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.
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, the weighted average maturity of the program's portfolio must not exceed five years according to program guidelines.
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.
RATING SENSITIVITIES
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.
CREDIT PROFILE
CalSTRS' CEP currently generates additional income for the pension system by providing a total of $1.5 billion in credit and liquidity support for 17 municipal and bank obligors through confirming or direct-pay LOCs and other liquidity facilities. These transactions, which largely consist of tax supported and water/wastewater utility pledges, are scheduled to mature within the next five years. While the CEP has a maximum allocation that is limited to 3% of invested assets (or $4.9 billion), management expects that program commitments will not exceed $2.5 billion.
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.
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 65% of the current commitments are to obligors rated in the 'AA' category or higher. Obligor pledges are also strong as roughly 69% of the enhanced credits have tax-supported or water/wastewater utility pledges. Approximately 94% of the facilities expire within three years with the longest CEP obligations maturing within five years. Written detailed funding procedures are also maintained specifying the timing and from which funds moneys would be tapped to satisfy a draw.
AVAILABLE LIQUIDITY
Fitch's second area of assessment 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 potential discounting of available assets for perceived timing delay.
As of June 30, 2013, CalSTRS' investment portfolio totaled $164 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 $4.9 billion limit. Even when Fitch applied additional stresses that severely discounted invested assets, system resources were still more than sufficient to satisfy maximum CEP draws and continue making near-term benefit payouts.
PENSION SYSTEM FINANCIAL CONDITION
Fitch 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, 2012), CalSTRS' pension plan was 67% funded. Using Fitch's more conservative 7% liability discount rate assumption, the plan is funded at a low 64%. Fitch also considered the plan's funded ratio using an adjusted asset value based on the rolling five-year average of market value, which removes the impact of the system's three-year smoothing period. Under this adjusted scenario, the plan's funded ratio is 67%.
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 the sponsor, the state's contributions account for approximately 20% of fiscal year ending 2012 total additions (defined benefit program). Nevertheless, state pension contributions, like debt service and school funding, are a priority payment.
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 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. Fitch expects that the state legislature will begin to address the system's underfunding during the 2013-2014 session.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 3, 2013);
--'Closed-End Fund Debt and Preferred Stock'(Aug. 15, 2012).
--'Criteria for Assigning Short-Term Ratings Based on Internal Liquidity' (June 13, 2013).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499
Rating Closed-End Fund Debt and Preferred Stock
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686101
Criteria for Assigning Short-Term Ratings Based on Internal Liquidity
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708640
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=797154
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