OREANDA-NEWS. Fitch Ratings has assigned an 'AA-' rating to the $445.7 million State of California veterans general obligation (GO) bonds, series CK, CL and CM.

Fitch has also affirmed the 'AA-' rating on the following outstanding bonds:

--Approximately $446 million state of California Veterans GO bonds;
--Approximately $360 million Department of Veterans Affairs home purchase revenue bonds.

The Rating Outlook is Stable.

SECURITY
The primary source of payment for the bonds is monies from the 1943 Fund. In addition, the veterans GO bonds are secured by the full faith and credit of the State of California and have an equal claim against the general fund of the state of California as other state GO bonds.

Home purchase revenue bonds are special obligations of the State Department of Veterans Affairs (the department) payable solely from, and by a pledge of, an undivided interest in the assets of the 1943 Fund and the Veterans Debenture Revenue Fund which is secondary and subordinate to any interest or right in the fund of the people of the state of California and the holders of veterans GO bonds.

There is also a bond reserve account in the Veterans Debenture Revenue Fund which was funded and is maintained in an amount equal to at least 3% of the outstanding revenue bonds to be used for the purpose of paying principal and interest on the bonds.

KEY RATING DRIVERS

FINANCIAL PERFORMANCE: The Stable Outlook reflects the program's continued improvements. There was a gain in fiscal year 2014, and the program nearly broke even in 2015, after almost six consecutive years of financial losses.

RETAINED EARNINGS: The 'AA-' rating reflects the retained earnings in the program, which were equal to 16.9% of bonds outstanding at June 2015. June 2015 program operations resulted in a small loss of $512 thousand and retained earnings as a percentage of bonds outstanding decreased slightly from 18.8% in FY 2014. This retained earnings reduction was primarily due to a prior period pension obligation of $14.6 million.

IMPROVED MORTGAGE PORTFOLIO: Approximately 50% of the loan portfolio (based on dollar amount) was originated from 2005 to 2014, making these loans susceptible to significant loan to value (LTV) volatility. However, housing values continue to improve in the state showing strength in single-family housing valuations which should lead to a reduction of the amount of borrowers with loans that are greater than the market value of their homes.

NEW LOAN EXPECTATIONS: Any new loan originations are expected to be VA insured or be uninsured with a LTV below 80%.

REDUCTION OF REOs CONTINUE: The amount of real estate owned (REO) properties in the portfolio has declined measurably. The REO properties decreased to 10 loans or $1.3 million in June 2015, compared to 51 loans or $8 million as of November 2012.

RATING SENSITIVITIES

OPERATING LOSSES: Management's inability to control expenses could lead to operating losses, which would reduce retained earnings. Additionally, increased portfolio delinquencies resulting in increased losses to the loan portfolio could also increase operating losses. These factors could reduce retained earnings, reduce the asset parity ratio and put pressure on the rating.

CREDIT PROFILE

The veteran GO and home purchase revenue bonds are secured by a $820 million contract loan portfolio at June 30, 2015. Overall the program's delinquency rate has declined over the last four fiscal years from a high of over 8.5% in 2011, to approximately 3.1% in July 2015.

The Stable Outlook is based on the return to nearly break even operating results in 2015, albeit due to a prior period pension adjustment of over $14.6 million at the end of this fiscal year. The program and department operations incurred a small operating loss of $512 thousand in FY 2015. Last year the department had a gain of $8.6 million. Prior to last year the program had experienced losses of $4.3 million in 2013, $1.7 million in FY 2012, $5 million in 2011 and $36 million in 2010. Program operations performed more favorably over the last two fiscal years and seem to have stabilized with the strengthening of the California economy.

As of June 30, 2015, the program had retained earnings of $135.8 million, or 16.9% of bonds outstanding and 17.2% of contracts outstanding. The 'AA-' rating on the veterans GO and revenue bonds continues to be based on the amount of retained earnings maintained in the program and the asset parity coverage. While the current amount of surplus funds is sufficient to address Fitch's stress cash flow scenarios at its current rating level, additional portfolio losses incurred by the program and any transfers to the state could erode surplus funds, thereby reducing asset parity coverage.

A bond reserve account in the Veterans Debenture Revenue Fund that was funded and is maintained in an amount equal to at least 3% of the outstanding revenue bonds is a credit strength. These reserves can be used for the purpose of paying principal and interest on the bonds if necessary.

FY 2015 saw continued improvement in many areas. REO and loan losses are at the lowest level since 2006. Over 60 day plus delinquencies at currently 3.1% is an improvement from February 2011 when the 60 day plus was 8.63%. Fitch believes that the department currently has enough assets to absorb projected loan losses.

Based on contract dollar amount, approximately 50% of the portfolio was originated between 2005 and present, 30% was originated in the years 2000-2004, and 20% was originated prior to 2000. Credit concerns stem from the 50% of the portfolio (based on $ amount) that was originated from 2005 to present, making these loans susceptible to substantial loan to value (LTV) volatility given the housing valuations in recent years within the state of California.