CHICAGO--(BUSINESS WIRE)--Fitch Ratings affirms its 'AAA' long-term rating and 'F1+' short-term rating on the credit enhancement program (CEP) sponsored by the California Public Employees' Retirement System (CalPERS).
The Rating Outlook is Stable.
SECURITY
CalPERS' CEP provides letters of credit (LOCs) and standby bond purchase agreements (SBPAs) for municipal issuers. CalPERS is unconditionally obligated to provide liquidity/credit enhancement from available short- or long-term assets.
KEY RATING DRIVERS
LOW-RISK CEP PROFILE: CalPERS' CEP obligors include high-quality credits in California and several other states. In addition, the weighted average maturity of the portfolio may not exceed five years.
HIGH LIQUIDITY CUSHION: Fund assets cover the maximum CEP exposure by a wide margin, even with significant discounting of assets. The 'F1+' short-term rating reflects the availability of highly liquid assets that could immediately cover draws on the program.
PENSION FUNDING REMAINS ADEQUATE: The overall funded status of the pension fund is considered adequate, even after applying Fitch's more conservative discount rates and assessment of fund asset value.
SHORT DURATION LIMITS SPONSOR IMPACT: While the credit quality of the state (California general obligation bonds rated 'A' by Fitch) is below average and many of the employers are not rated by Fitch, exposure to the sponsor and employers is largely offset by the short duration of the CEP relative to the life of the pension liabilities and the current funding level of the pension fund.
FUND INDEPENDENCE A STRENGTH: The statutory framework and legal rulings, which give CalPERS the power to raise contribution rates, enhance the likelihood of continued adequate pension funding.
RATING SENSITIVITIES
STRONG LIQUIDITY ESSENTIAL: Maintenance of a strong liquid cushion over potential CEP liabilities and benefit payouts is critical to maintaining the current rating level.
FUND PERFORMANCE CRITICAL: Declines in the pension fund's overall funding level and/or rising fund payouts that outpace inflows could erode credit quality.
SUCCESSFUL CHALLENGE TO PENSION CLAIMS: A successful challenge by any CalPERS' members in bankruptcy court that allows for a reduction in payments to CalPERS could have negative implications to the credit quality of the CEP. Nevertheless, CalPERS' ability to equally reduce benefit payouts to a member's beneficiaries and to beneficiaries of any other agency that fails to make its contribution is likely to offset any concern.
CREDIT PROFILE
CalPERS' CEP currently generates additional income for the pension system by providing a total of $1.3 billion in credit and liquidity support for seven municipal obligors through LOCs and/or SBPAs. These facilities, which primarily consist of tax-supported and water/wastewater utility pledges, are scheduled to expire by Dec. 13, 2016 or earlier. While the CEP has a maximum allocation limit of $10 billion, management expects that program commitments will not exceed $2.5 billion.
FACTORS CONSIDERED IN ANALYSIS
Fitch's evaluation of CEP programs considers five broad areas: the CEP's risk profile, available liquidity, the financial condition of the pension system, sponsor quality, and management. Fitch does not rate the retirement system.
CEP RISK PROFILE
Fitch evaluates the overall operations of the CEP to determine potential exposure the CEP may face with regard to obligors to whom it has extended LOCs or SBPAs. This includes an assessment of obligor credit quality and diversification of obligors.
The CEP's maintenance of prudent underwriting guidelines and funding procedures minimizes program risk. While the guidelines require that an average obligor credit quality rating of 'A' be maintained, approximately half of the current commitments are to obligors rated at least 'AA' or higher.
Obligor pledges are also strong, as approximately 82% of the enhanced credits have tax-supported or water/wastewater utility pledges. Currently, the longest CEP obligation matures in 2016; this is well within the program's required five-year weighted average maturity. Detailed funding procedures are also maintained specifying the timing and the funds from which monies would be tapped to satisfy a draw.
The CEP maintains prudent policies and procedures that minimize risk. Like most LOC and SBPA providers, the CEP had some draws in 2008 and 2009, which until that time had been virtually unprecedented for municipal obligations. An increase in liquidity draws represents greater risk on the CEP. In 2008 and 2009, there were 43 liquidity draws on the CEP, representing seven of the program's then 15 issuers.
These draws totaled $237 million in aggregate, with a maximum of $115 million outstanding at one time. Most of the draws were outstanding under 30 days, although 14 (mostly related to the State of California) were outstanding between 31 and 75 days. CalPERS used its cash reserves and established procedures to liquidate high quality fixed income investments, which enabled all commitments to be met on a timely basis. Since August 2011, there have been no draws on the CEP.
The CEP is an off-balance-sheet component of CalPERS investment portfolio. Program commitments are accounted for as contingent liabilities. Management does not rank the priority of the program's commitment draws for making beneficiary payouts, as it is CalPERS expressed intent to fully meet every obligation in a timely manner.
AVAILABLE LIQUIDITY
Fitch also considers the liquidity available to meet CEP obligations. This analysis includes a comparison of the fund's liquid assets available to pay potential CEP liabilities and near-term obligations, as well as any discounting of available assets for potential timing delay.
As of June 30, 2013, CalPERS' investment portfolio totaled $258 billion, reflecting a 13.2% return on investments at fiscal year-end. The market value of the fund's assets totaled approximately $288 billion as of March 31, 2014. CalPERS investment policies are designed to allow the system to achieve a long-term total return. Therefore, management's objective is to broadly diversify assets to minimize the effects of short-term losses.
Within this portfolio, management maintains an abundance of cash and high-quality fixed income investments to fund any draws under the CEP at the maximum $10 billion limit. Based on a three-year historical daily average, liquidity resources total approximately $42 billion per day. Furthermore, when Fitch applies stresses that severely discount the market values of invested assets, system resources are still more than sufficient to satisfy maximum CEP draws and continue making near-term benefit payouts.
PENSION SYSTEM FINANCIAL CONDITION
Fitch evaluates the pension fund's overall health. In assessing the pension fund, Fitch considers the funding progress of accrued liabilities, the discount rate and the fund's investment strategy.
As of the latest actuarial valuation (June 30, 2013), CalPERS' pension plan was 83.1% funded. Using Fitch's more conservative 7% liability discount rate assumption, the plan is funded at an adequate 78.8%.
SPONSOR CREDIT QUALITY
Fitch considers the sponsors' credit quality, given that pension funds face the risk that sponsor payments may be delayed during periods of financial stress.
Exposure to the state's below-average credit quality is of some concern. However, Fitch believes the short duration of the CEP relative to the life of the pension liabilities, the liquidity of the CEP and the current adequate funding level of the pension fund sufficiently mitigate this concern. As of June 30, 2013, 1,581 public agencies and 1,508 schools were contributing to the fund. The state is the sponsor and largest employer, accounting for approximately 30% of total Public Employees' Retirement Fund members. With the exception of one small hospital district, all employers are currently making their required contributions.
MANAGEMENT
Fitch also considers the management of the CEP, which includes an assessment of policies and procedures, as well as the independence of the pension fund's governing body and statutory framework of the fund itself.
By law, employers must fund their annually required contributions at 100% and CalPERS has the authority to increase the funding requirement from employers to make up any contribution shortfalls. This power to raise contribution rates enhances management's ability to maintain full funding of pension liabilities. In addition, CalPERS sets all other policies for its system and has sole investing power, except for specific investments prohibited by the state legislature.
Uncertainty exists regarding the outcome of ongoing bankruptcy proceedings relating to the cities of San Bernardino and Stockton and the ability of employers to restructure/reduce pension liabilities. Any legal judgments that result in a permanent reduction in a member's ongoing pension obligation may open up the possibility of other employers filing bankruptcy to reduce their payments to CalPERS.
However, if a member were to reduce its payments it is expected that CalPERS would reduce member benefits for that entity by the same amount; state law prohibits the use of CalPERS' assets to fund benefits of non-participating agencies. Consequently, Fitch believes there is a small likelihood that any reduction of payments alone would weaken CalPERS' funding status or liquidity.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 2013);
--'Closed End Fund Debt and Preferred Stock' (August 2013);
--'Rating U.S. Public Finance Short-Term Debt' (December 2013).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
Rating Closed-End Fund Debt and Preferred Stock
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=716220
Rating U.S. Public Finance Short-Term Debt
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724680
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=839862
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