BILL ANALYSIS
AB 2364
Page 1
ASSEMBLY THIRD READING
AB 2364 (Correa)
As Amended April 26, 2004
2/3 vote. Urgency
PUBLIC EMPLOYEES 7-2
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|Ayes:|Negrete McLeod, Levine, | | |
| |Chan, Correa, Kehoe, | | |
| |Laird, Maldonado, | | |
| | | | |
|-----+--------------------------+-----+--------------------------|
|Nays:|Campbell, Nakanishi | | |
| | | | |
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SUMMARY : Authorizes public pension systems to establish credit
enhancement programs to assist issuers of municipal and public
finance debt, as specified.
EXISTING LAW declares that the retirement boards of public
pension and retirement systems have fiduciary responsibility
over the assets of the public pension or retirement system.
FISCAL EFFECT : According to the California Public Employees
Retirement System (CalPERS), despite the obvious risk associated
with any investment program that CalPERS administers, the fund
is expected to receive fee income which would make the credit
enhancement program (CEP) an income producer. The following
information on fee generation has been provided by CalPERS.
While the Investment Committee will decide how much of CalPERS
contingent liability it will allocate to this fee generating
program, the rating agencies generally deem as prudent 5-10% of
total market value of assets (or $7-15 billion). Staff suggests
that a 2% allocation (or approximately $3 billion) would be
appropriate as its initial allocation.
Fees will be generated from annual commitment fees, up-front
structuring fees, interest on funded bond purchases, operational
draws, and amendment and waiver fees. In developing fee
projections, staff has consulted widely, drawing from a
financial institution's 25-year history of providing credit
enhancement of municipal bonds. As a result, staff is
comfortable that, within a fairly narrow range, credit
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enhancement fees should be sufficient to provide net returns to
CalPERS of 40 basis points per annum. For CalPERS, the chart
below demonstrates the projected gross fee income and
outstanding commitments for CEP. Initially, annual business
expenses of approximately $75,000 are contemplated for limited
due diligence travel and yearly rating agency surveillance fees.
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| |Year 1 |Year 2 |Year 3 |
|-----------------------------+-----------+-----------+-----------|
| | | | |
|Total CalPERS' CEP Portfolio |$1.0 Bil |$2.0 Bil |$3.0 Bil |
|($ Billion) | | | |
|-----------------------------+-----------+-----------+-----------|
| | | | |
|-----------------------------+-----------+-----------+-----------|
|Minimum Projected Fee Income |$4.0 Mil |$8.0 Mil |$12.0 |
|($ Million) | | |Mil |
| | | | |
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COMMENTS : One of the new programs CalPERS Fixed Income staff
has proposed under the 2002-03 Annual Plan is to establish a
CEP. Staff has been exploring program options to provide credit
enhancement to support infrastructure development throughout the
United States (U.S.), including the feasibility of working with
a Strategic Partner/Third Party provider willing to participate
in every transaction with CalPERS on a pro-rata basis, and/or in
conjunction with a consortium of large public U.S. pension funds
led by a large U.S. financial institution.
The primary objective of CEP is to earn fee income. The fee
income is pursued on an expected zero loss underwriting basis.
Risk minimization is a desired objective, which may result in
lower fee income. CEP will be an off-balance sheet component of
the Investment Portfolio, enabling CalPERS to use its asset base
and liquidity strength to generate fee income, in circumstances
that are expected to be highly infrequent. As a result, the
Strategic Asset Allocation plan is not likely to be affected.
Credit enhancement is a substitution of a highly rated financial
institution's credit rating for that of a lower rated public or
private entity. It is an agreement by a third party (CalPERS)
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to pay the investor scheduled interest and/or principal payments
in the event the primary obligor does not meet the terms and
conditions of the bond indenture. This substitution (for a fee)
allows the public or private entity access to the capital
markets at a lower interest rate. The most utilized form of
credit enhancement is a financial instrument known as
letter-of-credit (LOC). LOC is an unconditional promise to make
payments up to a stated amount for a specified period upon
receipt of a proper notice. The commitment is irrevocable.
Another form of credit enhancement is called a "liquidity
enhancement (LE)." LE is used for short-term or variable rate
securities to give investors confidence in the amount of
liquidity associated with a specific security. Most LEs contain
a lesser degree of credit exposure than LOCs.
The following types of LOCs are utilized:
1)Direct Pay Letter-of-Credit: For this LOC, the investor
(through the Trustee) looks to the Direct Pay LOC Bank (could
be CalPERS) for all interest and principal payments to
investors. The obligor (company or municipality seeking
credit) then reimburses the Direct Pay Bank. If the obligor
fails to reimburse for the LOC drawing, the fronting bank,
with the first loss position in the obligor's
creditworthiness, reimburses CalPERS (Direct risk or 1st loss
position).
2)Confirming Letter-of-Credit: For this LOC, the investor
(through the Trustee) looks to the bank supporting the obligor
to make the interest and principal payments to investors. If
the bank fails to make these payments, the Trustee calls upon
CalPERS to make the payment. CalPERS would then demand
reimbursement from the bank (Indirect risk or 2nd loss
position).
3)Liquidity Facility: This form of LOC is an availability to
purchase securities under specific situations. The bonds or
commercial paper that this facility supports may be remarketed
on a daily, weekly, or monthly basis. There is a need to have
their marketability guaranteed to SEC standards (247 Rule).
If there is a failed remarketing, CalPERS may be required to
"purchase" these bonds and receive pre-agreed interest
payments. In the case of a liquidity facility, the commitment
may terminate immediately (Indirect risk or 2nd loss
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position).
Analysis Prepared by : Clem Meredith / P.E., R. & S.S. / (916)
319-3957
FN:
0005197