As the municipal bond market deepens its scrutiny of revenue pledges after legal rulings in Puerto Rico's Title III case, the Illinois State Toll Highway Authority’s upcoming $300 million deal will arrive bearing a related downgrade.
A ratings split developed on the bonds May 31, when Moody’s Investors Service downgraded them one notch to A1 as Fitch Ratings and S&P Global Ratings affirmed the tollway’s AA-minus ratings. All three assign a stable outlook.
Moody’s had placed the rating on review for a downgrade May 10, a move prompted by the Puerto Rico bankruptcy rulings.
The legal rulings along with rating agency actions more closely linking some revenue credits to their local or state governments' general obligation ratings have taken some of the shine off special revenue/lien credits by shaking the long-held belief that special revenue pledges were isolated from their related government’s distress and would continue to be paid during a bankruptcy proceeding.
Moody’s action on the tollway is driven by the concern that Baa3-rated Illinois, should its fiscal distress escalate to the point of default, could move to degrade the tollway’s autonomy.
The authority doesn’t rely on state funds and its rating of five notches above the state’s Baa3 rating recognizes strong bondholder protections, but Moody’s believes “in the event of serious fiscal distress and potential default by the state on its own bonds, risk remains that the authority could be negatively affected by emergency fiscal actions taken by the state in such an unprecedented scenario.”
That
“While there is currently no provision for states to pursue a bankruptcy filing, in times of financial stress a state could pursue actions not contemplated under current laws. This risk suggests a closer alignment of ISTHA’s rating with that of the state,” Moody’s said of the rating cut.
The 1st Circuit affirmed the lower court’s decision that held special revenues pledged to revenue bondholders are only exempt from the automatic stay that halts creditor payments if the municipality voluntarily pays the special revenues to bondholders.
The revenue structures still enjoy an improved bargaining position and standing when it comes to recovery in an exit plan.
The toll authority responded to Moody’s downgrade by highlighting the strengths behind its revenue pledge and the “firewall” that insulates the authority from the state by its governing statutes, the state constitution, and bond trust indenture. Its authorizing legislation restricts the use of excess revenues for tollway purposes only and voters in 2016 amended the constitution putting a lockbox on transportation related revenues.
The tollway also points to the lack of federal authority for states to file bankruptcy and lack of state authority for local borrowers to file Chapter 9 in Illinois.
“While we appreciate Moody’s role in providing credit ratings, this change was predicated on a legal case in Puerto Rico that bears little if any resemblance to the tollway’s position,” the authority said in a statement.
The authority also underscored the Fitch and S&P rating affirmations. “These ratings indicate the strong position of the Illinois Tollway as we continue improving our roadways to benefit our customers, local communities and the region,” the tollway's executive director, José Alvarez, said in a statement.
Though ratings have been issued for the upcoming deal, the authority as of Tuesday would not offer details about a financing team or sale date.
The tollway’s rating benefits from its essentiality to the northeast region of Illinois “evidenced by its long-term growing traffic base and moderate price elasticity,” Fitch wrote, while also citing ISTHA's "prudent debt management" and strong historical and projected debt service coverage ratios with a major capital program underway.
“The potential risks posed by ISTHA's large capital program are largely mitigated by a history of delivering capital programs on time and under budget, a very robust balance sheet position, and an already implemented 60% aggregate commercial toll increase phased in from 2015-2017, which complements the 88% passenger vehicle toll increase in 2012," Fitch said.
S&P said it doesn’t see a likelihood that state lawmakers would rewrite, eliminate, or ignore the authority’s strong legal protections in a time of severe distress but “if the state's financial situation materially weakens it could cause downward pressure on the ISTHA's ratings since, in our opinion, the likelihood of the state diverting ISTHA revenues for non-ISTHA purposes increases.”
Buyside
The downgrade or concerns over revenue credits shouldn’t deter investors or raise yields on the upcoming sale, said Brian Battle, director of trading at Chicago-based Performance Trust Capital Partners.
“I think they will overlook it,” Battle said of investors. “The tollway is already suffering for being related to the state so it’s cheaper than it should be and I don’t think a disagreement on methodology between the rating agencies will impact pricing. It’s a good credit in a bad state.”
Battle also believes investors are still gauging how or even whether to price Puerto Rico risk given the precedent-setting ruling. It directly impacts states only in the 1st Circuit although it can influence decision in other circuits. “We are all learning as we go,” Battle said.
Kroll Bond Rating Agency and S&P have not taken any rating actions directly linked to the legal rulings but S&P has previously revised criteria more closely linking some revenue credits to the general credit of its related government.
Fitch Ratings in April put seven credits on watch including several California school districts, two healthcare credits, the Chicago Public Schools capital improvement tax levy-backed rating, and Chicago water utility rating, all of which are six or more notches above the issuer rating. It affirmed the pledged special revenue qualification of five other California districts on May 31. It rates the tollway five notches above its BBB rating of Illinois.
Fitch on May 20 issued a report concluding that “U.S. states do not have the ability to file for bankruptcy, so the concept of special revenue debt contained in the municipal bankruptcy code is not applicable to them, and the ruling has no impact on state-level debt.”
Fitch does “typically limit the distance of a state dedicated tax rating above the state's issuer default rating unless the security is clearly segregated from state operations and has no nexus with general state functions,” a position the tollway believes is evidenced in its governance.
In addition to its tollway action, Moody’s placed seven water/sewer utilities and one special assessment district under review for downgrade for the same reason and they remain under review, Moody's said Tuesday.
The Authority
The authority operates 294 miles of interstate tollways for 12 counties in northern Illinois, including the greater Chicago area.
Proceeds of the sale will help finance $704 million of capital spending this year that’s part of the ongoing 15-year, $12 billion Move Illinois program that began in 2011. It was expanded in 2017 to $14.3 billion. About $10 billion is for improvements and $4 billion for expansion projects.
The board has raised toll rates to help finance the program. Tolls account for 98% of system revenues and provide about 2.7 times coverage.
The authority has issued $2.8 billion to fund the program since 2013 and after the upcoming sale plans $2.6 billion more of senior lien borrowing including $400 million later this year and $1.4 billion of bonds between 2020-2022 and $800 million between 2023-2025.
The debt service profile is being structured to wrap around existing debt service, with an estimated $12 million amortizing in 2036-2038 and the remaining $288 million amortizing from 2039-2044 which Fitch said had already been factored into its prior analysis.
The authority in December refunded $500 million of debt, some for savings and some to trim floating-rate exposure in its $6.1 billion debt portfolio and shed swaps.
The authority’s debt structure includes $721 million of variable-debt paper that is swapped to a synthetic fixed rate. The negative valuation is at $117 million. The authority has been moving more of its debt to a fixed-rate in recent years in addition to new money borrowing in a fixed-rate mode.
The yield on the 10-year in the tollway's December sale landed at 2.78%, a spread of 38 basis points to the Municipal Market Data's top-rated benchmark.
The authority is heading into the market under a new board following the November election of a new Illinois governor.
State lawmakers passed bipartisan legislation earlier this year adopting ethics reforms and
Pritzker tapped Will Evans, a former president of People Gas and North Shore Gas, to serve as board chair. The other members have local government, legislative, business, or labor backgrounds.
The executive director is approved by the board and usually hand-picked by the governor. Alvarez is the former chief operating officer for the Chicago Housing Authority.
While leadership has shifted over the years, the current finance team is led by Chief Financial Officer Michael Colsch, who has been with the tollway since 2003 after spending a decade as state debt manager, and tollway debt manager William O’Connell. Both have managed finances under multiple governors from both parties.
