Fitch Rates MassDOT's Metro Highway System Senior Revs 'A+'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'A+' rating to the Massachusetts Department of Transportation (MassDOT), Metropolitan Highway System's (MHS) senior revenue refunding bond issuance of approximately $450.4 million. The Rating Outlook is Stable.

Fitch currently rates MHS's outstanding $1.01 million senior revenue bonds 'A+'. The Rating Outlook is 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. MHS has recently adopted a moderately sized five-year (FY 2017 to 2021) Capital Investment Plan (CIP) of $418.9 million, which will be funded with anticipated toll revenues and reserves. MHS's robust coverage, contractual assistance on debt service, and ample cash balances would therefore provide adequate mitigation of the potential impact of macroeconomic stresses or temporary revenue shortfalls. In fiscal 2015, debt service coverage was 4.63x and leverage was 5.96x, reflecting strong performance within the 'A' category.

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:

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 five-year CIP for MHS is $418.9 million and will focus on system reliability and the rollout of the AET system. The CIP will be funded with anticipated net toll revenues of $329 million and current unrestricted reserves of $141.9 million.

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 throughout maturity.

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 4.6x in FY2015 and is projected to average about 3.2x under Fitch's base case projection as senior lien debt service requirements increase. Although coverage is high, current leverage at around 6x rises to a maximum of about 8.3x (7.4x with Contract Payments offsetting net debt), which is high for the rating category. Leverage could potentially increase depending 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.

RATING SENSITIVITIES

Negative

--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.

Positive

--Declining leverage to a 5x-6x range on a sustained basis.

SUMMARY OF CREDIT

The issuance of the 2016 senior revenue refunding bonds will be used for the advanced refunding of the callable Series 2010B fixed rate bonds. This is structured to achieve level savings for a total of $42 million or 8.8% of refunded par on a net present value (NPV) basis. The bonds are expected to mature in 2037.

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 the roll out of the AET system, at the end of October 2016, should allow a smoother flow of traffic.

Toll rates at each gantry will be adjusted with the goal of revenue neutralization. For example, original toll rates on the tunnels are now 50% less, but one-way tolling was changed to bi-directional. Thus, 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 6.6% and 6.5% of total revenues, respectively, on the Boston Extension and the Tunnels.

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. The five-year capital program (fiscal 2017 through 2021) for MHS is $418.9 million and current projects 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. MHS projects $329 million in net toll revenues to become available over the next five years for the CIP combined with $89 million in reserves. The system maintains $141.9 million in unrestricted reserves, well above the reserves required for the CIP; $257.9 million of the projects are already underway and a series of new projects will be evaluated for the remaining balance of the capital plan. In Fitch's view, the use of internally generated additional funds for MHS's capital plan is favourable to the rating; however, material erosion in liquidity could result in increased leverage and rating concerns if the CIP expands.

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+' general obligation (GO) rating of the Commonwealth.

Management's updated five-year financial forecast assumes a decline in toll revenues in FY2017, which accounts for leakage during the roll-out of AET. Expenses are also expected to increase by 0.4% in FY2017, followed by an average of 1.5% until FY2021. Average five-year DSCR over the forecast period is 3.85x and leverage falls to 6.2x (5.5x with Contract Assistance).

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 0.5% 10-year CAGR in toll revenue growth. Fitch adopts management's operating expense forecast for FY2017, but increases expenses by 3% annually, slightly higher than inflation. Although revenue leakage accounts for 6.4% of toll revenues and evolves down to 3% by FY2026, MHS still demonstrates financial resilience, as 10-year average DSCR is 3.30x and five-year leverage is 7.2x (6.5x with Contract Payments offsetting debt).

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 FY2018 onwards, which is reasonable given a history of growing expenses. The combined stresses result in an average 10-year DSCR of 2.8x and five-year leverage of 7.4x (6.6x with Contract Payments offsetting debt). While coverage is on the high end for the 'A' rating category, the rating is constrained by its higher projected leverage and cash flow used towards capital and maintenance needs.

SECURITY

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.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Rating Criteria for Infrastructure and Project Finance (pub. 08 Jul 2016)

https://www.fitchratings.com/site/re/882594

Rating Criteria for Toll Roads, Bridges and Tunnels (pub. 11 Aug 2016)

https://www.fitchratings.com/site/re/886038

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1015225

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https://www.fitchratings.com/regulatory

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Fitch Ratings, Inc.
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or
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Director
+1-212-908-0716
or
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or
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Contacts

Fitch Ratings
Primary Analyst
Jamie Goh
Analyst
+1-212-908-0746
Fitch Ratings, Inc.
33 Whitehall Street,
New York, NY 10004
or
Secondary Analyst
Tanya Langman
Director
+1-212-908-0716
or
Committee Chairperson
Yvette Dennis
Senior Director
+1-212-908-0668
or
Media Relations
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com