Fitch Ratings assigns an 'AA+' rating to the following bonds issued by the Ohio Water Development Authority (OWDA or the authority) through its community assistance program (CAP):
--Approximately $12.4 million water development refunding revenue bonds, community assistance series 2013 (federally taxable).
In addition, Fitch affirms its 'AA+' on the following bonds:
--Approximately $113 million in outstanding water development revenue bonds.
The Rating Outlook is Stable.
The refunding bonds (and all parity bonds) are secured by borrower loan repayments, a debt service reserve fund, surplus fund, construction fund, and interest earnings. In addition, OWDA covenants to use available moneys in the unrestricted account of the cross-collateralization fund (CCF) to cure program deficiencies, on a subordinate basis, if necessary.
KEY RATING DRIVERS
SUFFICIENT DEFAULT TOLERANCE: Fitch's cash flow modeling demonstrates that the program can continue to pay bond debt service even with loan defaults equal to Fitch's 'AA' liability default hurdle, as produced using Fitch's Portfolio Stress Calculator (PSC).
STRONG PROGRAM MANAGEMENT: OWDA's established loan underwriting criteria and solid portfolio monitoring efforts have contributed to the strong loan performance despite the speculative credit quality of the borrowers. To date, only one pledged borrower has experienced a default and was subsequently de-pledged from the portfolio.
MODERATELY DIVERSE POOL: The combined pledged loan pool is moderately diverse in comparison to similar municipal pools rated by Fitch. The pool consists of about 190 borrowers. The largest participant, Ottawa County (water and sewer system debt not rated by Fitch), represents 7.7% of the total portfolio.
BORROWERS MOSTLY WEAKER CREDITS: Fitch's analysis considered the nature of the program which functions primarily to service communities for whom it would be an economic hardship to finance projects at market interest rates. To account for the likely lower credit quality of the borrowers, Fitch assumed unrated borrowers to be in the 'B' category in its model analysis as opposed to the 'BB' for other municipal pools.
LOWER STRESS PERFORMANCE: Deterioration in structural enhancement resulting in default tolerance levels below Fitch's 'AA' stress hurdle could put downward pressure on the rating. The Stable Outlook reflects Fitch's view that such deterioration is unlikely to occur.
The OWDA was created in 1968 and administers other revolving loan programs similar to the CAP, including clean water, safe water, pure water, and fresh water programs. The CAP, formerly known as the 'hardship program' because of its service to communities unable to finance projects at market interest rates, was established in 1983. The CAP was initially funded with amounts derived from various surplus funds under prior programs.
FINANCIAL STRUCTURE EXHIBITS SUFFICIENT DEFAULT TOLERANCE
Semi-annual debt service coverage, which includes pledged loan repayments divided by debt service on the revenue bonds is projected to be a minimum of 1.05x. However, this excludes additional coverage provided by amounts in the surplus, the debt service reserve, the construction funds, the Build America Bonds subsidy, and amounts provided by releases to the unrestricted CCF. All-in coverage of debt service including loan repayments, surplus funds, debt service reserves, and construction fund amounts is approximately 1.8x.
Cash flow modeling demonstrates that the program can continue to pay bond debt service even with hypothetical loan defaults of 100% over any four year period. This is in line with Fitch's 'AA' liability default hurdle as produced by the PSC, which is derived from the overall pool credit quality as measured by the rating of underlying borrowers, size, loan term, and concentration.
Fitch assigned internal credit opinions to the top 33% of the borrower pool in accordance with Fitch's criteria. Fitch assumed other unrated borrowers to be in the 'B' category, which was roughly consistent with the average credit opinions assigned to the top 33%. Fitch's criteria states that the floor rating for unrated borrowers will be assessed at 'BB' unless program borrowers are perceived to have a lower average credit rating, which is the case with the CAP pool.
BORROWER POOL IS MODERATELY DIVERSE
The overall composition of the CAP loan portfolio is largely similar to the composition during Fitch's last review in December 2012. The portfolio now has 191 borrowers, up from 132 borrowers in 2007. The top 10 borrowers represent 30.2% of the pledged loan pool, down from 45.6% in 2005 and 58.6% in 1997. Ottawa County, the largest borrower in the portfolio, represents 7.7% of the pledged loan principal, down from 12.4% in 2007. Fitch views the changes in portfolio diversity over time as a credit positive, as diverse portfolios tend to spread credit risk and therefore reduce portfolio loss and volatility over time. As such, Fitch's PSC model stresses reflect a more diverse portfolio in the form of lower default hurdles.
Most of the CAP borrowers' water or sewer system debt obligations are not publically rated. Also, CAP loans provided to borrowers are generally secured by water and/or wastewater utility revenue pledges, which are generally considered strong pledges. However, due to the hardship nature of the program, such revenue pledges may not be as stable in comparison to publically rated utilities. Nevertheless, the loan portfolio is well seasoned, with a strong repayment history.
STRONG PROGRAM MANAGEMENT AND UNDERWRITING
The authority is governed by eight board members, five of whom are gubernatorial appointees, subject to state senate confirmation for staggered eight-year terms. The current executive director has served in this position since 1988.
The authority underwrites subsidized loans generally with interest rates in the 1%-2% range. Certain criteria must be met to secure financing under the program, including: borrowers must prove that conventional financing for public water supply projects would result in economic hardship to the community; borrowers must meet Safe Drinking Water or Clean Water Act requirements; and the projected annual cost per residential utility system user must be over certain Ohio Environmental Protection Agency (EPA) affordability criteria.
Since program inception in 1983, only one pledged borrower (the city of Sparta, which represented less than 1% of the portfolio) has defaulted on a loan payment. Sparta's loan has since been de-pledged from the CAP portfolio as allowed under the trust agreement. The solid performance of the pool is attributable to OWDA's established loan underwriting criteria and portfolio monitoring efforts.
AVAILABLE RESERVES PROVIDE ADDITIONAL STRUCTURAL ENHANCEMENT
Loan repayments exceeding the amounts needed to pay debt service and fund the debt service reserve will be deposited in the CAP surplus fund. If amounts are insufficient to pay CAP debt service, surplus fund deposits will first be used to cure such deficiencies. After two years, proceeds may be used by the authority for any lawful purpose. The surplus fund balance currently stands at $3.1 million.
Additional bondholder protection is provided by the CAP debt service reserve fund. The debt service reserve is required to be maintained at maximum annual debt service (MADS) on all parity bonds. Investment income on the reserve provides additional debt service coverage. Amounts in the reserve fund will be drawn upon depletion of the surplus fund. The DSRF balance currently stands at $12.7 million.
Bond proceeds are deposited in the CAP construction fund and provide the moneys necessary to make loans to local governments that will finance water, wastewater, and sewerage projects. In 2005, OWDA amended its 1997 trust agreement by pledging the unencumbered account of the construction fund to CAP bondholders. Amounts in the construction fund will be drawn upon depletion of the debt service reserve fund. The construction fund balance currently stands at $20.4 million, including $10.5 million unencumbered and immediately available to the CAP.
Fitch assumed in its analysis that the full encumbered construction fund balance was loaned to borrowers, and therefore conservatively subjected the amounts to stresses in Fitch's cash flow model. Because it is pledged and immediately available to bondholders, the unencumbered construction fund balance was given full credit in the form of additional reserves.
CROSS-COLLATERALIZATION FUND ADDS TERTIARY PROTECTION
Security enhancement is also provided by a subordinate lien on surplus revenues released from the authority's unrestricted account of the CCF established under OWDA's 1995 fresh water program. The CCF is now supplied with moneys released after two years from the authority's CAP, pure water, safe water, clean water, and fresh water surplus funds.
If moneys from the unrestricted CCF are not needed to cure deficiencies in any senior or parity fresh water programs, the CCF is available to make up deficiencies in the CAP debt service and debt service reserve funds. Excess moneys in the unrestricted CCF are released annually on Dec. 1.
Approximately $35.8 million is available in the CCF fund with about $5 million unrestricted. Although this amount is pledged to the CAP, Fitch has not applied credit to these amounts in its model analysis although it recognizes it as an added strength.
The authority also jointly administers the federally authorized wastewater and drinking water programs with Ohio EPA. OWDA has administered loans totaling more than $8 billion of financing for more than 4,000 water and sewer projects throughout 88 counties, under various programs to entities.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--Revenue-Supported Rating Criteria (June 12, 2012);
--State Revolving Fund and Leveraged Municipal Loan Pool Criteria (May 21, 2012);
--Rating Guidelines for State Credit Enhancement Programs (June 19, 2012);
--Counterparty Criteria for Structured Finance Transactions (May 30, 2012).
Applicable Criteria and Related Research
Revenue-Supported Rating Criteria
State Revolving Fund and Leveraged Municipal Loan Pool Criteria
Rating Guidelines for State Credit Enhancement Programs
Counterparty Criteria for Structured Finance Transactions
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
Elizabeth Fogerty, +1-212-908-0526 (New York)
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