Priority Lien Tax Revenue Debt

Transcription

1 Priority Lien Tax Revenue Debt Criteria Request for Comment Copyright 2017 by S&P Global. All rights reserved.

2 Priority Lien Debt Scope WHAT IT COVERS Approximately 1,300 credit ratings Bonds with a specific claim on revenues that occurs prior to other claims, including operating expenditures (and except for senior debt). Pledged revenue is typically limited Pledged revenue is not derived from the operations of a municipal enterprise, and could include certain fees and assessments. WHAT IT DOES NOT COVER - Bonds secured by ad-valorem property taxes - Tax increment revenue bonds - Revenues from municipal enterprise (liquor, casino, tribal, etc). - General obligation pledges Examples: sales taxes, hotel taxes, vehicle registration fees, court docket fees 2

3 Criteria Objectives INCREASE TRANSPARENCY of our methodology and assumptions to the marketplace IMPROVE CONSISTENCY of our view on limited property tax pledge ENHANCE GLOBAL COMPARABILITY of ratings to other sectors and asset classes 3

4 Criteria Update: Special Tax/Priority Lien Why is S&P Global Ratings Updating its Special Tax Criteria now? To clarify our position and replace existing Special Tax criteria To align our rating methodology of Priority Lien debt with other methodologies RFC Limited Tax General Operating Debt RFC Ratings Linked to the Obligor s General Creditworthiness To more formally link tax-secured ratings to the ICR (issuer credit rating), which represents our opinion of an obligor s general creditworthiness To reflect the lessons of recent cases of municipal distress, which demonstrate that legal protections and security structure cannot substitute for credit fundamentals 4

5 Analytical Framework Chart 1 Economic Fundamentals 20% Coverage & Liquidity 50% Revenue Volatility 30% Rating Caps Initial Indicative Rating Positive / negative Overriding Factors Holistic Analysis Limited by applicable caps Indicative Rating Continued next slide 5

6 Analytical Framework Chart 1 continued Indicative Rating Links to obligor and state general creditworthiness Priority Lien Rating Application of other relevant criteria such as Rating above the Sovereign. Final Issue Rating 6

7 Economic Fundamentals (20%) 7

8 Key economic drivers: population within the taxing boundaries, income levels, & participation in a large, broad and diverse MSA. 8

9 Economy Assessment is based on a preponderance of factors A very strong assessment typically includes a combination of: Participation in a broad and diverse MSA that encompasses over about 1 million residents A population within the obligor s taxing boundaries exceeding about 500,000 residents, and Income levels exceeding approximately 65% of the national level A very weak assessment typically includes a combination of: A population within the taxing boundaries less than about 10,000; Income levels below approximately 70% of the national level, and Lack of participation in a large, broad and diverse MSA. 9

10 Economy - Adjustments Positive considerations could include: A taxing base that is the economic hub for a smaller regional economy; A stabilizing economic presence such as major university or state capital; Negative considerations could include: A population base that has declined by more than 5% in three years or one that is expected to decline by over 5% in the next three years; A concentrated economic base; An economic base that is particularly subject to seasonality or cyclicality; Economic activities from which pledged non-operating revenues are derived are very limited in comparison to the area s broader economic base. 10

11 Coverage and Liquidity (50%) 11

12 The assessment first looks at expected coverage and then may make an adjustment for liquidity. 12

13 Prospective View of Coverage The assessment of coverage is based on our expectation of future coverage levels, which may be informed by: The Additional Bonds Test; Maximum Annual Debt Service Coverage; Our view on the likelihood of economic stress Our expectation of the likelihood of additional debt The entity's reliance on excess pledged revenues for operations Volatility of the pledged revenue stream and The ability of the obligor to affect coverage (for instance by changing tax rates) 13

14 Expected Future Coverage.depending on our views of the likelihood of economic stress, additional debt, volatility in the pledged revenue stream and other factors that can impact coverage. Table 4a Coverage Factor Assessment Assessment Coverage (x) 1 (Very Strong) > (Very Weak) <

15 Coverage Positive Adjustments Positive Coverage Considerations Include: (to the extent not already incorporated into our initial view of coverage): We believe coverage will grow due to debt retirement or revenue growth; Debt service is structured such that we expect coverage to improve within the next two years; A closed lien prohibits the issuance of additional parity debt and we believe that it will strengthen coverage. There are characteristics that we believe lend stability to our view of coverage, such as unusual tax rate (or assessment) flexibility or debt service is funded prior to the release of excess revenues. 15

16 Coverage Negative Adjustments Negative Coverage Considerations Include: (to the extent not already incorporated into our initial view of coverage): No limitations on the issuance of additional parity obligations, or when we view the ABT provides minimal protection against coverage dilution We believe coverage will decrease due to potential revenue deterioration Exposure to interest-rate sensitivity via variable-rate debt that we believe could negatively affect coverage 16

17 Coverage Negative Adjustments [continued] Negative Coverage Considerations Include: Annual debt service is not fully funded prior to release of any excess revenues, such as when funds are set aside for debt service payments proportionately throughout the year, and we believe this results in an increased risk of non payment We believe seasonal variance in coverage could affect debt service payments; Pledged revenues include revenues share by another government entity (such as a state or county) and we believe uncertainty exists with respect to such revenues, such as potential changes to the allocation formula 17

18 Liquidity Adjustment We may adjust the Coverage and Liquidity Assessment down in certain circumstances Focuses on liquidity required in the bond documents Generally does not consider other sources of liquidity if they are not legally pledged and required to be maintained Based on the principle that liquidity becomes more important when coverage is low and volatility is high 18

19 Liquidity Adjustment We may negatively adjust the coverage assessment when any of the following are true: No required reserve Reserve not funded in an amount or manner we consider sufficient Reserves are cross collateralized and we believe that such cross collateralization may lead to an under-funded reserve, or Bond documents do not provide for timely reserve replenishment If a required reserve falls short of the sufficiency standard, but provides some liquidity support, we may take that into consideration in applying the liquidity adjustment 19

20 Liquidity Adjustment Table Liquidity Adjustment Volatility Assessment Coverage V. Low Low Moderate High V. High Very Strong Strong Adequate Weak 0/ /1.5 Very Weak / / A coverage and liquidity assessment of very weak caps the rating in the bb category. 20

21 Liquidity We consider reserves to be sufficient when (a) and (b) are true (a) Reserve is set at either the lesser of standard 3 prongs, or some other amount we estimate to be on par with 3 pronged test, AND (b) Reserve is required to be replenished under the bond documents. Reserve is not sufficient if (a) funded by a 3 rd party and we believe 3 rd party is unlikely to provide support or (b) reserve is springing 21

22 Revenue Volatility (30%) 22

23 We consider historical volatility of the economic activity being taxed 23

24 Macro-Level Volatility Assessment Our analysis of macro-level volatility risk takes into account both Historical volatility of the economic activity being taxed as well as Our forward-looking view of societal, demographic, political, and other factors that could potentially affect the economic activities being taxed We assign an assessment score of 1 (very low) to 5 (very high) to the overall macro-level volatility based on general characteristics of the economic activity being taxed. 24

25 Volatility Assessment: Methodology For revenue types that are commonly observed, we have published a criteria-related commentary (see Related Research) that provides our assessment of macro-economic revenue volatility by revenue type Hotel Sales Hospitality 3 2 Gas & Motor Sales and Use For revenue types that are less commonly observed or composed of mixed revenue streams. our macro-level assessment reflects the proportion of expected revenues attributable to each stream, as well as whether we believe there is any additional stability provided by the inclusion of revenue streams that we believe have low or negative correlation. 25

26 Volatility Assessment Factor Score Very low Low Moderate High Very High General Characteristics The economic activity being taxed has exhibited low historical volatility. The activity represents a necessary good or service that stands to grow in the future because of (or despite) any technological advancements or shifting societal conditions. The economic activity being taxed has exhibited low-to-moderate historical volatility. The demand for the activity being taxed is expected to remain relatively stable through various economic cycles. Future shifts in technology and/or society are not expected to negatively affect future economic activity. The economic activity being taxed has exhibited moderate historical volatility. The magnitude of changes in demand for the economic activity mirror general economic conditions. Potential technological or societal changes are not expected to materially impact future activity. The economic activity being taxed has exhibited moderate-to-high historical volatility. The activity being taxed is somewhat discretionary in nature, and could experience declines that are slightly higher in magnitude than general economic conditions alone. Potential changes in technology and/or society could have a negative future impact or such impacts are uncertain at this point. The economic activity being taxed has exhibited high historical volatility. The good or service represents discretionary spending with a high elasticity of demand. Potential technological or societal changes will likely negatively impact this economic activity. *We generally would not lower the initial indicative rating below bb- based on revenue volatility risk 26

27 Micro level volatility adjustments Positive considerations include: Internal or structural characteristics that we believe lend additional stability to the revenue source relative to the macro-level assessment such as basis of taxation, revenue sharing formula or composite revenue stream and External factors such as a greater diversity in the tax remitters than would be typical for the economic activity being taxed or an unusually stable tax base. Negative considerations include: Internal or structural characteristics that we believe increase revenue volatility relative to our macro-level assessment such as the basis of taxation revenue sharing formulas or a composite revenue stream and; External factors such as actual (or expected) taxpayer concentration, or exposure to an unusually cyclical or volatile taxing base, or dependence on a major sector experiencing a slowdown that is expected to negatively affect future pledged revenue. 27

28 Linkage to General Creditworthiness 28

29 Capping PL ratings relative to obligor credit Rating caps above obligor general creditworthiness 4 notches We view operating risk as remote. We believe pledged revenues are sufficiently separated from operations Examples: Special purpose entity securitization (Assignment/sale), Operating lease 2 notches Operating risk is present, but mitigated by revenue collection mechanisms that limit obligor control until after priority lien obligations are paid Example: Intercept and lockbox (pre-default) 1 notch Operating risk is present and unmitigated, but we believe priority lien obligations are likely to be paid before other, non-priority lien obligations 29

30 Revenue Sharing Risk When revenues shared by another government entity are needed for debt service, we will cap the priority lien rating at the level of the revenue-sharing entity s general creditworthiness if we believe that budgetary pressure on the revenue-sharing entity may become a primary driver of priority lien credit risk Absent this condition, we can still consider the extent to which revenue sharing arrangements may affect revenue volatility and coverage through adjustments, overrides, and holistic analysis 30

31 Appropriation Risk We generally would consider appropriation risk mitigated in cases where: 1. We believe a failure to appropriate would not benefit the obligor through increased financial flexibility, OR 2. When pledged revenue is automatically set aside in amounts sufficient to fund full annual debt service regardless of whether an appropriation has been made. 31

32 Rating Caps Perceived change in obligor s willingness to honor obligations. Coverage and Liquidity assessment of weak. Coverage and liquidity assessment of very weak. Volatility assessment of very high. Less than 1.0 DSC and we do not expect coverage to grow. b category bbb category bb Category a category bb Category 32

33 Projected Impact and Request for Comments 33

34 Projected Impact on Ratings * 20% About will not change 45% About 1 notch up/down 20% About 2 notches up/down 15% About more than 2 notches Most rating changes will be modest, only one to two notches, assuming credit fundamentals for particular credits do not change between now and transition to the criteria. * Based on testing. Results are estimated and preliminary. 34

35 RFC questions 1. What is your view of the scope of these criteria, that is, the description of the types of debt that would be evaluated as priority lien tax revenues under these criteria? Specifically, are there certain types of debt you believe should be excluded from or included in this proposal? 2. What is your view of the various factors that combine to the initial indicative rating, including economic fundamentals, coverage, and liquidity, and revenue volatility including their weightings and the various quantitative and qualitative factors used to assess them? 3. What is your view of the various caps, overrides, and adjustments proposed, including those that notch the indicative rating, those that cap the rating at an absolute level, and those that cap the rating relative to the general creditworthiness of a state or local government? 4. Are there any other views regarding this criteria proposal that you would like to bring to our attention? 35

36 Next Steps 36

37 Request for Comment Period Submit your written comments by January 15, To submit comments, go to and follow the link for All Requests for Comment. Can also submit comments to All comments must be published. Those providing comments may choose to have their remarks published anonymously. 37

38 Contact Information Horacio Aldrete-Sanchez, Dallas (1) ; Sarah Sullivant, San Francisco (1) ; Liz Sweeney, New York (1) ; Steve Tencer, New York (1) ; 38

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