Fitch Rates Texas Water Development Bd's Series 2016 SWIRFT Rev Bonds 'AAA'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has assigned a 'AAA' rating to the following bonds issued by the Texas Water Development Board (TWDB):

--Approximately $574.9 million State Water Implementation Revenue Fund for Texas (SWIRFT) revenue bonds, series 2016 (Master Trust).

Bond proceeds will be used to provide financing to governmental entities within the state for water-related projects and to pay for the cost of issuance. The bonds are expected to price via negotiation the week of September 19.

In addition, Fitch has affirmed its 'AAA' rating on the following bonds:

--Approximately $810.4 million SWIRFT revenue bonds, series 2015A and 2015B.

The Rating Outlook is Stable.

SECURITY

Bonds are primarily backed by loan repayments and pledged accounts. In addition, although not pledged nor a legal requirement, the TWDB in its sole discretion may request that funds be transferred from the approximately $1.9 billion corpus of the State Water Implementation Fund for Texas (SWIFT) program to the SWIRFT program to protect against bond debt service shortfalls. All SWIRFT bonds are separately secured from one another.

KEY RATING DRIVERS

PROGRAM ASSETS PROVIDE SUPPORT: Funds available in the SWIRFT assistance account and the SWIFT investment portfolio provide sound security to bondholders under Fitch's various stress scenarios. Cash flow modeling demonstrates that program resources are sufficient to cover hypothetical SWIRFT portfolio defaults in excess of Fitch's 'AAA' liability rating stress hurdle, as produced by Fitch's Portfolio Stress Calculator (PSC).

ESSENTIALITY OF SWIRFT PROGRAM: Fitch believes that the essentiality of the SWIRFT program, given its role in implementing the Texas State Water Plan (SWP), has been demonstrated by the strong state and voter support which led to the enabling legislation and creation of a constitutionally dedicated fund to capitalize the program (the SWIFT account).

SWIRFT PORTFOLIO HIGHLY RATED YET CONCENTRATED: The combined loan pool (the pool) is highly rated but, at only 29 borrowers, is also small and highly concentrated. For example, the pool's top-10 concentration is approximately 86% versus Fitch 'AAA' median equivalent of 55%. Fitch believes that ample program resources exist to provide loss protection to bondholders, thereby tempering concentration risk. Additionally, concentration is expected to improve over time to coincide with the growth of the SWIRFT program.

INVESTMENT PERMORMANCE VITAL TO PROGRAM LONGEVITY: The Texas Treasury Safekeeping Trust Company (TTSTC) is responsible for the management of the SWIFT investments, the growth of which would aid the growth of the SWIRFT program by providing future borrower subsidies.

STRONG MANAGEMENT OF SWIRFT EXPECTED: Management of SWIRFT program borrowers is provided by the TWDB. The TWDB has extensive experience in managing large state programs such as the TWDB's Clean Water State Revolving Fund (CWSRF).

RATING SENSITIVITIES

REDUCTIONS IN ENHANCEMENT: Substantial reductions in the availability of State Water Implementation Fund assets due to encumbrance, market value declines, or a move toward less liquid asset types could also put negative pressure on the rating.

PROGRAM DETERIORATION: Deterioration of the Texas Water Development Board's State Water Implementation Revenue Fund for Texas program borrowers' credit quality or a significant increase in program leverage could put negative pressure on the rating.

CREDIT PROFILE

The SWIRFT and SWIFT programs were approved by voters in November 2013 for the purpose of meeting the state's rapidly growing water needs. The TWDB's SWIRFT program facilitates the issuance of revenue bonds, the proceeds of which provide favorable financing to local government borrowers for eligible SWP projects. The SWIFT program provides interest rate subsidies to SWIRFT borrowers and, although not a legal requirement, also may be used (at the sole discretion of the TWDB) to protect bondholders from any potential payment shortfalls. The SWIFT program was capitalized in 2013 with a one-time transfer of $2 billion from the state's economic stabilization fund.

The series 2016 bonds are the third series of bonds issued under the SWIRFT program. With this issue, approximately $74.8 million is projected to be transferred on or before closing from SWIFT to the credit of the SWIRFT assistance account; this amount equals the present-value of the interest rate subsidies projected over the life of the 2016 bonds.

PROGRAM RESOURCES PROVIDE STRONG DEFAULT TOLERANCE

Fitch's cash flow modeling demonstrates that the availability of program resources allow for hypothetical loan defaults of 100% in the first, 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) while still paying bond debt service in full. This is in excess of Fitch's 'AAA' liability rating stress hurdle of 38%, thereby indicating a passing result under Fitch's model analyses.

The funds available in the SWIRFT assistance account combined with the discounted SWIFT investments (as described below) allow for the strong default tolerance demonstrated in Fitch's cash flow model analysis. Although the previously issued (series 2015) bonds and the series 2016 bonds are separately secured, the borrower pools and associated cash flows were combined in Fitch's analysis given that the monies credited to the SWIFT account are not tied to any specific series of bonds.

LOSS PROTECTION PROVIDED BY PLEDGED ACCOUNTS AND SWIFT INVESTMENTS

Bondholders are secured primarily by loan repayments from the local governmental borrowers and amounts initially transferred from SWIFT to the SWIRFT assistance account to provide borrowers' interest rate subsidies. Sufficiency of loan revenue is calculated 40 days prior to the bond debt service payment date, allowing for time to work out any potential delinquencies. If loan repayments are insufficient to cover bond debt service, funds held in the SWIRFT assistance account may be utilized. Inclusive of the outstanding amounts remaining from issuance of the series 2015 bonds, an estimated $154.4 million is expected to be available in the respective assistance accounts at closing, equating to approximately 11% of total bonds outstanding.

If funds available in the assistance account are not used or are not available, the TWDB, in its sole discretion and subject to the laws of the state, has the ability to enter into a funds transfer agreement with the TTSTC, whereby funds could be transferred from the SWIFT corpus for the benefit of the SWIRFT bondholders. Although the transference of funds from SWIFT to SWIRFT to cover debt service shortfalls is not a legal requirement, Fitch views the likelihood of such a transfer to be high due to the essentiality of the SWIRFT program in implementing the SWP and the Texas constitutional restrictions limiting the use of SWIFT to SWP-related funding (such as the SWIRFT program).

As of June 30, 2016, the market value of the SWIFT investment pool including funds to be transferred to the SWIRFT assistance account was approximately $1.9 billion. Application of Fitch's baseline 'AAA' discount factors results in approximately $467 million of available SWIFT investments to cover losses, which equates to approximately 34% of projected outstanding bonds. The discounting methodology applied to the assets is described in Fitch's 'Rating Closed-End Funds and Market Value Structures' (CEF criteria). Fitch notes that the discounted value will likely change based on market-value fluctuations, encumbrance, and as the SWIFT investments move more towards policy targets.

Surplus amounts after payment of bond debt service and administrative expenses may be deposited into the program account held by the master indenture trustee. Amounts in each of these accounts are available to cover shortfalls in bonds issued under the master indenture on a pro rata basis. If such amounts are not needed, they could be transferred from SWIRFT to SWIFT. Given the sum-sufficient debt service coverage expectation, surplus amounts may be minimal and are therefore not considered in Fitch's analysis.

SWIRFT PORTFOLIO HIGHLY RATED YET CONCENTRATED

Fitch's quantitative analysis of the pool's default risk is completed using Fitch's PSC (as described in Fitch's State Revolving Fund and Municipal Loan Pool Criteria). The PSC produces a pool-level liability rating stress hurdle based on the obligors' credit ratings, relative size, term and concentration. The rating stress hurdle is then measured against the amount of available program resources to cover hypothetical default-driven losses to determine if the program passes at a given rating stress. Availability of program resources, or enhancement, is measured in Fitch's cash flow model analysis, as described above.

Upon issuance of the series 2016 bonds, the SWIRFT portfolio is expected to consist of 29 obligors, approximately 92% of which are rated investment grade and 66% are rated at or above 'AA-'. The single largest borrower, the Tarrant Regional Water District (water revenue bonds rated 'AA' by Fitch with a Stable Outlook) is 26% of the pool total and the top-10 obligors represent 86% of the total. Based on this composition, the SWIRFT portfolio's 'AAA' liability rating stress hurdle is calculated to be approximately 38%, while Fitch's comparable median is 31%. The higher-than-average hurdle is primarily due to the pool's elevated weighted-average life.

While pool concentration is viewed by Fitch as being extremely high, from both a single-obligor and top-10 standpoint, Fitch views concentration risk as mitigated given the high ratings of the borrowers and the ample program resources. Further, concentration should improve over time as the program grows to meet its intended long-term funding goals.

SWIFT ACCOUNT INVESTMENTS MANAGED BY THE TTSTC

The TTSTC manages the SWIFT investments in the name of the TWDB. Its investment objective is to 'maintain sufficient liquidity while striving to preserve the purchasing power of the fund.' The SWIFT investment policy targets holdings in cash (5%), fixed income (25%), private debt (20%), equity (30%) and real assets (20%). In Fitch's analysis, each asset bucket is subjected to varying degrees of stress based on the CEF criteria.

The TTSTC will be annually audited and will provide financial reporting to the TWDB and the SWIFT Advisory Committee. The advisory committee is a seven-member group established by the legislation to monitor and advise SWIFT. The committee consists of the state Comptroller or designee, three members of the state Senate appointed by the Lieutenant Governor, and three members of the state House of Representatives appointed by the Speaker of the House. The advisory committee submits comments and recommendations to the TWDB regarding the use of SWIFT money in adopting policies and procedures.

STRONG MANAGEMENT EXPECTED

The TWDB, the administrator of both the SWIFT and SWIRFT programs, is responsible for the majority of long-range water resource planning in the state. Since its inception in 1957, the TWDB has initiated more than $19 billion in loans and grants under various water and sewer-related programs. The TWDB has never experienced a default in its nearly 60-year history.

Program loans are required to be secured by general obligation (GO), water and/or wastewater utility system revenue pledges, or a combination of GO/assessment/utility pledges (including electric or gas revenues). Subordinate or junior revenue pledges typically also require reserves equal to 1.0x average annual debt service and a suitable additional bonds test.

EXTENSIVE STATE WATER NEEDS

The state's population growth, which is projected to increase 70% by the year 2070, coupled with the state's near record drought from 2011 to 2015 precipitated the need for the SWIFT and SWIRFT programs. The SWP details the objectives needed to address the state's water needs over the next 50 years. Full implementation of the SWP is projected to cost approximately $63 billion. The SWIRFT is intended to provide funding for about one-half of these costs.

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

Applicable Criteria

Rating Closed-End Funds and Market Value Structures (pub. 11 May 2016)

https://www.fitchratings.com/site/re/881003

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

State Revolving Fund and Leveraged Municipal Loan Pool Criteria (pub. 29 Oct 2015)

https://www.fitchratings.com/site/re/872307

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Contacts

Fitch Ratings
Major Parkhurst
Director
+1-512-215-3724
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Tim Morilla
Associate Director
+1-512-813-5702
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
or
Media Relations
Alyssa Castelli
+1-212-908-0540
New York
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Major Parkhurst
Director
+1-512-215-3724
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Tim Morilla
Associate Director
+1-512-813-5702
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
or
Media Relations
Alyssa Castelli
+1-212-908-0540
New York
alyssa.castelli@fitchratings.com