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COMMENTS

Credit FAQ: A Review Of Transportation Criteria: Liquidity And Debt Service Coverage In Light Of COVID-19


Credit FAQ: A Review Of Transportation Criteria: Liquidity And Debt Service Coverage In Light Of COVID-19

Frequently Asked Questions

The virtual collapse of demand levels for many transportation infrastructure providers as a result of the COVID-19 pandemic is focusing attention on their liquidity, reserves, financial flexibility, and projected financial performance. As we evaluate the magnitude and impact of these severe volume declines on issuers in the context of a global recession, key metrics outlined in our criteria and other financial flexibility measures provide a critical, forward-looking view of how long the enterprise can operate while meeting near- and longer-term financial obligations. Importantly, understanding these measures of liquidity, including how we view unrestricted versus restricted assets, days' cash on hand, cash burn rates, and debt service coverage (DSC), as well other adjustments, provides the market with uniform benchmarks to allow comparative analysis at a time when management teams are proactively using all available tools to meet their obligations.

In this commentary, we review these key metrics and their significance to our assessment of overall credit quality, addressing how external support or liquidity injections, such as federal grants from the CARES Act made available to airport and transit operators, will be incorporated into our analysis, and examining how other cash flow analysis can be useful in the coming months.

What are the key criteria S&P Global Ratings uses to evaluate transportation infrastructure enterprises and mass transit entities, and how important are financial performance and liquidity measures?

Issuers and issue ratings in the public finance transportation sector are analyzed using two primary criteria frameworks: "U.S. And Canadian Not-For-Profit Transportation Infrastructure Enterprises: Methodologies And Assumptions" (published March 12, 2018) and global "Mass Transit Enterprise Ratings: Methodology And Assumptions" (published Dec. 18, 2013). The TIE framework is calibrated to recognize the generally strong business and financial profiles of issuers in this sector. However, core methodological factors that typically drive rating differentiation are our market position assessment (60% weighting) within our enterprise profile assessment, and DSC (55%) and debt and liabilities (35%) assessments within our financial profile assessment. Additionally, to determine the initial financial profile assessment, we also evaluate an enterprise's liquidity and financial flexibility assessment, which has a lower weight (10%) among our financial profile factors. The interaction of these assessments explains most of the variation among the final rating outcomes.

Similarly, our mass transit ratings criteria follow a similar framework and consider both the enterprise risk profile and the financial risk profile of the system. The key factors considered for the enterprise risk profile include market position (35% weighting), industry risk (25%), and management and governance (20%). Those factors considered for the financial risk profile include our assessment of financial policies (10%), DSC (20%), liquidity (25%), financial flexibility (30%), and debt burden (15%).

While some liquidity factors may have lower relative weights in our consideration of the long-term rating, in times of severe financial stress, liquidity is obviously critical, and especially weak liquidity metrics can worsen a financial profile score under our criteria.

Starting with transportation infrastructure, what are the key liquidity metrics, how are they calculated, and what are the ranges associated with your measures of liquidity and financial flexibility?

The liquidity and financial flexibility assessment measures how a TIE's sources of available liquidity may affect its debt servicing capability by primarily evaluating a TIE's unrestricted days' cash on hand (UDCOH) and unrestricted reserves as a percent of total debt. For airports, ports, toll roads, and parking systems, we generally view UDCOH as the more important of the two measures. For stand-alone passenger facility charge (PFC) debt and airport special facility projects that have minimal operating or administrative expenses, we generally view unrestricted reserves-to-debt as the more important of the two measures.

UDCOH reflects an entity's financial flexibility and capability to withstand operating challenges while still covering its operating expenditures. A higher days' cash ratio may also indicate greater resources available to fund other investment or debt service needs. UCDOH is calculated as available unrestricted liquidity divided by S&P Global Ratings-adjusted annual operating expenses, then multiplying the result by 365 days.

Unrestricted reserves as a percent of total debt measures financial flexibility, and is a way of assessing debt capacity and debt servicing ability. We calculate this metric as all available unrestricted liquidity divided by total debt outstanding. How we assess each factor is shown in table 1.

Table 1

Liquidity And Financial Flexibility Assessment-- Initial Assessment
Extremely Strong Very Strong Strong Adequate Vulnerable Highly Vulnerable
Unrestricted days’ cash on hand >800 800-400 400-250 250-120 120-60 <60
Unrestricted reserves to debt (%) >85 85-50 50-20 20-7.5 7.5-3.0 <3
Are there considerations that can influence how these TIE-related metrics are interpreted?

Yes--our assessment of all factors related to TIE is based on our forward-looking view of the entity's performance. Typically, we begin our assessment by examining historical and current performance metrics, including the volatility and trend of past results. Our view of future performance may differ from historical or current results. Our forward-looking view of a factor is informed by our opinion of macroeconomic, legislative, and regulatory conditions; our view of entity-specific factors such as competitive position, capital plans, revenue stream trends, and management actions; and the entity's own forecast.

For example, in evaluating DSC metrics, the trend of historical results and our understanding of the reasons for those trends may inform our view of whether coverage will improve, worsen, or remain comparable to historical levels. However, if an entity has debt plans that will result in higher debt service, we could base our final assessment of coverage on our forward-looking view of the coverage level, after taking into account the entity's debt plans and other potential factors. In the current environment, in which issuers face a virtual collapse of demand and related net revenues, we would expect to base our financial performance assessment or liquidity metrics on pro forma estimates, taking into account our view of the duration and severity of the decline as well as our view of post-recovery operating performance. This allows us to discount sudden shocks to DSC or liquidity in our assessment if we believe them temporary. However, downward rating pressure still exists, if we believe future metrics will likely be markedly lower than pre-shock levels for an extended period.

What about mass transit issuers? What are the liquidity metrics, calculations, and ranges associated with measures in S&P Global Ratings' criteria?

For the mass transit issuers we rate, liquidity metrics measure their ability to fund current obligations from unrestricted funds on hand, bank lines or loans, and access to capital markets. While internal liquidity is important, we also understand that maintenance of high levels of unrestricted cash is not common in the mass transit sector. Many mass transit systems have typically had access to external liquidity via committed lines of credit or the issuance of debt in capital markets. In most cases, the systems are able to adjust service levels to reduce variable costs, if needed, which boosts (albeit with a lag) net internal resources to pay debt service.

We review days of available cash and total cash-to-debt service for the base year to form an initial liquidity score. Considering cash in these measures, we also include the undrawn amounts of any committed bank lines and ongoing available liquidity lines from a related government. Drawn amounts are included with debt service and total debt outstanding. If a debt service reserve fund (DSRF) exists, the amount is included in the cash-to-debt service measure but not in the days' cash measure, because these funds are generally restricted for the payment of debt service. The ranges are shown in table 2.

Table 2

Assessment Of Liquidity
Cash to debt service (including DSRF and lines)
Days of available cash (including lines, excluding DSRF, which is restricted) More than 8.0x 5.0x to 8.0x 2.0x to 4.99x Less than 2.0x
More than 180 1 1 2 2
90-180 2 2 2 3
30-89 3 4 4 5
20-29 4 5 5 6
Less than 20 5 5 6 6
Qualitative factors positively affecting the initial score
-Projections for the current year and the following year suggest a better initial score.
-If access to external liquidity is exceptional, , the score is improved by two points; if strong, the score is improved by one point.
Qualitative factors negatively affecting the initial score
-Projections for the current year and the following year suggest a worse initial score.
-If access to external liquidity is limited or uncertain and days' cash is less than 180 days, the score worsens by one point; if access to liquidity is uncertain and cash to debt service is less than one, the score worsens by two points.
-Aggressive use of investments as evidenced by short-term equity and other high-yield assets.
-Cash flow volatile and unpredictable at times, or fiscal year-end liquidity is skewed by seasonality or is otherwise not indicative of actual daily working capital levels.
-High refinancing risk over the next two to three years.
-Exposure to contingent liabilities likely payable within 12 months.
The liquidity score equals the initial score adjusted up or down for each qualitative factor, except that the final score may be no more than two points away from the initial score. If there is uncertain access to capital markets or other forms of external liqudity, yet such access is necessary for the mass transit system to meet or refinance an obligation due within a year to maintain regular operations or to fund a critical capital project, the liquidity score is capped at '6'.
How will S&P Global Ratings evaluate external sources of liquidity for TIE, e.g., federal grants of financial support provided for in the CARES Act?

The passage into U.S. law of the approximately $2 trillion CARES Act federal stimulus package--including $10 billion in grants for U.S. airports and $25 billion for transit providers--is a credit positive, and for many issuers it will alleviate immediate liquidity pressures and assist with near-term operational funding requirements, including debt service. S&P Global Ratings maintains the flexibility to evaluate external sources of financial support in various scenarios for TIE, but will likely view stimulus funding as nonrecurring non-operating revenue and view the additional funds only in our liquidity assessments. Much like any balance-sheet item, liquidity is a point-in-time snapshot of resources available to management for meeting operational needs, capital expenditures, and unforeseen requirements, such as debt service. However, long-term credit implications across all sectors have yet to unfold, and we expect greater visibility on the broader impacts on issuers' financial and business profiles in the coming months.

Table 3

Hypothetical TIE Example--Stimulus Funds as Liquidity
Total operating revenue ($) A 1,000
Operating and maintenance expenses (excluding D&A) ($) B 500
Net operating income ($) C=A-B 500
Interest income ($) D 100
S&P Global Ratings net revenues E=C+D 600
Debt service ($) F 400
Total debt outstanding ($) G 5000
Available liquidity ($) H 400
Available stimulus money for liquidity ($) I 100
Total available liquidity ($) J=H+I 500
S&P Global Ratings':
Debt service coverage K=E/F 1.5
Debt to net revenues L=G/E 8.3
Days' cash on hand M=(J/B)*365 365
Liquidity to debt (%) N=J/G 10
How does S&P Global Ratings determine what qualifies as available liquidity for transportation infrastructure enterprises?

Available liquidity typically consists of unrestricted cash, unrestricted short-term investments, and unrestricted long-term investments as reported in audited financial statements, net of contingent liabilities. Any reserve for which funds can be available for any purpose (i.e., not already included as part of unrestricted cash and investments) can also be included, as well as any emergency and contingency funds and other cash that may be designated in purpose but not restricted or earmarked for debt service, fiduciary purposes, asset retirement obligations, or capital improvements. The debt service reserve, which is restricted, would not be included.

Undrawn portions of committed credit facilities maturing beyond the next 12 months could also be included. If covenants are present, we will only include the portion of committed credit facilities that we estimate is available without a covenant breach. Committed credit facilities contractually exclusive for specific purposes, such as interim funding for capital needs, will be excluded. Undrawn portions of committed short-term bank credit facilities that we believe will be used to meet working capital uses or short-term debt maturities, such as commercial paper, are included. While committed lines of credit provide a good source of short-term liquidity because they are renewable instruments, we consider available cash reserves to be a more reliable long-term source of financial flexibility. Therefore, we would be unlikely to assign a liquidity and financial flexibility assessment of "extremely strong" or "very strong" unless unrestricted reserves alone supported such an assessment, without including lines of credit.

How does S&P Global Ratings view the presence, or absence, of debt service reserve accounts in its criteria and for the purposes of your review of the transportation sector? Are they included in sources of liquidity?

Typically, DSRFs provide only liquidity, rather than full credit protection, because they provide only temporary, not sustained, protection against stresses. Therefore, long-term rating differentials resulting from the presence of DSRFs are, in most cases, limited (see "Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations," published Nov. 29, 2011). However, in instances of unanticipated shocks to demand and similar liquidity events, the presence of debt service reserves, undrawn lines of credit, or commercial paper, or other sources of unrestricted resources, are viewed favorably in bridging any near-term funding gaps between funds from operations and debt service principle and interest payments. Our criteria take a conservative view and do not incorporate cash-funded debt service reserves or surety policies in calculations of liquid reserves, debt outstanding, or other leverage ratios.

How is DSC for transportation infrastructure enterprises calculated? How are other sources of revenue incorporated, and what are the ranges associated with your measures of financial performance?

We generally consider total DSC to be the most important factor in assessing an enterprise's cash flow in cases where there is rate-setting flexibility (as is typical for airports, ports, toll roads, and parking systems), and coverage of maximum annual debt service in cases where there is very limited or no rate-setting flexibility (such as stand-alone PFC debt transactions). Coverage metrics capture an enterprise's financial health and ongoing ability to service its debt. In assessing the financial performance of a TIE, we may take additional considerations into account, which could result in an assessment that is stronger or weaker than table 4 indicates.

Table 4

Financial Performance Assessment
Extremely Strong Very Strong Strong Adequate Vulnerable Highly Vulnerable
Coverage >4.75x 4.75x-3x 3x-1.25x 1.25x-1.1x 1.1x-1x <1x

Regardless of where in the flow of funds the payment of operating and maintenance expenses occurs, or how coverage is calculated for achieving rate covenant compliance, we calculate coverage in the same way. First, we sum total operating revenues, interest income, other committed recurring revenue sources (limited to obligations referred to by the denominator), and net transfer out (added back if we consider it debt-like, and included as part of total operating expenses). We next subtract total operation and maintenance (O&M) expenses, other recurring charges, and net transfers out (if not included as part of total operating expenses, and considered O&M expense-like). Finally, we divide the result from the first two steps by the summation of the annual revenue bond debt service requirement, other recurring obligations paid by enterprise or project revenues, and those net transfers out we consider debt-like (see table 5).

Table 5

Coverage Calculation Detail*
First, we add items 1-4
1: Total operating revenues,
2: Interest income,
3: Other committed recurring revenue sources, and
4: Net transfer out (added back if included as part of total operating expenses and we consider it debt-like).
Second, we subtract items 5-7 from the result computed from the step above.
5: Total operation and maintenance (O&M) expenses,
6: Other recurring charges, and
7: Net transfers out (if not included as part of total operating expenses and we consider it O&M expense-like).
Finally, we divide the result from the first two steps by the sum of items 8-10.
8: Annual revenue bond debt service requirement for all debt obligations with no debt service offsets,
9: Other recurring obligations paid by enterprise or project revenues, and
10: Net transfers out we consider debt-like.
*For stand-alone PFC debt transactions the coverage calculation is annual PFC revenues divided by PFC MADS, if there is no rate-setting flexibility, and by annual PFC debt service, if rate-setting flexibility exists.

For more details on how S&P Global Ratings calculates DSC for TIE, please refer to the criteria in Related Research below.

For mass transit, how is DSC calculated, how are other sources of revenue incorporated, and what are the ranges associated with your measures of coverage?

For mass transit credits, DSC measures near-term capacity to service debt from recurring net revenues to assess issuers' ongoing ability to pay annual debt service, given current and evolving revenue and expense positions. Because nearly all transit systems rely on some form of ongoing government subsidy or nonoperating revenues, such as sales taxes (whether or not specifically pledged to repay debt), we include such operating subsidies or nonoperating revenues in the calculation of net revenues available for debt service. This more accurately depicts all revenues generally available for debt service when calculating DSC. See table 6 for the ranges we consider for DSC.

Table 6

Assessment Of Debt Service Coverage (Or EBITDA Coverage)
Debt service coverage Initial score
Greater than 2x 1
1.24x-1.99x 2
1.10-1.23x 3
1.0-1.09x 4
Less than 1x but not negative 5
Negative 6
Qualitative factors positively affecting the initial score
-Projections for the current year and the following year suggest a better initial score.
-The planned use of designated rate stabilization funds improves the DSC to at least 1.0x, as long as we expect concurrent action to result in recurring net revenues providing at least 1.0x.
Qualitative factors negatively affecting the initial score
-Projections for the current year and the following year suggest a worse initial score.
-Revenue variability is high as evidenced by at least one year in the past three years where operating revenues declined by more than 25% from the prior year without corrective action.
-Government subsidies are highly vulnerable to uncertain political decisions, have a recent history of significant delays or have been materially below budgeted levels, or other nonoperating revenues such as sales taxes have been subject to significant volatility.
-Systems that perform down to the level of permissive legal covenants, such as the use of certain cash balances toward satisfying a rate covenant or additional bonds test (more typical for issue ratings in the U.S.) and potentially creating misalignment between revenues (including nonoperating revenues which reflect local, state or federal support) and expenses.
-Cases where there has been a DSC covenant (also sometimes called a rate covenant) violation.
-Extremely high likelihood that the enterprise will need significant revenue growth to meet future obligations or risk having to refinance around a bullet maturity.
The DSC score equals the initial score adjusted up or down for each qualitative factor, except that the final score may be no more than two points away from the initial score.
How does S&P Global Ratings evaluate external sources of liquidity for mass transit, e.g., federal grants of financial support provided for in the CARES Act?

Similar to TIE credits, the federal stimulus package is viewed as credit positive and will alleviate immediate liquidity pressures for many issuers, as well as assist with near-term operational funding requirements, including debt service. S&P Global Ratings maintains the flexibility to evaluate external sources of liquidity in various scenarios. We would likely evaluate any external liquidity as nonrecurring, and view the additional funds in our assessment of liquidity.

How does S&P Global Ratings evaluate near-term cash flow measures?

S&P Global Ratings evaluates near-term (i.e., next six months') liquidity, or refinancing or remarketing risks faced by issuers, with primary attention on issuers with weaker credit profiles and lower liquidity, with the expectation that the significant declines we've seen potentially extending into the late summer or early fall. We expect to analyze issuers' available cash on hand, unrestricted and restricted assets, capital funding requirements and capital deferrals, and receivables, and any currently dedicated resources that may be available to meet near-term obligations, including use of federal stimulus money. Ultimately, S&P Global Ratings will evaluate an entity's ability and willingness to meet its financial obligations.

Can you provide an example of how S&P Global Ratings would evaluate an entity's estimated monthly cash burn rate?

When a TIE or mass transit operator is operating at a monthly cash flow deficit, where expense outflows are greater than revenues received in that period, we may evaluate the entity's cash burn rate. For example, if an entity's revenues (operating revenues and recurring nonoperating revenues) are $100 and its operating expenses and nondeferrable capital expenditures are $80, with required debt service deposits of $40, then the cash burn rate for that period is $20 ($20 = cash inflows of $100 minus cash outflows of ($80+$40)).

 

Related Research

  • U.S. And Canadian Not-For-Profit Transportation Infrastructure Enterprises: Methodologies And Assumptions, March 12, 2018
  • Mass Transit Enterprise Ratings: Methodology And Assumptions, Dec. 18, 2013
  • U.S. Transportation Infrastructure Sector Update And Medians: U.S. Large-Hub Airports, Dec. 23, 2019
  • Ratings Outlooks On U.S. Transportation Infrastructure Issuers Revised To Negative Due To COVID-19 Pandemic, March 26, 2020
  • All U.S. Public Finance Sector Outlooks Are Now Negative, April 1, 2020
  • An Already Historic U.S. Downturn Now Looks Even Worse, April 16, 2020

This report does not constitute a rating action.

Primary Credit Analyst:Kenneth P Biddison, Centennial + 1 (303) 721 4321;
kenneth.biddison@spglobal.com
Secondary Contacts:Kurt E Forsgren, Boston (1) 617-530-8308;
kurt.forsgren@spglobal.com
Joseph J Pezzimenti, New York (1) 212-438-2038;
joseph.pezzimenti@spglobal.com
Todd R Spence, Farmers Branch (1) 214-871-1424;
todd.spence@spglobal.com

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