CHICAGO--(BUSINESS WIRE)--Fitch Ratings affirms its 'AA+' long-term rating and 'F1+' short-term rating on the credit enhancement program (CEP) sponsored by the California State Teachers' Retirement System (CalSTRS).
The Rating Outlook is Stable.
PROGRAM DETAIL AND SECURITY
CalSTRS' CEP provides direct and confirming letters of credit (LOCs) and other liquidity facilities for municipal issuers. CalSTRS is unconditionally obligated to provide liquidity/credit enhancement from available assets.
KEY RATING DRIVERS
LOW-RISK CEP PROFILE: CalSTRS' CEP obligors include high-quality credits throughout the state and nation. In addition, program guidelines require the weighted average maturity of the program's portfolio 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 BELOW ADEQUATE: The overall funded status of the pension fund is considered below adequate by Fitch, even before applying Fitch's more conservative liability discount rates.
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, credit exposure 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.
STATUTORY FRAMEWORK LIMITS FLEXIBILITY: CalSTRS' contribution rates are set by statute and require legislative action to change, unlike other public pension systems which have the power to raise contribution rates.
STRONG LIQUIDITY ESSENTIAL: Maintenance of a strong liquid cushion over potential CEP liabilities and annual benefit payouts and expenses is critical to maintaining the current rating level.
FUND PERFORMANCE CRITICAL: Significant declines in the pension fund's overall funding level and/or rising fund payouts that outpace inflows, particularly in light of statutory funding limitations, could erode credit quality. This sensitivity is less of a concern due to the anticipated wind-down of the CEP over the next three years.
CalSTRS' CEP currently generates additional income for the pension system by providing a total of $1 billion in credit and liquidity support for 15 municipal and bank obligors through confirming or direct-pay LOCs and other liquidity facilities. These transactions largely consist of tax supported and water/wastewater utility pledges.
The CEP has a maximum allocation that is limited to 3% of invested assets (or $5.5 billion). However, in September 2013, CalSTRS announced that it would suspend new underwriting and completely wind-down the CEP by fiscal 2017. While the program has not sustained any losses in its 20-year history, management believes that the CEP is no longer an attractive opportunity due to heightened credit risk and a resulting unfavorable risk/reward profile.
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 other liquidity facilities. 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 all obligors have an investment grade rating, approximately 90% of the current commitments are to obligors rated in the 'AA' category or higher. Obligor pledges are also strong, as roughly two-thirds of the enhanced credits have tax-supported or water/wastewater utility pledges. Detailed funding procedures are also maintained specifying the timing and the funds from which monies would be tapped to satisfy a draw.
Fitch's second area of assessment 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 potential discounting of available assets for perceived timing delay.
As of May 30, 2014, CalSTRS' investment portfolio totaled $184.8 billion. 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 $5.5 billion limit. Even when Fitch applies additional stresses that severely discounted 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 also 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), CalSTRS' pension plan was funded at a low 67%. Using Fitch's more conservative 7% liability discount rate assumption, the plan is funded at 63%.
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 and the liquidity of the CEP sufficiently mitigate this concern. As of June 30, 2013, roughly 1,700 school districts, community college districts, county education offices and regional occupational programs were contributing to the fund. As the sponsor, the state's contributions accounted for approximately 5% of fiscal 2013 additions to the program.
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.
Unlike its public employee counterpart CalPERS (CEP rated 'AAA'/'F1+' by Fitch), CalSTRS' contribution rates are set by statute and require legislative action to change. This legal framework limits CalSTRS' ability to maintain full funding of pension liabilities and is viewed by Fitch as a negative credit factor.
On June 24, 2014, California's governor signed into law AB 1469, which addresses CalSTRS' unfunded liability and incorporates a detailed funding plan to ensure that the system remains viable. The funding plan requires increased contributions, effective July 1, 2014, from all CalSTRS stakeholders - school districts, the state and teachers. While the increased contributions are projected to improve the system's funded ratio (estimated 70% funded by 2024), the increased contributions will likely add pressure to CalSTRS' stakeholders.
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
Rating Closed-End Fund Debt and Preferred Stock
Rating U.S. Public Finance Short-Term Debt