Coronavirus Pandemic: The Toughest Credit Test to Date for Toll Facilities

Managing through a health and economic crisis – While credit analysis is about assessing legal, economic and financial factors, key presumptions are that the macro environment, law and order, and health and safety will remain in a familiar range.  This crisis has turned everything on its head.  As analysts, we recognize that before one can revert to looking at traditional credit fundamentals one must get to firmer ground and that in this case needs to be a reliably safe environment to live and work.  We also realize that while it will be tough, it is mainly a matter of time and we will have a new normal.  When it comes to credit fundamentals, these actions are likely:

Operating Costs – While there are modest benefits, there are variable toll collection costs that will fall with lower demand, routine and major maintenance activities that can be deferred, and mandates to reduce overtime that can all help the bottom-line without adding meaningful medium-term credit risk.

Revenue Exposure Largely Uncontrollable – This risk is more difficult to mitigate given the lack of management control on broader economic activity and state and local actions to impose or lift restrictions.  This is compounded by the need to eliminate cash collection for safety reasons, waive fees, and increase exposure to electronic toll collection.  The ability to process the spike in pay-by-plate transactions and higher violations impact both timing and actual collections.  In such a situation revenue loss is what it is, so mitigating public health risk and operator liability is more important.

All ETC Opportunity – Where prior public relations concerns may have precluded it; this crisis will provide operators an opportunity to shift more fully to electronic toll collection.  This will have long term benefits to the user and the toll entity.

Bond Indenture Restrictions – While bond indentures vary they retain some flexibility for modified or toll-free operation to comply with local laws and regulations and for public safety purposes, so the risk of bondholder challenges for operational adjustments that impact revenue during the depths of this crisis are unlikely.  From a credit perspective prudent safety-related management actions that result in reduced revenue are not viewed negatively.  However, extending them longer than needed once the health risks have meaningfully dissipated will be a credit concern.

Bond Indenture Protections – Toll rate covenant violations and debt service reserve draws are not currently likely, but a possibility if social restrictions are protracted.  Rate covenants are intended to incentivize decision-making under a “normal” set of operating conditions to protect investors.   So, typically a rate covenant violation or a debt service reserve draw would be an indication of a more serious medium- to long-term risk – either the economic strength of the facility is weaker than originally anticipated or management is unwilling for some reason to raise rates.  Neither of those applies in this situation.  So, credit analysts will more likely focus on available liquidity and management’s actions to rectify the situation when some normalcy returns.  Practical considerations and the uncertain strength of the recovery may suggest that rate hikes in the near-term are unadvisable or may in fact be counterproductive.  On the other hand, once the economic foundation is firmer (in 1 or 2 years) the expectation will be for the rate covenant to be honored.

Liquidity Provides Cushion – Practically, many toll systems have maintained financial flexibility in the form of high discretionary liquidity levels and revenues well in excess of rate covenant levels to justify their higher credit quality.  Depletion of some of this liquidity and coverage is understandable in the current environment to sustain ongoing initiatives and investments as long as there is a predictable near-term path to regaining prior levels of financial strength.

Capital Investment Flexibility – While it is possible the economy roars back to life the pace of recovery is unknown, so modifying capital investment plans to provide more “dry powder” to navigate through uncertain times would be viewed positively from a credit perspective.  In these circumstances cash is king and having flexibility to offset cash-flow weakness is very valuable.  Where prudent it is also an opportunity to advance construction projects to lower cost and accelerate delivery given the availability of more day-time hours with fewer operational impediments.

Debt Restructuring – The medium- to long term view of core infrastructure assets like toll roads remains strong, so a tool available to issuers is restructuring debt to mitigate near-term risk and provide more flexibility.  This can shore up a window of weakness.  However, being careful not to materially eat into future flexibility will be an important balance to maintain.

Glide-Path More Important – We do analyze the range of outcomes, and despite commonly held opinions to the contrary, credit analysts do make every effort not to just assume the worst.  We know this is a difficult situation and 2020 will not look good.  We also realize that credit quality is defined by more than operating performance in one year, but on the overall profile while considering the weaker aspects.  If efforts are made to mitigate near-term risk and we see a reliable path to historical financial strength in 2-3 years we will tend to take the long view.  This does not mean a negative outlook, or a rating watch won’t be assigned depending on the perception of risk, but we won’t overreact.

Conservative Debt Structures Have Value – There has been a pattern over the last two decades to “modernize” indentures, often to provide management more flexibility.  This typically has also meant weakening bondholder protections and permitting products that take on more market risk, such as using short-term instruments, lowering additional bonds tests and reducing structured reserves.  This crisis reinforces the importance, particularly for publicly managed entities, to limit risk and maintain financial flexibility, i.e. dry powder, as they need to focus not just on operating a stable facility but also on supporting broader public policies.

Transparency and Good Communication – Lastly, transparency in decision-making is beneficial as lack of information and not understanding management strategy raises concern and can impact the assessment of credit risk.