The municipal curve is expected to flatten over the balance of 2016 and through 3Q 2017

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1 The muicipal curve is expected to flatte over the balace of 2016 ad through 3Q 2017 Rates themes Q17 Rate Forecast (%) Our ecoomics team expects real GDP growth of 2% i 4Q16 ad 1.8% for all of 2016, with somewhat lower 2017 growth of 1.7% Core CPI, is projected to rise from 1.9% i 3Q16 to 2.2% i 4Q16, risig to 2.5% by year-ed 2017 We project 2yr ad 5yr US Treasury yields will rise about 40bps, ad 10yr yields will rise about 15bps, while 30yr rates fall about 15bps, through 3Q17 We aticipate that 10yr ad 30yr tax-exempt rates will fall by about 15bps to 1.55% ad 2.30%, respectively, by 4Q16 I 2017, we expect 5yr ad 10yr yields will rise by about 15-20bps, with 30yr yields risig by oly 5bps Major sources of volatility: November-December techicals, regulatory iitiatives, global govermet policy/yields, ad fud flows I our view, the Fed will likely raise the Federal Fuds rate by 25bps at the December 2016 meetig ad i Jue ad December i 2017 By 3Q17, the muicipal curve is largely expected to flatte with the 5s/10s arrowig by 22bps, the 10 s-30 s (18bps), 2s/30s (40bps), ad 2s/10s (22bp) Ø Most probable risk to our rage boud forecast is a chage to cetral bak policy as: Fed is reivestig $200b, ECB 960b euro, ad BOJ 80tr ye 1 1mo 4Q16 1Q17 2Q17 3Q17 Treasury 11/4/2016 ahead Forecast Forecast Forecast Forecast 2yr yr yr yr AAA Tax-exempt 2yr yr yr yr AAA / TSY Ratios 2yr 104% 95% 95% 85% 82% 84% 5yr 90% 89% 85% 82% 80% 82% 10yr 95% 92% 88% 92% 86% 90% 30yr 98% 98% 96% 98% 92% 96% Bechmark Rates Curret Yield (%) Spread to record low (bps) Spread to mea (bps) AAA 2 Year Yield AA 2 Year Yield A 2 Year Yield BAA 2 Year Yield AAA 5 Year Yield AA 5 Year Yield A 5 Year Yield BAA 5 Year Yield AAA 10 Year Yield AA 10 Year Yield A 10 Year Yield BAA 10 Year Yield AAA 30 Year Yield AA 30 Year Yield A 30 Year Yield BAA 30 Year Yield Source: Thomso Reuters, J.P. Morga: As of 11/04/2016. Avg back to 1990.

2 Net supply i 2017 is expected to follow seasoal patters Net issuace i 2017 is expected to follow the typical market patters with sizable reivestmet capital i mid ad yeared periods All else equal, the demad curve shifts higher whe buyers have redemptio ad coupo capital to reivest i the market To the extet possible, issuers should target Jue-August ad December-February periods Distict seasoal treds emerge i 2017 Reivestmet capital of Dec-Feb of $88b ad Jue-Aug of $113b Net issuace is expected to be approximately +$10b i 2016 Net supply, $b July-August et was egative $20b Nov. is expected to have slightly egative et supply of -$1b Dec. et eg supply of -$15b Net supply durig the March- May period i 2016 was high at $26b Forecast Ja Feb Mar Apr May Ju Jul Aug Sep Oct Nov Dec Source: Thomso Fiacial, Bloomberg, J.P. Morga 2

3 Issuers could be exposed to stroger seasoal iflueces i 2017 Muicipal ivestors covet tax-exempt icome which limits their reivestmet optios To the extet possible, issuers should target December February 2017 ($88b) ad Jue - August ($113b) periods whe ivestors are better capitalized The March-April period ($62b) is characterized by low reivestmet capital ad low demad or outflows, as idividuals pay tax liabilities, the electio results will likely have a impact o realized gais Next year, issuers will likely rely more o reivestmet capital, as fud flows are expected to be more middlig, resultig i stroger seasoal iflueces Maturig Bods, Coupo Paymets, Pre-refudigs i 2016 ad 2017 $b Reivestmet capital i Dec 16- Feb 17 $88b Reivestmet Jue-August i 2017 is high at $113b Ja Feb Mar Apr May Ju Jul Aug Sep Oct Nov Dec Source: Thomso Fiacial, Bloomberg, J.P. Morga 3

4 Fud iflows have wavered i high-yield ad log-term fuds The curret iflows of $61b, raks 4th i total dollar amout, based o data sice 1992 The huge iflux of capital has smoothed the distributio of record October ($53b) ad year-to-date 2016 ($403b) issuace Log-term ad high-yield fuds have give some capital back recetly, with log-term fuds experiecig outflows i 3 of the past 4 periods (-$852m) ad high-yield fuds sustaiig outflows i 4 of the past 5 periods (-$957m) Itermediate fuds cotiue to see iflows ad all-term fuds have oly had oe period of outflows i the past moth Sustaied iflow ad outflow periods sice 1992 Millios Fud flows, $b /8/ /01/92-10/13/93: 86 of 93 weeks $52.5b 8/5/1992 3/3/1993 Fud Flow $b 9/29/1993 4/26/ /22/1994 6/21/1995 1/17/1996 8/14/1996 3/12/ /8/1997 5/6/ /2/1998 6/30/1999 1/26/2000 8/23/ /01/01-10/09/02 76 of 92 weeks $38.5b 3/21/ /24/2001 5/22/ /18/2002 7/16/2003 2/11/2004 9/8/2004 4/6/ /27/05-09/17/ of 178 weeks $74b 11/2/2005 5/31/ /27/2006 7/25/2007 2/20/2008 9/17/ /14/09-08/045/10 93 of 96 weeks $111b 4/15/ /11/2009 6/9/2010 1/5/ /07/11-03/13/13 75 of 80 weeks $65b 8/3/2011 2/29/2012 9/26/2012 4/24/ /20/2013 Sice 10/7/15 iflows of $61b 01/22/14-03/25/15 56 of 62 weeks $35b 6/18/2014 1/14/2015 8/12/2015 3/9/2016 Source: Lipper, J.P. Morga 4

5 What factors ca istigate a outflow cycle? Fud Flows to remai supportive abset higher tha expected rise i log dated yields AAA Tax-exempt Yield, % Fud Flows, $b Source: Tomso Reuters, Lipper US Fud Flows, J.P. Morga Lookig at fud flow patters back to 1999, the primary catalyst for fud outflows has bee risig iterest rates By order of magitude, log-dated U.S. Treasury yields would eed to rise at least 40bps, ad sustai the risig yield patter for at least oe quarter. Agai, this is ot our forecast The most prevalet risks to the status quo are: Tight labor markets spark wage iflatio or US growth/iflatio exceed 3% Eergy prices spike due to supply related catalyst November Presidetial ad Cogressioal electios results egatively impact the perceived value of UST debt Global cetral baks fade moetary easig 5

6 Trump to decrease taxes meaigfully while Clito would icrease taxes margially Political gridlock is expected to persist after the electio as either party maitais all three braches of govermet After this weeked s surge i the poles by Republica presidetial cadidate Doald Trump, Hillary Clito still leads by a 3.3ppts, dow from a over 7.7ppts advatage i mid-august Based o RCP data, Clito would require just 20% of the estimated 142 udecided electoral votes to reach the madated 270 votes eeded to wi the Presidecy Ulikely that either democrats or republicas will hold all three braches. While bills oly require a majority vote, overridig a Presidetial veto requires 2/3 votes of both houses, ad ivokig cloture to block a filibuster i the Seate requires a 3/5 vote Trump corporate tax policy (15% from 35%), while difficult to push through, would hurt muicipal liquidity as bak holdigs of muicipal securities ($507b) have almost doubled sice 1Q 2011 ad P&C s hold $333b Tax Curret Trump Clito Top Idividual Icome Tax Bracket for Married Filers Tax brackets of 10%, 15%, 25%, 28%, 33%, 35%, ad 39.6%/$464.85K Tax brackets of 12%, 25% ad 33%. Adds a 4% surtax o icome over $5 millio. Icrease Social Security taxes o wealthy AMT Y Elimiate 30% +$1m Corporate Tax rates 35% Lower rate to 15% from 35% ad elimiate deferral of overseas profit Uspecified Itemized Deductios Y Phases out all deductios except for the charitable deductio ad the mortgage iterest deductio Capital gais/iterest icome 20% Log-term cap gais ad divideds of 0%, 15%, ad 20% Net ivestmet surcharge 3.8% et Ivestmet Surcharge Elimiate Cap tax beefit of itemized deductios at 28% of deductios. Disallow IRA cotributios for IRA above a certai amout (mega-iras) Top rate o short-term gais remais 43.4% (39.6% + 3.8%). Raises rates o medium-term capital gais (ivestmets held less tha 6-years) to betwee 24% ad 39.6%. Adds a 4% surtax o icome over $5 millio. Maitais the surcharge Tax-Credits Various Not Specified Creates a ew tax credit of up to $1,200 for caregivers. Corporate Tax Iversios No limitatio Eds the deferral of overseas corporate icome but preserves the foreig tax credit. Eacts a deemed repatriatio of foreig icome at a 10% rate Estate Tax Federal top rate is 40% Elimiates the estate tax Other Taxes Federal top rate is 40% * Cadidate views o the muicipal icome exclusio are ukow/ot specified Taxes carried iterest at ordiary icome rates. Places a "reasoable cap" o the deductibility of iterest agaist the corporate icome tax Stregthes rules prevetig iversios ad creates a "exit tax" o urepatriated earigs of U.S. firms goig through iversios. Icreases the top Federal estate ad gift tax rates to 45% (from 40%), ad lowers the estate tax exclusio to $3.5 millio (from $5.45 millio) Taxes carried iterest at ordiary icome rates. Iitiates a tax o high-frequecy fiacial trasactios. Creates busiess tax credits for profit-sharig ad appreticeships Source: Source: J.P. Morga 6

7 How much do margial tax rates really matter? We compare the top margial tax rate ad the average tax rate for the top 5% of filers, to 20yr muicipal/treasury ratios, goig back to 1988, usig the average of the 10yr ad 30yr Treasury rates as a proxy for 20yr Treasury yields The data actually shows a very teuous correlatio betwee the iterest paid of a 20yr AAA bod (represeted usig the muicipal/treasury ratios) ad tax levels The correlatio betwee the top tax rate ad 20yr mui/tsy ratios is ad the correlatio betwee the average tax rate o the top 5% of filers ad the 20yr mui/tsy ratio is This idicates a very weak egative correlatio betwee tax rates ad the relative value of muicipal bods to Treasuries Chages to idividual tax rates have historically ot drive relative cost of capital Source: IRS, Thomso Reuters, J.P. Morga 7

8 Meaigful pedig regulatio Fudametal Review of Tradig Book (FRTB) The ew regulatio, dubbed Fudametal Review of Tradig Book (FRTB), was desiged to elimiate differeces i regulatory capital requiremets betwee the bakig book ad tradig book Implemeted by Jauary 1st 2020 ad apply to tradig books held at ay fiacial istitutio regulated by the Fed, OCC, or the FDIC.) Federal Reserve allow muicipals as 2B HQLA The fial rule icludes some muicipals as level 2B liquid assets uder the Liquidity Coverage Ratio (LCR) rule The criteria for iclusio of U.S. Muicipal securities as Level 2B liquid assets are as follows: 1) U.S. Geeral Obligatio Muicipal Securities 2) Ivestmet Grade 3) Prove record as a reliable source of liquidity 4) Not a obligatio of a fiacial sector etity Other agecies (OCC & FDIC) have ot followed House Bill HR 2209 Qualifyig Muicipals as 2A liquid assets passed to Seate O 2/1/2016, the House passed legislatio (H.R. 2209) allowig large baks to cout liquid/ivestmet-grade muis as level 2A assets, uder HQLA for federal bak liquidity. To move forward, the Seate must pass its Seate equivalet (H.R. 3404) Rough estimates for FRTB madated capital withholdig for GO debt rise expoetially for BBB ad lower rated bods Capital Withholdig Curret *Projected FRTB Proportio Chage (X) AAA 1.60% 0.5% 0.31 AA 1.60% 2.0% 1.25 A 1.60% 3.0% 1.88 BBB 1.60% 6.0% 3.75 BB 1.60% 15.0% 9.38 B 1.60% 30.0% CCC 1.60% 50.0% * Rough projectio based o kow parameters Source: Basel Committee o Bak Supervisio, J.P. Morga Note: Percetages show are a proportio of market value SEC 22e-4: Ope-ed fud liquidity risk maagemet Would require each registered $1b or higher ope-ed fud, icludig ope-ed ETFs, but ot icludig moey market fuds, to establish a writte liquidity risk maagemet program Fud assets would be segregated by the time it would take to liquidate the positio with a impact o the market price of the security. The six proposed liquidity beaks are: 1 busiess day; 2-3 busiess days; 4-7 caledar days, 8-15 caledar days, caledar days, ad 30 or more caledar days The 15% limit o illiquid assets defied as ay security that could ot be sold withi 7 days at the positio mark) Level 2A assets are subject to a 15% haircut, ad the aggregate amout of level 2A ad 2B liquidity assets is limited to o more tha 40% of a covered compay s HQLA amout. Level 2B liquid assets are subject to a 50% haircut ad may ot exceed 15% percet of a covered compay s HQLA amout S 3257 The Muicipal Bod Market Support Act Would icrease the size of Bak Qualified bod deals to $30m from $10m, curretly vetted by Seate Fiace Committee 8

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