Fitch Rates $573MM Build Illinois Bonds 'AA+'; Outlook Stable
--$150 million junior obligation tax-exempt series A of September 2016;
--$60 million junior obligation taxable series B of September 2016;
--$164.305 million junior obligation tax-exempt refunding series C of September 2016;
--$198.62 million junior obligation tax-exempt refunding series D of September 2016.
The bonds are expected to sell via competitive sale on Aug. 24, 2016 for series A & B and on Aug. 25, 2016 for series C & D.
Fitch has also affirmed the following ratings:
--$1.86 billion of outstanding State of Illinois Build Illinois senior lien bonds at 'AA+';
--$654.4 million of outstanding junior obligation bonds at 'AA+'.
The Rating Outlook is Stable.
SECURITY
Build Illinois bonds have a first and prior claim on the state share of the 6.25% unified sales tax and a first lien on revenues deposited into the Build Illinois Bond Retirement and Interest Fund (BIBRI). Debt service payments on the junior obligation bonds are subordinate to outstanding senior lien debt service; the senior lien is not closed.
KEY RATING DRIVERS
EXCEPTIONAL RESILIENCE: Debt service coverage on both the senior and subordinate lien bonds is exceptional. Given minimal legal ability to leverage sales tax revenues, both at the senior and subordinate levels, pledged revenues can sustain a significant level of decline and still maintain ample debt service coverage.
ECONOMY A CREDIT STRENGTH BUT RECOVERY IS SLOW: With a slowly growing economy—Illinois' economic performance, while positive, has lagged that of the U. S. as a whole - pledged revenues are expected to experience modest real growth.
STRONG LEGAL PROVISIONS: Build Illinois bonds have a statutory first lien on the state's share of the sales tax, strong non-impairment language, and no requirement for annual appropriation. In Fitch's opinion, these provisions insulate the bonds from state operations and support a rating level that is higher than that of the state's Issuer Default Rating ([IDR] 'BBB+', Rating Watch Negative).
JUNIOR LIEN BONDS RATED ON PAR WITH SENIOR: No rating distinction is made between the senior and junior obligation bonds. The junior bonds benefit from the security provisions of the senior lien bonds, including the first lien on the state's share of the sales tax. The additional bonds test is more liberal but still very strong at 10.2 times (x) maximum annual debt service (MADS) coverage.
RATING SENSITIVITIES
The rating is sensitive to the performance of sales tax revenues and debt service coverage levels. Limits on additional debt issuance that require very high historical coverage provide significant cushion against revenue declines.
CREDIT PROFILE
LEGAL PROVISIONS SUPPORT RATING HIGHER THAN THE STATE GO
Build Illinois bonds are secured by a first priority pledge of the state portion of the sales tax as well as a lien on the moneys in the fund that receives monthly transfers of the sales tax receipts (BIBRI). The enabling legislation includes strong non-impairment language wherein the state pledges that it will not limit or alter the basis on which the sales taxes are collected and transferred to the BIBRI account. In Fitch's opinion, the statutory lien on revenues, the strong non-impairment language, and a standing appropriation for debt service insulate the bonds from state operations and support a rating level that is higher than the state's IDR.
The effect of detailed legal requirements is that the trustee and the state's debt manager transfer monthly 1/12th of the greater of 150% of the certified annual debt service or 3.8% of the state's share of the sales tax up to the certified annual debt service requirement. The 3.8% of revenues has, since fiscal 2013, been greater than the debt service requirement, accelerating annual debt service funding.
As noted in Fitch's criteria for rating state dedicated tax bonds higher than the state IDR, although contract clause protections under federal and state constitutions restrict the ability of a state government to impair its obligation to pay bondholders from the dedicated tax, the contract clause does not impose an absolute constraint when there is a fiscal emergency. Therefore, the amount of credit Fitch will give to such a structure is tempered by the risk that a state, faced with extreme financial stress, could exercise its sovereign powers to the detriment of bondholders.
JUNIOR OBLIGATION BONDS BENEFIT FROM SECURITY PROVISIONS
No rating distinction is made between the senior and junior obligation bonds, despite the lower position of the junior obligation bonds in the flow of funds, as the junior bonds benefit from the security provisions of the senior lien bonds, including the first lien on the state's share of the sales tax. The junior obligation bonds do not have a claim on the debt service reserve fund (funded at 50% senior lien MADS), but this is not a material rating factor.
Coverage of annual debt service and MADS requirements is very high for both the senior and junior obligation bonds. Additional security features include additional bonds tests that require debt service be no more than 5% of the state's prior year sales tax receipts to issue senior lien bonds and 9.8% to issue junior obligation bonds; this effectively requires 20x coverage to issue senior lien bonds and 10.2x coverage to issue junior obligation bonds.
MODEST GROWTH IN REVENUES
With a relatively slowly growing economy, Fitch expects pledged revenues to experience modest real growth. Sales tax revenues are economically sensitive, declining a cumulative 12% during the recession. Revenue performance has been strong since the end of the recession, demonstrating solid year-over-year growth in all years except 2013. More recently, sales tax revenues grew 4.1% and 4.5% in fiscal years 2014 and 2015, respectively. Current performance is somewhat softer, with just 0.7% year-over-year growth in sales tax revenues in fiscal 2016, caused in part by lower gasoline prices. The state taxes gasoline sales as a percentage of the per-gallon price.
Illinois' economic performance, while positive, has lagged that of the U. S. as a whole. Employment growth has been well below the national average through the recovery/expansion period. Both GDP and personal income declined at a steeper rate in Illinois during the recession and have been increasing at a slower rate during the expansion. State wealth levels remain above average.
HIGH DEBT SERVICE COVERAGE FROM PLEDGED REVENUES
Sales taxes are imposed at a unified state and local rate of 6.25%, with 80% of collections representing the state's share. The sales tax generated $8.6 billion in fiscal 2016, with pledged revenues providing 26x coverage of MADS on aggregate debt, including the junior obligations.
The Fitch Analytical Scenario Tool (FAST) output indicates a possible 3% drop in revenue in a moderate U. S. recession scenario (1% U. S. GDP decline). As noted above, the largest consecutive decline in sales tax revenues since 1999 has been a 12% drop during the recession. Given minimal legal ability to leverage sales tax revenues - both at the senior and junior lien levels - pledged revenues can sustain an exceptional level of decline and still maintain ample debt service coverage.
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