SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned the following Central Puget Sound Region Transit Authority, WA (Sound Transit or the authority) ratings:
--$615,267,000 2016 Transit Infrastructure Finance and Innovation Act (TIFIA) Loan (Northgate Project) 'AA+';
--$1,990,267,000 TIFIA Loan Master Credit Agreement (MCA) 'AA+';
--Issuer Default Rating (IDR) 'AA+'.
In addition, Fitch has upgraded the following outstanding rating:
--$1,330,000,000 2015 TIFIA Loan (East Link Project) to 'AA+' from 'A+'.
The Rating Outlook is Stable.
The TIFIA loan agreements are scheduled to close on or about Dec. 20, 2016. The Northgate loan is the first loan under the MCA. The authority plans to draw on the MCA TIFIA loans between 2017 and 2024 to support the ongoing expansion of the Seattle region's rail rapid transit system.
The TIFIA loans are payable from a fourth lien on pledged motor vehicle excise taxes (MVET), sales taxes, and rental car taxes. The authority has amended and expanded the pledge since the closing of the 2015 TIFIA loan, adding the MVET.
KEY RATING DRIVERS
The 'AA+' IDR reflects strong revenue growth, solid expenditure flexibility, extraordinary gap closing capacity and a low debt burden, balanced against a limited legal ability to raise revenues.
The upgrade of the TIFIA loan ratings reflects implementation of Fitch's 'U.S. Tax-Supported Rating Criteria', published April 18, 2016, and a change in Fitch's expectations for overall financial performance, which have improved with voter approval of new taxes. The revised criteria places greater weight on Fitch's expectations for leverage than on the legal additional bonds test. The 'AA+' loan ratings reflect solid growth prospects for revenues, an exceptional degree of resilience to modeled revenue declines at expected leverage levels, and the IDR cap.
Economic Resource Base
Sound Transit provides light rail, commuter rail and express bus services to the Seattle metropolitan area. The authority's service area includes about 41% of the population of the state of Washington (IDR 'AA+', Outlook Stable). It includes the urbanized portions of King, Pierce and Snohomish counties. The region produces the majority of the state's economic output and is home to major employers such as Microsoft, Boeing and Amazon.
Revenue Framework: 'a' factor assessment
Revenue growth is strong and expected to continue to outpace both inflation and U.S. economic growth. Policymakers' independent legal ability to raise revenues is limited, though voters have repeatedly increased taxes to support the development of regional mass transit.
Expenditure Framework: 'aa' factor assessment
Expense growth is expected to keep pace with but not exceed the authority's strong revenue growth, as the system expands services. Expenditure flexibility is strong with a low fixed cost burden, a very manageable labor framework, ample ability to adjust service levels and significant ability to adjust capital spending.
Long-Term Liability Burden: 'aaa' factor assessment
Fitch expects the long-term liability burden to remain low relative to the economic resource base and relative to authority cash flows. The authority does not have direct pension or other post-employment benefit (OPEB) liabilities.
Operating Performance: 'aaa' factor assessment
The authority's strong reserve position and expenditure flexibility provide extraordinary gap closing capacity in economic downturns. Budget management in times of recovery is also very strong with thorough long-term financial planning, strong capital investment, and rapid rebuilding of financial flexibility after periods of economic weakness.
LEVERAGE AND REVENUE GROWTH: The ratings could come under downward pressure if revenue growth prospects falter or if the authority's debt burden rises more rapidly than expected. The rating is unlikely to move higher due to the limited independent legal ability to raise revenues and expected increases in the long-term liability burden.
The Seattle metropolitan area is large and affluent with strong growth prospects. Both the city of Seattle and King County are rated 'AAA' with a Stable Outlook. While the region's very large corporations - Boeing, Microsoft and Amazon - continue to have an outsized influence on the regional and state economies, the economy has diversified over the years and is less dependent on manufacturing than in past years with significant trade, tourism, technology and governmental sectors. The Seattle metropolitan area benefits from above average incomes with per capita personal income at about 125% of the national average in 2015 and high educational attainment. Population and employment growth have outpaced the nation over the past decade, and the Seattle metropolitan area's unemployment rate is below average.
The authority's revenue framework is dominated by sales, rental car and motor vehicle taxes, which provide about 75% of total revenues and 86% of revenues available to fund operations. Fares and intergovernmental revenues (primarily capital grants) provide the balance of the authority's income. Voters approved tax rate increases and imposition of a new property tax at the November 2016 election, which should further diversify and add to the stability of revenues in the years ahead.
Revenue growth prospects are strong. The compound annual growth rate of revenues (excluding capital grants and adjusted for constant tax rates) exceeded both inflation and economic growth at 3.4% over the past decade. Actual revenue growth was much stronger over the past decade due to increases in tax rates, and the authority expects recently approved tax increases to roughly double tax collections over the next three years. While Fitch recognizes the positive near-term implications of tax policy changes, Fitch's assessment of growth prospects for revenues seeks to measure underlying trends, reflecting the revenue structure's ability to capture growth in economic activity rather than the impact of tax policy changes. The key revenue growth metric also excludes volatile capital grants, which cannot be used for operations.
The authority has limited legal ability to raise revenues. The authority may not increase sales, motor vehicle excise or property taxes without a vote of the people. Allowable increases in rental car tax rates and feasible increases in transit fares are too small to offset typical cyclical revenue fluctuations.
Capital spending dominates the fast-growing transit agency's expenditure profile. Labor and other operating expenses make up a lower percentage of overall spending than at more established agencies, but are expected to rise gradually as a percent of spending over time.
Fitch expects the authority's spending to remain in line with its healthy revenue growth. The authority faces demand for increased services and greater capital investments, but such demands have generally been matched with rising revenues. The authority has only indirect and fairly limited exposure to the pressures of legacy costs such as pensions and retiree health benefits that can drive expenditure pressures in other governments.
Expenditure flexibility is unusually strong for a local government. The relatively fixed carrying costs of debt service, pensions and OPEB were low at about 9% of expenditures in fiscal 2015, reflecting the young agency's lack of legacy retirement programs. The authority also has sound control over labor costs because only a handful of its direct employees are unionized. Sound Transit contracts with other governmental entities and private rail companies for the bulk of system operations. While the cost of such services includes expenses related to labor contracts that the authority does not control, Sound Transit can adjust the amount of the services purchased, and the overall costs of such services are relatively low proportion of the overall budget, which is dominated by capital investments.
Fitch believes the authority - like most transit agencies - has ample ability to adjust service levels to match spending to available resources. Sound Transit also benefits from significant spending flexibility due to the ability to temporarily defer some pay-go capital spending during downturns or to shift funding strategies from pay-go to debt financing during periods of stress. The authority's 2017-2021 capital improvement program includes an average of $1.3 billion a year in pay-go capital spending.
Long-Term Liability Burden
The authority's long-term liability burden is low relative to both its large economic resource base and cash flows. The debt burden is composed entirely of sales, MVET and rental car tax revenue bonds and loans. The agency is relatively young and does not provide defined benefit pensions. Direct debt to personal income was 1.1% at the end of 2015 and will rise to about 1.3% of personal income after incorporating the issuance of $400 million of debt in 2016. Debt to funds available for debt service was also low at 3.1x at the end of 2015 and will remain low at 4.3x in 2016 (based on the issuer's financial forecast). Debt-to-net plant assets was also low at 28% in 2015.
The rated TIFIA loans will add significantly to the agency's long-term liability burden in dollar terms as they are drawn down over the next decade, but debt is expected to remain low relative to both cash flows and personal income. The $2.3 billion long-term liability burden will more than double with $3.3 billion of borrowing via the Master Credit Agreement TIFIA loans and the previously rated East Link TIFIA loan more than offsetting about $633 million amortization over the next decade. However, rapid increases in revenues with rising tax rates and continued growth in personal income should keep debt ratios in a range that Fitch considers low.
A variation from the referenced criteria was applied in this analysis. The committee assessed the long-term liability burden via a modification to the debt metrics supporting the long-term liability assessment. The district is a local, tax supported government enterprise. Fitch's credit opinion is that the district debt burden is best analyzed by combining measurement methods typically used in self-supporting enterprises (debt to funds available for debt service and debt to net plant assets) and the approach usually applied to local governments (debt to personal income).
Sound Transit is very well positioned to withstand typical cyclical revenue variability. Unrestricted cash and investments equaled $865.8 million, or a strong 348% of total expenses (1,270 days cash) at the end of fiscal 2015. The authority posts consistently positive margins with all-in net revenue coverage of debt service averaging a very strong 4.8x over the five years ended in fiscal 2015. The reserve cushion equals almost 97x the 3.6% revenue loss that the Fitch Analytical Sensitivity Tool (FAST) suggests the authority may experience in Fitch's standard moderate economic downturn scenario (a 1% decline in U.S. GDP). The FAST estimate is based on an analysis of the authority's long-term revenue performance across economic cycles. The authority is likely to draw the unusually high 2015 reserve position down over the next five years as it invests heavily in capital, but Fitch expects the authority to maintain compliance with board policies that require reserves equal to at least two months of operating and maintenance expenses and to maintain significant capital reserves.
In a downturn, Fitch expects the authority to adjust service levels, fares and capital spending to maintain a strong financial cushion across economic cycles. Fitch also expects the authority to increase debt funding of capital, which is typical for capital intensive enterprises and would not materially affect Fitch's long-term liability assessment for the authority. The ability to shift between capital funding sources (locally generated pay-go, grants from higher levels of government and use of debt) is a key source of financial flexibility.
Budget management in times of recovery is very strong. The authority maintains solid reserves across business cycles and engages in thorough long-term financial and capital planning. It has also identified funding to support ongoing investments to maintain a state of good repair for existing assets as it rapidly expands the system.
TIFIA Loan Ratings
The TIFFIA loans are supported by a fourth lien on the pledged revenues. Approximately $2.3 billion of first and second lien bonds will be outstanding after the sale of the authority's 2016 revenue bonds. The third lien is currently unused and reserved for future commercial paper or variable rate demand obligations. The TIFIA loan ratings are capped at the Sound Transit's IDR because Fitch believes debt service payments could be subject to an automatic stay in the unlikely event of a bankruptcy by authority.
Growth prospects for the pledged revenues are solid. Revenue growth generally outpaces inflation but not U.S. GDP growth. The 10-year compound annual growth rate of policy adjusted pledged revenues was 2.5% in 2014 and 2015. Fitch's analysis of historical revenue volatility holds tax rates constant at 2015 levels. Actual pledged revenue growth exceeded GDP historically due to changes in tax rates, and pledged revenues are expected to jump sharply again over the next three years due to tax policy adjustments; however, Fitch expects the underlying pace of growth to roughly track the 10-year compound annual growth rate (CAGR).
The additional bonds test (ABT) is very weak. The authority may issue additional parity debt if pledged revenues (net of payments on more senior debt) equals 1.1x maximum annual debt service. On an all-in basis, the ABT would allow the authority to leverage very close to 1x and provides no meaningful protection against overleveraging or cyclical revenue fluctuations.
The ABT does not weigh on the rating significantly because Fitch believes the authority is highly unlikely to leverage near to the ABT because the authority relies on the pledged revenues for the majority of operating expenses and to fund a significant pay-go capital program. The authority's financial policies require enterprise-wide net revenue coverage of 2x on average and no lower than 1.5x in any given year. Given that most of the agency's revenues come from taxes, meeting the net revenue coverage policy requires much higher coverage than the ABT on the dedicated tax bonds and loans, which are supported by gross revenue pledges.
While the net revenue coverage policy does not translate into precise coverage expectations for the dedicated tax bonds, Fitch's rating assumes the authority will not leverage the pledged revenues to a degree that would reduce the standalone assessments of financial resilience below the level of the IDR. The IDR both caps and drives the rating on the loans. Based on a review of the entities capital and issuance plans, Fitch expects coverage to remain well above the 2.35x threshold for the highest financial resilience assessment for a dedicated tax bond with the authority's revenue volatility. The 2015 pledged tax revenues provided 3.3x all-in MADS coverage of the outstanding bonds and the Northgate and East Link TIFIA loans. Approved tax increases would provide much higher coverage in years ahead, and maximum annual debt service (MADS) does not occur until 2041. Debt service on the TIFIA loans is level, but debt service escalates somewhat on more senior debt. A change in leveraging practices could put downward pressure on the ratings, but Fitch does not expect such changes.
Strong Resilience at Expected Leverage Levels
To evaluate the sensitivity of the dedicated revenue stream to cyclical decline, Fitch analyzes the degree of coverage cushion that current revenues provide at MADS. Fitch measures the coverage relative to both modelled recessionary revenue declines (using its standard 1% decline in GDP scenario) and the largest decline in revenues over the period covered by the revenue sensitivity analysis. The FAST model generates a 4.2% decline in pledged sales tax revenues in a recession, reflecting economic cyclicality of the sales-tax dominated revenue stream. The largest consecutive decline was a 18.9% decline during the Great Recession.
Assuming issuance up to the 1.1x additional bonds test (ABT), the structure could not tolerate any meaningful declines in revenues. Fitch does not expect the authority to leverage to the ABT. Given limits on use of revenues, Fitch believes the authority is unlikely to leverage the revenue stream beyond 2.35x debt service coverage on an all-in basis. At 2.35x coverage, pledged revenues could fall 57% before reaching 1x debt service coverage. The 57% coverage cushion is 13.6x the recessionary decline scenario produced by the FAST model and 3x the largest consecutive decline in the analyzed revenue history. Actual all-in debt service coverage by pledged revenue was much stronger at 7.6x in 2015.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
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