TRS 2011 Comprehensive Annual Financial Report

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TEACHER RETIREMENT SYSTEM OF TEXAS COMPREHENSIVE ANNUAL FINANCIAL REPORT 2011 Notes to the Financial Statements depreciation) is exchanged, rather than just the cash flows. Investment managers or sponsors of Real Asset Funds investments in commodities are limited to swaps and instruments that constitute a security that is underlain by a financial instrument as opposed to a physical commodity. Option Contracts An option contract provides the right, but not the obligation, to buy or sell a specific amount of a specific security within a predetermined time period. During fiscal year 2011 and at August 31, 2011, respectively, the system entered into and held no option contracts. G. DEPOSITS AND INVESTMENTS RISK FACTORS Deposits and investments of state and local governments are exposed to risks that have the potential to result in losses. GASB Statement No. 40, Deposit and Investment Risk Disclosures - an amendment to GASB Statement No. 3 updated the custodial credit risk disclosure requirements of Statement 3 and established more comprehensive disclosure requirements addressing other common risks of deposits and investments such as credit risk, concentration of credit risk, interest rate risk and foreign currency risk. The required disclosures related to these risks are presented on the following pages. Custodial Credit Risk – Deposits The custodial credit risk for deposits is the risk that, in the event of bank failure, the government will not be able to recover deposits or will not be able to recover collateral securities that are in the possession of an outside party. The system does not have a formal deposit policy for custodial credit risk. The State Treasury has specific guidelines for cash and deposits that are maintained in the State Treasury. The deposits in the bank in excess of the insured amount are uninsured and uncollateralized. As of August 31, 2011, the balance of uncollateralized cash in U.S. and non-U.S. banks for investments pending settlement was $151,906,367. Custodial Credit Risk – Investments The custodial credit risk for investments (including exchange traded investment derivative instruments) is the risk that, in the event of a failure of the counterparty, the government will not be able to recover the value of investment or collateral securities that are in the possession of an outside party. The system does not have a formal investment policy for custodial credit risk. Short-Term investments totaling $5,112,558,134 are held by the custodian’s agent in an investment pool not evidenced by a security, and are not exposed to custodial credit risk. All other investments (including exchange traded investment derivative instruments) are registered in the name of Teacher Retirement System or in the name of the system’s custodian which was established through a master trust custodial agreement. The securities are held by the custodian in the name of the system. Any cash collateral received associated with investment derivative activity is invested in an agent managed pool that is not evidenced by securities that exist in physical or book entry form. At August 31, 2011, the system held $30,300,000 associated with investment derivative activity. At August 31, 2011, the deposits with broker to open futures contracts in the amount of $505,261,049 were uninsured and uncollateralized. Credit Risk of Investment Derivative Instruments and Debt Securities The credit risk for the system’s investments in debt securities, Short-Term Investment Funds, and over-the-counter investment derivative instruments in asset positions is the risk that an issuer or other counterparty to an investment will not fulfill its obligations. The system’s investment policy establishes tracking error limits that are intended to reduce the tracking error of the asset class. The system does not have a formal credit risk policy relating to its investments in Short-Term Investment Funds. For over-the-counter (OTC) derivatives, any counterparty in a transaction with TRS must have a credit rating of at least A- (Standard & Poors or Fitch) or A3 (Moody’s) or better at the inception of the contract. All OTC derivative transactions, including those managed through Agency Agreements, must be subject to established ISDA Master Agreements and have full documentation of all legal obligations of TRS under the transactions. All ISDA Master Agreements provide that netting applies. To minimize the system’s exposure to loss related to credit risk, the system may use collateral arrangements to mitigate counterparty credit risk. The system has negotiated thresholds for each counterparty above which collateral must be posted. The net market value of all over-the-counter derivative positions, less collateral posted, for any individual counterparty may not exceed $500 million. The net market value of all over-the-counter derivative positions, without consideration collateral, may not exceed five percent of the total market value of the fund. The system’s investment policy clarifies that termination of the transaction is allowed. Repurchase transactions and triparty repurchase transactions may not exceed five percent of the market value of the total investment portfolio, including cash and cash equivalents, unless those transactions are covered by a third-party indemnification agreement by an organization that bears a long-term NRSRO credit rating of A- or better and is enhanced by acceptable collateral. A securities lending agent must be an organization rated A- or better by a NRSRO. The system’s rated counterparties on investment derivative instruments in an asset position, and rated debt investments as of 48 FINANCIAL SECTION
TEACHER RETIREMENT SYSTEM OF TEXAS COMPREHENSIVE ANNUAL FINANCIAL REPORT 2011 Notes to the Financial Statements August 31, 2011, using the Standard & Poor’s (S&P) rating scale, are as follows: Investment Derivative Instruments - the aggregate fair value of investment derivative instruments in asset positions at August 31, 2011, was $50,308,626. This represents the maximum loss that would be recognized at August 31, 2011, if all counterparties failed to perform as contracted. This maximum exposure is reduced by $30,300,000 of collateral held and by $173,448,571 of liabilities included in netting arrangements with those counterparties resulting in a zero net exposure of investment derivative instruments to credit risk. The aggregate fair value of investment derivative instruments in asset positions of $50,308,626 at August 31, 2011, was executed with two counterparties, 27% with an S&P rating of AA and 73% with an S&P rating of A. Debt Securities: Investment Type S&P Rating Fair Value Short-Term Investment Fund NR $ 7,070,923,524 Other Short-Term NR 5,142,858,134 Total Credit Risk of Short-Term $ 12,213,781,658 Short-Term Foreign Currency Contracts $ (44,158) Total Short-Term (Exhibit I) $ 12,213,737,500 U.S. Government Agency Obligations AA $ 9,349,765 U.S. Government Agency Obligations NR 32,240 Total U.S. Government Agency Obligations $ 9,382,005 Asset and Mortgage Backed Obligations AAA $ 6,973,360 Asset and Mortgage Backed Obligations AA 62,311,003 Asset and Mortgage Backed Obligations A 43,094,307 Asset and Mortgage Backed Obligations BBB 16,269,703 Asset and Mortgage Backed Obligations BB 23,726,965 Asset and Mortgage Backed Obligations B 101,352,584 Asset and Mortgage Backed Obligations CCC 323,948,592 Asset and Mortgage Backed Obligations CC 106,903,363 Asset and Mortgage Backed Obligations D 75,975,316 Asset and Mortgage Backed Obligations NR 218,794,880 Total Asset and Mortgage Backed Obligations $ 979,350,073 (to next page) FINANCIAL SECTION 49
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Teacher Retirement System of Texas
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TRS 2011 Comprehensive Annual Financial Report

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