Fitch Rates State of California Veterans Affairs' Home Purchase Revs Series 2016 A&B 'AA-'
The Rating Outlook is Stable.
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 the state of California veterans general obligation (veteran 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: Unaudited financial statements indicate that the program sustained an operating loss of approximately $2 million in fiscal year 2016. However, retained earnings remain ample, equalling approximately 14% of bonds outstanding as of June 30, 2016.
MORTGAGE PORTFOLIO: Approximately 25% 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 June 2016, the portfolio is comprised of 49% VA guaranteed contracts, 21% Radian insured and 29% 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 19 loans or $2.9 million in June 2016, compared to 51 loans or $8 million as of November 2012.
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.
The home purchase revenue bonds and the veteran GO bonds are secured by an $848 million contract loan portfolio at June 30, 2016.
Unaudited financial statements indicate that the program sustained an operating loss of approximately $2 million in fiscal year 2016. The 2016 results benefited from a $2.2 million reversal in the provision for loan losses and follow a relatively flat operating performance in fiscal year 2015. The program 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 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 over 110% 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 2016 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 to approximately 2.1% as of June 2016. While unaudited financials report that real estate owned (REO) properties increased to $2.9 million in FY 2016, compared to $1.3 million at the end of FY 2015, management expects the recovering housing market will enable it to recover approximately half the value of the REOs reported for FY 2016.
Based on contract dollar amount, approximately 55% of the portfolio was originated between 2005 and the present, 27% was originated in the years 2000-2004, and 18% was originated prior to 2000. Credit concerns stem from the 24.5% 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.