NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the 'AA-' rating on the following California Department of Veterans Affairs (Cal Vets, or the Department) bonds:
--Approximately $758 million state of California general obligation (GO) veterans bonds;
--Approximately $472 Cal Vets home purchase revenue bonds.
The Outlook for the bonds remains Negative.
SECURITY
The primary source of payment for the bonds is monies from the 1943 Fund. In addition, the veterans GO bonds are secured by the full faith and credit of the state of California and have an equal claim against the general fund of the state of California.
Home purchase revenue bonds are special obligations of the department payable solely from, and by a pledge of, an undivided interest in the assets of the 1943 Fund and the Veterans Debenture Revenue Fund which is secondary and subordinate to any interest or right in the fund of the people of the state of California and the holders of GO veterans bonds. There is also a bond reserve account in the Veterans Debenture Revenue Fund which was funded and is maintained in an amount equal to at least 3% of the outstanding revenue bonds to be used solely for the purpose of paying principal and interest on the revenue bonds.
KEY RATING DRIVERS
NEGATIVE FINANCIAL PERFORMANCE: The Negative Outlook reflects the program's $1.5 million operating loss in FY 2012, marking the fifth consecutive year of financial losses. The Department projects annual losses for the next two fiscal years in the $10 million-$12 million dollar range.
ABOVE-AVERAGE AMOUNTS OF RETAINED EARNINGS: The 'AA-' rating reflects the above-average amount of retained earnings in the program which are equal to 12.7% of bonds outstanding and 13.5% of loans outstanding in FY 2012, which increased from 11.6% and 11.8%, respectively, in FY 2011. This is the third straight year of increases albeit due to decreasing bond and loan balances.
PORTFOLIO PRESENTS RISKS: Approximately 47% of the loan portfolio (based on dollar amount) was originated from 2005 to 2008, making these loans susceptible to significant loan to value (LTV) volatility given pronounced housing value declines from the vintage 2006 peak in single-family housing valuations within the state of California.
NEW LOAN EXPECTATIONS: Any new loan originations are expected to be VA insured or be uninsured with a loan-to-value (LTV) below 80%.
HIGH LEVEL OF REOs CONTINUE: The portfolio still contains a high percentage of loans in the real estate owned (REO) status (48 loans or $8.6 million as of September 2012).
WHAT COULD TRIGGER A RATING DOWNGRADE
ADDITIONAL OPERATING LOSSES: Additional operating losses will further deteriorate retained earnings, thereby reducing asset parity coverage.
INCREASED DELINQUENCIES: Any increase in delinquencies or foreclosures could result in additional program losses.
CONTINUED WEAK STATE ECONOMY: A continuation of high unemployment levels and a general economic weakness within the state could result in increased delinquencies and foreclosures.
WHAT COULD CAUSE AN OUTLOOK REVISION
OPERATING INCOME: Operations of the Department break even annually for a few years.
CALIFORNIA HOUSING MARKET STABLILITY: The housing market in California stabilizes in all regions throughout the state.
UNEMPLOYMENT DECLINES: State unemployment levels maintain percentages below national averages or maintain levels under 6 percent.
CREDIT PROFILE
Overall, the program's delinquency rate, while high, has stabilized over the last two fiscal years at approximately 7%, which is reduced from a high of over 8.5% in 2011. The GO Veteran and home purchase revenue bonds are secured by a $1.2 billion contract loan portfolio which has demonstrated weak performance in recent years. As of September 2012, the portfolio had a delinquency rate (more than 60 days delinquent, including REO and foreclosures) of 7.07%, which is a slight increase from the 6.93% delinquency rate the program had in September 2011.
The Negative Outlook is based on continued operating losses and their subsequent negative impact on the program's surplus funds. The program and department operations incurred an operating loss of $1.5 million in FY 2012, which marks the fifth consecutive year of operating losses and the ninth fiscal year loss in the last 10 years (FY 2007 being the exception). The program has previously experienced losses of $5 million in 2011, $36 million in 2010, and $21 million in 2009. The program has performed more favorably in the last two fiscal years in comparison to FY 2009 and 2010, as actual losses were reduced by one-time program revenues of $10.9 million and $13.3 in FY 2012 and 2011, respectively. The losses in those 2011 and 2012 were aided by one-time revenue transfers of $5.5 and $13.4 million, respectively.
As of June 30, 2012, the program had retained earnings of $155 million, or 12.7% of bonds outstanding and 13.5% of contracts outstanding. The 'AA-' is based on the high amount of retained earnings still in the program and the asset parity coverage they provide. While the current amount of surplus funds is sufficient to address Fitch's stress cash flow scenarios at its current rating level, additional portfolio losses incurred by the program could quickly erode surplus funds, thereby reducing asset parity coverage. Fitch projects that the department has enough assets to absorb projected loan losses. However, if retained earnings are further diminished by increased loan losses, it is highly likely that the remaining amount will not be able to adequately address 'AA-' stress scenarios and maintain the appropriate asset parity ratio for its current rating level.
Approximately 40% of the contract portfolio (by number of contracts) was originated from 2005 to present, 32% from 2000 to 2004, and 28% of the portfolio was originated before 2000. Based on dollar amount however, 54% of the portfolio was originated between 2005 and present, 36% was originated in the years 2000-2004, and 10% was originated prior to 2000. Credit concerns stem from 54% (47% from 2005 to 2008) of the portfolio (based on dollar amount) being originated from 2005 to 2008, making these loans susceptible to substantial LTV volatility given the decline in housing valuations in recent years within the state of California. That volatility has started to ebb in Riverside county where approximately 11% of the portfolio is concentrated.
Fitch expects to review updated consolidated cash flows in the next few weeks.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'State Housing Finance Agencies - Single Family Mortgage Program Rating Guidelines' (Aug. 06, 2012).
--'U.S. RMBS 2Q12 Sustainable Home Price Projection" (January 4, 2013).
Applicable Criteria and Related Research:
U.S. RMBS 2Q12 Sustainable Home Price Projection
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=697778
State Housing Finance Agencies: Single-Family Mortgage Program Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684412
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.