SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings affirms the following New Jersey Casino Reinvestment Development Authority (CRDA) bonds:
--$241.2 million luxury tax revenue bonds, series 2014.
The Rating Outlook is Stable.
The bonds are special, limited obligations of the authority, secured by luxury tax receipts levied in the city of Atlantic City, collected by the state of New Jersey, and deposited with the trustee, with residuals left after paying debt service deposited with the authority. Luxury taxes consist of a 9% tax levied on hotel rooms, a 9% tax on ticket purchases at entertainment venues, and a 3% per alcoholic beverage tax at premises located in the city.
KEY RATING DRIVERS
ANTICIPATED WEAK PERFORMANCE: Loss of four large casino/hotel in 2014 reduced luxury tax revenue bonds coverage to 1.8x based on estimated 2015 pledged revenues. The 'BBB+' rating incorporated this expectation and reflects the narrow, volatile, and economically sensitive nature of the pledged tax revenues.
INDUSTRY STABILIZATION WITH UNCERTAINTIES: The city's gaming industry is expected to be stable in the near term after recent consolidation. Long-term expected growth in activities subject to the luxury tax may be affected by increases in alternative regional gaming options.
SATISFACTORY LEGAL PROVISIONS: Legal provisions are adequate and bond counsel has satisfactorily opined on the separation of the pledged revenue stream from any financial difficulties related to the city of Atlantic City.
SOUND FLOW OF FUNDS: Pledged tax revenues are collected by the state of New Jersey and then flow to a revenue fund held by a trustee. After required set asides for semi-annual debt service expense, excess luxury tax revenues flow out to fund convention center operations.
The 'BBB+' rating is sensitive to changes in disposable dollars spent on gaming, entertainment, and attendance at conventions in Atlantic City, which is influenced in turn by consumer tastes and behavior, the attractiveness and availability of rival gaming options in the mid-Atlantic region, as well as competing convention center venues. Further declines in pledged tax revenue beyond current expectations or further leveraging through additional debt issuance could put downward pressure on rating.
Pledged luxury tax revenues consist of a 9% hotel room tax, a 9% tax on ticket purchases at theaters, exhibitions, and other places of amusement, and a 3% tax on on-premises alcoholic beverage consumption, levied in the city. Drinks, hotel rooms, and tickets that are provided on a complimentary basis are not subject to the tax. There is some seasonality in revenue collections with the highest amounts collected in the summer and spring months (33% and 27% of revenue collections, respectively).
REVENUE LOSS EXPECTED
The impact of casino closures was felt in 2015 and the magnitude of the pledged revenue decline was in line with prior expectation. Atlantic Club, Revel, Showboat and Trump Plaza ceased operations in 2014, resulting in a loss of 4,443 available rooms, or 23% of the hotel component of the luxury tax revenue. While remaining hotels benefitted from overflowing demand evidenced by higher occupancy rates, the improvement was limited. Hotel tax revenue fell by 3% in calendar year 2014, followed by a more significant drop of 19% year-to-date (YTD) in 2015 through July.
Recent casino closures have had a limited impact on the proportion of pledged revenues coming from each tax source given that hotel closures have also shuttered associated restaurant and entertainment venues. Hotel tax revenue makes up 71% of total pledged revenues, with liquor (14% of total) and entertainment taxes (14%) generating the remainder. Closures have dented overall visitor demand. The alcohol-by-the-glass tax proved to be more volatile, losing 7% in 2014 and 23% YTD 2015, compared with 4% and 11% declines experienced by entertainment tax.
Overall pledged revenue loss after adjustments was 2.2% and 18.1% in 2014 and YTD 2015, respectively. This is in line with Fitch's prior expectation of a cumulative loss of 20% by 2015, although Fitch had expected non-hotel taxes to be more resilient.
STILL SOUND COVERAGE
Assuming the full year 2015 pledged revenue decline mirrors YTD performance of minus 18.1%, estimated annual debt service coverage is a still sound 1.81x. At this level, pledged revenues would remain sufficient to cover debt service with 2% annual declines throughout the life of the bonds.
In Fitch's base case scenario, coverage is expected to stay around 1.8x in the near term and above 1.3x over the life of the bonds. Material deterioration in pledged revenues beyond Fitch's base case resulting in lower than expected coverage ratios would likely lead to negative rating action.
LUXURY TAX TREND REVERSAL
Despite the ongoing decline in the city's casino industry, reflected in 3.6% average annual decline in visitor numbers and 8.6% annually in gross gaming revenue produced in the city from 2007 to 2013, pledged luxury tax revenue was historically fairly resilient, recording 4.1% average annual growth during the same period.
This trend no longer holds. An estimated cumulative decline of 20% in pledged luxury tax revenues was greater in magnitude when compared with gaming revenue's 8.5% contraction in 2014 and an estimated further 6-8% decline in 2015.
INDUSTRY STABLIZATION, MEDIUM-TERM UNCERTAINTY
Fitch expects the city's gaming industry to return to stability in the near term, given continued economic improvements and lack of new regional competition in the next two years. In the medium term, as competition in surrounding areas ramps up, notably Catskills, NY and Philadelphia, PA, and potentially in northern New Jersey, the gaming industry and luxury tax revenues in Atlantic City could be negatively impacted. The gaming industry additionally faces headwinds such as competition from online and social gaming, lotteries, as well as unfavorable demographics changes.
Fitch stress tests included assumed 2% annual declines in pledged revenues in the next three years, followed by 10 years of 5% decline due to increased competition. MADS stays above 1x under this scenario.
SATISFACTORY LEGAL PROVISIONS
While the tax is levied by the city, bond counsel has advised that the revenue from the tax should not be treated as the property of the city in the event of a bankruptcy filing by the city. Bond counsel opined at closing that bondholders have a first lien on the revenue stream prior to its being available to fund operations of the convention center. Under applicable state law, the city may not reduce or abolish the tax as long as any bonds secured by the tax, including the current issue, are outstanding. The state has also agreed to non-impairment of bondholder rights.
Pledged revenue is collected by the state (GO bond rating of 'A' with a Stable Outlook) and collections are briefly deposited in the state's general fund prior to allocation to a special revenue fund held by a trustee for the benefit of bondholders. Revenues are pledged on a gross basis; however, once sufficient funds have been set aside for semi-annual debt service payments, the remaining revenue, up until six months prior to the next semi-annual debt service payment date, is available to fund operations, maintenance, and capital expense of the convention center properties located in the city (Boardwalk Hall, the West Hall, and the 'new' convention center). However, such net luxury tax revenues remain subject to the lien of the indenture until spent.
A historical 1.5x additional bonds test provides some protection against overleveraging. The 2014 issuance addressed a five-year capital improvement plan and additional near-term capital needs are not expected.
Additional security is provided through a standard debt service reserve fund equal to the lesser of MADS; 125% of average annual debt service expense; or 10% of the proceeds of the bonds.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors, Underwriter, and Bond Counsel.
Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to fewer than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by Jan. 20, 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.
Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. State Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
Dodd-Frank Rating Information Disclosure Form