Director’s Summary

General Information

The Credit Enhancement Program commenced in 1994 with the purpose of generating additional fee income for CalSTRS by underwriting credit instruments (e.g., letters of credit, lines of credit) on variable rate municipal debt. Over this timeframe, the availability of credit in the capital markets and the banking system has fluctuated. The program commenced during a period of economic downturn and is currently operating in a period of global economic challenge. While the U.S. economy continues to slowly improve, the municipal market has progressed at an uneven rate, with many entities still dealing with the aftermath of the Great Recession. Opportunities to underwrite credit enhancement for the stronger credits have declined due to many issuers refinancing at fixed rates or delevering their balance sheets. Currently, the landscape for enhancers is very competitive due to the U.S. banking industry having a rejuvenated appetite for credit risk and being aggressive in pricing in order to win transactions.

The CEP has not experienced any losses during its 20-year history. We have followed conservative underwriting standards and in the past few years focused our underwriting efforts on essential service projects (e.g., water, sewer, transportation) with strong debt service coverage. Over its 20-year history, the CEP has earned $101.3 million for the Fund.

All commitments in the CEP portfolio are investment grade and the average credit quality is high at AA-/Aa3, a rating level which denotes very low credit risk. The weighted average maturity of the commitments is 1.40 years and no commitment has a term beyond four years. The commitments are diversified by sector, geography and issuer. As of December 31, 2013, outstanding commitments under the program were $1.2 billion. Fee income for the calendar year was $10.5 million.

As was discussed and announced at the Investment Committee meeting on September 10, 2013, we have suspended new underwriting because we do not view credit enhancement as an attractive opportunity due to heightened credit risk and an unfavorable risk/reward profile. Municipal issuers continue to face challenging operating environments, many with persistent structural deficits. Opportunities to credit enhance high quality variable rate debt have also declined due to lower bond issuance and the refinancing of outstanding debt to fixed rate. Competition among credit enhancers is fierce for the shrinking book of business, thereby pressuring fees. Because of these unfavorable trends, we are not underwriting new business. We are managing the CEP portfolio in an orderly manner to allow CEP commitments to run off and terminate at their respective maturity dates. We expect the CEP portfolio wind-down to be completed by 2017.

Seth Hall,
Portfolio Manager

Margot Wirth,
Director of Private Equity

Christopher J. Ailman,
Chief Investment Officer

December 31, 2013