SACRAMENTO, Calif. - CalPERS officials seek to aid financially squeezed municipalities in California and across the country while generating fee income from a new $5 billion credit-enhancement program.
What's more, officials at the $134 billion California Public Employees' Retirement System, Sacramento, hope other public pension funds will join a consortium that would extend the funds' top-rated credit to lower-rated municipal bond issuers.
Municipalities can slash their yields on bonds backed by letters of credit issued by AAA-rated CalPERS, saving millions of dollars in interest expense. Meanwhile, CalPERS' staff hopes to generate, eventually, $17.5 million in annual fee income - with very little risk to the pension fund and without upsetting the fund's existing asset mix.
"We are bridging the gap for municipalities with good ratings to get to market. The program will provide support for California municipalities and others across the nation while adding value to our investment portfolio," said Brad Pacheco, a CalPERS spokesman.
CalPERS is not the first public fund to rent out its credit rating. The $92 billion California State Teachers' Retirement System, Sacramento, has been running a credit enhancement program since 1994, and currently has $1.5 billion in outstanding guarantees, but for California issuers only. CalSTRS spokeswoman Sherry Reser said there have not been any formal discussions about CalSTRS participating in a national consortium.
An opportune time
The time might be ripe for CalPERS to enter the market. Japanese banks, which dominated the market 10 years ago, have fled as their credit ratings plunged, noted a memo from CalPERS staff. Meanwhile U.S. banks have retrenched and industry consolidation has reduced the number of players, the memo added.
And market demand will be increasing, according to Gail Sussman, managing director at Moody's Investors Service, New York.
Memos from CalPERS' staff said the fund will be at little risk from the program, which will be considered by the investment committee on Feb. 18. CalPERS would provide confirming letters of credit, putting it at indirect risk in case of default.
Plus, the CalPERS program would carry an average credit rating of A-1/A+, and would back only variable-rate debt that typically has three- to seven-year maturities. The pension fund would lend its credit rating only to municipalities that are rated investment grade and are backed by tax revenues. And CalPERS would only back bonds that have low default rates, such as general obligation bonds, and revenue-backed utility, transportation and public education bonds.
The pension fund would find a strategic partner to originate, co-invest in and vet all deals. CalPERS officials hope to generate 35 basis points a year in gross fees, on the assumption of incurring no losses. In comparison, CalSTRS' benchmark is 22 basis points, based on the same risk level, according to a CalPERS analysis. The average credit rating for the CalSTRS program also is higher, at A+/Aa3, which tends to generate lower fees. Where the CalPERS program really differs is that it would be nationwide in scope.
Like CalSTRs, the $22 billion Tennessee Consolidated Retirement System, Nashville, also backs state and agency commercial paper, but officials there have no plans to expand its program.
"I'm pretty certain we wouldn't look at that," said Tom Milne, CIO for the system. He said the program operates as a standby purchaser of notes in case the state has problems going to market.
Steve Curry, assistant to the Tennessee state treasurer, said the fund earned 7.5 basis points when the state's general-obligation bond rating was AAA. The fund now gets 12 basis points because the state's rating has slipped to AA, generating $350,000 a year in income.