Fitch Affirms South Jersey Transportation Auth's Sr & Subordinate Bonds 'BBB+'/'BBB-'
The ratings reflect the authority's adequate debt service coverage ratios (DSCR), which are expected to remain above 1.5x for senior and 1.4x for subordinate debt over the forecast period respectively. The ratings also incorporate SJTA's economic flexibility to raise tolls given current low rates, which is supported by a rate covenant requiring the authority to implement toll rate increases in case continued revenue declines result in lower coverage. The ratings also reflect reduced debt service obligations over the next five-years as a result of the 2014 refunding, which effectively deferred higher debt service in exchange for near-term financial flexibility. Fitch expects that coverage will remain in-line with the assigned rating levels, with respective 10-year average senior and all-liens coverages of 1.54x and 1.47x in Fitch's rating case. The two-notch ratings distinction between the senior and subordinate bonds reflects the deeply subordinated nature of the subordinate bonds as well as a weaker security package.
KEY RATING DRIVERS
Asset with Long History, Subject to Industry Risks (Revenue Risk - Volume: Weaker): The authority's anchor asset, the Atlantic City Expressway (ACE), has over 50 years of operating history. However, the expressway is exposed to leisure-oriented traffic which is dependent on the health of the Atlantic City gaming industry and visitors to the southern New Jersey seashore resort towns. Traffic on the expressway has declined in the past six years primarily as a result of the economic downturn and increased gaming competition in the region. However, traffic has shown signs of stabilizing the past two years. The average toll of $1.49 for the expressway is reasonable, which offers the authority flexibility to raise tolls. The last toll increase was implemented in November 2008 which increased tolls by 50%.
Moderate Pricing Ability (Revenue Risk - Price: Midrange): The authority benefits from unlimited legal authority to change toll rates as needed. The authority has historically demonstrated willingness to raise rates when debt service coverage has declined or prior to the development of a large capital program. Willingness to raise rates will be critical in the next five years given any necessary maintenance work and an increasing debt service profile.
Large Discretionary Capital Program (Infra Development & Renewal Risk - Midrange): The authority's 10-year capital program for 2016 - 2025 is large, totalling $737.2 million, with $337.9 million for the airport and $399.3 million for the expressway. However, many projects are discretionary and depend upon available funding with no capacity constraints given current traffic forecasts. Management has indicated no additional debt issuance is anticipated and the current plan allows for a delay in spending. Fitch notes that a significant delay and deferred maintenance could affect traffic and revenue and should be monitored; however, this is partially mitigated by annual road inspections.
Fixed Rate Debt (Debt Structure: Senior/Sub - Stronger/Midrange): The authority has two liens of debt, both with fixed-rate and fully amortizing debt profiles. In 2014, the authority refunded all outstanding variable rate debt with the issuance of the 2014A&B bonds reducing some risks to interest costs. Total debt service requirements decreased from $29 million in 2016 to $27.6 million in 2019, but increases to $34 million in 2020 with MADS at $35.1 million in 2030. On the subordinate lien, a weak sum-sufficient covenant coupled with structural subordination provide for weaker bondholder protection.
Moderate Leverage, Adequate Financial Flexibility: The expressway generates sufficient toll revenues to provide adequate financial cushion while also supporting Atlantic City International Airport (ACY), which continues to operate at a deficit. Senior and subordinate lien DSCRs for 2015 were 1.71x and 1.63x, respectively, an expected improvement from last year. Senior leverage and total leverage is considered moderate at 6.8x and 7.1x net debt to cash flow available for debt service (CFADS), respectively, while liquidity of $51.2 million of unrestricted cash (as of December 2015), equivalent to 353 days cash on hand, is considered adequate. In Fitch's rating case, 10-year coverage levels are expected to average 1.54x senior and 1.47x for both liens, while leverage is expected to decline to 4.77x for the senior lien and 4.85x for all-liens, which is consistent with the current rating levels.
Peers Analysis: Peers for SJTA include: Mid-Bay Bridge Authority (senior lien rated 'BBB+' and springing lien rated 'BBB') and Rhode Island Turnpike Authority (rated 'A'), both of which have exposure to leisure traffic. While Mid-Bay Bridge has higher coverage ratios, leverage is considerably higher than SJTA. Rhode Island Turnpike has more favorable coverage and leverage than SJTA, but has a sizable capital plan.
--Negative: Sustained underperformance of traffic and failure of the authority to implement adequate or timely toll increases leading to deterioration of DSCR profile below 1.5x - 1.7x for the senior lien and 1.4x for all liens on a sustained basis;
--Negative: Increased airport subsidies drawn from expressway revenues and/or additional borrowings to fund capital improvements which will result in lower range of coverage and/or higher leverage.
--Positive: Given SJTA's traffic and revenue outlook for forthcoming years, a positive rating action is not envisaged in the near term.
SUMMARY OF CREDIT
Traffic on the expressway increased by 0.3% in 2015 and continued to grow to 3.4% in the first five months of 2016. Toll revenues have increased by 1.6%, which is viewed favourably as it indicates a stabilizing traffic base. A combination of factors (2008 recession, Hurricane Sandy, and casino closures) had resulted in year-over-year declines in traffic post-recession up until 2014.
The expressway continues to be exposed to the surrounding gaming industry as approximately 30% of traffic utilizes the expressway to get to Atlantic City. Casino revenues in Atlantic City have been on a declining trend, but increased slightly this year. Fitch expects 2016 and 2017 to be relatively stable with no new competition in the near-term. Outside of Atlantic City, potential competition could come from the legalization of gaming across New Jersey and one to two new casinos opening in the surrounding areas. Although there was consensus that New Jersey's regulatory structure for online gaming is appropriate, disappointing cash flows generated so far in the three legalized states (New Jersey, Nevada and Delaware) have reduced interest in state-wide legalization of online gaming.
The 2014 debt refunding has reduced near-term debt service obligations at the cost of increased debt service obligations in 2020. Debt service coverage is slightly higher in 2016 compared to last year's due to an increase in traffic volume and revenues. Senior DSCR in 2015 is at 1.71x and 1.63x including subordinate debt. Total debt service escalates from $29 million to $34 million in 2020, pressuring the authority's coverage ratio in that year and thereafter. Failure to adjust tolls in the face of traffic and revenue underperformance, increases in operating expenses, and escalating debt service may result in a weaker DSCR profile than currently expected.
Fitch's base case assumes that traffic will decline at a CAGR of -0.9% over the next four years. This is reasonable given that the authority had a -1.44% CAGR over the last five years, mainly driven by a slower recovery from the recession. As debt escalates, Fitch's base case assumes a 25% increase in tolls would be needed in 2020 to mitigate rising debt service costs while maintaining its DSCR profile. As part of this scenario, Fitch assumes a 6% decline in transactions in the year that tolls increase, and a small recovery in transactions between 2021 and 2026. The resulting base case senior and total 10-year DSCR average is 1.54x and 1.47x, respectively, weighed down by a weaker profile between 2023 and 2026.
Fitch's rating case assumes an average annual decline of -0.9% in the first four years which is similar to the base case, followed by higher traffic volatility from 2020 onwards. Fitch assumes a 50% toll rate increase in 2020 would be needed to allow the authority to maintain DSCR consistent with the rating levels. In response to a toll increase, traffic is assumed to decline by 12% in 2020. A small economic shock to traffic of -7% is assessed in 2021, in line with expectations of an economic cycle. Traffic remains slightly depressed (-0.5%) in the next two years, followed by a recovery from 2024 - 2026 (average annual growth rate of 2.3%). Under this scenario, senior and total 10-year average DSCR is 1.54x and 1.47x, respectively.
In light of flat to negative medium term traffic expectations reflecting Atlantic City's declining importance as a regional leisure destination (approximately 30% of ACE's traffic), Fitch believes that the authority's ability and willingness to raise tolls on a proactive basis to manage its DSCR coverage profile will be critical for the maintenance of the current ratings.
Fitch also looked at a break-even toll revenue growth scenario, which reflected 1.95% growth in toll revenues and 3% expense growth in order to maintain a 1.0x aggregate DSCR. Fitch assumed drawings on cash reserves and the debt service reserve fund (DSRF) in order to supplement CFADS in meeting debt service obligations.
Senior bonds are secured by pledged revenues after provision for an operating reserve equalling 15% of pledged project operating expenses. Pledged revenues primarily include toll revenues from the expressway, as well as certain parking and bus management fees. Current investment income is also pledged, along with fund balances. Airport revenues generated to cover debt service on bonds issued to fund airport projects are also pledged. Unlike other transactions, the subordinate bonds are paid not only after senior debt service obligations but they are also subordinate to a debt service reserve fund and rehabilitation and repair fund. In addition, the subordinate bonds have a weak sum sufficient rate covenant.