S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Special Tax BondsAdditional bonds tests regarding subordinate liendebt would ideally be calculated using historicalsales tax revenue, divided by combined maximumannual debt service payments of both senior andjunior lien debt. Some junior lien tests use only netrevenues after prior payment of senior lien debt,and this can effectively dilute the additional bondstest to a lower coverage multiple, unless therequired junior lien coverage multiple is high.Analytically, Standard & Poor’s discounts thismethod of coverage calculation and employs a combinedcoverage ratio to evaluate junior lien debt.Rating distinctions between junior and senior lienare not automatic. Junior lien sales tax debt may berated on par with senior debt if the senior lien isclosed, or if no additional senior lien debt is otherwiseexpected. No distinction may also be made ifcombined current and expected future coverage levelsare so high that the importance of the lien positionbecomes minimal given the resulting low riskof insufficient coverage. On the other hand, if juniorlien debt service coverage is significantly lowerthan on senior lien debt, there could be a greaterrating distinction.A debt service reserve fund that is fully fundedfrom a portion of bond proceeds, or through asurety agreement with an investment-grade ratedentity, may add liquidity in times of stress but doesnot enhance fundamental credit quality.Most special tax bonds typically have an openflow of funds, whereby revenues not needed to paydebt service revert to the municipality. If excess revenuesare used to fund municipal operations, thiscan be a disincentive to issue additional debt, aspayment of increased prior debt service mightrestrict the monies available to fund municipaloperations. In such an example, a city might bemore likely to maintain high debt service coverageeven in the event of weak legal protections regardingadditional parity debt issuance. As such, anopen flow of funds may help support a higher salestax bond rating where the excess revenues areessential to fund municipal operations, even whenthe additional bonds test is not particularly strong.Sometimes bond legal provisions specify a closedflow of funds. In this case, excess tax revenues,after payment of debt service, can typically be usedonly for bond redemption. This provision can dramaticallyreduce average maturity and quickly raisefuture coverage, if at the same time no additionalparity bonds are allowed. As such, a much lowercoverage could be accepted for an equivalent ratingin the initial years, if the risk is mostly in the outyears, when effective coverage could grow to a dramaticallyhigher level with any sort of economic orinflationary growth and debt is continuouslyretired, or defeased early.Certain specialized tax revenue streams entailspecial considerations.Hotel Tax BondsHotel tax bonds are secured by lodging roomfees—either a percentage of room rentals, or afixed tax per room. In practice, few hotel taxbonds pledge purely hotel tax revenues: many alsoinclude sales taxes on restaurant sales or car rentalfees, with similar tourism based analytical concerns.Hotel tax bonds often fund capital facilitiesfor convention centers, which typically need regularrenewal or expansion.The approach to analyzing hotel tax revenuebonds, and food and beverage tax revenue bonds,follows the general special tax criteria. However,because the hotel tax base is narrower and morecyclical than broad revenues streams, such as generalsales taxes, higher coverage levels and bondholders’legal protections may be needed for equivalentrating levels. Specific considerations for hotel taxbonds include the issuer’s ability to generate hoteltaxes by attracting overnight visitors, the nature ofsuch visits (discretionary trips versus nondiscretionarytrips), historic hotel occupancy levels, andplanned expansion.Additional key areas of the hotel tax bond analysisinclude:■ The historic demand for hotel rooms within thetaxing jurisdiction;■ Occupancy rate trends;■ The number of room rentals; and■ Average room rates over a period of severalyears.A distinction also is made between the natureof travel to a given community. Although discretionarytravel—vacations and business trips—areaffected by economic cycles, vacations exhibitgreater sensitivity. A feasibility study is helpful intracking demand trends. These studies typicallyuse historical patterns to estimate future tends.Standard & Poor’s often finds analysis of historicalhotel tax trends more valuable than predictionsfor the future. A debt service reserve fullyfunded from bond proceeds to the maximumannual debt service takes on added importancefor a cyclical hotel/motel tax revenue bond issue,as well as one secured by restaurant and beveragetaxes. Hotel/motel tax revenue bonds or food andbeverage tax revenue bonds also typically have ahigher range of 1.5x-2x for their additional bondstest, unless the issuer’s hotel market is especiallybroad and diverse. One of the strengths that hoteltax and food and beverage tax revenue bondsshare with sales tax bonds is their response toinflation. Pledged tax receipts and debt servicewww.standardandpoors.com73