Fitch Affirms Arizona Water Infrastructure Finance Authority's SRF Bonds at 'AAA'; Outlook Stable

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings has affirmed its 'AAA' rating to the following bonds issued by the Water Infrastructure Finance Authority of Arizona (WIFA or the authority):

--Approximately $606.270 million outstanding parity bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by certain loan repayments payable from local borrowers, pledged account and reserve funds, and account investment earnings.

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).

LOSS PROTECTION PROVIDED BY OVERCOLLATERALIZATION: WIFA's bonds benefit from overcollateralization as surplus loan repayments provide minimum annual debt service coverage of 1.3x. The debt service reserve account (DSRA) and the financial assistance account (FAA) provide additional protection from losses.

MODERATE POOL CONCENTRATION: WIFA's combined loan pool is small and moderately concentrated. The top 10 borrowers represent 54% of the pool, displaying average concentration relative to Fitch's 2015 'AAA' median of 55%.

AVERAGE POOL QUALITY: Approximately 62% of WIFA's loan pool consists of borrowers exhibiting investment-grade ratings. Loan security is very strong, with nearly 90% backed by utility system revenues, general obligation debt, or a combination of the two.

EFFECTIVE PROGRAM MANAGEMENT: Prior to loan origination, WIFA completes a due diligence review of each of the borrower's legal, managerial, technical, and financial capabilities. The authority adheres to consistent and conservative underwriting policies.

RATING SENSITIVITIES

REDUCTION IN MODELED STRESS CUSHION: If the Water Infrastructure Finance Authority of Arizona's revolving loan program were to experience significant deterioration in aggregate borrower credit quality, increased pool concentration, or increased bond leveraging resulting in its inability to pass Fitch's liability default 'AAA' hurdle, downward pressure on the rating would occur.

CREDIT PROFILE

WIFA is an independent authority of the state of Arizona and was established to provide below-market financing for the construction, rehabilitation, and improvement of drinking water, wastewater, wastewater reclamation, and other water quality facilities/projects within the state.

FINANCIAL STRUCTURE EXHIBITS 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 33%, 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, an 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 WIFA's program is strong at approximately 1.5x, slightly below Fitch's 2015 'AAA' median level of 1.9x.

AVERAGE POOL QUALITY WITH MODERATE CONCENTRATION

Fitch estimates that approximately 62% of program participants exhibit investment-grade credit quality. In aggregate, pool credit quality is in line with similarly-rated municipal pools, as reflected by a 'AAA' PSC liability stress of 33% which is slightly above Fitch's median of 31% (lower liability stresses correlate to stronger credit quality). Loan security provisions are strong with nearly 90% backed by utility system revenues, general obligation debt, or a combination of the two.

The program consists of 73 active borrowers, the top 10 of which comprise a high 54% of the total pool. The two largest borrowers are Peoria (8.5%, Peoria's senior lien water and wastewater WIFA loan rated 'AA'/Stable Outlook) and Lake Havasu (7.6%, Lake Havasu's senior lien wastewater WIFA loan rated 'A'/Stable Outlook). The remaining top 10 borrowers range in size from 3.1% to 6.0% of the total pool.

LOSS PROTECTION PROVIDED BY OVERCOLLATERALIZATION

Under the program's financial structure, each series of bonds is protected from losses by borrower loans made in excess of bond debt service (overcollateralization). On an annual basis, loans overcollateralize bonds by a minimum of 1.3x. Also protecting bonds from losses are the DSRA and the FAA.

Loan repayments are deposited into each respective clean water and drinking water state revolving fund FAA, which are then available to make debt service payments on any bonds issued under the master trust indenture. Once the aforementioned payments are made, excess amounts in each account can be transferred to the other to make up any deficiencies, resulting in cross-collateralization of the two funds. This increases the diversity of the aggregate loan pool and lessens the risk of any one borrower's default eroding reserve balances and threatening bondholder payments. Any such transfer creates a repayment obligation by the deficient account, but the obligation is subordinate to the trust estate's pledge under the bond indenture. Due to the cross-collateralization feature, Fitch combines the programs in its cash flow modeling.

After taking into account all transfers from the FAAs, the DSRA will be used to cure debt service payment shortfalls. The program indenture requires that the DSRA be maintained at the least of: 10% of the original balance of all outstanding bond principal; 1.0x maximum annual debt service; or 1.25x of the average annual debt service remaining. The DSRA may be funded with cash or a letter of credit, surety bond or other similar arrangement.

The total DSRA balance is projected to be approximately $71.2 million on July 1, 2016, which will equate to 11.7% of bonds outstanding. At the same time, the FAA is expected to be funded at approximately $304.1 million (or 50.1% of outstanding bond principal). The total of all pledged accounts, including the FAA and the DSRA, are projected to provide an additional 66.5% in loss protection to the bonds.

EFFECTIVE PROGRAM MANAGEMENT AND UNDERWRITING

WIFA's loan underwriting guidelines, evidenced by extensive formalized policies and procedures, are a key credit strength. Prior to loan origination, WIFA staff performs a due diligence review and a financial capability review. The due diligence review includes determination of legal, managerial, technical, and financial capability. The financial capability review focuses on a borrower's historical performance over the previous three-year period, with results used to analyze trends and project future performance.

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

Applicable Criteria

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. 20 Oct 2016)

https://www.fitchratings.com/site/re/888966

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013543

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013543

Endorsement Policy

https://www.fitchratings.com/regulatory

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Source: Fitch Ratings

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