Fitch Affirms CalPERS Credit Enhancement Program at 'AAA/F1+'

NEW YORK--()--Fitch Ratings has affirmed the 'AAA/F1+' rating assigned to the credit enhancement program (CEP) sponsored by the California Public Employees' Retirement System (CalPERS, the system).

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 for any facilities under the CEP program from available short- or long-term assets. Fitch reviews the investments of the Public Employees' Retirement Fund (PERF, the Fund), which is the primary fund of CalPERS 15 programs, and the source of liquidity for any draws under the CEP.

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 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, and many of the participating 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 adequate funding level of the pension fund.

FUND INDEPENDENCE A STRENGTH: The statutory framework, which give CalPERS the power to raise contribution rates and the ability to adjust payouts if an entity is not paying into the Fund, enhance the likelihood of consistently 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. 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: CalPERS' ability to continue to diversify assets and 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

CalPERS' CEP currently generates additional income for the pension system by providing a total of $604 million in credit and liquidity support for seven municipal obligors through LOCs and/or SBPAs. These facilities, which consist of tax-supported and water/wastewater utility pledges, are scheduled to expire by March 6, 2018 or earlier. While the CEP has a maximum allocation limit of $10 billion, management expects that program commitments will not exceed $2.5 billion.

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 its potential exposure 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 an average obligor credit quality rating of 'A' be maintained, and all but two of the current seven commitments are to obligors rated at least 'AA' or higher.

Obligor pledges are also strong, as all of the enhanced credits have tax-supported or water/wastewater utility pledges. Currently, the longest CEP obligation matures in 2018; this is well within the program's required five-year weighted average maturity. Written 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 July 2009, 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 and Investment Portfolio

Fitch also considers the liquidity available to meet CEP obligations. This 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, 2014, CalPERS' PERF investment portfolio totaled $301 billion, an increase from $260 billion the prior fiscal year. This reflects an 18.4% return on investments at fiscal year-end. 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. Fitch views CalPERS' ability to continue to diversity assets and 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 Fund's liquidity is strong and able to meet the CEP's maximum obligations. 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 $10 billion limit. Based on a three-year historical daily average, liquidity resources, derived from cash and highly rated fixed income securities total approximately $42 billion a day (without applying any Fitch discounts). Fitch also applied conservative discounts to the Fund'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 state had 1,580 public agencies and 1,513 schools contribute to the Fund. The state is the sponsor and largest employer accounting for approximately 30% of total PERF members. 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.

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.

Further, if a member were to reduce its payments, it is expected that CalPERS would reduce member benefits for that entity by the same amount, as state law prohibits the use of CalPERS' assets to fund benefits of other non-participating agencies. Consequently, Fitch currently believes there is limited concern that any reduction of payments alone would weaken CalPERS' funding status or liquidity.

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

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=987909

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=987909

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