Fitch Affirms Sonoma-Marin Area Rail Transit District, CA's Sales Tax Revs at 'A'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed Sonoma-Marin Area Rail Transit District, California's (SMART) bonds as follows:

--$170.7 million Measure Q sales tax revenue bonds series 2011A at 'A'.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from a senior lien on Measure Q sales tax revenues collected in Marin and Sonoma Counties, net of collection expenses. The bonds are additionally payable from a standard cash-funded debt service reserve fund.

KEY RATING DRIVERS

ADEQUATE MADS: Coverage of fiscal 2015 annual debt service (ADS) was strong at 4.0x; coverage of maximum annual debt service (MADS) was a much lower 1.54x due to escalating debt service. No additional borrowings are planned.

STRONG ECONOMY, DIVERSE TAX BASE: The regional economy exhibits strong characteristics, including high incomes, low unemployment, and access to a very large and diverse employment market. SMART's diverse sales tax base suffered from a significant decline during the housing-led recession but has since expanded in each of the past five years.

WEAK PROJECTED OPERATING MARGINS: Issuer projections show a low farebox recovery ratio of below 25%. Periods of low to no growth or volatility in sales tax revenues could limit the ability of the system to cover all its operating needs from internal resources once it opens, indicating limited financial flexibility. The issuer plans to fund a six-month operating reserve before operations commence, which provides some offset to short-term sales tax volatility.

LIMITED DEMAND: Fitch considers the project's essentiality as weak, given that management estimates fully ramped-up average daily ridership (ADR) at about 3,000 (1% of total bi-county employment). While ridership may ease congestion along the U.S. 101 corridor somewhat, Fitch views essentiality as weaker than for other transit systems.

LOW REVENUE CORRELATION: Risks to system revenue from potentially weaker than expected ridership are modest since the system's revenues will derive predominantly from sales taxes.

SATISFACTORY LEGAL PROVISIONS: The bonds include a cash-funded debt service reserve fund funded to the IRS maximum. The somewhat permissive additional bonds test (ABT) requires revenues to cover MADS a satisfactory 1.50x.

RATING SENSITIVITIES

DEBT SERVICE COVERAGE: An unexpected and material change in debt service coverage from current expectations could lead to rating action.

FINANCIAL OPERATIONS: Operating performance that varies materially from Fitch's analysis could result in a rating action.

CREDIT PROFILE

SMART will operate rail service in the northern San Francisco Bay Area once the route becomes operational in 2016. It will serve the counties of Marin, population 260,000, (Fitch implied general obligations rated 'AAA') and Sonoma, population 500,000, (implied general obligations rated 'AA+'),. Voters in 2008 approved by a wide margin the Measure Q quarter-cent sales tax, which is the district's primary funding source and which secures the sales tax revenue bonds.

DIVERSE SALES TAX BASE CONTINUES TO EXPAND

SMART's sales tax base benefits from strong economic fundamentals and low concentration levels, with the top 25 payers generating just 21% of total sales tax revenues in fiscal 2015. Sales taxes are also well-diversified by sector.

Although SMART enjoys high taxpayer diversification and a fundamentally strong economy, taxable sales were significantly affected by the housing-led recession. Sales tax activity has recovered a significant 34.4% through fiscal 2015 from the sharp 17.1% drop at the beginning of recession. Fiscal 2016 revenues are budgeted to increase 1.6%, but actual receipts in the first quarter trended slightly higher at 2.3%. Management expects receipts to rise by 3% for fiscal 2017, which Fitch views as reasonable, and then flatten out.

SLIM MADS COVERAGE

Fitch estimates budgeted revenues of $34.4 million will cover fiscal 2016 ADS by a strong 2.65x. Due to escalating debt service, however, the revenues are expected to cover MADS at a much lower level of 1.56x based on fiscal 2016 budget. Rising sales tax revenues increased MADS coverage above the 1.28x level achieved in fiscal 2012, yet Fitch considers the coverage adequate given the economically sensitive nature of sales tax revenues.

Because MADS is not achieved until fiscal 2028, Fitch believes the district can achieve some degree of sales tax growth so that coverage may remain consistent with that of the current rating. The risk of additional leverage is mitigated somewhat by the bonds' satisfactory 1.5x MADS ABT. The ABT's definition of revenue is somewhat permissive, allowing for any 12 of the past 24 months of revenues. The district has no plans for further bond issuances, and its projected reliance on surplus sales tax revenues to operate the transit system could result in an effective barrier to leveraging that may ultimately be more stringent than the legal ABT.

COVERAGE STANDS UP WELL TO STRESS SCENARIOS

Debt service coverage stands up well to various Fitch-designed stress scenarios. As mentioned, under a no-growth scenario, coverage would fall to 1.56x in fiscal 2028, the year MADS is reached, though Fitch notes that the system would come under significant operational pressure in such a scenario. Fitch estimates that sales tax revenues would need to fall by 36% from fiscal 2016 budgeted levels for MADS coverage to reach 1.0x. This is about double the 17.9% cumulative loss experienced during the recession. Alternatively, Fitch estimates sales tax revenues would need to decline 3.6% annually through fiscal 2028 before ADS coverage would reach 1.0x.

STRONG UNDERLYING ECONOMIES

The district serves the counties of Marin and Sonoma, with a combined population of 748,000. Marin County's per capita income levels are extremely high at 184% and 196% of state and national levels, respectively. Sonoma County's income levels are lower, but still above average at 112% and 119%. Residents benefit from their location within the large and diverse San Francisco Bay Area employment market. Unemployment is well below the state average, and below the national rate. Poverty rates are low compared to the state and nation.

WEAK PROJECTED FINANCIAL OPERATIONS

In a sensitivity case, Fitch projects pledged revenues will cover debt service and projected operational costs within a low range of 1.01x-1.13x from fiscal 2017 (the first projected full year of system operations) to fiscal 2020, conservatively assuming no sales tax revenue growth. These concerns are mitigated somewhat by a six month operating reserve with an expected balance of $13 million by fiscal year end 2016 (when operations are expected to commence), which provides some offset to short-term sales tax volatility. The issuer's projections, which include modest annual sales tax growth, show net coverage consistently at or above 1.16x through fiscal 2020.

The estimated farebox recovery ratio through the life of the bonds is a low 22.3%, which Fitch considers to be a weak pricing framework. The district views the conservative adjustments made by the district to numerous revenue and expense estimates produced by its consultants as prudent given the district's lack of operating history.

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

Fitch recently published exposure drafts of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015 and Exposure Draft: Incorporating Enhanced Recovery Prospects into U.S. Local Tax-Supported Ratings, dated Feb. 2, 2016). The drafts include a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published in the beginning of the second quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis.

Applicable Criteria

Exposure Draft: Incorporating Enhanced Recovery Prospects into US Local Tax-Supported Ratings (pub. 02 Feb 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=875108

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1000818

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000818

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Shannon Groff
Director
+1-415-732-5628
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble
Senior Director
+1-415-732-5611
or
Tertiary Analyst
Daniel Adelman
Associate Director
+1-312-368-2082
or
Committee Chairperson
Barbara Ruth Rosenberg
Senior Director
+1-212-908-0731
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Shannon Groff
Director
+1-415-732-5628
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble
Senior Director
+1-415-732-5611
or
Tertiary Analyst
Daniel Adelman
Associate Director
+1-312-368-2082
or
Committee Chairperson
Barbara Ruth Rosenberg
Senior Director
+1-212-908-0731
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com