Fitch Affirms CalSTRS Credit Enhancement Program at 'AA+/F1+'

NEW YORK--()--Fitch Ratings has affirmed the 'AA+/F1+' rating assigned to the credit enhancement program (CEP) sponsored by the California State Teachers' Retirement System (CalSTRS, the system).

The Rating Outlook is Stable.

SECURITY

CalSTRS' CEP provides direct and confirming letters of credit (LOCs) and standby bond purchase agreements (SBPAs) for municipal issuers. CalSTRS is unconditionally obligated to provide liquidity for any facilities under the CEP program from available short- or long-term assets. Fitch reviews the investments of the State Teachers' Retirement Plan (STRP, the Plan), which is the primary source of liquidity for any draws under the CEP.

KEY RATING DRIVERS

LOW-RISK CEP PROFILE: CalSTRS' CEP obligors include largely high-quality credits in California and several other states. In addition, the weighted average maturity of the remaining portfolio is less than one year.

HIGH LIQUIDITY CUSHION: Fund assets cover the maximum CEP exposure by a wide margin, even with the significant Fitch discounting of assets. The 'F1+' short-term rating reflects the highly liquid assets that are available to immediately cover draws on the program.

SHORT DURATION LIMITS SPONSOR IMPACT: While the credit quality of the state (California general obligation [GO] bonds rated 'A+' by Fitch) is below average relative to other state ratings, exposure to the sponsor and various employers is largely offset by the short duration of the CEP which is in run off mode with its final commitment due in 2017.

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.

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. Fitch applies conservative stresses to ensure that even with severe discounting of the Fund's assets, resources would still be sufficient to meet benefit payouts (including contributions and administrative expenses) and the CEP's maximum allocation.

FUND INVESTMENT PERFORMANCE IMPORTANT: CalSTRS' ability to achieve investment results that consistently meet or outpace (on average) the benchmark return on investments is important to maintaining the credit quality of the CEP.

CREDIT PROFILE

CalSTRS' CEP currently generates additional income for the pension system by providing a total of $488 million in credit and liquidity support for 12 municipal and bank obligors through confirming or direct-pay LOCs and/or SBPAs. These facilities, which consist of tax-supported and water/wastewater utility pledges, are scheduled to expire by March 1, 2017 or earlier. While the CEP has a maximum allocation limit of $5.8 billion, management reports that the CEP is in wind down mode and is not entering into new commitments.

Fitch's evaluation of CEP programs considers four broad areas: the CEP's risk profile, available liquidity and the investment portfolio, 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 to the CEP 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. The guidelines require that all obligors have an investment grade rating and approximately 83% of the current commitments are to obligors rated at least 'AA' or higher. The CEP maintains written detailed funding procedures specifying the timing and the funds from which monies would be tapped to satisfy a draw.

Available Liquidity and Investment Portfolio

Fitch also considers the liquidity available to meet CEP obligations. This includes a comparison of the Plan'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 May 31, 2015, CalSTRS' STRP investment portfolio totaled $193 billion, an increase from $185 billion the prior year. This reflects a 7.7% return on investments from 2014 and payment of benefits. CalSTRS investment policies are designed to allow the system to achieve a long-term total return. Fitch views CalSTRS' ability to continue to achieve investment results that meet or outpace (on average) the benchmark return on investments as an important factor in maintaining the credit quality of the CEP.

The STRP's liquidity is strong and within the investment portfolio, management maintains an abundance of cash and high-quality, highly-rated fixed income investments to fund any draws under the CEP at the maximum $5.8 billion limit. Based on a one-year historical monthly average, liquidity resources, derived from cash and highly rated fixed income securities total approximately $15 billion a month (without applying any Fitch discounts). Fitch also applied conservative discounts to the STRP's net assets per Fitch's criteria. These scenarios demonstrated that even with severe discounting of the market values of total invested assets, system resources are still more than sufficient to satisfy maximum CEP draws on any day and continue making near-term benefit payouts.

Sponsor Credit Quality

Though pension funds face the risk that sponsor payments may be delayed during periods of financial stress, Fitch believes the short duration of the CEP relative to the life of the pension liabilities, the liquidity of the CEP assets, and the current adequate funding level of the pension fund sufficiently mitigate this concern.

As of June 30, 2014, the CalSTRS members included employees of approximately 1,700 school districts, community college districts, and county education offices and regional occupational programs and were contributing to the STRF. The employees consist of approximately 480,239 members with Los Angeles Unified School district as the largest single employer accounting for approximately 8% of the total membership. 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 the 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 addressed CalSTRS' unfunded liability and incorporated a detailed funding plan to ensure that the system remains viable. The funding plan required increased contributions, effective July 1, 2014, from all CalSTRS stakeholders - school districts, the state and teachers. In March 2015, CalSTRS reported that the funding gap has shrunk slightly. Last year's projections marked a funding shortfall of $73.7 billion and this year demonstrated a 1.6% increase in the funded ratio from 66.9% to 68.5%.

Due to the new funding structure, for the first time in nearly 10 years, projections indicate that contributions are sufficient to meet future needs (based on the current 7.5% investment assumption) and the program is expected to be fully funded by 2046.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Rating Closed-End Fund Debt and Preferred Stock (pub. 04 Sep 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=765528

Rating U.S. Public Finance Short-Term Debt (pub. 07 Jan 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=846969

Additional Disclosures

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=987898

Dodd-Frank Rating Information Disclosure Form

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=987898

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Maura McGuigan
Senior Director
+1-212-908-0591
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kasia Reed
Analytical Consultant
+1-212-908-0500 x5065
or
Committee Chairperson
Douglas Offerman
Senior Director
+1-212-908-0889
or
Media Relations:
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Maura McGuigan
Senior Director
+1-212-908-0591
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kasia Reed
Analytical Consultant
+1-212-908-0500 x5065
or
Committee Chairperson
Douglas Offerman
Senior Director
+1-212-908-0889
or
Media Relations:
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com