Fitch Rates Maine Health & Higher Educational Facilities Auth's $62.3MM Series 2016A Revs 'AA'
--\\$62.3 million revenue bonds, series 2016A.
The series 2016A bonds are expected to price via negotiation the week of June 6. Bond proceeds will be used to refund certain outstanding bonds for debt service savings.
In addition, Fitch affirms the following MHHEA reserve fund resolution bonds at 'AA':
--\\$750 million in outstanding revenue bonds.
The Rating Outlook is Stable.
Bonds are secured by loan repayments and pledged reserve funds.
KEY RATING DRIVERS
STABLE FINANCIAL STRUCTURE: Fitch's cash flow modeling demonstrates that MHHEFA's reserve fund resolution program (the program) can continue to pay bond debt service even with portfolio loan defaults consistent with Fitch's 'AA' liability rating stress hurdle, as produced using Fitch's portfolio stress calculator (PSC).
SUITABLE PROGRAM CREDIT ENHANCEMENT: Bondholders are protected from losses by a debt service reserve (DSR) funded at maximum annual debt service (MADS) and backed by the state's moral obligation. Additionally, a supplemental reserve account was funded in 2010 and pledged to bondholders.
CONCENTRATED POOL: MHHEFA's pool is highly concentrated, as the largest 10 obligors represent 71% of the total pool. The program's top-10 concentration compares unfavorably to Fitch's 2015 sector median of 61%. To account for concentration risk, concentrated pools are subjected to higher stresses in Fitch's PSC.
FAVORABLE PROGRAM MANAGEMENT AND UNDERWRITING: MHHEFA maintains sound underwriting and loan monitoring procedures as evidenced by the pool's strong overall historical performance.
WEAKENING POOL QUALITY: Recent increases in pool concentration driven by refundings and a moratorium on new bond issuance have somewhat weakened overall pool quality. As pool concentration continues to increase, Maine Health and Higher Educational Authority's reserve fund program may eventually fail to pass Fitch's 'AA' liability rating stress hurdle, at which point the program could be downgraded.
MHHEFA is an instrumentality of the state created to assist health care and higher education institutions in financing the construction and improvement of related facilities. Most of the state's eligible institutions use the authority as their primary borrowing vehicle because it offers participants the lowest cost of capital.
Program metrics have been somewhat declining over the last few years due to the aforementioned increases in pool concentration. However, Fitch's most recent internal assessments of the largest borrowers have demonstrated some credit improvements thereby resulting in slightly improved overall pool quality.
ADEQUATE FINANCIAL STRUCTURE
Fitch measures the financial strength of municipal loan pool programs by calculating each program's asset strength ratio (PASR). The PASR is calculated by summing all pledged resources and dividing this sum by total scheduled bond debt service. MHHEFA's PASR is 1.1x, which is considered adequate for the rating level yet is well below Fitch's 2015 sector median PASR of 1.9x.
Cash flow modeling demonstrates that the program can continue to pay bond debt service even with hypothetical loan defaults of 99% in the first four-year period and 100% in the middle and last four year periods of the program's life (per Fitch criteria, a standard 90% recovery is applied in its cash flow model when determining default tolerance). This is in excess of Fitch's 'AA' liability rating stress hurdle of 58%, as produced by the PSC, which is derived based on the overall pool credit quality as measured by the rating of underlying borrowers, size, loan term, and concentration.
In accordance with its latest criteria, Fitch also ran lower recovery scenarios in its cash flow model to account for the authority's 'non-traditional' municipal loans. Fitch's recovery range for non-traditional loans, or those loans secured by borrowers without taxing power or so-called 'natural monopolies' with the ability to raise rates to meet bond legal covenant requirements, is 60%-70% but can be scaled up or down based on factors such as the seniority of the pledge, strength of program management, and historical performance of the program. Given the program's 'AA' liability rating stress hurdle of 58%, Fitch's model analyses showed that an average recovery of at least 83% would be necessary to ensure full payment of bond debt service. Fitch believes that this minimum recovery value is justified at an 'AA' rating level based on the historical performance of the program's borrowers, the aggregate pool credit quality, and other structural features of the program including available reserves and the state's moral obligation pledge.
LOSS PROTECTION PROVIDED BY RESERVES
Loss protection is provided to bondholders via a DSR funded by bond proceeds at 100% of MADS. As of March 2016, the DSR totaled \\$83 million, which equated to approximately 11% of bond principal outstanding. In addition, the authority has approximately \\$25.1 million in pledged supplemental reserves that were transferred from its operating fund in 2010. The reserves are invested in tax-exempt municipal bonds (rated at least in the 'A' category), money market accounts, and investment agreements with certain counterparties that must post collateral upon downgrade below 'A-'.
If there is a shortfall requiring DSR funds to be used, the executive director of MHHEFA is required to certify to the governor whether additional funds are necessary to restore the DSR to its required level. Although this is not legally enforceable, Fitch believes that the broad public purpose of the authority creates incentive for the state to honor its moral obligation.
While not pledged, bondholders are afforded additional protection from approximately \\$20.6 million in operating funds, which MHHEFA expects to use first in the event of a loan repayment shortfall. The operating fund balance has been steady over time. The authority also has the ability to intercept any funds held by the state treasurer that are payable to the borrowers. To date, the intercept mechanism has never been tested.
SIGNIFICANT POOL CONCENTRATION
The aggregate pledged loan pool is composed of approximately 41 combined system obligors (or 54 individual borrowers), with the top 10 representing approximately 71% of the pool total. Combined system obligors include individual borrowers backed by a guarantee or similar provision with a parent. On a combined basis, Central Maine Healthcare is the program's largest obligor, representing 15.1% of the total pledged portfolio. At 13.7%, 12.9%, and 10.4%, respectively, the next three largest obligors are the University of New England, MaineHealth, and Eastern Maine Healthcare. None of these borrowers are publicly rated by Fitch, but each is assessed to be at least investment grade. The remaining top 10 borrowers range in size of 2.9%-4.1%. Top-10 concentration compares unfavorably to Fitch's sector median of 61% and has shown a slightly increasing trend over the last few years as new money issuance continues to be frozen.
Pool credit quality is mostly solid with approximately 62% of the pool's loans held by what Fitch assesses to be investment-grade borrowers. Approximately 76% of the outstanding pool loans are to borrowers in the healthcare industry (i.e., hospitals, mental health facilities, community care retirement communities and social service organizations) and the remaining 24% are to higher education institutions.
PROGRAM MANAGEMENT AND UNDERWRITING ARE SOUND
MHHEFA maintains sound underwriting and loan monitoring procedures. The authority requires all borrowers to submit detailed credit applications. Borrowers are also required to provide a senior lien pledge of gross revenues and a mortgage on property and/or equipment being financed. Generally, the terms of the financings are prohibited from exceeding the useful life of the financed asset.
Borrower loan repayments are made on a monthly basis, which allows time for the authority to intervene before each bond payment date if there is a problem. Borrowers must demonstrate the sufficiency of the source of revenues available to repay the financings. Among other provisions, borrowers must have demonstrated a history of responsible financial management and willingness to pay their obligations. In the past, MHHEFA has rejected or required modifications to applications it determines to be below its quality standards. Borrowers must submit annual audits, which are reviewed and monitored by the authority for key financial and debt statistics.
The program has recorded only one pledged obligor default since it was established in 1991. In October 2015, the authority executed a partial acceleration following Parkview Adventist Medical Center's bankruptcy filing in June of the same year. The total pool exposure was an insignificant 0.06%. Nevertheless, the authority prudently used its non-pledged operating funds to cure the default.
PROGRAM QUALITY REMAINS STRONG WITH LIMITED ISSUANCE
The Internal Revenue Service requires that the senior elected official in the state of Maine approve the sale of any tax-exempt bonds in accordance with the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). In June 2011, Fitch was informed that the governor reportedly will not sign any TEFRA approval letters for proposed tax-exempt bond sales which utilize the state's Moral Obligation Reserve Fund Program.
This decision by the governor means that MHHEFA can only issue refunding bonds for the foreseeable future. While this decision does not materially impact the credit quality of the program bonds in the near term, Fitch will continue to monitor the any changes in credit quality of the program that could result from increased pool concentration.