Fitch Rates Iowa Finance Auth.'s Ser. 2016 Revolving Fund Bonds 'AAA'; Outlook Stable
--Approximately $161 million state revolving fund revenue bonds, series 2016 (green bonds).
Bond proceeds will be used to finance clean water state revolving fund (CWSRF) and drinking water state revolving fund (DWSRF) loans to eligible borrowers within the state and to pay for the costs of issuance. The bonds are expected to sell via negotiation during the week of Oct. 3.
In addition, Fitch has affirmed its 'AAA' rating on the following:
--Approximately $801 million outstanding state revolving fund (SRF) revenue bonds.
The Rating Outlook is Stable.
The series 2016 bonds and outstanding parity bonds are secured by loan principal and interest amounts pledged under the master trust agreement (MTA), account investment earnings, and amounts held in the pledged equity fund.
KEY RATING DRIVERS
SOUND FINANCIAL STRUCTURE: Fitch's cash flow modeling demonstrates that IFA's SRF program (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).
MODERATE POOL DIVERSITY: Due to the large number of borrowers (approximately 640), pool diversity is favorable. The top 10 borrowers and largest single borrower represent 49% and 16% of the pool, respectively. These numbers are better than Fitch's 2015 'AAA' medians of 55% and 18%.
LARGELY UNRATED PORTFOLIO: Approximately 77% of the IFA's loan portfolio does not carry a public rating. In its analysis, Fitch assumes unrated borrowers to be of sub-investment grade quality ('BB'). Therefore, overall pool quality is below average in comparison to similar programs rated by Fitch.
EFFECTIVE PROGRAM MANAGEMENT: IFA and the Iowa Department of Natural Resources (DNR) jointly manage the program, following underwriting and loan monitoring procedures set forth by the MTA. Reflecting the strength of program management, the program has not experienced a default of any pledged borrower to date.
REDUCTION IN MODELED STRESS CUSHION: Significant deterioration in aggregate obligor credit quality, increased pool concentration, or increased leveraging resulting in the Iowa Finance Authority state revolving fund program's inability to pass Fitch's 'AAA' liability rating stress hurdle would put downward pressure on the rating.
The IFA provides financing to governmental entities within the state for eligible CWSRF and DWSRF infrastructure projects. Bond proceeds are combined with federal grants and a state matching requirement to provide loans for such projects.
FINANCIAL STRUCTURE EXHIBITS SOUND 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 53%, thereby indicating a passing result under Fitch's quantitative analysis.
As an additional measure of financial strength, Fitch calculates the program asset strength ratio (PASR). The PASR, a total asset-to-liability ratio, includes total scheduled loan repayments plus any additional pledge funds divided by total scheduled bond debt service. The resulting PASR for IFA's SRF program is sound at approximately 1.6x, although it falls somewhat below Fitch's 2015 'AAA' median level of 1.9x.
LOSS PROTECTION PROVIDED BY OVERCOLLATERALIZATION AND PLEDGED EQUITY FUNDS
The bonds' primary form of bondholder loss protection is provided by surplus loan repayments made in excess of bond debt service (overcollateralization). On an annualized basis, such surplus loan repayments overcollateralize bond debt service by a minimum of 1.2x. This compares closely to Fitch's median equivalent of 1.3x.
Additional loss protection is provided by amounts available in the program's pledged equity and revenue funds. The combined and unencumbered equity and revenue fund balance totals approximately $197 million, which equates to around 20% of the projected bond balance after issuance of the 2016 bonds. Equity funds are primarily invested in money market funds, U. S. treasury and agency securities, and highly rated municipal bonds. Moneys may be released from the MTA pledge if a coverage ratio test of 1.2x is met.
LARGELY UNRATED LOAN POOL WITH MODERATE DIVERSITY
At 644 individual obligors, the combined CWSRF and DWSRF loan pool is large. However, many of the borrowers do not carry a public rating. Inclusive of two internal credit opinions assigned by Fitch, only 27% is estimated to be investment grade or better. This is low in comparison to Fitch's 'AAA' median, which was 70% in 2015. As a result of its below-average quality, the pool's liability rating stress hurdle, as produced by the PSC, is high at 53% (versus a median of 31%); high stress hurdles correlate to lower credit quality.
The pool's top-10 borrowers represent 49% of the pool's total. Consistent with Fitch's last review, the Des Moines Wastewater Reclamation Authority (not rated by Fitch but assessed to be of very strong credit quality) remains the largest borrower, representing 16% of outstanding pool loan principal. The remaining top-10 borrowers range in size from 2% to under 7% of the total pool. Overall, the pool is somewhat less concentrated than other 'AAA'-rated municipal loan pools monitored by Fitch. The large majority of pool loans are backed by water and/or wastewater revenue pledges.
CROSS-COLLATERALIZATION ENHANCES BONDHOLDER SECURITY
The MTA provides for cross-collateralization between the CWSRF and DWSRF accounts, meaning that deficiencies in one SRF payment account may be covered by available moneys from the other SRF. This feature enhances bondholder security by providing additional sources of revenues from which to draw for debt service and increases the overall diversity of the portfolio, allowing analysis of the program as one pool instead of separate SRF portfolios. Any such transfer creates a repayment obligation by the deficient SRF, but the obligation is subordinate to the trust estate's pledge under the MTA. The cross-collateralization mechanism is provided for in the equity fund.
EFFECTIVE PROGRAM MANAGEMENT AND OVERSIGHT
IFA is ultimately responsible for the arrangement of financing for borrowers. This includes the review, processing, underwriting, and approval of program-eligible loans that meet the minimum coverage requirements. The IFA board consists of nine members appointed by the governor, with the approval of two-thirds of the members of the state Senate. Management of the program is supplemented by DNR. DNR is responsible for performing ongoing SRF program operations, monitoring project progress, and providing technical support to participants. DNR provides technical assistance to loan participants and monitors all projects to ensure conformity with SRF and DNR rules and regulations.
The IFA has established a set of administrative rules to evaluate loan applications, focusing on applicant needs, ability to complete construction within the necessary time frame, and ability to repay the loan. Loan participants that pledge system revenues on parity with outstanding debt are required to establish and maintain utility rates that produce 1.1x debt service coverage prior to the release of loan funds. Subordinate lien pledges are also permitted if utility rates produce 1.05x coverage on combined senior and subordinate-lien bonds