Fitch Rates Massachusetts School Building Authority's $625MM Senior Sales Tax Bonds 'AA+'
--$425,000,000 senior dedicated sales tax bonds, 2016 series B;
--$200,000,000 senior dedicated sales tax refunding bonds, 2016 series C.
The bonds are scheduled to be offered via negotiated sale on or about Oct. 5, 2016.
In addition, Fitch takes the following actions on outstanding ratings of MSBA sales tax bonds:
--$5.3 billion in senior dedicated sales tax bonds, affirmed at 'AA+';
--$293.3 million in subordinate dedicated sales tax bonds, upgraded to 'AA+' from 'AA';
--$450 million in bank notes associated with subordinate dedicated sales tax bond anticipation notes, upgraded to 'AA+' from 'AA'.
The upgrade reflects application of Fitch's revised criteria for U. S. state and local government credits, released on April 18, 2016. The revised criteria include more focused consideration of historical revenue performance and overall revenue sensitivity relative to maximum annual debt service (MADS) and the additional bonds test (ABT) for dedicated tax bonds.
The Rating Outlook is Stable.
The Authority's bonds are secured by an irrevocable dedication of one cent of Massachusetts's 6.25-cent sales tax, with some exclusions.
KEY RATING DRIVERS
STRONG GROWTH PROSPECTS: Performance of the dedicated sales tax securing the bonds, consisting of one cent of the Commonwealth's 6.25% sales tax, is strong and likely to remain so over time, reflecting the strength of the Commonwealth's economy. Sales tax revenues have been subject to some cyclicality, including a steep, three-year decline in the last recession.
SOLID COVERAGE: The ABT provides substantial cushion to ensure coverage of aggregate debt service, including under stress scenarios consistent with Fitch's tax supported criteria covering the impact of a moderate, national downturn and based on the highest consecutive historical revenue decline.
STRONG AND WEALTHY ECONOMY: The Commonwealth has a broad and diverse economy with strong economic fundamentals, including high education levels, solid wealth indicators and population growth approximating national averages.
STRONG STRUCTURAL PROTECTIONS: Revenues dedicated for school capital are segregated from the Commonwealth general fund, and the Authority has no role in funding school operations. Strong legal covenants protect against diversion of revenues or lowering of the tax rate, although the base can be changed.
PLEDGED TAX PERFORMANCE: The rating is sensitive to the performance of the pledged sales tax revenue and continued expectations for solid debt service coverage levels.
The ratings on MSBA's dedicated sales tax revenue bonds are based on the solid growth prospects and resilience of dedicated sales tax revenue, the adequacy of debt service coverage and the ABT, and structural protections that insulate the bonds from the Commonwealth's general operations, reflected in Fitch's 'AA+' Issuer Default Rating (IDR) for the Commonwealth.
The Commonwealth has imposed a sales tax since 1966, and although performance in the last recession was weak, coverage of MADS remained strong. Coverage based on fiscal 2017 estimated pledged revenues is solid at 2.2x for senior bonds and 2x for aggregate debt service, without consideration of the federal interest subsidies associated with Build America Bonds and Qualified School Construction Bonds.
Average annual sales tax growth has been about 6.3% since the inception of the tax in 1966, and dedicated sales tax performance has been solid since the one-cent tax pledge for MSBA was fully phased in, in fiscal 2011. Actual year-over-year growth was 5% in fiscal 2015 and 4.5% for fiscal 2016, which ended on June 30. Collections toward the end of fiscal 2016 and in the first few months of fiscal 2017 have slowed somewhat relative to prior year levels and benchmark expectations, with fiscal 2017 year-to-date receipts through August only about 0.9% above the prior year baseline and 3.8% below benchmark. The Commonwealth's forecast anticipates sales tax revenues growing 4.9% in fiscal 2017. Coverage would remain high even if actual growth remains below the forecast level.
Additional bond issuance under the Authority's $10 billion authorization requires 1.4x MADS coverage for senior bonds and 1.3x coverage of total MADS for subordinated bonds, providing a substantial cushion to ensure coverage relative to potential cyclicality.
To evaluate the sensitivity of the dedicated revenue stream to cyclical decline, Fitch considers both revenue sensitivity results (using a 1% decline in national GDP scenario) and the largest actual decline in revenues over the period covered by the analysis. Based on a 15-year pledged revenue history, Fitch's analytical sensitivity tool (FAST) generated a 2.2% scenario decline in pledged revenues. The largest consecutive historical decline was 7.9%, based on recessionary losses during the fiscal 2008-2010 period.
Under both scenarios, dedicated revenue remains ample to ensure coverage of MADS on an aggregate basis. For senior bonds, the coverage cushion provided by the ABT equates to 13.2x the scenario decline and 3.6x the largest historical decline, based on fiscal 2016 results. On an aggregate basis, the coverage cushion equates to slightly lower 10.7x the scenario decline and 2.9x the largest historical decline.
Dedicated revenues are segregated from the Commonwealth general fund, and the Authority has no role in funding school operations. Strong legal covenants protect against diversion of revenues or lowering of the dedicated tax rate, although the base can be changed. Most, but not all, of the Authority's senior lien bonds issued to date have had a standard debt service reserve fund, as will the current bonds. The debt service reserve level is not a rating factor for Fitch given the strong coverage and structural features of the bonds.
Dedicated sales tax revenues are credited to the School Modernization and Reconstruction Trust (SMART) fund, which is held by the Commonwealth treasurer exclusively for the purposes of the Authority, and disbursed to the bond trustee on a monthly basis. The revenues in the fund are not commingled with Commonwealth funds and are not subject to appropriation. Bondholders have first claim on the dedicated sales tax.
The Authority can choose to transfer excess dedicated sales tax revenues to the Commonwealth, but the Commonwealth has relinquished all claims to the revenue. The Authority consists of seven members: the Commonwealth Treasurer (chair), four treasurer appointments, and two ex-officio members. The authorizing legislation specifies that the treasurer shall act as trustee as it relates to the SMART fund and not on account of the Commonwealth.
The Authority was created in 2004 to address a substantial backlog of programs funded under the Commonwealth's prior school building assistance program and create a sustainable system for school capital funding going forward. Pre-existing contract assistance commitments to localities, a declining obligation through 2024, are paid annually from dedicated revenues after payment of debt service. The Authority was authorized to fund up to $500 million in new projects annually starting in fiscal 2008 (with the limit adjusted up or down each year by the lesser of the dedicated sales tax revenue increase/decrease or 4.5%); approval of new projects is contingent upon the availability of funds for this purpose. The Authority does not have a waiting list.
As noted above, pledged revenues are segregated from general operations of the Commonwealth, and thus bond security and the 'AA+' rating are driven by sales tax performance and closely linked to overall economic performance. Fitch does not view the rating on the bonds as being capped by the Commonwealth's 'AA+' IDR. However, based on Fitch's criteria for rating state dedicated tax bonds above the IDR, the amount of credit Fitch will give to such a structure is tempered by the risk that a state could exercise its sovereign powers to the detriment of bondholders.
Massachusetts has a fundamentally strong economy with solid growth prospects. A dynamic, service-oriented economy includes numerous institutions of higher education and health care that lend stability, in addition to supporting development and innovation in other areas. At 128% of the U. S. average, per capita personal income is the second highest of the states. Educational attainment is very high, and population growth has approximated that of the U. S. during this decade, a shift from historical experience of slow population gains. Despite this shift, the Commonwealth's population profile remains older than the U. S. average, consistent with other states in the region.
Economic performance has been highly sensitive to national trends. In the most recent recession, economic performance was significantly better than the national experience, in contrast to 2002-2004 when Massachusetts suffered among the steepest employment drops in the country. Employment losses in the most recent recession in the Commonwealth were slightly less severe than those of the U. S. (down 6% in Massachusetts versus 6.3% for the U. S.), and employment since then has risen more than the U. S. (up 12.1% in Massachusetts versus 11.5% for the U. S.).