Fitch Affirms Kentucky Infrastructure Auth.'s SRF Bonds at 'AAA'; Outlook Stable
AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings affirms the following bonds issued by the Kentucky Infrastructure Authority (KIA) at 'AAA':
--Approximately $278.9 million wastewater and drinking water revolving fund revenue bonds.
The Rating Outlook is Stable.
The bonds are secured by pledged loan repayments, pledged funds and accounts, and investment earnings on such funds and accounts.
KEY RATING DRIVERS
STRONG FINANCIAL STRUCTURE: Fitch's cash flow modeling demonstrates that the program can continue to pay bond debt service even with loan defaults in excess of Fitch's 'AAA' liability rating stress hurdle, as produced using Fitch's Portfolio Stress Calculator (PSC).
SOLID BORROWER POOL: Approximately 59% of KIA's state revolving fund (SRF) loan pool consists of borrowers exhibiting investment-grade ratings. Loan security is very strong as borrowers are secured by net utility system revenue pledges.
SOMEWHAT ELEVATED POOL CONCENTRATION: The loan portfolio has slightly above-average borrower concentration, with the top 10 borrowers representing approximately 57% of the loan pool. At 17% of the total pool, Sanitation District No.1 is the largest borrower.
EFFECTIVE PROGRAM MANAGEMENT: KIA's SRF program serves many small cities and towns which are exposed to risks associated with limited economic diversity. As a result, a limited number of KIA's borrowers have experienced payment hardships. Management has effectively worked with such borrowers to prevent permanent program defaults.
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 'AAA' liability rating stress hurdle would put downward pressure on the rating. The Stable Rating Outlook reflects Fitch's view that these events are unlikely to occur.
KIA provides financing to certain governmental entities within the state for eligible clean water and drinking water SRF infrastructure projects. Bond proceeds are combined with federal grants and a state matching requirement to provide loans for such projects. KIA's SRF program bondholders are primarily protected from losses by pledged loan repayments made in excess of bond debt service.
FINANCIAL STRUCTURE EXHIBITS STRONG DEFAULT TOLERANCE
Due to the program's available enhancement, cash flow modeling demonstrates that the program can continue to pay bond debt service even with hypothetical loan defaults of 85% in the first four years of the program's life and 100% over the middle and last four years (per Fitch criteria, a 90% recovery is applied when determining default tolerance). This is in excess of Fitch's 'AAA' liability rating stress hurdle of 39% as produced by the PSC. The liability stress hurdle is calculated based on overall pool credit quality as measured by the rating of underlying borrowers, size, loan term, and concentration.
Fitch calculates the pool program's asset strength ratio (PASR), which includes total scheduled pledged loan repayments divided by total scheduled bond debt service, to be very strong at approximately 3.0x. This compares favorably to Fitch's SRF portfolio 'AAA' median PASR of 1.6x. In addition, minimum annual debt service coverage (DSC) is also robust at 2.5x.
SOLID BORROWER POOL WITH ABOVE-AVERAGE CONCENTRATION
Fitch estimates that approximately 59% of program participants exhibit investment-grade credit quality. In aggregate, pool credit quality is slightly worse than similar municipal pools, as reflected by a 'AAA' PSC liability rating stress hurdle of 39%, which is higher than Fitch's median of 33% (lower liability stresses correlate to stronger credit quality). Underlying loan security is very good with all loans secured by water and/or wastewater system revenue pledges.
The pool program consists of 161 borrowers, the top 10 of which comprise approximately 57% of outstanding loan obligations. Consistent with Fitch's last review, Sanitation District No.1 (not rated by Fitch but assessed to be of very strong credit quality) remains the largest borrower, representing 17% of outstanding pool loan principal. The remaining top 10 borrowers range in size from 2.6% to 6.5% of the total pool. Concentration is somewhat above average.
Fitch notes that the program's default tolerance results and pool composition are mostly in line with observations at Fitch's rating in July 2012.
ENHANCEMENT PROVIDED PRIMARILY BY OVERCOLLATERALIZATION
KIA's SRF utilizes a cash-flow structure, wherein program bonds are primarily protected from losses by overcollateralization, or surplus loan repayments made in excess of bond debt service. Additional enhancement is provided from the program's $290.3 million in available surplus funds. While not legally pledged, these resources would likely be used if available and needed to meet payment deficiencies. Incorporation of KIA's unpledged surplus funds into Fitch's cash flow model results in a 100% default tolerance in all stress scenarios.
CROSS-COLLATERALIZATION PROVIDES ADDITIONAL PROTECTION
In the event that drinking water revenues are insufficient to cover debt service on the outstanding drinking water obligations, then wastewater revenues will be used to make up the deficiency to the extent that wastewater revenues exceed the debt service on its own obligations for that interest payment date and vice versa. Because of this cross-collateralization, Fitch combines both pools in its modeling analyses.
EFFECTIVE PROGRAM MANAGEMENT AND OVERSIGHT
The authority maintains effective loan underwriting policies consisting of review of historical audited financial statements, cash flow projections, and rate affordability. Monitoring procedures include annual review of audited financial statements.
The program has never experienced a permanent loan default but has had a limited number of stressed borrowers. This is likely due to the below-average socioeconomic makeup of portions of the state and, in particular, the fact that many of the smaller borrowers are exposed to risks associated with limited economic diversity. Currently, one borrower representing less than 1% of total pool principal is experiencing a payment hardship and is expected to be removed from the pledged pool.
Unlike most SRF programs, the General Assembly of Kentucky, which established the authority, has authorized KIA to directly impose service charges on any borrowers pursuant to its loan agreement and adjust and increase such service charges, if necessary. Under certain circumstances, an increase in service charges may be subject to approval by the Public Service Commission of Kentucky.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'State Revolving Fund and Leveraged Municipal Loan Pool Criteria' (April 28, 2014);
--'State Revolving Fund and Leveraged Municipal Loan Pool 2013 Peer Review' (Oct 31, 2013);
--'Revenue-Supported Rating Criteria' (June 16, 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
State Revolving Fund and Leveraged Municipal Loan Pool Criteria
State Revolving Fund and Leveraged Municipal Loan Pool (2013 Peer Review)