Fitch Affirms MassDOT's Metro Highway System Sr Revs at 'A+'; Outlook Stable
The rating reflects MHS's monopolistic position and continued stability of the asset as evidenced by its long history of traffic and revenue growth. Medium-term performance in revenue collections and expense control is uncertain, however, due to the roll out of the All-Electronic Tolling (AET) system in fiscal 2017. The AET roll-out could potentially result in lower future net revenues in the initial years. However, MHS's current robust coverage, contractual assistance on debt service, and ample cash balances would provide adequate mitigation of the potential impact of macroeconomic stresses or temporary revenue shortfalls. Barring meaningful toll increases, an increase in their debt service profile from FY2015 onwards combined with a sizable capital plan to address a decade of deferred capital maintenance would strain revenues and reserves as well as leverage, placing a constraint on the current rating.
KEY RATING DRIVERS
Established Road System (Revenue Risk - Volume - Stronger): The MHS is a highly monopolistic asset providing key interstate connections for commercial and passenger traffic located in a strong service area with a stable and relatively inelastic demand profile. Toll rates are also relatively low and therefore provide significant economic ratemaking flexibility.
Moderate Pricing Power (Revenue Risk - Price - Midrange): The system operates in a highly politicized toll environment, as the Commonwealth of Massachusetts (Commonwealth) acts as a practical limit on ratemaking ability.
New Capital Program; Deferred Capital Maintenance (Infrastructure Renewal & Development - Midrange): Significant lifecycle costs are anticipated in the near future after a decade of deferred capital maintenance. In 2016, MassDOT and MBTA collaborated on establishing a new five-year capital improvement plan (CIP; 2017-2021) to invest in system reliability, asset modernization and capacity expansion. Total cost of the CIP for MHS remains unclear, though $389.8 million is available for the five-year period to focus on repair and rehabilitation and the roll-out of AET.
Escalating Debt Service (Debt Structure - Midrange): MHS's debt profile is divided almost equally between senior and subordinate issuances. Additionally, the structure is exposed to swap contracts in place to hedge existing variable-rate debt, which comprise almost 50% of total debt outstanding. Debt service also began escalating in FY2015 but MHS's stable traffic and revenue performance, ample cash balances, and debt service reserve funds will be adequate for debt service coverage through the medium term.
Supportive Commonwealth and Strong Coverage: The Commonwealth (GOs rated 'AA+'/Stable Outlook) provides meaningful enhancement to the MHS debt service coverage ratio (DSCR) profile in the form of annual dedicated payments for the senior and subordinate liens. DSCR was robust at 4.63x in FY2015 and is projected to average about 3.0x under Fitch's base case projection as senior lien debt service requirements increase. Although coverage is high, current leverage at around 6x rises to about 8x, which is high for the rating category and depends on cash flow available after the funding of the capital plan. The Commonwealth's prohibition of additional senior and subordinate bonds for MHS and MassDOT helps to manage debt levels.
Peer Group: Central Florida Expressway Authority (CFX, 'A/A-'/Stable Outlook) and Illinois State Toll Highway Authority (ISTHA), 'AA-'/Stable Outlook) are MHS's closest peers, each operating large expressway systems in a metropolitan area. MHS is less leveraged and features higher coverage than CFX, consistent with its higher rating at the top of the 'A' category. However, under Fitch's rating case, leverage is projected to be much higher than ISTHA, which constrains the rating from moving up to a similar category.
--Inability to control expenses to maintain historical levels of financial flexibility;
--Sustained declines in revenues, inability to recover from revenue shortfalls, or an increasing expense profile which results in DSCR consistently below 1.7x.
--Capital needs in excess of revenues, reserves and other available funding which result in a material depletion of cash and reserves.
--Declining leverage to a 5x-6x range on a sustained basis.
SUMMARY OF CREDIT
Traffic volume increased by 1.6% in FY2015 (ended June 30) compared to FY2014, slightly higher than projections from the prior year. This positive trend continued in FY2016 as transactions increased by 4.1%, the highest in the past five years, while toll revenues (non-GAAP adjusted) increased by 5.1%. Management attributes the growth in transactions to lower gas prices, which encouraged traveling. Over the next few years, management expects traffic volume to increase as MassDOT rolls out the AET system by the end of October 2016, which should allow a smoother flow of traffic. Toll rates at each gantry will be adjusted with the goal of revenue neutralization and a vote on rates and fees will be held on Oct. 6, 2016. Assuming the proposed rates are accepted, drivers may or may not see an increase in toll fees collected, depending on the routes travelled and transponder usage. Fitch will continue to monitor traffic and revenue performance, as leakage is currently expected to impact approximately 5% of total revenues.
MassDOT and MBTA have collectively developed a capital plan of $14.8 billion, with approximately 60% allocated to improving the reliability of the core transportation system and 20% for modernizing system assets to accommodate current and anticipated growth. Specifically, the available funding for the five-year capital program (fiscal 2016 through 2021) projected for MHS is $389.8 million but the total cost could be higher. Current projects underway focus on AET implementation as well as asset renewal and replacement. As of this review, MHS's capital plan will be funded with toll revenues and MHS reserves; $257.9 million of the projects are underway and a series of new projects will be evaluated for the remaining $131 million of the capital plan. In Fitch's view, the use of internally generated additional funds for MHS's capital plan is favorable to the rating, though material erosion in liquidity could result in increased leverage and rating concerns given the uncertainty in the total cost of the CIP.
The senior debt benefits from the excess contract assistance payments after the required subordinated debt service plus a $25 million annual dedicated payment by the Commonwealth of Massachusetts. The remaining net senior debt service is covered by net revenues of the MHS. The senior net DSCR as calculated by management was 26.6x in FY2014, largely reflecting the very low net debt service amounts due to the aforementioned contract payments. DSCR in FY2015 declines to a still robust 4.63x due to an escalating debt profile, where net debt service increases to $24.4 million in FY2015 from $3.8 million in FY2014, and averages $28.6 million from 2016 to 2026. The legislation that merged MHS into the MassDOT precludes any additional debt under the existing indenture.
The Commonwealth provides $100 million in annual dedicated payments to the MassDOT for the benefit of the subordinated debt which adequately covers all expected subordinate debt service payments with the excess applied to the senior debt service requirement. As a result, the subordinated debt rating is linked to the 'AA+' GO rating of the Commonwealth.
Management's five-year financial forecast assumes slight declines in toll revenues in FY2017 and FY2018, which accounts for leakage during the roll-out of AET. Expenses are also expected to increase by 6.9% and 14.8% in FY2017 and FY2018, respectively, followed by 2.1% growth through 2021. Fitch's base case forecast spans 10 years (2017 to 2026) and assumes slightly heavier stresses in the first five years compared to management's case. While traffic and revenue are assumed to grow at 1.5% annually throughout the forecast period, revenue leakage is assumed as well with the transition to AET, resulting in a 1.2% 10-year CAGR in toll revenue growth. Fitch adopts management's operating expense forecast for FY2017 and FY2018, but increases expenses by 3% annually, slightly higher than inflation. Although revenue leakage accounts for 6.4% of toll revenues and evolves down to 2.6% by FY2026, MHS still demonstrates financial resilience, as 10-year average DSCR is 3.03x and five-year leverage is 6.35x.
Under Fitch's rating case, DSCR and leverage still hold up for the current rating level. The rating case applies similar assumptions to traffic and revenue growth in the first four years, followed by a moderate economic downturn that results in a 4% traffic and revenue decline in FY2021. This decline continues in FY2022, but at a lower rate of 1%. Fitch's scenario mirrors historical performance during the 2008 recession, where traffic declined over two years but at a higher rate. A partial recovery in traffic and revenue is assumed from FY2023 to FY2026, averaging a 1% growth rate annually. Similar to the base case, revenue leakage is also taken into consideration. Operating expense is stressed at 3.5% annually from FY2019 onwards, which is reasonable given a history of growing expenses. The combined stresses result in an average 10-year DSCR of 2.59x and five-year leverage of 7.86x. While coverage is on the higher end of the 'A' rating category, the rating is constrained by its higher projected leverage, capital and maintenance needs, as well as the current uncertainty surrounding the roll-out of AET.
The bonds are secured by a senior pledge of net revenues and on all funds and accounts created under the trust agreement (other than the rebate fund) including all tolls, rates, fees, rental, other charges, and certain investment income. Contractual assistance payments of $100 million and $25 million benefit the subordinate and senior lien, respectively. Payment in excess of the subordinate debt service is applied to the senior lien.