2016 Mass Investor Conference (Part 2): the MBTA

The Massachusetts Bay Transportation Authority (MBTA or the Authority) is a body politic and corporate and a political subdivision of the Commonwealth of Massachusetts.  It is also a component of the Massachusetts Department of Transportation.  Created in 1964, it is the oldest and fifth largest transit system in the country.  Its authority is derived from Massachusetts General Laws Chapter 161A (as restated by Section 151 of Chapter 127 of the Acts of 1999 and amended by the Control Board Act, Chapter 46 of the Acts of 2015) and also Section 35T of Chapter 10, which together are known as the “Enabling Act.”  The Enabling Act does not provide for the Authority to be a debtor under the federal bankruptcy code.

Under the Enabling Act, the MBTA is authorized to finance and operate mass transportation facilities mostly within its territorial area which includes 175 Massachusetts communities.  The Authority serves 4.8 million people through a transit system that includes commuter rail, streetcars, light rail and more than 1,000 buses. Other passenger services include commuter boats, paratransit vans and express buses.  The transit system averages 1.3 million passenger trips daily and accounts for 55% of all trips into Boston.

Besides capital improvements, the Enabling Act provides funding for a substantial portion of the MBTA’s operations.  The Act authorizes a “Dedicated Sales Tax,” which is equal to the greater of a base revenue amount (as defined) or 1% of the state’s sales tax plus $160 million annually.  In addition, the Authority receives at least $136 million of annual “Assessments” paid by the cities and towns within its operating territory.  Together, the Dedicated Sales Tax and Assessments comprise the “Dedicated Revenues” of the MBTA.

Under the Enabling Act, the Dedicated Revenues are deposited into a trust for the benefit of MBTA bondholders on a monthly basis.  As long as bonds or notes secured by a pledge of the Dedicated Revenues remain outstanding, the Commonwealth covenants that it will not divert the Dedicated Revenues.  Likewise, as long as the Dedicated Revenues are necessary for the purpose for which they have been pledged – presumably to meet interest and principal payments on such bonds and notes – it promises that it will not reduce the rate of the sales tax below the amount specified in the Dedicated Sales Tax agreement and that the annual Assessments will not be reduced below $136 million.  Under the Enabling Act, the pledge and payment of Dedicated Revenues is not contingent upon the MBTA’s provision of transportation services.  Notes and bonds secured by the pledge of the Dedicated Revenues are not a general obligation of the Authority.

In April 2015, Governor Baker established a special panel to review the management practices and financial condition of the MBTA in the wake of widespread system failures during the 2015 winter season.  That led to legislation which dissolved the MBTA’s Board of Directors and created a Fiscal and Management Control Board (FMCB).  The FMCB will oversee the Authority’s operations and finances until June 2018 (and possibly to June 2020).  The FMCB Act amended the Enabling Act, but requires that the rights of bondholders and the trust that administers the Dedicated Revenues shall not be altered or impaired.  The FMCB Act also amends other applicable laws to allow for the possible privatization of the MBTA’s operations.

The FMCB has a lot of work to do.  The MBTA has operated throughout most of its history without making a concerted effort to rein in spending and promote operating efficiency.  For example, its operating expense per unlinked trip (e.g. counting a commuter’s bus trip followed by a train trip as two trips) has grown at a compounded annual rate of 4.4% since 2000, well above the average annual rate increase of 2.2% in Northeast consumer prices and 2.5% in transportation-related producer prices.

Over the past fifteen years, the Authority’s operating expenses have grown at a 5% compounded annual rate; but in fiscal 2016, the FMCB’s first year at the helm, the MBTA’s operating expenses increased by 2.5%, the lowest increase since 2000.  Fiscal 2016 operating expenses, excluding depreciation, increased by 1.3%.

The Authority is seeking to control costs by setting monthly financial targets for its managers, increasing the transparency of its performance figures, reducing overtime, renegotiating contracts, outsourcing certain services and functions to save money (including possibly its paratransit services), pooling purchasing power with other state agencies where possible, reducing corporate overhead and increasing growth in ancillary revenues, such as advertising, parking and real estate.  Through these initiatives, the MBTA says that it has reduced its fiscal 2016 structural deficit by about 50% from $170 million to $86 million.

Similarly, the MBTA is looking to save money through its treasury operations by bringing certain financial functions in-house, such as investment management and debt service reserve reporting, implementing a new cash management platform and reducing the average cost of its borrowings.  Through its July 2016 issuance of $218 million in Senior Sales Tax Bonds and $119 million in Assessment Bonds, the proceeds of which were used to repay existing debt, the Authority will save $163 million in future interest payments over the life of these issues.

Dedicated Revenues are a key component of the MBTA’s annual budget.  In fiscal 2016 (ended June 30) the Authority generated $693 million in operating revenues and recorded $1.69 billion of operating expenses (excluding depreciation).  That shortfall of about $1.0 billion was covered by nonoperating revenues, including $984 million in dedicated sales tax revenues and $163 million in assessment, revenues partially offset by a net expense of $124 million (from interest expense and other items).

Since the MBTA does not generate sufficient revenues from operations to meet its operating expenses, it must pledge its Dedicated Revenues to cover the debt service on its outstanding bonds in order to obtain a high credit rating.  At the end of fiscal 2016, $4.74 billion or 89% of its total outstanding $5.32 billion of bonds and notes payable consisted of Sales Tax Series, Assessment and Prior Obligation bonds (including Build America Bonds), all backed by Dedicated Revenues.

In fiscal 2016, the total annual debt service (principal and interest) on those revenue bonds was $470 million, equal to 41% of total Dedicated Revenues. (Principal payments on these bonds, however, are usually covered by the proceeds from the issuance of new bonds.)

Over the next five fiscal years (2017 to 2021), principal payments on the MBTA’s outstanding debt will average $273 million annually, while interest payments (assuming no refinancing) will average $229 million annually.  In fiscal 2016, the MBTA reported total interest expense of $267 million.

The Authority’s Sales Tax Bonds are rated Aa2 by Moody’s and AA+ by Standard & Poor’s.  Moody’s rating is one notch below its rating of the Commonwealth’s general obligation bonds; while S&P’s AA+ rating is equal to the its credit rating for the Commonwealth.  As noted above, the bonds are backed by the greater of a Base Revenue Amount (BRA) or 1% statewide sales tax plus $160 million.  Under the Enabling Act, the BRA provides a floor protected by an inflation-adjustment that can never be reduced.  In fiscal 2015, the Commonwealth increased the BRA by $160 million (perpetually).  The BRA has exceeded the 1% sales tax for at least the past 10 years.

Likewise, the Assessment Bonds are secured by absolute and unconditional assessments on the 175 cities and towns in the MBTA’s operating area by the Commonwealth.  Bondholders also benefit from a substantial debt service reserve fund.  Although the legal floor for the assessments is $136 million, the floor must be sufficient to provide at least 1.2 times debt service coverage for outstanding Assessment Bonds.  Otherwise, the aggregate assessment must be increased.  By law, the assessment cannot be impaired by the Legislature and is not affected by changes in operational or financial changes at the MBTA.  The Assessment Bonds are also cross-collateralized with the MBTA’s Sales Tax Credit, which provides an extra level of protection.

In fiscal 2016, the MBTA’s Assessment revenues were $164 million, well above the $136 million floor.  Over each of the next 25 years, the $136 million floor is projected to provide debt service coverage in excess of 2.0 times.

Assuming no major economic downturn, the MBTA should have little difficulty in meeting its outstanding debt obligations.  Despite its already AA credit rating, it is still an improving credit story.  A severe recession could put pressure on its operating revenues and also the amount received from the dedicated sales tax.  However, the MBTA is an essential service necessary to keep the Massachusetts economy functioning.  For that reason, the Commonwealth will find a way to both pay bondholders and keeping the transit system operating, if at all possible, even in tough times.  Conceivably, part of the MBTA’s operations could be subject eventually to privatization.

Links to related articles:
Notes and Analysis from the 2016 Mass. Investor Conference – Part 1
2016 Mass. Investor Conference (Part 3): the MWRA

February 20, 2017

Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
(908) 448-2246

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