SAN FRANCISCO - Moody's Investors Service on Friday placed on review for downgrade the credit enhancement policies of California's two state pension systems, as well as California State University bonds, while affirming the University of California's credit rating.

Under review for downgrade are the Aaa long-term issuer ratings of the California Public Employees Retirement System and the California State Teachers' Retirement System. The ratings were issued in connection with each system's municipal credit enhancement program. Moody's affirmed both programs' Prime-1 short-term ratings.

Moody's issued a split decision on the state's two large university systems after viewing their exposure to the state government, which it downgraded to Baa1 earlier last week.

In the case of California State University, Moody's said its downgrade review "reflects the increased risk of steep cuts and lengthy deferrals of state payments to the CSU, which account for 45% of the CSU's operating revenues."

The action affects $3.13 billion in outstanding systemwide revenue bonds, rated Aa3, and $492 million in outstanding A1-rated State Public Works Board bonds. Cal State's P-1 commercial paper rating is unaffected.

For the University of California, while it is "not immune" from state funding cuts, "we expect that combinations of tuition and other revenue increases, expense controls including planned furloughs and other operating efficiency initiatives will allow the university to sustain healthy operating performance," Moody's said.

The agency affirmed the university system's Aa1 general revenue bond rating, and affirmed the system's other ratings, all of which retain a stable outlook.

Moody's cited three major reasons behind placing the pension systems' issuer ratings on watch for downgrade: market declines that reduce the funding status of both systems; the declining credit profile of the plans' sponsor, California, as reflected in last week's downgrade; and increased risk that the plans will actually have to pay out money as part of their credit enhancement commitments, due to recent disruptions in the municipal market.

"Even though CalPERS and CalSTRS have honored these guarantees to date without undue strain, the ratings had previously incorporated an expectation that the likelihood of draws under the programs was remote," Moody's said. "Experience has shown this not to be the case."

According to Moody's, thus far there have been draws under the programs, but no credit losses.

As of March 31, CalSTRS reported enhancing $2.62 billion, with projected fee income of almost $4.2 million during fiscal 2009. It reported credit enhancement commitments in seven states, but 67% of the total was in California.

As of Dec. 31, CalPERS reported its credit enhancement program had $2.3 billion in commitments, and had generated $3.9 million in net earnings the previous year.

It had commitments in seven states, with California representing $48% of the total.

Earlier in 2008, the CalPERS board had approved a policy change allowing the program to increase its maximum commitments to $10 billion from $5 billion, but found a challenging market environment, according to the program's annual report.

"Many of our financial partners have exited the credit enhancement market altogether or scaled back in volume of deals done," the report said. "As a result, staff has had difficultly finding partners and co-investors for many credit enhancement program transactions."

On the other hand, the report said, the program had been able to take advantage of improved pricing and better negotiating position for enhancement terms.

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