NEW YORK – Fitch Ratings upgrades to 'A+' from 'BBB+' the long-term rating on the Massachusetts Dept. of Transportation's (MassDOT), formerly the Massachusetts Turnpike Authority (the authority), Metropolitan Highway System (MHS) $1.2 billion 1997 series A (senior) and $89.1 million 1997 series C (senior) revenue bonds. The Rating Outlook on both liens is Stable. Additionally, Fitch upgrades the outstanding MHS subordinated revenue bonds which are expected to be refunded by the 2010 series A and B bonds to 'AA-' from 'A'.
Also, Fitch assigns an 'AA-' rating to MassDOT MHS revenue bonds (subordinated) commonwealth contract assistance secured $277.2 million series B. Fitch assigns an underlying 'AA-' rating to the MHS revenue bonds (subordinated) commonwealth contract assistance secured variable rate demand obligations 2010 series A, sub-series A-3 and A-6 bonds which are expected to carry the support of letters of credit. Five additional sub-series of the variable rate demand obligations 2010 series A bonds (sub-series A-1, A-2, A-4, A-5, and A-7) are expected to carry the support of standby bond purchase agreements. Fitch will assign both long-term and short-term ratings to all variable rate demand obligations series A bonds nearer to closing.
Bond proceeds will be used to refund all outstanding fixed rate subordinated series 1997 series B and 1999A series A bonds. With the issuance of the 2010 series A variable rate demand bonds, MassDOT MHS will reduce the prior swap mismatch caused by the exercise of fixed-payer swaptions, effectively creating synthetically fixed-rate debt.
In addition, MassDOT MHS will issue the series B bonds as fixed-rate debt. MassDOT intends to refund various senior lien obligations later this year to effectively eliminate the remaining swap mismatch. In total, the refinancings are expected to reduce total debt service costs and sculpt MassDOT MHS's amortization profile to better align with contract assistance payments from the Commonwealth.
The upgrade to 'AA-' on the subordinate bonds is a result of the restructured debt service profile whereby commonwealth contract assistance is expected to fully cover all subordinate debt service obligations every year until maturity, including the substantial bullet maturities in the final two years that were previously not covered. The 'AA-' rating of the subordinate bonds also reflects the general obligation pledge of the Commonwealth (rated 'AA' with a Stable Outlook by Fitch) to make contract assistance through 2039, greatly improving MassDOT MHS's access to liquidity; the $36 million in basis risk reserve fund; and the closed lien. The rating also reflects the form of the pledge in a set amount of $100 million, not-full debt device, leaving the lien exposed to potential risks associated with variable rate demand bonds (VRDBs).
Monies from the previous subordinated debt service reserve fund will fund a $36 million basis risk reserve fund to mitigate potential basis risk associated with LIBOR-based swap receipts and the SIFMA based coupon on the bonds. The basis reserve fund requirement, currently $36 million, will reduce pro rata with subordinate debt amortization, and will not be refilled with toll revenues. The subordinate debt service reserve requirement is reduced to zero as contract assistance covers all subordinate debt service payments.
The upgrade to 'A+' on the senior bonds reflects expectation that swap mismatches will be eliminated, reducing senior debt service obligations and thereby allowing greater coverage of senior debt service by remaining amounts of the $100 million in annual contract assistance pledged first to subordinate debt service payments. The rating also reflects the existing pledge of $25 million in contract assistance from the Commonwealth for the Central Artery/Tunnel (CA/T) project paid directly to the senior bond debt service fund, limiting of refunding issuances by statute, as well as the MHS's very strong service area, the critical nature of the transportation links provided by the roadways and tunnels, and stable traffic base which is relatively inelastic to toll increases. The rating also reflects a rising debt service profile, increasing capital expenditures as a result of years of deferred maintenance, a politicized rate-setting environment, and a debt portfolio with counterparty risk, basis risk, and swap termination potential.
The ratings on both liens will be significantly influenced by the rating of the Commonwealth. As contract assistance is a commonwealth general obligation, changes in the credit quality of the Commonwealth's obligations will have a direct affect on the MHS bond ratings.
On July 21, 2009, Fitch affirmed the MHS senior bonds at 'BBB+' and upgraded the MHS subordinate bonds to 'A' from 'BBB', due to action by the Commonwealth that significantly relieved financial pressures facing the MHS. The Commonwealth merged various state transportation agencies under the new MassDOT and pledged $100 million annually in contract assistance to the MHS's subordinate and senior lien bonds. The $100 million in contract assistance, a general obligation pledge of the Commonwealth, is pledged as a dedicated payment first to debt service on the subordinate lien bonds with the remainder pledged to debt service on the senior lien bonds. Netted against debt service payments for coverage purposes, the contract assistance will be provided by the Commonwealth every year that the MHS debt is outstanding and is not subject to appropriation. As an additional strength, both MHS's liens were legislatively closed and amendments were made to the trust agreement specifically prohibiting additional Subordinate lien debt with the exception of refinancings.
MassDOT is governed by a five-person board appointed by the Governor, with both the MHS and the Western Turnpike now eligible to participate in the Commonwealth's statewide road and bridge program. The pledge to MHS and Western Turnpike bondholders and covenants of the respective trust agreements remains unchanged by the succession of the authority by MassDOT. The bonds continue to be secured by net toll revenues after operations and maintenance expenses collected on the MHS. Revenues continue to be deposited directly into a trust account and disbursed according to the MHS trust agreement with rate covenants remaining at 1.2(x) times, 1.15x, and 1.0x for the Senior, Combined, and Combined debt service plus capital reinvestment.
With the subordinate lien bond debt service payments effectively paid by Commonwealth, the senior lien debt service payments, net of remaining subordinated-pledged contract assistance and $25 million in senior-pledged contract assistance, are left to be covered with MHS operating revenues. For fiscal year (FY) 2010, MassDOT MHS budgets $186.4 million in operating revenues with $104.4 million in operating expenses resulting in net revenues of $82 million. Pro forma net senior lien debt service including the expected refinancing of senior lien debt is projected to be $6 million in FY 2011, growing to $20 million in FY 2013 and $28.9 million by FY 2015. Debt service remains at this approximate level before jumping to $39.4 million in FY 2021. Absent toll increases, with low traffic growth ranging from 0.75% to 1.2% and operating expense growth of 5%, coverage remains well above 2.0x as debt service ramps, eventually dropping below 2.0x in FY 2019.
Given limited expected traffic growth, controlling the growth in operating expenses will be a key factor in maintaining healthy debt service coverage ratios and providing sufficient surplus revenues for capital expenditures. Since FY 2007 when the MHS completed its expansion and the authority took full control over the maintenance of the entire facility, operating expenses have grown only 2% from $97.8 million to $99.8 in 2009. Additionally, lower cost state-wide pension benefits packages and administrative efficiencies under MassDOT are expected to reduce future costs. However, limited history of operating expense growth on the completed facility and historical reluctance to raise tolls make controlling the rate of operating expense growth critical to the MHS's senior bond ratings.
Capital expenditures and maintenance on the MHS have been largely deferred for the past 10 years, as stagnant toll revenues were used to fund increasing debt service payments on a growing system. The average annual capital reinvestment in the facility from FYs 2004 to 2008 was only $12 million. In FY 2009, $15.9 million was deposited for capital expenditures. In FY 2010, capital reinvestment is budgeted at $40.9 million given the increased contract assistance. With the expected refinancings, Fitch expects the MHS to generate approximately $425 million or $71 million per year over the next five years, and approximately $630 million over the next 10 years. MassDOT MHS has a 10-year capital plan of $1 billion, with major capital needs centering on the Boston University Viaduct deck replacement ($60 million), the Boston Extension Route 128 overpass deck replacement ($45 million), and the Sumner Tunnel ceiling and plenum repairs ($53 million) over the next five years. The expected surplus revenues put MassDOT MHS in a markedly better financial position than it has been in the past decade; however, although MassDOT MHS's financial plan does not call for toll increases, Fitch believes inflationary toll increases may be needed over the medium term to close the gap in the capital funding plan.
For the first six months of FY 2010, traffic on the facility has been up 1.4%, after being down 5.4% in FY 2009. Revenue has remained generally flat. Electronic toll penetration on the facility also appears to be increasing given MassDOT's decision to completely subsidize transponders and require transponders in cabs and commercial vehicles with total penetration levels now around 75%. Based on the economic strength of the service area and low to moderate toll rates, the facility has the ability to absorb significant increases and still maximize revenue. This is evidenced by the $0.30 January 2008 toll increase that yielded $23.4 million more annual in revenue. Historically, however, toll increases on the facility have been met with heavy political resistance, even to the point of causing the authority to draw upon cash reserves to meet debt service payments, an action uncharacteristic of a mature facility in a very economically strong service area. Toll inequity also hinders political will for toll increases, chiefly because tunnel users are only charged on westbound routes and several interchanges and ramps remain legislatively prohibited from tolling.
With the results of the transportation reform legislation, commonwealth contract assistance, and access to the variable rate demand market reducing debt service costs, MassDOT MHS now has a larger window of financial flexibility than has existed in the past decade. Though moderate medium-term toll increases may be necessary to preserve financial flexibility in the face of potential operating expense growth, MassDOT MHS now has the ability to provide significant near-term capital reinvestment while maintaining healthy coverage levels.
