Fitch Rates Wisconsin's $98.6M Clean Water Rev Ref Bonds 'AA+'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has assigned an 'AA+' rating to the following bonds issued by the State of Wisconsin (the state):

--Approximately $98.6 million clean water revenue refunding bonds 2016 series 1.

The bonds are expected to sell via negotiation the week of March 14, 2015. Bond proceeds will be used to advance refund outstanding bonds and to pay for costs of issuance.

In addition, Fitch has affirmed the 'AA+' rating on the following outstanding parity bonds:

--$698.2 million clean water revenue bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are secured primarily by pledged loan repayments and amounts in the reserve and subsidy funds.

KEY RATING DRIVERS

SOLID FINANCIAL STRUCTURE: Fitch's cash flow modeling demonstrates that the state's Clean Water Fund Program (CWFP) can continue to pay bond debt service even with hypothetical loan defaults in excess of Fitch's 'AA' liability rating stress hurdle without causing bond payment interruptions.

STATE INVESTMENT EXPOSURE: Significant portions of CWFP's bond debt service are subsidized by Wisconsin general obligation (GO) bond holdings (GOs rated 'AA' with a Stable Outlook by Fitch) in the program subsidy fund are required, in addition to loan repayments, to produce 1.0x debt service coverage (DSC). This structural reliance on state GO bond repayment, combined with the somewhat below-average financial metrics in comparison to similar state revolving fund (SRF) programs, limit the rating to 'AA+'.

STRONG PORTFOLIO QUALITY WITH INTERCEPT: Borrower loan provisions are strong, including the program's ability to intercept state aid payment otherwise due to delinquent borrowers. Approximately 79% of the CWFP's loan portfolio is estimated to be investment grade by Fitch.

HIGH SINGLE-BORROWER CONCENTRATION: The pledged pool consists of 167 borrowers, with the top 10 participants representing approximately 70% of the total portfolio. The largest participant, Milwaukee Metropolitan Sewer District (MMSD), represents a significant 39% of the total portfolio. However, MMSD's high credit rating (GO debt rated 'AAA' with a Stable Outlook) mitigates some of the overall concentration risk.

RATING SENSITIVITIES

REDUCTION IN MODELED STRESS CUSHION: Significant deterioration in aggregate borrower credit quality, increased pool concentration, or increased leveraging resulting in the program's inability to pass Fitch's 'AA' liability rating stress hurdle would put downward pressure on the rating. Fitch's believes that these events are not likely to occur.

CREDIT PROFILE

The state issues revolving fund revenue bonds under its leveraged portfolio to fund clean water loans for various governmental entities throughout the state. In addition, the state, through the Department of Administration (DOA), operates separate direct and proprietary loan portfolios for loans also made to governmental entities for clean water projects. Only loan repayments from the leveraged portfolio are pledged to CWFP bondholders.

SOUND FINANCIAL STRUCTURE

Fitch measures financial strength of SRFs by calculating each program's asset strength ratio (PASR). The PASR includes total scheduled pledged loan repayments, state subsidy payments and reserves divided by total scheduled bond debt service. The CWFP's PASR is 1.2x, which is somewhat below average but adequate in comparison to Fitch's 2015 sector median PASR of 1.9x. At approximately 1.0x, minimum annual DSC is also below average versus the overall sector median of 1.3x, but aligns favorably with Fitch's 'AA' median level.

Cash flow modeling demonstrates that the program can continue to pay bond debt service with hypothetical loan defaults of 100% over the first four years, and 100% in the middle and last four years of the program's life (as per Fitch criteria, a 90% recovery is also applied in its cash flow model when determining default tolerance). This is in excess of Fitch's 'AAA' liability rating stress hurdle of 16% as produced by the PSC. The rating stress hurdle is calculated based on overall pool credit quality as measured by the rating of underlying borrowers, size, loan term, and concentration. Despite the ability of the program to pass Fitch's 'AAA' hurdle, structural reliance on state subsidies and below average financial metrics currently limit the program rating to an 'AA+'.

The state subsidizes approximately 16% of the CWFP's debt service costs in the form of state GO bonds purchased for the program. The purchased bonds (and repayments) are held in the subsidy fund by the trustee. Cash flows produced by these holdings reduce local borrowing costs by allowing a lower yield on the underlying loans than the yield on the bonds. An additional benefit is that the subsidy is available to cure debt service deficiencies if reserve funds are insufficient. However, as the subsidy receipts are required to provide 1.0x DSC on the bonds, the rating incorporates the risk of the state's repayment. Liquidation of such subsidy funds (i.e. the state GO bonds) would likely lead to below 1.0x coverage unless such funds are replaced in subsequent periods; however, no replacement is required in the event of credit deterioration of the state's GO rating.

RESERVE FUNDS PROVIDE MAJORITY OF ENHANCEMENT

Typical for reserve fund SRF structures, annual surplus cash flow coverage is thin; therefore, the program's loan credit reserve fund (reserve fund) provides most of the loss protection for the CWFP bondholders. The current reserve fund balance totals approximately $74.9 million, which equates to approximately 11% of the outstanding bond balance (after the issuance of the series 1 bonds). This is a slight decrease from the reserve balance at Fitch's last review but is considered adequate for the rating.

The reserves are invested in the state's investment pool, forward-delivery agreements providing for the delivery of U.S. treasury securities, 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 invested. The state must cure reserve fund shortfalls before additional loan disbursements or bond issuances. In addition, defaulting borrowers must replenish any reserve draws.

LOAN POOL EXHIBITS HIGH CONCENTRATION

The combined pledged loan pool is composed of approximately 167 borrowers, with the top 10 representing approximately 70% of the aggregate loan pool. MMSD, the program's largest borrower, represents 39% of the total pledged portfolio. These numbers compare unfavorably to Fitch's 'AAA' medians, which show top 10 concentration at 55% and single borrower concentration at 18% in 2015. Each of the remaining pool participants represents no more than approximately 6% of the total pool. Because of the top 10 and single borrower concentration, Fitch views overall pool concentration as high. However, the 'AAA' rating of the pool's largest participant mitigates some of the concentration risk. The state also presents a degree of concentration risk to the program structure because of the CWFP's reliance on state subsidies to cover debt service in the form of state GO bond repayments.

STATE AID INTERCEPT PROVISION CONTRIBUTES TO STRONG POOL QUALITY

Fitch estimates that at least 79% of the pool's loans are to investment-grade borrowers, including borrowers based on the state's GO rating 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 conservatively uses an assumed 'AA-' rating for borrowers meeting Fitch's state aid intercept criteria in determining the composite portfolio stress hurdle.

The program's loan security is solid with approximately 58% of loan principal backed by GO pledges and remaining loans backed by water/sewer system revenue pledges or a combination GO/utility pledge. 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 permanent loan default.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

State Revolving Fund and Leveraged Municipal Loan Pool Criteria (pub. 29 Oct 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=872307

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1000826

Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000826

Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Julie Garcia Seebach, +1-512-215-3743
Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Major Parkhurst, +1-512-215-3724
Director
or
Committee Chairperson
Doug Scott, +1-512-215-3725
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Julie Garcia Seebach, +1-512-215-3743
Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Major Parkhurst, +1-512-215-3724
Director
or
Committee Chairperson
Doug Scott, +1-512-215-3725
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com