Fitch Rates $64MM West Virginia Excess Lottery Rev Bonds 'A+'
OREANDA-NEWS. Fitch Ratings assigns an 'A+' rating to the West Virginia School Building Authority's (SBA) issuance of $64.61 million excess lottery revenue bonds, 2015 series A.
The bonds are scheduled to be sold via negotiation on or about Nov. 4, 2015.
In addition, Fitch affirms the 'A+' rating on outstanding bonds secured by West Virginia's lottery and excess lottery fund revenues, as detailed at the end of this release.
The Rating Outlook is Stable.
Lottery and excess lottery revenue bonds are secured by separate statutory allocations of net profits of the lottery fund and state excess lottery revenue fund, special revenue funds of the state of West Virginia. The bonds hold successive lien positions against the pledged revenues.
The SBA excess lottery bonds currently offered are secured by a separate statutory allocation of $19 million from the state excess lottery revenue fund.
KEY RATING DRIVERS
AMPLE DEBT SERVICE COVERAGE WITH EXPECTED DECLINES: Debt service coverage is currently ample but is expected to decline in the near term due to revenues that are constrained by increasing competition and a weakened economy. Competing gaming venues are expected to continue to come online in the region, pressuring the lottery's revenue flow. There are no rating distinctions between various liens due to strong coverage levels; 5.4x coverage for all excess lottery bond debt service and 4.9x coverage of all lottery bond debt service was achieved in fiscal 2015.
RECENT LEGISLATIVE CHANGES HAVE IMPROVED DEBT SERVICE COVERAGE: Legislative changes made in the 2014 session provided for increased revenue pledged for payment of excess lottery revenue bonds and are expected to result in more modest declines in future coverage on these bonds rather than the previously expected sharper declines due to ongoing regional competition. The changes also provide for excess lottery funds, after payment of excess lottery debt service, to be available for payment of lottery debt service.
DISCRETIONARY REVENUE STREAM: Lottery and excess lottery revenues are derived from discretionary spending; are exposed to current and future competition; and are sensitive to population, personal income, and employment factors.
HIGH-PRIORITY CAPITAL PROJECTS: Projects funded by lottery bonds are high priorities of the state including improvements to water and wastewater infrastructure, higher education, schools, parks, and capitol facilities.
The ratings are sensitive to the performance of pledged lottery and excess lottery revenues, additional leveraging for capital projects, and continued solid coverage levels.
The 'A+' rating considers the discretionary nature of lottery revenues, which are sensitive to population, personal income, and employment factors, as well as to existing and future competition. Offsetting these inherent uncertainties is the ample coverage of debt service by lottery and excess lottery revenues, the success of the lottery commission to-date in adapting to an increasingly competitive environment, and the importance of the financed projects. Reflecting West Virginia's support for this security, the state enacted legislation in 2014 that expanded the revenue pledged to the repayment of the excess lottery revenue bonds and also provides for excess lottery revenues, after payment of corresponding debt service, to be available for the payment of lottery bonds on a subordinate basis. Lottery revenue, after the payment of lottery bond debt service, has historically been available on a subordinate basis for the payment of the excess lottery bonds and will remain available for this payment.
Annual savings expected to be generated by the current refunding bond issue will provide funding for a portion of the construction of a new middle school in Brooke County. To the extent moneys from the $19 million annual allocation are not required to pay debt service on SBA obligations, the balance is applied by the SBA to various school capital and improvement projects. There is a 2x maximum annual debt service (MADS) additional bonds test (ABT) to issue additional debt secured by the $19 million allocation; however, the SBA believes the statutory allocation will be fully leveraged until 2024 following the issuance of the current bond issue.
The lottery operates a mix of six games:
--Instant or scratch-off games (8.9% of fiscal 2015 lottery sales);
--Online numbers games (6.6% of fiscal 2015 lottery sales);
--Racetrack video lottery (47.9% of fiscal 2015 lottery sales);
--Limited video lottery (32.1% of fiscal 2015 lottery sales);
--Racetrack table games (4% of fiscal 2015 lottery sales); and
--Casino gaming at the Greenbrier Resort (a modest 0.5% of fiscal 2015 lottery sales).
With the addition and expansion of games, total lottery sales peaked at $1.56 billion in fiscal 2007; gross sales have mostly declined since then due to the expansion of gaming in neighboring states and a weakened state economy. Lottery revenue has also been affected by a change in the demographic profile of participants, with younger partakers demonstrating a greater interest in social gaming offerings over traditional slot machines. An 8.9% decline in sales in fiscal 2013 and a further 8.6% decline in fiscal 2014 reflects the ongoing competition for gaming revenue in the region.
House Bills (HB) 101 and 106, approved in 2014, enacted several positive changes to the lottery and excess lottery securities, in Fitch's view. Effective July 1, 2014 (fiscal 2015), HB 101 bolstered net revenue available for debt service payments from the state excess lottery revenue fund by reducing the amount of statutory transfers that were made from gross lottery and excess lottery revenue collections. Net revenue in the state excess lottery revenue fund was also increased through the allocation of additional net revenue from racetrack table games and casino gaming at the Greenbrier Resort and the reduction by 10% of certain racing-related statutory transfers and other fund allocations. HB 101 also specified that lottery and excess lottery debt service would be paid prior to any other appropriation from lottery or excess lottery funds. The increase in net revenues from enactment of the bill was wholly directed to the state excess lottery revenue fund. HB 106, effective as of March 14, 2014, created a backup pledge for the lottery fund from the excess lottery fund (after the payment of excess lottery fund debt service) and reconfirmed the existing backup pledge for the excess lottery fund from lottery fund revenues.
Enactment of HB 101 resulted in the state excess lottery revenue fund receiving $347 million in fiscal 2015, up from $266.8 million in fiscal 2014. This allocation incorporates additional net revenue from the racetrack video lottery and new net revenue allocations from casino table games and from the Greenbrier resort; the allocation is net of a senior citizen homestead credit of approximately $10 million. The lottery fund receives the state's share of net profits from instant and online games (traditional games) and from a portion of net terminal income derived from racetrack video lottery. A total of $160.8 million was received in fiscal 2015, down from $163.6 million in fiscal 2014.
The lottery's revenue forecast currently projects a fairly steep 10.9% decline in gross lottery revenues for fiscal 2016, incorporating the impacts of ongoing competition in the region and a weakened state economy. While the state's forecast results in a 13.5% decline in deposits to the excess lottery revenue fund and a 15.2% decline in deposits to the lottery revenue fund, Fitch notes that the lottery chooses to forecast fairly conservatively, although Fitch does expect a reduction in revenues in fiscal 2016. Through August 2015, gross lottery collections for the fiscal year that began on July 1, 2015 were 6.1% lower than one year prior.
The forecast decline in pledged revenues is expected to lower debt service coverage on excess lottery revenue bonds in fiscal 2016 following the improvement in fiscal 2015 from the recent legislation. The implementation of HB 101 improved debt service coverage for excess lottery fund revenue bonds in fiscal 2015 to 5.4x, following a decline in coverage of statutorily permitted debt service in fiscal 2014 to 4.8x from 5.4x in fiscal 2013. Coverage of statutorily permitted debt service on the lottery bonds declined to 4.9x modestly, from 5x in fiscal 2014, which was down from 5.4x in fiscal 2013. The state projects excess lottery bond debt service coverage to decline to a still comfortable 4.7x in fiscal 2015 and lottery bond debt service coverage to decline to 4.1x. Fitch believes additional gaming venues will continue to come online in the region, continuing to pressure the revenue flow from the state's facilities and likely lowering coverage ratios to an as yet to be determined gaming saturation point.
Although most states operate lotteries within their borders, relatively few issue debt against the lottery-generated revenue stream. In its analysis of state lottery-backed revenue obligations, Fitch focuses on:
--The nature of the legal pledge and covenants, including the ABT;
--The history of the revenue stream;
--Historical and projected debt service coverage levels and amortization; and
--Operating characteristics, including the nature of the games offered and the competitive environment for discretionary gaming spending.
For an 'A+' rating, Fitch expects a clear and strong legal pledge and covenants; an ABT of at least 3x MADS to offset the discretionary nature of the revenue stream; and historically sustained, solid lottery revenues. In the case of West Virginia, the statutory maximum on debt service and the ample coverage of that statutory maximum by pledged revenues mitigates concern over the less than 3x ABT for the current, as well as several other outstanding programs.
As part of this rating action, Fitch affirms the 'A+' rating on the following bonds secured by West Virginia's lottery and excess lottery fund revenues:
Lottery Revenue Bonds
--$142.4 million Economic Development Authority (EDA) lottery revenue bonds, series 2010A;
--$69.65 million Higher Education Policy Commission (HEPC) community and technical colleges (CTC) capital improvement revenue bonds, series 2009A.
Excess Lottery Revenue Bonds
--$144.1 million Economic Development Authority (EDA) excess lottery revenue bonds, series 2004;
--$225 million School Building Authority (SBA) bonds excess lottery revenue bonds, series 2008, series 2009 A&B, and series 2010 A&B;
--$72.5 million Water Development Authority (WDA) excess lottery revenue bonds, series 2014 A.
First revenues received into the excess lottery fund are applied to funding a senior citizen property tax credit (refundable credit.) The refundable credit totaled approximately $10 million for fiscal 2015. The EDA and SBA excess lottery bonds are secured by separate statutory allocations of $19 million each from the state excess lottery revenue fund. The WDA debt service transfer of $6 million and a HEPC transfer of $15 million is on parity with the SBA transfer; all transfers are subsequent to the EDA excess lottery fund transfer. Bondholders have no lien or other security interest in the projects.
The EDA lottery revenue bonds have a second lien on revenues of the lottery fund and are paid from a $10 million allocation, subordinate to an allocation of $18 million for SBA lottery debt service. The CTC bonds have a third lien position and are paid from a $5 million allocation. Bondholders have no lien or other security interest in the projects.