|[September 04, 2014]
Fitch Affirms Texas PSF Rating at 'AAA'; Outlook Stable
CHICAGO --(Business Wire)--
Fitch Ratings affirms its 'AAA' rating on the Texas Permanent School
Fund's (PSF) bond guarantee program (BGP).
The Rating Outlook is Stable.
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
RELATIVELY LOW-RISK BOND PORTFOLIO: The credit quality of the
participants in the guaranteed bond portfolio remains strong. Nearly all
of the bonds are backed by the districts' unlimited ad valorem tax
pledge. However, the PSF has marginally increased some risk to the
program by providing guarantees for certain charter school districts.
DISCOUNTED ASSETS PROVIDE STRONG COVERAGE: Under Fitch's stress
scenarios, the discounted asset portfolio is sufficient to cover
potential bond defaults for several years at a level that Fitch would
expect from a 'AAA' guaranteed portfolio.
SOLID STATUTORY AND OPERATING PROVISIONS: Leverage limitations set by
the state and federal governments enhance the program's guarantee.
STRINGENT PROGRAM OVERSIGHT: The state's oversight of Texas school
districts provides added protection to bondholders against program bond
DECLINE IN QUALITY OF GUARANTEED BOND PORTFOLIO: A material
deterioration in the aggregate quality of the guaranteed bond portfolio
could result in negative rating action.
DETERIORATION IN FUND ASSET QUALITY: Significant declines in asset
quality due to market losses or changes in asset allocations toward
securities to which Fitch gives little to no credit (e.g. land,
alternative investments) could cause negative rating pressure.
INCREASE IN LEVERAGE: A material increase in the amount of guaranteed
obligations relative to PSF assets as discounted by Fitch could cause
negative pressure on the rating. However, Fitch believes that the
program's current leverage limitations make this unlikely.
The PSF is a perpetual endowment that was established in 1854 to support
Texas public schools. As of July 31, 2014, the fund had a market value
of $37.4 billion and a book value of $27.3 billion. Funds are invested
in a diversified mix of equities; fixed income; land, minerals and real
assets; and alternative investments, with a small allocation to cash.
The PSF makes limited distributions to school districts to support their
operations. Over the past several years, these distributions have
accounted for only approximately 3% to 4% of the total fund and are
capped at 6%.
On Nov. 8, 1983, Texas voters approved a constitutional amendment
providing for the guarantee of school district debt by the PSF. The
commissioner of education, an appointee of the governor, typically
grants guaranties for voter-approved school district debt. Under law, a
school district must notify the commissioner no later than five days
before a maturity date if it will be unable to pay principal and/or
interest due to bondholders. The law charges the commissioner to
immediately instruct the comptroller of public accounts (the
comptroller) to transfer funds from the appropriate PSF account of the
state treasury to the paying agent for the bonds in an amount sufficient
to pay principal and interest that otherwise would default.
RATING FACTORS CONSIDERED IN PSF ANALYSIS
Fitch's evaluation of the Texas PSF BGP considers three quantitative
areas: the guaranteed portfolio's expected default risk, available PSF
assets after discounting/liquidation stress, and the trend of leverage
capacity. Fitch reviews the ability of the PSF to pay school district
debt under stress scenarios consistent with an 'AAA' rating that would
affect both the PSF's guaranteed debt and its asset portfolio. Fitch's
review also considers three qualitative areas: guaranteed bond portfolio
underwriting and monitoring, PSF investment policy, and fund
distributions to schools.
GUARANTEED PORTFOLIO CREDIT RISK
As of July 31, 2014, the PSF's BGP had guarantees outstanding totaling
$58.4 billion, up from $55.2 billion at fiscal year-end 2013. This total
represented roughly 2x leveraging of the book value of the fund's assets
as of that date. The current portfolio of 810 school districts is
moderately diverse with the top 10 districts accounting for
approximately 25% of total outstanding guaranteed bonds. The districts'
credit quality is generally strong. Fitch estimates that over 50% of the
outstanding guaranteed bond principal is in the 'A' and 'AA' categories.
No Texas school district has defaulted on its debt since the Great
Beginning in May 2014, the PSF began issuing guarantees for bonds
offered on behalf of a charter district by non-profit corporations. The
guarantee capacity under the program is based on a ratio of charter
students to public school students (currently 3.95%), as annually
determined by the Commissioner of Education. Ths percentage is applied
against the available capacity of the bond guarantee program. Currently,
there are nine charter school districts with an aggregate principal
amount of $273.3 million that are guaranteed under the PSF (0.49% of the
Fitch does not expect a significant concentration of charter school
district bonds guaranteed under the program due to current capacity
limits and stringent application requirements. However, the inclusion of
charter school district debt, which is not supported by ad-valorem taxes
like that of public school districts, marginally increases the risk of
In analyzing the credit risk of the guaranteed portfolio, Fitch uses its
Portfolio Stress Calculator (PSC). The PSC derives program rating
default stresses based on overall pool credit quality as measured by the
rating of issuers, size, bond term, and concentration. For the PSF,
Fitch's 'AAA' liability rating stress hurdle is 51.9% This means that
based on the credit quality of the portfolio, Fitch would expect program
enhancement to be greater than 51.9% to attain an 'AAA' rating. In its
stress analysis, Fitch also assumes a standard recovery rate of 90%,
which would result in the portfolio's total loss of 5.19% for four
years, or 1.3% annually.
AVAILABLE PSF ASSETS AFTER DISCOUNTING/LIQUIDATION STRESS:
In analyzing the sufficiency of asset coverage of PSF's investment
portfolio relative to guaranteed bond obligations, Fitch relies on its
market value methodology ('Rating Closed-End Fund Debt and Preferred
Stock Criteria' published Sept. 4, 2014.) The calculation standardizes
asset coverage by discounting portfolio holdings based on riskiness and
diversification of the assets and measuring their ability to cover
liabilities at the stress level that corresponds to the assigned rating
(in this case, 'AAA').
As a baseline, Fitch used published asset discount factors based on the
45-60 business day liquidation window in an 'AAA' scenario. Under such
stress, the invested asset portfolio, which had a market value of $20.1
billion on August 31, 2013, was risk-adjusted to $8.7 billion. In a
further stress, Fitch calculated asset coverage using peak-to-trough
discount factors, risk-adjusting the assets to $5.9 billion. Both cases
afforded no credit to less liquid holdings such as land and alternative
investments, which as of July 31, 2014 comprised 41% of the portfolio.
ANALYZING THE STRESS RESULTS
Fitch applied the guaranteed bond portfolio's stressed yearly loss of
1.3% and discounted portfolio values ($8.7 billion for a 45-60-day
stress and $5.9 billion for a peak-to-trough stress) to assess the
ability of the assets to pay school district debt. The results indicate
that the fund provides sufficient capacity to cover losses from
hypothetical defaulted school districts for several years under Fitch's
PROGRAM LEVERAGE CAPACITY:
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 (which
includes alternative investments to which Fitch gives no weight), the
State Board of Education (SBOE) annually reviews the state capacity
limit, which is currently 3x book value. SBOE must annually analyze its
legal authority to increase the limit, insuring it does not violate
federal law or jeopardize the bonds' 'AAA' ratings. As of July 31, 2014,
the PSF's book value totaled $27.2 billion, and the state capacity limit
was $81.75 billion. The BGP's leverage of $58.4 billion (including
charter school district guarantees) was 2x the book value, well below
the current state capacity limit and the static IRS limit of $117.3
The BGP's future 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.
DISTRIBUTIONS TO SCHOOLS:
In accordance with a constitutional amendment, the PSF makes annual
distributions to school districts to support their operations based on a
percentage approved by SBOE. The distribution comprises all dividend and
interest income earned by the PSF, including unrealized gains/losses.
Between 2006 and 2013, distributions averaged approximately 3% of the
fund's market value annually. Fitch believes that the risk that
distributions will hinder the PSF's ability to guarantee program debt is
small because Available School Fund distributions account for only a
small portion of the fund and annual distributions are limited each year.
GUARANTEE PORTFOLIO UNDERWRITING AND MONITORING:
BGP approval by the Commissioner of Education (Commissioner) is
restricted to bonds that are voter-approved and backed by a property tax
levy from an accredited school district, with the exception of certain
charter districts. 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. Fitch believes school district oversight
in Texas remains strong. The Texas Education Agency (TEA), which is
headed by the Commissioner, also provides control on school district
credit quality by reviewing performance and financials annually. 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 TEA.
The PSF's financial assets, with a fair market value of $30.2 billion
(excluding land assets) at July 31, 2014 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 while sustaining the market value for the purpose of the guarantee
Given that one of the SBOE's objectives is to grow the balance of the
fund, approximately 40% is allocated to a mix of domestic and
international equities, with another 41% allocated to alternative
investments and the remainder to fixed income securities (mostly U.S.
treasuries, government agency, and high-grade corporate obligations).
Land, real assets and minerals, which had a fair value of $7.2 billion
at July 31, 2014, are under the management of the School Land Board.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 16, 2014)
--'State Revolving Fund and Municipal Loan Pool Rating Guidelines'
(April 28, 2014)
--'Rating Closed-End Fund Debt and Preferred Stock' (Sept. 4, 2014)
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Rating Closed-End Fund Debt and Preferred Stock
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.
AVAILABLE ON (News - Alert) 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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE
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RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY
CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH
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