OREANDA-NEWS. Fitch Ratings has assigned an 'AA-' rating to the $100 million State of California veterans general obligation (GO) bonds, series CN.

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

--Approximately $574 million state of California Veterans GO bonds;
--Approximately $314 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 STABILIZES: The Stable Outlook reflects the program's improvement in fiscal year 2014 and maintenance in fiscal year 2015 after almost six consecutive years of financial losses from 2008 to 2013. The 'AA-' rating reflects the retained earnings in the program, which are equal to approximately 15% of bonds outstanding as of Dec. 31, 2015.

MORTGAGE PORTFOLIO: Approximately 40% of the loan portfolio (based on dollar amount) was originated from 2005 to 2008, making these loans susceptible to significant loan to value (LTV) volatility. However, single family housing values continue to improve in the state thereby reducing the amount of borrowers with outstanding loans that are greater than the market value of their homes.

NEW VA LOAN EXPECTATIONS: Any new loan originations are expected to be VA guaranteed or be uninsured with a LTV below 80%. Adding VA guaranteed loans will improve the risk profile of the loan portfolio. As of December 2015, the portfolio is comprised of 45% VA guaranteed contracts, 24% Radian insured and 31% uninsured contracts.

REDUCTION OF REOs: The amount of REOs in the portfolio has declined measurably over the last four years. The real estate owned (REO) properties decreased to 13 loans or $1.9 million in February 2016, compared to 51 loans or $8 million as of November 2012.

RATING SENSITIVITIES

CHANGES IN STATE HOUSING MARKET: Changes in the state of California's unemployment rates, employment levels and/or housing market trends could result in operating volatility for the program which could change the rating.

OPERATING LOSSES: Increased program operating losses due to potential loan losses, increased program expenses or transfers to the State could reduce retained earnings, thereby decreasing the asset parity ratio which could put negative pressure on the ratings.

CREDIT PROFILE
The veteran GO and home purchase revenue bonds are secured by an $840 million contract loan portfolio at Dec. 31, 2015.

The Stable Outlook is based the program's improvement in fiscal year 2014 and maintenance in fiscal year 2015 after almost six consecutive years of financial losses from 2008 to 2013. The program department operations incurred a small operating loss of $512 thousand in FY 2015 which was largely due to an increase in program administrative expenses which increased 33% from 2014. The program realized a small profit of $8.5 million in 2014 which stemmed from the reversal of a program loss provision in the amount of $3.6 million and a reduction in REO losses from 2013. Prior to 2014, the program had experienced losses ranging from $1.7 million to $36 million between 2010 and 2013.

As of June 30, 2015, the program had retained earnings of $135 million, or 16.8% of bonds outstanding and 17.1% 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. For fiscal year 2015, the program's asset parity was 116% which reflects a restatement due to the GASB 68 implementation. 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. Program cash flows demonstrate a minimum asset parity of 112% under all stress scenarios.

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.

In FY 2015 the program also experienced improvements in delinquencies, REO and loan losses which are at the lowest level since 2006. Overall the program's serious delinquency rate has declined over the last five years from a high of over 8.5% in 2011, to approximately 2.35% as of February 2016. The real estate owned (REO) properties decreased to 13 loans or $1.9 million in February 2016, compared to 51 loans or $8 million as of November 2012.

Based on contract dollar amount, approximately 50% of the portfolio was originated between 2005 and the present, 29% was originated in the years 2000-2004, and 19% was originated prior to 2000. Credit concerns stem from the 40% of the loan portfolio that was originated between 2005 and 2008 when housing valuations were at a high point. These loans could be susceptible to loan to value (LTV) volatility given housing valuations trends in recent years within the state of California. However, single family housing values continue to improve in the state thereby reducing the amount of borrowers with outstanding loans that are greater than the market value of their homes.

For further information on the State of California general obligation rating please see Fitch's press release 'Fitch Rates California's $2.3B GOs 'A+'; Outlook Stable', dated Feb. 25, 2016.