan Quality
VMTP,
Income Municipal Fund (NUM), MTP
$70.20
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3
Leverage
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Closed-End Fund Leverage – Structural Leverage
Source: Thomson-Reuters, Moody’s. 357 funds as of March 2013.
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State Municipal Bond Fund Total Leverage
Source: Moody’s. 161 rated state municipal-bond funds as of January 2013.
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Leverage Arithmetic
RNAV = (rportfolio – ileverage) * Portfolio / NAV
rportfolio = 5.0%
ileverage = 0.75%
Leverage = 1.6
RNAV = 6.8%
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TOB Leverage
»
A source of portfolio leverage
»
Arbitrages the slope of yield curve
»
Economic break-even a function of costs of funding and program
costs.
»
Cost of floating rate issuance is:
Yield: SIFMA (23 bps as of 17 April) + 20 to 25 bps.
Sponsorship: 30 to 60 bps. SFIMA
All-in: SIFMA + 50 to 85 bps.
»
Current long-term muni yields exceed 3%, total return ?
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TOB Leverage
Source: Nuveen Investments
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Yield Curve Shift, Year To Date, Has Been Insignificant
US Muni General Obligation AA+ Curve
Source: Bloomberg
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4
Financial Management
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Financial Management
»
Leverage issuers have used variable and fixed dividend rates.
»
Relative cost of liquidity providers and remarketing a factor
»
In a low rate environment, incentive exists to “term out” fixed-rate
financing
»
Issuance of “term trust” versus perpetual versus a marketing
consideration, given rising rate expectations.
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Variable Rate Demand Preferred Shares
»
Variable Rate Demand Preferred (VRDP) shares are issued by CEF
»
Bank enters into VRDP Purchase Agreements to provide liquidity
support to the VRDP shares.
»
The liquidity provider agrees to purchase any rated shares that have
been tendered for and not successfully remarketed on the 7th day
after notice of tender.
»
The VRDP shares' short-term ratings are based on the liquidity
support from the VRDP Purchase Agreement provider
i.e., linked to the short-term rating of the relevant bank
»
Long-term ratings are based on usual methodology
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Bank credit pressure and VRDP substitution
Rating Action: Moody's assigns Aa2/P-1 ratings to preferred shares issued by two New
Jersey closed-end funds managed by Nuveen
Global Credit Research - 17 Apr 2013
New York, April 17, 2013 -- Moody's Investors Service ("Moody's") has assigned Aa2 longterm ratings and P-1 short-term ratings to Variable Rate Demand Preferred (VRDP) shares
issued by two state-specific closed-end funds managed by Nuveen Fund Advisors, LLC
(Nuveen). Royal Bank of Canada (RBC), acting through its WFC, New York, Branch
(Aa3/P-1, stable), has entered into VRDP Purchase Agreements to provide liquidity support
to the VRDP shares. The VRDP shares' short-term ratings are based on the liquidity
support from the VRDP Purchase Agreement provider and are therefore linked to the shortterm rating of the Royal Bank of Canada. …
The VRDP shares issued by NNJ and NQJ were exchanged for previously outstanding
VRDP shares with a Purchase Agreement that had been provided by Citibank, N.A. A3/P-2.
Upon the completion of the exchange, the old VRDP shares will be terminated and their
ratings withdrawn.
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Municipal Term Trust
»
»
»
Trust matures on a date certain (eighteen years) and may choose to
target liquidation at par.
Portfolio durations may be managed to minimize mismatch of final
valuations and target, (with no guarantee).
Attractive to fund investors concerned about secular turn in interest
rates
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RVRMTP – Best of both worlds?
Rating Action: Moody's assigns an Aa1 rating to Remarketable Variable Rate Muni Term
Preferred Shares issued by the BlackRock Municipal Target Term Trust (BTT)
Global Credit Research - 10 Jan 2013
$750 million new RVMTP shares to be issued
New York, January 10, 2013 -- Moody's Investors Service has assigned a rating of Aa1 to
Remarketable Variable Rate Muni Term Preferred Shares (RVMTP Shares) issued by the
BlackRock Municipal Target Term Trust (BTT),
Description of RVMTP
The RVMTP are similar to other municipal term preferred stock, which is issued by
municipal closed-end funds to leverage the returns earned by their common share holders.
The shares will mature on 12/31/2030, which is the date of maturity of the term trust. The
dividend rate will be set at the SIFMA Municipal Swap Rate plus an applicable spread. The
securities can be remarketed every six months, and a new applicable spread may be set at
each remarketing. The ability to remarket the shares can be at the option of the fund or the
RVMTP shareholders.
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Neal M Epstein, CFA
+1 212 553-3799
neal.epstein@moodys.com
Managed Investments Group’s Website
www.moodys.com/managedinvestments
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Panel Discussion
Great Rotation: Risks and Rewards Considered in
“Making The Call”
Panel: Great Rotation: Risks and
Rewards Considered in “Making
The Call”
Daniel Serrao, Associate Managing Director, Managed Investments (Moderator)
Michael Mazier, Senior Fixed Income Strategist, Van Eck Associates Corporation
Leah Modigliani, Senior Vice President, Neuberger Berman Group, LLC
William T. Meyers, Managing Director, Nuveen Investments
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Thank You
Asset Management Conference: Will There Be A Great Rotation?
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Asset Management Conference: Will There Be A Great Rotation?