Maryland Department of Transportation The Secretary's Office

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1 November 30, 2016 Maryland Department of Transportation The Secretary's Office Larry Hogan Governor Boyd K. Rutherford Lt. Governor Pete K. Rahn Secretary The Honorable Edward J. Kasemeyer Chair Senate Budget and Taxation Committee The Senate of Maryland 3 West Miller Senate Office Building Annapolis MD The Honorable Maggie Mcintosh Chair House Appropriations Committee The Maryland House of Delegates 121 House Office Building Annapolis MD Dear Chairs Kasemeyer and Mcintosh: Attached is the report concerning Consolidated Transportation Bond Debt Affordability Criteria written in response to language set forth in the 2016 Joint Chairmen's Report, page 52 that states: "The committees are concerned about the increasing share of Transportation Trust Fund (TTF) revenues being consumed by debt service payments on Consolidated Transportation Bond (CTB) debt. By fiscal year 2021, the end of the current TTFforecast period. debt service is projected to require almost 11.0% of net TTF revenues. Furthermore. in fiscal year 2021, the TTFforecast anticipates that debt service will equal an amount equivalent to over 90. 0% of projected bond issuances. Given that CTB debt is part of total State tax-supported debt and total State tax-supported debt is approaching the State 's affordability limits, it is desirable that CTB-specific affordability criteria be developed. The committees therefore request that the Maryland Department of Transportation (MDOT) work with the Capital Debt Affordability Committee (CDAC) to develop affordability criteria that may be used to ensure CTB debt remains affordable vis-a-vis TTF resources. MDOT should submit a report to the committees detailing the recommended affordability criteria developed through this effort by December 1, 2016." My telephone number is Toll Free Number TTY Users Call Via MD Relay 7201 Corporate Center Drive. Hanover, Maryland 21076

2 The Honorable Edward J. Kasemeyer The Honorable Maggie Mcintosh Page Two If you have any questions or concerns, please contact Mr. Dave Fleming, MDOT Office of Finance Director, at or Of course, you may always contact me directly. Sincerely, Pete K. Rahn Secretary cc: Ms. Sarah Albert, Library Associate, DLS The Honorable Michael E. Busch, Speaker, The Maryland House of Delegates Mr. Dave Fleming, Director, Office of Finance, MDOT The Honorable Thomas V. Mike Miller, Jr., President. The Senate of Maryland

3 A Report to the Maryland General Assembly Senate Budget and Taxation Committee and House Committee on Appropriations Regarding MDOT Bond Debt Affordability Criteria (2016 Joint Chairman s Report, page 52) Prepared by The Maryland Department of Transportation December 2016

4 Introduction This report has been prepared in accordance with committee narrative in the 2016 Joint Chairmen s Report, page 52, on the Maryland Department of Transportation s (MDOT) debt service requirements. The language specifically directs: Consolidated Transportation Bond Debt Affordability Criteria: The committees are concerned about the increasing share of Transportation Trust Fund (TTF) revenues being consumed by debt service payments on Consolidated Transportation Bond (CTB) debt. By fiscal year 2021, the end of the current TTF forecast period, debt service is projected to require almost 11.0% of net TTF revenues. Furthermore, in fiscal year 2021, the TTF forecast anticipates that debt service will equal an amount equivalent to over 90.0% of projected bond issuances. Given that CTB debt is part of total State tax-supported debt and total State tax-supported debt is approaching the State s affordability limits, it is desirable that CTB-specific affordability criteria be developed. The committees therefore request that the Maryland Department of Transportation (MDOT) work with the Capital Debt Affordability Committee (CDAC) to develop affordability criteria that may be used to ensure CTB debt remains affordable vis-à-vis TTF resources. MDOT should submit a report to the committees detailing the recommended affordability criteria developed through this effort by December 1, Background Under Sections to 3.217, inclusive, of the Transportation Article of the Annotated Code of Maryland, the Maryland Department of Transportation (MDOT) is authorized to issue Consolidated Transportation Bonds (CTBs). CTBs are fixed rate bonds with maturities of up to 15 years, which MDOT issues to help finance the capital cost of its transportation facilities. They do not constitute a debt or a pledge of the faith and credit of the State of Maryland. The State s Capital Debt Affordability Committee (CDAC) annually reviews the State s tax supported debt, including MDOT s debt issuances. CTBs are a type of revenue bond in that the principal and interest are paid from the proceeds of certain pledged taxes, fees, and other revenues in the Transportation Trust Fund (TTF). The level of bonds issued depends on the net revenues of the Department. Bonds are issued to support the cash flow requirements of the planned capital program while staying within the debt service and coverage requirements. MDOT Debt Issuance Process MDOT maintains a six-year financial plan, which contains a forecast of revenues and operating and capital expenditures. The forecast is a planning tool that enables MDOT to evaluate its longterm financial resources, identify projects to be funded, and develop a plan to cover required operating and capital expenditures. MDOT uses the forecast to plan debt issuances, ensuring that debt-financed projects do not exceed the permitted statutory level or internal debt controls. The Maryland Board of Public Works must approve all MDOT debt issuances. 1

5 The MDOT Office of Finance s Debt Management Unit works with MDOT s financial advisor, principal counsel and bond counsel to prepare for the sale. This process includes obtaining the rating from the rating agencies, preparing and publishing all required notices and advertisements, and preparing and distributing the Official Statement. MDOT then uses an electronic bidding system for a competitive bid of the bonds. The award is granted to the bidder with the lowest true interest cost. The table below summarizes the process: Major Steps in Bond Selling Process: Forecast financing needs Letter of Intent signed by Secretary (based on FY budget) Work with financial advisor and bond counsel to structure bond issuance Obtain Board of Public Works approval Obtain bond rating from rating agencies Publish Preliminary Official Statement and Notice of Sale electronically to solicit bids for sale (approximately two weeks prior to sale) Sale (electronic) & Award to bidder with best true interest cost Current Limits on MDOT Debt There are numerous limitations currently in place to control MDOT debt. The aggregate amount of the outstanding and unpaid principal balance for CTBs is restricted by Maryland Statute (Statute) and by annual limits included in the budget bill. The current State law limits on CTBs are: The Statute (TR 3-202(b)) limits total Consolidated Transportation Bonds debt outstanding to no more than $4.5 billion in the aggregate. The Statute (TR 3-202(c)) also requires that the legislature enact an annual limit on debt outstanding in the budget bill. The Fiscal 2017 Budget Bill limits consolidated debt outstanding to $2,773,900,000 as of June 30, MDOT manages its debt outstanding by two coverage tests: pledged taxes and net revenues. The pledged taxes test captures MDOT s portion of the Maryland motor fuel tax, motor vehicle titling tax, corporation income tax, and sales and use tax on rental vehicles and compares it to maximum annual debt service. The net revenues test is a more stringent ratio measuring total receipts of the Department (excluding federal aid, bond proceeds, or other receipts not available for debt service) minus administration, operating and maintenance expenses and compares this net revenue available to maximum annual debt service. These types of coverage tests are known in the industry as an Additional Bonds Test (ABT). MDOT states in its bond covenants that it will not issue new bonds unless both the prior fiscal year receipts of pledged taxes and net revenues are each equal to at least two times the maximum annual debt service. Although both tests require two (2.0) times coverage, the Department s management policy is to provide two and one-half (2.5) times coverage, a level that is 25% higher than the level required under the bond covenants. The additional coverage serves as a cushion against revenue and expense variations, and thus allows time to adjust the financial strategies while maintaining the capital program. Further, the bond rating agencies look favorably on debt coverage levels of 2.0 or higher. 2

6 Rating Agencies View of MDOT Debt MDOT is sensitive to how its management policies and debt usage practices are viewed by the financial markets because this view translates directly into the cost of borrowing incurred by the Department. The rating agencies are a good measure of the market s perception. MDOT s CTBs currently receive some of the highest ratings assigned to transportation bonds by the three Bond Rating Agencies: AAA by Standard and Poor s; Aa1 by Moody s Investors Service; and AA+ by Fitch Ratings. The rating agencies have consistently assigned high ratings to MDOT debt having cited MDOT s prudent management practices and strong coverage of debt service as major strengths. MDOT bonds receive these ratings because of the debt management criteria and processes currently in use by the Department. All three of the rating agencies note a stable outlook based on the steady growth in revenues, maintenance of the working cash, and adherence to strong affordability criteria. The rating agencies have not raised issue with MDOT s level of debt or potential for additional future debt, giving credit strength to MDOT s leveraging of new revenues, strong management, and growth in traditional TTF revenues. The rating analyses state the only way our rating could be raised is with additional secured and stable revenue resources. Developing a CTB-specific Affordability Test The JCR language stated that the committees were concerned about the increasing share of TTF revenues being consumed by debt service payments on MDOT s CTB debt. The factors that triggered this concern were sighted as: the level of debt service in the final year of the TTF s Six-year Financial Plan measured, specifically, as a percentage of net TTF revenues in that year and as a percentage of the projected bond issuances in that year. A historical review of these measures was performed to examine how they changed over time and possibly determine what was driving the change. The historical summaries are shown in the appendixes to this report. Additionally, as a guide to developing an appropriate affordability test, MDOT examined debt affordability tests imposed by other states. Public Financial Management (PFM), MDOT s financial advisory firm, was engaged to review MDOT s current debt management policies and to conduct a survey of other states debt standards for DOTs. JCR Debt Service Measures - Historical Summaries MDOT compiled the debt service as a percentage of TTF revenues measure for the past 26 years. The results are shown in Appendix A. In the table, the percentage for the past five (5) years ( ) averaged approximately 11%. Interestingly, the percentage for the first five (5) years ( ) of the 26-year period averaged the same amount. Over the entire period examined, the percentage performed within a very narrow range. MDOT believes this tight range occurred due to the affordability constraints enforced by the current debt measures in place. MDOT s current coverage tests are in a way more stringent than this percentage measure in that they compare a smaller subset of TTF revenues to debt service: (1) pledges taxes and (2) net revenues after operating expense. In addition, the current tests do 3

7 not use the annual debt service for the year being tested, but rather it uses the maximum level of annual debt service the TTF will incur in any future year. This summary demonstrated that MDOT s current measures have been serving the purpose of keeping the CTB debt consistently affordable within the TTF resources, which was the concern of the JCR narrative. The other measure cited in the JCR narrative, debt service as a percentage of bond issuances was compiled for the same 26-year period. The results are shown in Appendix B. A review of this measure s history showed that the 90% number for FY 2021 in this year s financial plan was actually better than most years in the past. The historical data showed this measure to be unreliable in addressing the affordability concern. Survey of Other State DOT Debt Standards PFM surveyed the debt standards use by other states and their transportation agencies, and compared them with MDOT s affordability ratios. Some states incorporate their state tax backed transportation debt into their broader state debt affordability measures, while most simply manage the transportation revenue bonds through an ABT measure similar to MDOT. PFM s research found that the average DOT is more capital intensive than the average state general fund, which has caused a policy argument as to whether DOT tax revenue bonds should be excluded from the statewide general fund revenue debt affordability tests. Many transportation agencies are not included under the umbrella of the state s capital affordability criteria. In those state s where the transportation agencies are included, the affordability ratios are much higher than those used by Maryland. Where states have separated the transportation agencies debt, the established debt to revenue ratios are in the range of 15% to 20%. For those agencies using an ABT measure, MDOT s CTB requirements were in the national range when compared to other highly rated state transportation agencies. Capital Debt Affordability Committee Review MDOT met with a CDAC workgroup, comprised of staff from the Treasurer s Office, Department of Budget and Management, Comptroller s Office and Department of Legislative Services, on August 11, At the meeting, MDOT presented the historical worksheets and the analysis prepared by PFM. The workgroup discussed the current ratios, comparison with other state transportation agencies, and the fact that investors and rating agencies continue to value CTBs and have not indicated concern with MDOT s current debt management policies. On September 28, 2016, the topic of MDOT Affordability Criteria was brought before the CDAC. The committee reviewed and discussed the information presented to the CDAC workgroup. The workgroup presented two options to the committee for consideration: 1. MDOT s existing additional bonds test and statutory limits are sufficient to keep the CTB debt affordable for the State; therefore, no additional affordability criterion is needed. 4

8 2. MDOT should further study the issue and choose a workable ratio it can use as an additional debt management tool. Although not unanimous, the five-member committee voted four to one in favor of option 1, no additional affordability criterion is needed. Summary MDOT issues Consolidated Transportation Bonds (CTBs) to support the capital costs of its transportation programs. This debt is supported by tax and fee revenues in the Transportation Trust Fund (TTF), which is managed by the Department. MDOT follows an established debt issuance process to market its bonds, including getting approval from the Maryland Board of Public Works for each bond issue sold. There are a number of limitations currently in place on MDOT debt. Two limits are set by the General Assembly: Total debt outstanding is limited by statute to $4.5 billion. Annual limits are established in the Budget Bill each year for the maximum amount of bonds outstanding at the end of the coming fiscal year. MDOT manages its debt with two Additional Bonds Tests (Debt Service Coverage Ratios): Pledged Taxes shall equal at least two times the maximum annual debt service on all CTBs outstanding, and Net Revenues shall equal at least two times the maximum annual debt service on all CTBs outstanding. These ratios are managed to a level that is 25% higher than the level required under our bond covenants. The ratings agencies, Standard and Poor s, Moody s, and Fitch, have consistently cited the Department s prudent management practices and strong coverage of debt service as major strengths in the ratings reports and they are accepted in the marketplace as strong affordability criteria. An additional affordability measure will not benefit MDOT s ratings. Based on their ratings analysis, the only way our rating could be raised is with more secured and stable revenue resources. The MDOT debt service as a percentage of TTF revenues measure has remained stable and moved within a very narrow range for the past twenty-six years. This test showed that our current measures are serving the purpose of keeping MDOT debt affordable within the TTF resources, which was the concern of the JCR narrative. In fact, MDOT s current tests are more stringent because they compare a smaller subset of available revenues to debt service and use the maximum level of future annual debt service. In addition, MDOT s measures are consistent with those used by other highly rated state transportation agencies. MDOT current debt service coverage tests for CTBs are appropriate and ensure that the Department is keeping its debt affordable within the resources of the TTF. Based on the research compiled, the Department submitted and the CDAC concurred that an additional bond measure was not needed. 5

9 Appendix A Debt Service to Revenues Summary FINAL YEAR Final CTP Final Fiscal Year Net TTF Revenues Debt Service Debt Service to TTF Rev. Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % Dec , % 6

10 Appendix B Debt Service to Bond Sale Summary FINAL YEAR Final CTP Final Fiscal Year Debt Service Bond Sale Debt Service to Bond Sale Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec % Dec N/A Dec N/A Dec N/A Dec % Dec % Dec % Dec N/A Dec N/A 7