The CalSTRS Credit Enhancement Program is an off-balance sheet component of CalSTRS Investments. The CEP conducts its business in the short-term, variable rate municipal bond market. The primary objective of the program is to earn fee income through the enhancement of high quality municipal financings, such as tax-exempt bonds, industrial development bonds, tax and revenue anticipation notes, and commercial paper.
Credit enhancement through a letter of credit or liquidity facility enables issuers of municipal debt to substitute the issuer’s lower credit rating for the CalSTRS higher credit rating. This substitution allows the entity access to the capital markets and permits the entity to pay a lower interest rate to investors on its debt instrument.
The credit enhancement either guarantees the payment of principal and interest on the bonds in the event of a non-payment by the issuer and/or provides liquidity support in the capital markets. In return, CalSTRS earns fee income for these commitments.
CalSTRS has long-term credit ratings of Aa3/AA-/AA+ by Moody’s Investors Service, Standard & Poor’s, and Fitch Inc., respectively.
The program has a goal of zero losses and has underwritten low risk, high quality transactions on an opportunistic basis to generate fee income. The CEP has been able to maintain a high quality portfolio and has never had a loss in the program.
The annual fee income is determined, to a large degree, by market conditions. The number of credit enhancers, term spreads (i.e., interest rate differential between short-term and long-term interest rates), and credit spreads (i.e., interest rate differential between credit categories) influence fee levels. In general, when credit is tight and/or term spreads and credit spreads are wide, fee levels rise.
The program is comprised of a team of two and one-half investment staff who are led by a portfolio manager. Oversight is provided by another portfolio manager and the Director of Private Equity.
Since 2003, the external service agent has been responsible for all CEP operational functions, including draw payments, letter of credit pay downs, invoicing and correspondence. Utilizing a service agent has allowed the CEP staff to concentrate on monitoring portfolio risk and, until just recently, underwriting new transactions. State Street Bank has served as the CEP’s service agent since April 2008.