Fitch Affirms Texas Permanent School Fund at 'AAA'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has affirmed its 'AAA' rating on the Texas Permanent School Fund's (PSF) bond guarantee program.

The Rating Outlook is Stable.

SECURITY

Local school district bonds approved under the program are guaranteed by the corpus and income of the PSF. By law, a school district must notify the Commissioner of Education at least five days before a maturity date if it will be unable to pay debt service. Funds would then be transferred from the appropriate PSF account of the state treasury to the paying agent in an amount sufficient to pay debt service.

KEY RATING DRIVERS

QUALITY BOND PORTFOLIO: The bond guarantee program's (BGP) portfolio of school districts is mostly highly rated and diverse in comparison to similar municipal pool structures rated by Fitch. Nearly all of the school districts in the BGP are backed by unlimited ad valorem tax pledges.

FUND ASSETS PROVIDE STRONG COVERAGE: The discounted market value of the PSF's asset portfolio is sufficient to cover hypothetical BGP defaults in excess of Fitch's 'AAA' rating stresses.

INCREASES IN LEVERAGE: Sufficient program capacity exists to support further increases in the amount of guaranteed obligations relative to PSF assets (i.e. leverage) beyond what is currently allowed by statute.

STRINGENT PROGRAM OVERSIGHT: The state's oversight of Texas school districts provides added protection to bondholders against program bond defaults. No Texas school district has defaulted on its debt since the Great Depression.

RATING SENSITIVITIES

GENERAL PROGRAM DETERIORATION: Deterioration of the bond guarantee program's credit quality, substantial reductions in the market value of the fund assets, a move toward less liquid asset types, or a significant increase in program leverage could put negative pressure on the rating.

CREDIT PROFILE

The PSF is a perpetual endowment that was established in 1854 to support Texas public schools. In 1983, voters approved a constitutional amendment providing for the guarantee of school district debt by the PSF. As of April 30, 2015, through its guarantee program the PSF supported approximately $60.7 billion in school district and charter school bonds from nearly 830 issuers in the state of Texas.

QUALITY SCHOOL DISTRICT BOND PORTFOLIO

Fitch's quantitative analysis begins by calculating the default risk of the BGP using Fitch's Portfolio Stress Calculator (the PSC--as described in Fitch's State Revolving Fund and Municipal Loan Pool Criteria [MLP criteria]). The PSC produces a portfolio-level liability rating stress hurdle based on the obligors' credit ratings, relative size, term and concentration. The rating stress hurdle is measured against the amount of structural enhancement, or the amount of discounted PSF assets available to cover hypothetical BGP losses (principal and interest), to determine if the program passes at a given rating stress.

The BGP consists of nearly 830 obligors, approximately 64% of which are rated investment grade or higher and 52% are rated at or above 'AA-'. The top 10 obligors represent just 24% of the BGP total and none are larger than 4% of the total. Based on this composition, the PSF's 'AAA' liability rating stress hurdle is calculated to be approximately 44%. Taking into account Fitch's standard MLP criteria recovery assumption of 90%, based on $99.6 billion of current schedule of principal and interest payments, the projected losses at a 'AAA' stress level would be $4.4 billion.

FUND ASSETS PROVIDE LOSS PROTECTION

After sizing for the default risk of the BGP, Fitch then calculates the amount of available fund assets to cover such attributable losses under an 'AAA'-level liquidation stress. At fiscal-year end 2014, the market value of the PSF's asset pool was approximately $38.4 billion. Application of Fitch's baseline 'AAA' discount factors results in $9.4 billion of available assets to cover the projected BGP losses of $4.4 billion. The discounting methodology applied to the assets is described in Fitch's 'Rating Closed-End Fund Debt and Preferred Stock Criteria' (CEF criteria).

As of the last fiscal year, investments managed by the State Board of Education (SBOE) on behalf of the PSF included approximately 38% domestic and international equities, 30% alternative investments, and 12% fixed income securities (mostly U.S. treasuries, government agency, and high-grade corporate obligations). The remaining investments, managed by the School Land Board, included cash (5%), plus land, real assets and minerals (15%). In Fitch's analysis, each asset bucket is subjected to varying degrees of stress based on the CEF criteria.

PROGRAM LEVERAGE LIMITED BY STATUTE

The BGP's leverage capacity is restricted by both state statute and IRS rules. While both allow leverage up to 5x the PSF's book value, the SBOE annually reviews the state capacity limit and is in the process of extending such capacity from 3x to 3.25x. Based on the $28.5 billion PSF book value as of April 30, 2015, the BGP's current leverage limit of 3.25x would allow bond guarantees of up to approximately $95 billion (taking into account a current 5% reserve requirement).

As further increases in leverage are probable, Fitch ran stress scenarios which demonstrate that given the current composition of the BGP, the BGP's aggregate debt service schedule, and the current market value and investment allocations of the fund assets, an increase in leverage of up to 4.0x would still likely exhibit 'AAA' rating characteristics. However, the BGP's future leverage capacity will be dependent upon the fund's investment performance, school district bond issuance and the state and federal limits. Fitch views positively the requirement that SBOE annually adjust the limit if the credit quality of the program is threatened.

GUARANTEE PORTFOLIO UNDERWRITING AND MONITORING

Qualification for the BGP is restricted to bonds that are voter approved and backed by a property tax levy from an accredited school district. Approval is granted to districts issuing new money bonds for capital facilities, districts issuing refunding bonds which produce debt service savings, and districts with less than $1,982 annual debt service per student in average daily attendance at the time of the application for the guarantee. Charter school district bond guarantees require approval by the Attorney General, an unenhanced investment-grade rating from a nationally recognized investment rating firm, and completion of a limited investigation conducted by the Texas Education Agency (TEA). The TEA, which is headed by the Commissioner of Education (the commissioner), also provides control on school district credit quality by reviewing performance and financials annually. Fitch believes school district oversight in Texas is strong.

Beginning in May 2014, the PSF began issuing guarantees for bonds offered on behalf of a charter school district by non-profit corporations. The guarantee capacity under the program is based on a ratio of charter students to public school students (currently 4.36%), as annually determined by the commissioner. This percentage is applied against the available capacity of the bond guarantee program. Currently, there are 11 charter school districts with an aggregate principal amount of $532.5 million that are guaranteed under the PSF (0.9% of the guaranteed portfolio).

SOUND FUND MANAGEMENT

The PSF's SBOE financial assets are managed under the direction of the SBOE, with management duties delegated to the PSF's investment office, a division of the TEA. The investment objective is to grow the fund's market value to meet the required school district distribution rate, which is used to support school operations, while sustaining the market value for the purpose of the guarantee program. Over the past several years, distributions, have accounted for approximately 3% to 4% of the total fund and are capped at 6%.

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

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

State Revolving Fund and Leveraged Municipal Loan Pool Criteria (pub. 22 Oct 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=792908

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=989055

Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=989055

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

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Contacts

Fitch Ratings
Primary Analyst:
Major Parkhurst, +1-512-215-3724
Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst:
Julie G. Seebach, +1-512-215-3743
Director
or
Committee Chairperson:
Vincent J. Barberio, +1-212-908-0505
Managing Director
or
Media Relations:
Sandro Scenga, +1-212-908-0278
New York
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Major Parkhurst, +1-512-215-3724
Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst:
Julie G. Seebach, +1-512-215-3743
Director
or
Committee Chairperson:
Vincent J. Barberio, +1-212-908-0505
Managing Director
or
Media Relations:
Sandro Scenga, +1-212-908-0278
New York
sandro.scenga@fitchratings.com