CHICAGO--()--Fitch Ratings assigns an 'AA+' rating to the following bonds issued by the state of Wisconsin (the state):
--$80,360,000 clean water revenue refunding bonds, 2013 series 1.
Bond proceeds will be used to refund certain outstanding clean water revenue bonds.
In addition, Fitch affirms its 'AA+' rating on the state's state
revolving fund (SRF) debt (pre-refunding):
--Approximately $890 million in outstanding clean water revenue bonds.
The Rating Outlook is Stable.
The bonds are primarily secured by pledged loan repayments, amounts in the reserve and subsidy funds, and other pledged amounts.
KEY RATING DRIVERS
SOLID FINANCIAL STRUCTURE: The rating reflects the strength of the SRF financial structure, including the combination of pledged loan repayments as well as subsidies and reserves, which allow the state's Clean Water Fund Program's (CWFP) leveraged portfolio to withstand borrower defaults in excess of Fitch's stress tests without causing bond payment interruptions.
STATE OF WISCONSIN EXPOSURE: Significant portions of CWFP's bond debt service are subsidized by general obligation (GO) bonds issued by the state of Wisconsin (GOs rated 'AA' with a Stable Outlook by Fitch) and are required to provide 1.0x coverage. This structural reliance on the state to provide subsidies limits the program's rating to 'AA+'.
HIGH POOL QUALITY WITH INTERCEPT: Borrower loan provisions are strong, with the majority of loan principal secured by general obligation or water/sewer system revenue pledges. At least 73% of the CWFP's loan portfolio is estimated to be investment grade by Fitch. This is largely attributable to the program's ability to intercept state aid payments otherwise due to delinquent borrowers. The state aid intercept reduces the risk of program debt service shortfalls.
HIGH SINGLE-BORROWER CONCENTRATION: The pledged pool consists of 203 borrowers, with the top 10 participants representing approximately 71% of the total portfolio. The largest participant, Milwaukee Metropolitan Sewer District (MMSD), represents a significant 32% of the total portfolio. MMSD's high credit rating (GO debt rated 'AAA' with a Stable Outlook) somewhat mitigates this concentration risk.
Credit quality of the bonds is linked to repayment performance on the program's loan portfolio, quality of invested reserves and sustained subsidy commitment from the state.
Pursuant to the federal Clean Water Act of 1987, the state created its CWFP to provide financial assistance to wastewater projects throughout the state. The state provides for two separate environmental financing programs under its Environmental Improvement Fund: the CWFP and the Safe Drinking Water Loan Program. The 2013 bonds along with previously issued bonds are issued under the CWFP.
STRONG FINANCIAL STRUCTURE LIMITED BY RELIANCE ON STATE SUBSIDIES
Pledged loan repayments, subsidy amounts and reserve funds provide solid security to Wisconsin's SRF bond program. Fitch's cash flow modeling demonstrates that the SRF program can continue to pay bond debt service even with portfolio loan defaults and modeled recoveries (the default tolerance rate) of 94% over the first four years and 100% over the middle and last four years of the bonds' life. This is in excess of Fitch's 'AAA' liability default hurdle of 28.9% as produced using Fitch's Portfolio Stress Calculator (the PSC), which is based on the overall pool borrower's credit quality, size, loan term, and concentration. Despite the ability of the program to meet Fitch's 'AAA' liability default hurdle, structural reliance on state subsidies currently limits the program rating to an 'AA+'.
The state subsidizes approximately 20% of the CWFP's debt service costs in the form of state GO debt service payments of outstanding bonds purchased for the program. The purchased bonds (and repayments) are held in the subsidy fund by the trustee. This contribution reduces local borrowing costs by allowing a lower yield on the underlying loans than the yield on the bonds. The corpus of the subsidy fund GOs totaled about $167 million in February 2013, or about 19% of outstanding bonds, and is available to cure debt service deficiencies if reserve funds are insufficient. Currently, the subsidy fund also carries a cash balance totaling $10 million, which is applied to debt service.
The program's reserve fund, called the loan credit reserve fund, is
sized based on the estimated credit quality of the loan portfolio and is
available to cure debt service deficiencies. The state must cure reserve
fund shortfalls before additional loan disbursements or bond issuances.
In addition, defaulting borrowers must replenish any reserve draws. As
of Feb. 13, 2013, the loan credit reserve fund totaled approximately
$107 million (12% of outstanding bonds), which is slightly greater than
the current minimum requirement of $106 million. The reserves are
invested in the state's investment pool, forward delivery agreements
providing for the delivery of U.S. treasury securities, a collateralized
repurchase agreement and Wisconsin GO bonds. Pursuant to the CWFP
documents, the reserves must be invested with institutions or
instruments that are rated at least as high as the rating category on
the clean water revenue bonds at the time the funds were initially
Within the CWFP, the state's Department of Administration (DOA) operates three separate loan portfolios, including the leveraged portfolio, which consists of pledged loans funded with bond proceeds. DOA also operates the direct portfolio, which includes loans made directly from federal capitalization grants and required state match amounts, as well as the proprietary portfolio, which funds loans using state GO debt. While only the leveraged loan portfolio is pledged to the bonds, DOA has the ability to sell or exchange loans between portfolios to avoid delinquencies in the leveraged portfolio, which Fitch considers a key credit strength.
STATE AID INTERCEPT PROVISION CONTRIBUTES TO STRONG POOL QUALITY
Fitch estimates that at least 73% of the pool's loans are attributable to investment-grade borrowers, including borrowers rated off the state by virtue of state aid credit enhancement. In the event a borrower becomes delinquent, the DOA must intercept that entity's state aid payments - including state-shared revenues paid to cities, villages, and towns - and transportation aid, where available. The CWFP currently asserts priority over other agencies for intercepted funds, which is viewed by Fitch as a structural positive for bondholders. Fitch uses an assumed 'AA-' rating for borrowers meeting Fitch's state aid intercept criteria in determining the composite portfolio stress hurdle.
Furthermore, the program's loan security is solid, with about approximately 80% of loan principal backed by GO pledges and the remaining loans backed by water/sewer system revenue pledges. A minimum coverage ratio of 1.1x is required for new revenue-backed loans. Final loan maturity generally does not exceed 20 years, and level debt service schedules are typical, with principal amortization beginning one year after project completion. Unpaid system fees must be added by municipalities as a special charge to the property tax bill of the delinquent user. Under the individual loan agreements, the DOA may appoint receivers to take over troubled projects.
An internal database is used to track compliance. Additionally, each borrower's audited financials are monitored on an annual basis. To date, there has not been a loan default.
LOAN POOL EXHIBITS MODERATE-TO-HIGH CONCENTRATION
The combined pledged loan pool is composed of approximately 203 loans, with the top 10 obligors representing approximately 71% of the aggregate loan pool. MMSD, the largest borrower, represents about 32% of the total pledged portfolio. Because of high single-borrower concentration, Fitch views overall pool concentration as moderate to high. Each of the remaining pool participants represents no more than 5% of the total pool.
In addition to the high concentration represented by MMSD, the state also presents a degree of concentration risk to the program structure because of its reliance on state subsidies to cover debt service in the form of state GO bond repayments. As of February 2013, expected state subsidy amounts totaled approximately 19% of total debt service.
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'State Revolving Fund and Leveraged Municipal Loan Pool Criteria' (May 21, 2012);
--'Counterparty Criteria for Structured Finance Transactions' (May 30, 2012).
Applicable Criteria and Related Research:
Counterparty Criteria for Structured Finance Transactions
State Revolving Fund and Leveraged Municipal Loan Pool Criteria
Revenue-Supported Rating Criteria