Fitch Rates Connecticut's $1B Special Tax Ob. Bonds 'AA-'; Downgrades Outstanding on Criteria Change
Fitch Ratings has assigned 'AA-' ratings to the following State of
Connecticut special tax obligation (STO) bonds:
--$800 million in STO bonds, transportation infrastructure purposes,
2016 series A;
--$200 million in STO refunding bonds, transportation infrastructure
purposes, 2016 series B.
The bonds are scheduled to be offered via negotiated sale on Sept. 13,
2016.
In addition, Fitch has downgraded the ratings on outstanding STO bonds
as follows:
--$4.2 billion in outstanding STO senior lien bonds to 'AA-' from 'AA';
--$257 million in outstanding STO second lien bonds to 'AA-' from 'AA'.
The Rating Outlook remains Stable.
SECURITY
The bonds are secured by a gross lien on pledged revenues and other
receipts deposited to the state's special transportation fund prior to
any other uses.
KEY RATING DRIVERS
The downgrade reflects the application of Fitch's revised U.S.
Tax-Supported Rating Criteria, published on April 18, 2016.
Underlying credit factors since the time of Fitch's last review of the
STO bonds are stable; however, the structure does not meet the
requirements for rating a dedicated tax bond higher than the state IDR
under the revised criteria.
Although pledged revenues supporting the STO bonds would warrant a
higher rating, the credit quality of the STO bonds is limited by the
exposure of the special transportation fund (STF) to general state
operations, and hence limited by the 'AA-' Issuer Default Rating (IDR)
of the state. The Stable Outlook on the STO bonds' rating reflects
Fitch's Stable Outlook on Connecticut's IDR.
Growth Prospects Steady: Most of the transportation-related revenues
pledged to the bonds, including motor fuels taxes and motor vehicle
receipts, are generally stable over time but have limited growth
potential, while the oil companies' tax is more volatile. Expansion of
pledged revenues to include a portion of the statewide sales tax
diversifies pledged receipts beyond those linked to
transportation-related activity.
Established & Stable Program: The STO bond program is a well-established
part of a comprehensive and legislatively authorized long-term
transportation infrastructure program. Management strengths include
active revenue monitoring, multi-year forecasting, and the ability to
curtail capital spending in the event of revenue weakness.
Leverage Limits: A 2.0x maximum annual debt service (MADS) test for
additional bonds limits leverage of pledged resources. The bonds also
carry a 2.0 times (x) annual coverage requirement.
Linkages with General Fund: Interdependence with general fund operations
has led to periodic revenue and cost shifts, which Fitch expects will
continue in the future.
RATING SENSITIVITIES
Link to State Credit Quality: The rating is sensitive to changes in the
State of Connecticut's 'AA-' IDR, by which it is capped.
Consistently Solid Coverage: The rating is also sensitive to
consistently solid coverage by pledged revenues and to ongoing careful
management of the transportation fund.
CREDIT PROFILE
The downgrade of Connecticut's STO bonds, to 'AA-' from 'AA', reflects
the application of Fitch's Tax-Supported Rating Criteria, published in
April 2016. The program's strengths include a solid 2x ABT and a 2x
annual coverage requirement, and the state carefully manages the
condition of the special transportation fund (STF). However, given
frequent statutory changes that shift pledged revenues or costs between
the STF and the state's general fund based on general fund budgetary
needs, Fitch views the credit quality of STO bonds as being linked to
the state's general operations, and hence capped by the state's 'AA-'
IDR.
ESTABLISHED & STABLE PROGRAM
The STO bonds are issued under a senior and second lien, and are secured
by pledged revenues deposited to the STF. Both senior and second liens
carry an additional bonds test requiring 2x coverage of aggregate
principal and interest. Moreover, the state covenants under the second
lien that any senior issuance must meet all second lien requirements,
both senior and second lien bonds are subject to an annual 2x debt
service coverage test. The bonds are also backed by an aggregate debt
service reserve funded at maximum annual debt service (MADS).
Pledged revenues include taxes and fees on motor vehicle fuel, casual
vehicle sales and licenses. The legislature expanded pledged revenues in
its 2015 session as part of a broader initiative, called 'Let's Go CT!'
to accelerate transportation capital spending. Revenue changes were
partly delayed during fiscal 2016 as the state sought to shore up
projected weak general fund performance in fiscal 2016 and 2017.
Under the 2015 expansion of pledged resources, all taxes on oil
companies' gross earnings and a designated portion of the statewide
sales tax are being deposited directly to the STF and pledged to
bondholders; the sales tax deposit is being phased in through fiscal
2018. The inclusion of sales taxes in pledged revenues broadens the base
of economic activity from which collections derive beyond transportation
and tying future trends more closely to underlying state economic
performance. Oil companies' tax collections are correlated to broader
energy market trends, which exposes the STF to more heightened
cyclicality, in Fitch's view.
At present, $4.2 billion in senior lien bonds and $257 million in second
lien bonds are outstanding. Senior lien bonds have been issued
periodically under a 1984 indenture, with second lien bonds issued since
1990 for new money and refunding purposes. Pledged revenues are
available first for senior lien debt service and reserves, followed by
second lien debt service and reserves. Thereafter, pledged revenues are
available for transportation-related state general obligation bond debt
service and operating expenses of the departments of transportation and
motor vehicles.
MULTI-YEAR PLANNING
The state actively manages the STF through a five-year forecast period
to maintain ample resources for projected debt service, capital program
needs and operating expenses. The STO bond program is very well
established, with a 20-year maturity for each series and flexibility to
slow capital projects as necessary. Offsetting these strengths are
forecast debt service that generally rises faster than pledged revenues
and large planned spending for transportation capital.
Connecticut announced a major expansion of transportation capital
spending in 2015 under the 'Let's Go CT!' initiative, intended as a
multi-decade effort to address longstanding transportation needs beyond
those already funded through the existing capital program. The
initiative applies the expanded revenues to support additional STO
borrowing, beginning with $275 million in fiscal 2016 and rising to $706
million by fiscal 2020. Even with new authorization, the state has
actively managed the pace of borrowing in the past to conform to
available STF resources, including reducing issuance during periods of
revenue weakness.
GENERAL FUND SHIFTS
Interdependence with the state general fund has led to revenue or cost
shifts during periods of general fund fiscal stress, most recently in
fiscal 2016. Although the 'Let's Go CT!' initiative included the
statutory designation of the STF as a perpetual fund, limiting the use
of resources only for transportation, new designation did not prevent
the state from delaying the originally planned sales tax allocation
phase-in to address general fund revenue underperformance.
As of fiscal 2016, revenues in the STF consist of motor fuels tax (38%),
motor vehicle receipts (18%), oil companies' tax (18%), license, permit
and fee revenues (11%), and a portion of statewide sales tax (8%). The
latter reflects the first year of the sales tax phase-in through fiscal
2018, when it is forecast to constitute 21% of STF revenues.
UNDERLYING GROWTH PROSPECTS STEADY
Underlying performance of most of the transportation-related receipts
deposited to the STF has been steady, although not fast-growing, and
Fitch expects growth prospects going forward to generally match
historical trends.
Motor fuels taxes rose only 0.3% in fiscal 2016, slower than in recent
years. Going forward, the state forecasts lower motor fuel tax receipts
in fiscal 2017, with very slow gains in the forecast period through
fiscal 2020. Motor vehicle receipts rose only 0.8% in fiscal 2016, with
the state forecasting slightly faster gains during the forecast period.
Oil companies' tax, by contrast, has been more volatile reflecting
broader oil price trends. The tax fell 26% in fiscal 2016, although is
expected to grow rapidly in fiscal 2017 and beyond with forecast gains
in oil prices. The general statewide sale tax deposited to the STF is
currently forecast to grow to $373 million in fiscal 2020, from $109
million in fiscal 2016.
Estimated FY 2016 STF revenues fell 0.5% from FY 2015, reflecting the
impact of lower oil prices on the oil companies' tax and the delayed
phase-in of the sales tax deposit, as well as generally flat motor fuels
and motor vehicle receipts. Fiscal 2016 is estimated to have ended with
a cumulative fund surplus of $150.4 million, or about 11.1% of net
revenues. Pledged revenues covered combined outstanding FY 2016 senior
and second lien debt service by 2.8x. Including the current sale, Fitch
calculates that FY 2016 pledged revenues cover projected MADS in FY 2018
by 2.5x.
The state's multi-year forecast assumes annual bond issuance rising to
approximately $900 million in FY 2020. Based on these assumptions,
annual coverage of outstanding senior and second lien bonds would drop
to 2.3x in FY 2020. Over the forecast period through FY 2020, pledged
revenues would grow at an average pace of 6.6% annually given the
phase-in of newly-pledged revenues.
HIGH RESILIENCY IN DOWNTURN SCENARIO
To evaluate the sensitivity of the dedicated revenue stream to cyclical
decline, Fitch considers the results of the Fitch Analytical Sensitivity
Tool (FAST), using a 1% decline in national GDP scenario, as well as
assessing the largest decline in revenues over the period covered by the
revenue sensitivity analysis. Based on a 15-year pledged revenue
history, FAST generates a 3% scenario decline in pledged revenues.
Pledged revenues could withstand a nearly 17% decline, assuming full
leveraging to the ABT, or almost 6x the scenario output, a high level of
resiliency.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
https://www.fitchratings.com/site/re/879478
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