Michael Comes, CFA - Munis: Chicago, Detroit, Puerto Rico and More

Munis: Chicago, Detroit, Puerto Rico and More Puerto Rico-An Economy Held Hostage by Politics September 2015

Michael Comes, CFA Portfolio Manager & Vice President Research Michael.Comes@cumber.com

ŠCopyright 2015 Cumberland AdvisorsŽ. Further distribution prohibited without prior permission.

Private Sector Employment Private Sector Employment has Stabilized 950

390

370

850

350 750 330 650 310 550 290

450

270

350

250

Total Private - State (000s)

Government - State (000s)

Source: BLS ŠCopyright 2015 Cumberland AdvisorsŽ. Further distribution prohibited without prior permission.

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Service Sector 750

Service Sector has Recovered since the Recession

700

210

190

650 170 600 150 550 130 500 110 450

90

400

350

70

Private Service-Providing - State (000s) lhs

Manufacturing - State (000s) rhs

Source: BLS ŠCopyright 2015 Cumberland AdvisorsŽ. Further distribution prohibited without prior permission.

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Housing Market Remains Strong $125,000

$120,000

$115,000

$110,000

$105,000

$100,000

$95,000 2005

Source: Census Bureau

2006

2007

2008

2009

2010

2011

2012

2013

2014

Median Value Owner Occupied Home

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Population Pyramid Population Pyramid resembles those of Japan and Western Europe 85+ 80-84 75-79 70-74 65-69 60-64 55-59

50-54 45-49

Men

40-44

Women

35-39 30-34 25-29 20-24 15-19 10-14 5-9 0-5 -8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Source: Cumberland Advisors, Census Bureau ŠCopyright 2015 Cumberland AdvisorsŽ. Further distribution prohibited without prior permission.

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Adjusted Debt-GDP Adjusted Debt-GDP Tells A Different Story Centralized Government compared to U.S. States

Source: National Public Finance Guarantee ŠCopyright 2015 Cumberland AdvisorsŽ. Further distribution prohibited without prior permission.

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Liquidity: Low, but Improving

Days Cash on Hand 120 100 80 60 40 20 0 2009

2010

Puerto Rico

2011

2012

2013

U.S State Median

Source: Puerto Rico Annual Disclosures, Investortools, Inc. ŠCopyright 2015 Cumberland AdvisorsŽ. Further distribution prohibited without prior permission.

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Annual Financing Gap: Puerto Rico Annual June 30, 2011 Sales Tax Revenue

Annual June 30, 2011

Annual June 30, 2011

1,129,006

1,144,659

1,170,748

8,279,118

8,028,704

8,244,567

Total Revenue

15,307,468

15,244,255

15,773,369

Total Expense

19,278,137

21,108,141

21,513,373

Personal Income Tax Revenue Corporate Income Tax Revenue Fuel Tax Revenue Total Tax Revenue

(3,970,669)

(5,863,886)

(5,740,004)

Capital Grants and Contributions

457,725

152,591

110,249

Net Government Transfers

230,551

219,794

246,908

Total Change in Net Assets

(3,282,393)

(5,491,501)

(5,382,847)

CA Financing Gap

(1,210,471)

(3,239,556)

(2,953,470)

Revenue Over Expense

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Path to Fiscal Stability Gray economy estimated at 25% of total output • Puerto Rico collects only 56% of the sales taxes due on all taxable transactions.

– At current tax rates, 100% collection would increase revenues by approximately $1 billion annually, 1/3 of amount needed to plug annual financing gap

• By instituting reforms, Puerto Rico could stabilize its fiscal condition without impairments to general government creditors.

Source: Comments of Dominic Frederico, CEO of Assured Guaranty, on 2Q Earnings Call ©Copyright 2015 Cumberland Advisors®. Further distribution prohibited without prior permission.

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Chapter 9: Not a Solution Chapter 9 for sake of Political Expediency is not a solution • Not a ‘get-out-of-jail free card’ • Passage of Chapter 9 and determining if insolvency standard has been met could take years – Think Harrisburg bankruptcy or San Bernardino

• Chapter 9 Restructuring – Hurts Commonwealth’s credibility with investors – Restricts market access for decades

Source: Comments of Dominic Frederico, CEO of Assured Guaranty, on 2Q Earnings Call ©Copyright 2015 Cumberland Advisors®. Further distribution prohibited without prior permission.

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Government Dysfunction • Puerto Rico is not so much problem as is the dysfunction of government • Been a recent shift in support by Governor for honoring Puerto Rico debt • Has resulted in credibility crisis – Commonwealth unable to sell $750 million in PRASA debt in late August – Governor has stated publicly that government debt is “not payable.”

Source: Comments of Dominic Frederico, CEO of Assured Guaranty, on 2Q Earnings Call ©Copyright 2015 Cumberland Advisors®. Further distribution prohibited without prior permission.

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Spreads Remain Elevated Barron’s Puerto Rico Article Published

S&P Downgrade to Junk

Initial Restructuring Legislation Passed

Puerto Rico governor states debts “not payable”

Source: Municipal Market Analytics, Bloomberg ©Copyright 2015 Cumberland Advisors®. Further distribution prohibited without prior permission.

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Closing Thoughts  Health of economy better than headlines suggest  Liquidity and debt crisis on governmental level can be solved

 Chapter 9 not a solution  Recent about-face from governor on debt repayment  Investors still trading bonds flat based on expected impairments

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Disclosure All material presented is compiled from sources believed to be reliable. However, accuracy cannot be guaranteed. Past performance is no guarantee of future results. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk.

ŠCopyright 2015 Cumberland AdvisorsŽ. Further distribution prohibited without prior permission.

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