Fitch Rates Maryland Stadium Authority's Baltimore School Bonds 'AA'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has assigned an 'AA' rating to the following bonds of the Maryland Stadium Authority (MSA):
--$320,000,000 MSA Baltimore City Public Schools (BCPS) construction and revitalization program revenue bonds, series 2016.
The bonds are scheduled to be sold via negotiated sale on or about April 20, 2016.
Fitch originally rated the bonds on Dec. 23, 2015, but the sale date was subsequently delayed.
The Rating Outlook is Stable.
The bonds are limited obligations of the authority payable from pledged deposits to the financing fund derived from multiple revenue sources: state education aid subject to appropriation by the General Assembly, state lottery revenue, city beverage container tax and casino rental revenues subject to appropriation by the city, and certain other city gaming receipts. City pledged deposits are further backed by an intercept of city income tax receipts held by the state, if needed.
KEY RATING DRIVERS
AMPLE COVERAGE OF PLEDGED DEPOSITS: The bonds are secured by funds deposited into the BCPS construction financing fund (the financing fund) derived from multiple state of Maryland and city of Baltimore sources, with total pledged deposits sized to cover debt service on the maximum authorized borrowing. Coverage by individual revenue sources for specific pledged deposits is exceptional, providing ample cushion against underperformance.
CLOSE STATE OVERSIGHT: The borrowing benefits from careful oversight by the state of Maryland, whose GO bonds are rated 'AAA'/Outlook Stable.
BACKUP INTERCEPT OF CITY INCOME TAX: The ample level of interceptable city personal income tax (PIT) receipts provides a stronger pledge than the underlying city tax and gaming sources intended to pay the bonds. PIT receipts are the second largest source of city general fund revenues, and benefit from the city's diverse though less wealthy economic profile. Fitch's assessment of the PIT intercept reflects the credit quality of the city of Baltimore.
LOTTERY REVENUES DISCRETIONARY: State lottery revenues net of administrative costs and prizes provide strong coverage of the fixed pledged deposit. Fitch views lottery sales over the long run as subject to discretionary consumer purchasing trends and sensitive to personal income, employment, demographic and competitive pressures.
STATE ROLE IN SCHOOL FUNDING: The state is the primary driver of education funding in Maryland and provides more than two-thirds of BCPS revenues. A constitutional education funding requirement and the state's expanded funding over the last decade underscore the state's commitment to school funding.
MAINTENANCE OF LOTTERY COVERAGE: Despite the strong coverage of state lottery pledged deposits, the discretionary nature of lottery activity likely limits the rating at the current level. Evidence of significant shifts in discretionary lottery activity that narrow coverage over time could affect the rating.
STRENGTH OF CITY INCOME TAX BACKUP: The rating is sensitive to erosion in the economic, revenue and budget performance of the city given the strong enhancement of city pledged deposits provided by city PIT receipts collected and subject to intercept by the state.
CONTINUED STATE EDUCATION FUNDING: Significant changes in the state's commitment to education funding that materially reduce the appropriations from which pledged deposits are drawn, or a change in the state's GO rating, could result in a rating change, although Fitch believes that such changes are unlikely.
The 'AA' rating on MSA's construction and revitalization program revenue bonds is based on Fitch's assessment of the credit quality of the varied revenue sources from which individual pledged deposits are made. The state of Maryland, whose GO bonds are rated 'AAA', is the source of most pledged deposits intended for debt service and the credit is further supported by the state's broader role in authorizing the bonds, overseeing their repayment, and implementing the program.
However, the rating is limited by both the credit quality of state lottery receipts, which Fitch views as a narrow and discretionary source of repayment despite the exceptional coverage it provides for state lottery pledged deposits, and by the credit quality of the city, whose PIT revenues are subject to state intercept in the event that city pledged deposits from intended beverage tax and certain gaming revenues are below the statutory thresholds. Fitch views the intercept of city PIT revenues as being a stronger repayment source than the underlying city pledged deposits and as linked to the broader credit quality of the city itself.
STATE AUTHORIZATION AND OVERSIGHT
The new bonds are authorized under 2013 state statutes providing for a maximum issuance of $1.1 billion to be supported by $60 million in annual pledged deposits from all sources. The current sale is the first of several planned to fund the repair or replacement of up to 28 Baltimore school facilities over 5 years.
The 2013 authorizing statutes established the bonds' multiple repayment sources and expanded the MSA's role to issuing the bonds, coordinating their repayment, and overseeing completion of the projects. Legislation established two funds under MSA oversight and held by the state treasurer: the BCPS financing fund receives pledged deposits from or on behalf of the state, BCPS and city, and the BCPS facilities fund holds other funds intended for construction and excess city pledged deposits, if any, including a reserve established at MSA's discretion, discussed in further detail below. Pledged deposits are in a closed loop, and the financing fund may not revert to the general or any special fund of the state.
Only deposits made to the financing fund are pledged to bondholders, although statutory uses of the facilities fund includes bond repayment. Annual pledged deposits from varying sources are statutorily phased in to reach a minimum of $60 million as of fiscal year 2017. A separate trust agreement establishes accounts held by the trustee, including the construction fund to which bond proceeds are deposited and the debt service fund which receives transfers by the MSA from the financing fund.
Fitch views the state's inherent credit strengths, reflected in its 'AAA' GO rating, as supporting the high credit quality of the new bonds. The bonds are integrated into the state's careful and centralized capital and debt management frameworks, despite not being considered state tax-supported debt, and are supported by allocations of statewide-revenue sources and appropriations of state education aid. The 2013 authorizing legislation required the MSA, BCPS, city, and the interagency committee on school construction, which oversees school capital projects, to conclude a memo of understanding (MOU) to carry out the program, subject to approval by the BPW (which consists of the governor, treasurer and comptroller). The 2013 legislation also requires annual reporting to the governor, BPW and legislature on program progress. As with state GO and other tax-supported issues, borrowing under the current authorization must be approved by the BPW.
PLEDGED DEPOSITS FROM STATE LOTTERY
Pledged deposits include a fixed $20 million amount from state lottery sales receipts, net of administrative costs and prize winnings, and subordinate to a fixed $20 million senior payment for MSA facilities and a small variable annual deposit intended for a state veterans' trust fund. The state lottery pledged deposits made by the comptroller are statutorily required on an annual basis beginning in fiscal 2016, with at least $10 million due by Dec. 1 and the remainder due by fiscal year end; no appropriation is required. Lottery receipts after the pledged deposit are transferred to the state general fund.
Lottery sales provide ample coverage of pledged deposits despite the required payments senior to pledged deposits. In fiscal 2015, $526.5 million in lottery receipts net of prizes and administrative costs covered senior required payments and the pledged deposit for the current bonds by 13.1x.
The strong projected coverage by net lottery receipts compares favorably to other lottery-backed debt rated by Fitch and supports the rating at the 'AA' level. However, Fitch views lottery revenues to be an inherently less certain source of bond repayment than broader tax revenues, given the discretionary nature of consumers' lottery purchases and their exposure to cyclical, structural and administrative factors; these considerations limit the rating at the current level.
EDUCATION AID SUPPORTING THE BONDS
Education aid appropriated by the state and allocated to BCPS is intended to be the source of $30 million in pledged deposits on an ongoing basis, beginning in fiscal 2017. Under the bonds' authorization, the bonds are supported by two separate, fixed school aid amounts, one derived from unrestricted aid and the other derived from additional state aid resulting from a temporary school retiree health cost transfer from the city of Baltimore.
The bonds' authorizing statute requires the deposit of $10 million in fiscal year 2016 and $20 million annually thereafter from unrestricted state education aid. These amounts are withheld on a bimonthly basis by the comptroller and deposited on behalf of BCPS in the financing fund. Fiscal 2015 unrestricted aid allocated to BCPS totaled $907 million and covered the $20 million pledged deposit required beginning in fiscal 2017 by 45.4x.
Additionally, $10 million annually in additional school aid received by BCPS is withheld by the comptroller on a bimonthly basis and deposited to the financing fund. The additional school aid is generated from a separate transfer to BCPS by the city of funds which allow BCPS to maximize state maintenance of effort formula aid. The transferred city funds are intended for health costs of school retirees borne by the city; the transfer is ultimately returned to the city, which remains responsible for these costs. The $70.3 million in fiscal 2015 additional state aid covers the $10 million pledged deposit by 7x.
Subsequent legislative action allowed the $20 million in authorized fiscal 2016 deposits from both unrestricted and additional state aid sources to flow instead to BCPS given school budget needs and the absence of borrowing under the program to date.
EXTENSIVE STATE ROLE IN EDUCATION
Virtually all BCPS operating revenues derive from state, city and federal transfers, with more than three-fourths of general fund receipts consisting of state aid. As of fiscal 2015, 78% of general fund revenues consisted of state education aid with a further 20% from city sources. State statute caps BCPS debt at $200 million, excluding federally-qualified school construction bonds and lease revenue bonds, and as with school aid pledged deposits for the current bonds, debt service on BCPS-issued debt is withheld by the comptroller from appropriated state education aid. The school board overseeing BCPS consists of nine members appointed by the governor and mayor.
Although BCPS is a legally separate component unit of the city, Fitch views credit risks originating from it as limited given the state's primary role in setting statewide education policy, funding school operating and capital needs, and overseeing school governance.
The state's role in funding education is mandated by Maryland's constitution. Statutory formula provisions governing aid incorporate numerous factors including pupil counts and community wealth and are subject to legislative changes. However, protections of appropriated state aid are extensive and include a requirement that the governor seek appropriation of the amount requested by the state school superintendent and limits on reducing appropriated aid or using it for non-education purposes.
Maryland expanded statewide school aid significantly in the decade prior to the downturn, with small increases continuing since then. The state reports that the average increase in state aid for public schools rose 10.3% annually between fiscal years 2002-2008, a period during which the state was implementing far reaching changes in school funding. Despite the downturn and slow economic and revenue recovery thereafter, state school aid declined only slightly in fiscal year 2010 and has increased an average of 1.9% annually between fiscal years 2008-2016.
INTENDED CITY PLEDGED DEPOSITS
Unlike the fixed pledged deposits of state lottery and school aid, pledged deposits by the city are intended to achieve a minimum threshold each fiscal year and are additionally enhanced by a backup state intercept of city PIT receipts, which Fitch views as a stronger source of credit quality than the intended pledged deposits. The city's minimum pledged deposits must total $8 million in fiscal years 2015 and 2016 (fiscal year-end June 30), and $10 million annually from fiscal 2017 through final maturity; half of the deposits are required by Nov. 1 in each fiscal year, with the other half by May 1.
The intended source of city pledged deposits include beverage container taxes and certain gaming-related receipts. Receipts from beverage container taxes, levied at $0.05 per container on distributors of most bottled beverages, are required to be deposited to the financing fund in their entirety, subject to appropriation by the City Council. The tax generated nearly $10.4 million in fiscal 2015. The current rate has been in effect since fiscal 2014, and the tax was first enacted in fiscal 2010.
In addition, city pledged deposits include two gaming sources from the city's Horseshoe Casino, a privately-owned and operated casino that opened under state authorization in August 2014. Pledged deposits include 10% of the participation rent from the casino, subject to city appropriation, and half of the 5% of the casino's table games proceeds that is statutorily allocated to the city, but not subject to appropriation.
The casino operator is required to pay rent under a ground lease based on the greater of a fixed dollar amount or a percentage of gross gaming proceeds; 10% of this would be intended as a pledged deposit, or approximately $856,000 in the lease year ending Sept. 30, 2015. The allocated percentage of table games is payable only upon completion of Maryland's sixth and final casino, currently under construction near Washington, DC. Scheduled completion is in 2016.
Fitch views the short operating histories of the city's intended sources of pledged deposits as being inherent credit weaknesses. Moreover, the two gaming sources are exposed to a range of sector- and site-specific risks, including competitive pressures from expanded gaming in the mid-Atlantic region and the fact that revenues are generated at a single operating site in the city.
CITY PIT PROVIDES ENHANCEMENT
The intercept of city PIT receipts is an inherently stronger source of credit quality than the intended sources of city pledged deposits, in Fitch's view. Although collected and held by the state, Fitch's understanding is that city PIT receipts could be subject to interruption in the unlikely event that the state authorizes, and the city files for, bankruptcy. Consequently, Fitch views the credit quality of the intercept as being limited by the credit quality of the city itself.
All Maryland counties levy a PIT on the state's taxable income base at a rate determined by the county or the city of Baltimore up to a statutory cap of 3.2%. The city's PIT is levied at the cap, collected by the state comptroller, and remitted to the city on a quarterly basis, with some lag to account for refunds.
PIT trends generally track the broader economic cyclicality of the region and state. Baltimore's PIT receipts have grown an average of 3.9% annually since fiscal 2002; this incorporates a single rate increase in fiscal 2011, to 3.2% from 3.05%. PIT receipts are the city's second-largest source of tax revenue following property taxes; receipts totaled nearly $288 million in fiscal 2015, providing potential coverage of the ongoing $10 million minimum city pledged deposit by 28.8x.
Timing provisions for the intercept are adequate and coverage of the $10 million pledged deposit would be substantial. The bonds' authorizing legislation specifies that, in the event city pledged deposits are inadequate as of each Nov. 1 or May 1 deposit date and any reserve amounts held in the facilities fund are insufficient, the MSA must notify the comptroller, who withholds city PIT receipts in the state's custody and deposits them to the financing fund by the following Dec. 15 or June 15. The MSA transfers funds from the financing fund to the trustee for debt service on the following April 5 and October 5, for debt service on May 1 and Nov. 1.
RESERVE NOT PLEDGED TO BONDHOLDERS
In the event of insufficient city pledged deposits, the bond authorization requires that funds held in the reserve held in the facilities fund, if established by the MSA, be depleted first, before triggering the city PIT intercept noted above.
The reserve is established at the MSA's discretion within the facilities fund. In the event that city pledged deposits to the financing fund exceed the minimum thresholds, the MSA is authorized to transfer excess city pledged deposits to the facilities fund and retain up to $2.5 million annually in the reserve. A cumulative maximum of $20 million may be retained. These amounts may be increased by agreement of parties to the MOU.
Funds in the facilities fund, including excess city pledged deposits in the reserve, are not pledged to bondholders, and thus Fitch does not view the reserve account as providing additional bondholder protection.