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Fixed-Income Insights

Behind the improving credit quality for toll road muni bonds is a growing U.S. economy and low gas prices; both are driving traffic volume higher. 

The credit quality of toll road muni bonds has continued to improve over the past five years, boosted by strong demand for facilities, as well as rate increases, and operating efficiencies. Since 2014, of the 18 largest issuers (each with $1 billion in debt or more), 14 have been upgraded, one has been downgraded, and three have had their ratings affirmed by the major credit-rating agencies (see Table 1).

 

Table 1. The Credit Quality of Toll Road Muni Bonds Has Improved Over the Past Five Years

Source: www.governing.com. Criteria – Pure Toll revenue pledge, no express lanes, minimum $1 billion in long-term debt. Debt outstanding of entity not any particular lien. The ratings for PA Turnpike and Ohio Turnpike are Senior ratings. *Plan to convert to 100% by 2020.   ̂Over-written by recent legislation that is being contested.  Data as of October 30, 2019.

 

Behind the improving credit quality for toll roads is a growing U.S. economy and low gas prices; both are driving traffic volume higher, which in turn is lifting toll revenues. Since August 2014, the United States has added 9.8 million jobs and seen the unemployment rate drop to 3.7% in 2019 versus 6.1%. Although the price of gasoline has fluctuated over the five-year period, it remains low relative to the 10-year average, which is a factor in determining vehicle miles traveled (see Chart 1). The combination of these two factors along with population growth has allowed for traffic growth across the sector.

 

Chart 1. The Price of Gasoline Remains Low Relative to the 10-year Average
October 9, 2001-October 28, 2019

Source: www.gasbuddy.com. As of October 28, 2019

 

The five-year compound annual growth rate of traffic at all the facilities monitored by Moody’s was 3.2% from 2012-2017. At the same time, most toll roads have raised tolls or moved to inflation-adjusted toll policies. Of the 18 largest issuers of debt, 10 have changed to index price tolling (based on local inflation) and all but two have experienced a rate increase over the five-year period resulting in stronger revenue growth.

Conversion to all electronic tolling continues across the sector, which has lowered labor costs, as toll collectors are eliminated. Savings estimates in Florida were $10 million a year on the southernmost portion of the turnpike, and in California an all-electronic conversion of the Golden Gate Bridge is estimated to save $16 million over eight years.1 As collection technologies improve, so will revenue, in our opinion.

So what could stop toll roads in their tracks?

Slowing economic growth is one factor to watch for in terms of future toll road performance, but another is political risk. Intervention from government officials can negatively affect credit quality. For example in 2019, the Florida State legislature attempted to unwind the Miami-Dade County Expressway Authority through legislation that would create a new tolling authority which would reduce rates and limit future toll rates. The bill was passed and signed by the governor which led to downgrades of the authority by Moody’s, Fitch, and Standard & Poor’s and a subsequent lawsuit filed by the Expressway against Florida. The bill, HB 385, has since been overturned and deemed unconstitutional by the courts, but the damage has already been done with the Expressway’s credit falling lower, although remaining in the “A”-rated category.

Other potential political risk includes the siphoning of funds by struggling states from toll facilities. For years both New Jersey and Pennsylvania Turnpikes have sent millions of dollars to their respective state coffers, and an on-going risk remains that these transfers could increase as the states’ fiscal positions deteriorate. Currently, both these states have contracts in place that fix the amount of transfers, but with a new regime change there is also risk to changes in those contracts.

Our team believes that credit quality in the toll road sector will remain stable over the next year as traffic growth and rate increases will overshadow rising political risks.

 

1 All data herein from www.governing.com as of October 28, 2019 unless otherwise specified.

IMPORTANT INFORMATION

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice, and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state, and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional f actors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

The credit quality of the securities in a portfolio are assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range f rom 'AAA' (highest) to 'D' (lowest). Bonds rated 'BBB' or above are considered investment grade. Credit ratings 'BB' and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principle on these securities.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial advisor, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in this commentary are as of the date of publication and are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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