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US State* and Territory Unfunded Pension Liabilities

Jim Evans, CFA Director, Tax Advantaged Bond Strategies


MainStreet Advisors 2012 Conference

* Excludes the following states whose pension allocations were not provided by Fitch: Arizona, Arkansas, Colorado, Nebraska, New Mexico, North Dakota and Wyoming.

Eaton Vance
1. Eaton Vance believes that the condition of public pensions will become an even more important factor in determining creditworthiness in the municipal marketplace. 2. Why is this important to bond holders? Pension benefits are almost always constitutionally protected at the State level. Increased pension funding could pressure municipal cash flows and result in meaningful downgrades of municipal bonds. 3. While estimates vary as to the level of underfunding, a consensus exists that many public pensions are underfunded. 4. On July 2, 2012, Moodys proposed adjustments to its methodology regarding pension assumptions: These changes included discounting actuarial accrued liabilities using a high-grade long-term corporate index (5.5% in 2010 and 2011) rather than using issuer discount rates (which range between 7.5% and 8.25%). The proposed adjustments increase Moodys unfunded actuarial accrued pension liabilities (UAAL) for state and local governments to $2.2 trillion from $766 billion.

Source: Moodys Adjustments to US State and Local Government Reported Pension Data, July 2, 2012. 1

Eaton Vance
The following data may help evaluate the magnitude of the states unfunded liabilities: Page 3 - Debt as a percentage of State GDP Page 4 - Debt + Unfunded Pension as a percentage of state GDP using the states' assumed discount rates of 7.25% to 8.50% Page 5 - Debt + Unfunded Pension as a percentage of state GDP using a 5.5% discount rate for pensions. To arrive at the new unfunded liabilities, Eaton Vance used Moodys proposed adjustment methodology, whereby for each 1% difference between 5.5% and a plans discount rate, the actuarial accrued liability increased by roughly 13%. Page 6 - Same as page 5 but includes Puerto Rico Page 7 - State and Local tax burden as a percentage of per capita income Importantly, certain major pension reforms are being enacted. Since 2009, 43 states have enacted pension reforms, and the savings achieved from the 2010 and 2011 reforms are not reflected in the above estimated numbers. Examples of reform include, Rhode Island, which reduced its unfunded liability by an estimated $1.7 billion (39%) through benefit cuts enacted in 2011*, and in New York recently enacted reforms could save the state $80 billion over 30 years**.
*Source:Rhode Island Enacts Pension Reform Legislation, a Credit Positive, Moodys 11/21/11. ** New York State Pension Reform Provides Long-Term Credit Benefits to the State and Local Governments, Moodys 3/22/12. 2

State Debt as % of State GDP

* Data unavailable for AR, AZ, CO, ND, NE, NM and WY

Debt burden seems quite tolerable

3 Source: Debt is net tax supported debt from Moodys May 2012, GDP from the US Bureau of Economic Analysis June 2012.

Debt and Unfunded Pension Liability as % of State GDP


Discounting pension liabilities at various states assumed rates ranging from 7.25% - 8.5%.

* Data unavailable for AR, AZ, CO, ND, NE, NM and WY

States assumed discount rates seem unrealistic in todays market

Source: Debt is net tax supported debt from Moodys May 2012. Pension liabilities from The Widening Gap Update Pew Center on the States June 2012. States estimated pension liabilities are based upon the states share of the total state and local liabilities as per Fitch Ratings 4 Improving Comparability of State Liabilities (March 2012). GDP from the Bureau of Economic Analysis June 2012.

Debt and Unfunded Pension Liability as % of State GDP


Discounting pension liabilities at 5.5% consistent with Moodys new proposed methodology.

* Data unavailable for AR, AZ, CO, ND, NE, NM and WY

Even with Moodys more conservative assumptions, most states have manageable burdens

Source: Debt is net tax supported debt from Moodys May 2012. Pension liabilities from The Widening Gap Update Pew Center on the States June 2012. States estimated pension liabilities are based upon the States share of the total State and Local liabilities as per Fitch Ratings Improving Comparability of State Liabilities (March 2012). States pension plan discount rates from Enhancing the Analysis of US State and Local Government Pension Obligations Fitch February 2011. Eaton Vance then applied a 5.5% discount rate to pension liabilities, based on 5 Moodys Adjustments to US State and Local Government Reported Pension Data, July 2, 2012, where for each 1% difference between 5.5% and a plans discount rate, the actuarial accrued liability increased by roughly 13%. GDP from the US Bureau of Economic Analysis June 2012.

Debt, Unfunded Pension Liability as % of State/Territory GDP


Discounting pension liabilities at 5.5% consistent with Moodys new proposed methodology.

* Data unavailable for AR, AZ, CO, ND, NE, NM and WY

However, the Commonwealth of Puerto Rico stands out

Source: Debt is net tax supported debt from Moodys May 2012. Pension liabilities from The Widening Gap Update Pew Center on the States June 2012, PRs pension liability from PRs 2011 Comprehensive Annual Financial Report. States estimated pension liabilities are based upon the States share of the total State and Local liabilities as per Fitch Ratings - Improving Comparability of State Liabilities (March 2012), PRs share from Moodys June 8, 2012 rating report. States pension plan discount rates from Enhancing the Analysis of US State and Local Government Pension Obligations Fitch February 2011. Eaton Vance then applied a 5.5% discount rate to pension liabilities, based on Moodys 6 Adjustments to US State and Local Government Reported Pension Data, July 2, 2012, for each 1% difference between 5.5% and a plans discount rate, the actuarial accrued liability increased by roughly 13%. State GDP from the US Bureau of Economic Analysis June 2012. PR GDP from the CIA World Factbook.

State and Local Tax Burden as a % of Per Capita Income

Some states have more room to raise taxes than others

7 Source: The Tax Foundation, Special Report, February 2011, No. 189. State and Local Tax Burdens by Rank Fiscal Year 2009.

Tax-Advantaged Bond Strategies (TABS) Fund


Second Quarter 2012

Not FDIC Insured

Not Bank Guaranteed


For Investment Professional Use Only.

May Lose Value

Why TABS?
Relative Value Muni Trading
make bid/offer spread work for shareholders

Robust Credit analysis


A* and higher quality

Crossover
because munis arent always best

Funds offer a variety of Duration Targets


Short | Intermediate | Long

*Ratings are based on Moodys, S&P or Fitch, as applicable. Credit ratings are based largely on the rating agencys investment analysis at the time of rating and the rating assigned to any particular security is not necessarily a reflection of the issuers current financial condition. The rating assigned to a security by a rating agency does not necessarily reflect its

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assessment of the volatility of a securitys market value or of the liquidity of an investment in the security. If securities are rated differently by the rating agencies, the higher rating is applied. Ratings of BBB or higher by Standard and Poors or Fitch (Baa or higher by Moodys) are considered to be investment grade quality.

Credit: Avoiding Landmines


Unfunded Pension Liabilities

Strained Budgets

Dedicated Muni Credit Analysts

Downgrades / Defaults

Credit Agency 1 Rates as AA 1 But is it really AA ?

The Fund normally invests in Municipal securities and Taxable Municipal securities rated AA or higher, but may also invest up to 30% of its net assets in securities rated A. Ratings are based

on Moodys, S&P or Fitch, as applicable. Credit ratings are based largely on the rating agencys investment analysis at the time of rating and the rating assigned to any particular security is not necessarily a reflection of the issuers current financial condition. The rating assigned to a security by a rating agency does not necessarily reflect its assessment of the volatility of a securitys 15 market value or of the liquidity of an investment in the security. If securities are rated differently by the rating agencies, the higher rating is applied. Ratings of BBB or higher by Standard and Poors or Fitch (Baa or higher by Moodys) are considered to be investment grade quality.

Supply and Demand Imbalances Cause Price Inefficiencies


2011 Calendar Year Issuance

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Source: Bloomberg Finance LP. For illustrative purposes only. Data includes new issue volumes of all maturities. Not intended to reflect the holdings of any Eaton Vance product.

Make the Bid/Offer Spread Work for Shareholders


SEC Study1 - median spread for retail sized trades was 2.23%
Hypothetical Example

A dealer buys 1mm+ bonds at 110.032

Small block sold to customer at 2.2% mark-up

How much of a mark-up have buyers paid? To find out go to www.InvestingInBonds.com2

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1 2

Source: Report on Transactions in Municipal Securities, Securities and Exchange Commission, July 2004. Retail size trades are less 25K transactions size. Source: investinginbonds.com. For illustrative purposes only. The hypothetical example was chosen as a fair representation and does not represent the experience of individual

investors. Please refer to the back of this presentation for important information and disclosure.

Munis Always the Right Play?

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Source: Agency Yields Bloomberg Finance LP. Muni Yields Thomson Reuters. After Tax Agency yields are calculated by multiplying the pretax yield by the highest marginal federal tax rate at that time. (39.6% from 1992-1999 ; 35% 2000 to present). After Tax Muni yields are calculated by multiplying the pretax yield by an assumed 4% effective state tax rate. US Treasuries and FHLB Agencies are exempt from State tax. This is for informational purposes only and not intended to reflect the trading activity of any Eaton Vance product.

TABS Does it work?

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Source: Morningstar. Rankings are based on total returns for all funds within a respective category over the stated period. Past performance is no guarantee of future results. Rankings for other share classes offered by the funds are different. Absent expense waivers for Tax-Advantaged Bond Strategies Intermediate Term Fund and Tax-Advantaged Bond Strategies Long Term Fund, total return would be less.

Summary Why TABS?

1. High Quality
- A* and higher - robust credit analysis

2. Value Added - relative value muni trading


- crossover: because munis arent always best

For more information about Eaton Vance Municipals, visit: www.eatonvance.com/muni


20 *Ratings are based on Moodys, S&P or Fitch, as applicable. Credit ratings are based largely on the rating agencys investment analysis at the time of rating and the rating assigned to any particular security is not necessarily a reflection of the issuers current financial condition. The rating assigned to a security by a rating agency does not necessarily reflect its assessment of the volatility of a securitys market value or of the liquidity of an investment in the security. If securities are rated differently by the rating agencies, the higher rating is applied. Ratings of BBB or higher by Standard and Poors or Fitch (Baa or higher by Moodys) are considered to be investment grade quality.

About Risk: An imbalance in supply and demand in the municipal market may result in valuation uncertainties and greater volatility, less liquidity, widening credit spreads and a lack of price transparency in the market. There generally is limited public information about municipal issuers. As interest rates rise, the value of certain income investments is likely to decline. Investments in income securities may be affected by changes in the creditworthiness of the issuer and are subject to the risk of nonpayment of principal and interest. The value of income securities also may decline because of real or perceived concerns about the issuers ability to make principal and interest payments. While certain U.S. governmentsponsored agencies may be chartered or sponsored by acts of Congress, their securities are neither issued nor guaranteed by the U.S. Treasury. No Fund is a complete investment program and you may lose money investing in a Fund. The Fund may engage in other investment practices that may involve additional risks and you should review the Fund prospectus for a complete description. Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of a mutual fund. This and other important information is contained in the prospectus and summary prospectus, which can be obtained from a financial advisor. Prospective investors should read the prospectus carefully before investing. Not FDIC Insured Not Bank Guaranteed May Lose Value Investment Professional Use Only. Not To Be Used With the Public.

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Thank You.
For more information please contact us at: Eaton Vance Distributors, Inc. Two International Place Boston, MA 02110 800.225.6265 www.eatonvance.com Member FINRA/SIPC

5818-7/12

For Investment Professional Use Only.

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