Fitch Rates Florida's $88MM Lottery Revs 'A+'; Outlook Stable
Fitch Ratings assigns an 'A+' rating to the following State of Florida State Board of Education lottery revenue bonds:
--$87.905 million series 2012A.
The bonds are expected to sell via competitive bid as early as the week of Oct. 29, 2012.
In addition, Fitch affirms the following ratings:
--$2.8 billion in outstanding lottery revenue bonds at 'A+'.
The Rating Outlook is Stable.
The bonds have a first lien on lottery revenues deposited to the Education Enhancement Trust Fund (EETF).
KEY RATING DRIVERS
SOLID DEBT SERVICE COVERAGE: Debt service coverage from the first lien on lottery revenues deposited into the EETF is comfortable and pledged revenue has rebounded following a decline during the recession.
STRONG LEGAL PROVISIONS: Lottery proceeds are constitutionally dedicated to educational purposes and a non-impairment clause guards against changes in the percentage allocation to the EETF that would negatively affect pledged revenues. An additional bonds test requires three times (x) coverage of maximum annual debt service (MADS), limiting leverage of the pledged revenue stream.
RISKS ASSOCIATED WITH PLEDGED REVENUE: Lottery expenditures are discretionary and sensitive to personal income, employment, and population growth. The Florida lottery faces current and future competition, although the state has covenanted that any other similar state gaming revenues will be first applied to debt service on lottery revenue bonds.
STRONG CENTRAL MANAGEMENT: The Division of Bond Finance, the state's central debt issuing entity, has debt issuance oversight responsibilities for the lottery bonds.
Florida's voter-approved lottery began in 1988 and proceeds are constitutionally dedicated to educational purposes. Lottery sales are roughly evenly split between instant and online games with instant games gradually becoming more dominant since lottery inception. Total lottery sales grew every year from fiscal years 1999 to 2008 but fell during the recession, 5.7% in fiscal 2009 and a further 1% in fiscal 2010 before recovering slightly, 2.8%, in fiscal 2011. Stronger growth resumed in fiscal 2012 with 11% growth in sales. Prior to 2009, lottery revenues had only declined during three years since inception, none consecutively. Although revenues did decline during the recession, the reductions were less than that of other economically sensitive revenue sources, including the statewide sales tax and documentary stamp tax.
Fitch views lottery profits as a relatively weak source of bond security due to their sensitivity to income, employment, and population trends, their discretionary nature as well as the potential for changing tastes or the introduction and availability of other forms of gaming either within or outside the state. There are offsets to these inherent uncertainties, including, in this case, a 3x additional bonds test, strong statutory provision governing the distribution of revenues, and the solid historical coverage of both annual debt service and MADS by pledged revenues. Estimated fiscal 2012 pledged revenues provided 4.2x coverage of annual debt service and 4.0x coverage of MADS. Florida's lottery is mature, although structural adjustments have bolstered ticket sales over time.
Beginning in fiscal 2003, the percentage of instant game ticket revenues distributed as prizes was changed from a fixed to a variable percentage as a means to stimulate sales. This change was accompanied by a non-impairment covenant to maintain the revenues transferred to the EETF even as the prize percentage varies. In addition, any reduction in the allocation rate must produce revenues that provide at least 2x coverage of MADS. The pay-out percentage for online game revenues was similarly changed from fixed to variable in fiscal 2006.
While the enabling legislation allows 30-year bonds, issuance of 20-year bonds with level debt service has been legislatively directed. The state has covenanted that any other similar state gaming revenues would be first applied to debt service on lottery revenue bonds. Specifically, the state legislated in 2006 that any revenue derived from the tax on slot machine revenues, although not directly pledged, shall first be available to pay lottery revenue bond debt service in the event that lottery revenues prove insufficient. This provision applies to revenues generated by the slot machines at pari-mutuel sites in Broward County since 2006, as well as revenues from Miami-Dade County, which voted in 2008 to allow slot machines at three pari-mutuel sites, the first of which opened in October 2009.
The lottery has been a key source of funding for Florida's school building construction. The legislature in 1997 authorized a $2.5 billion lottery bond program for educational facilities to be supported by $180 million annual appropriations from the EETF. That original authorization proved insufficient when the expense of a 2002 constitutional amendment to reduce class size was added to the state's ongoing educational needs. Since then, the state has increased the lottery bond program by a total of $1.9 billion, to $4.4 billion. The 2011 legislature expanded the use of lottery bonds beyond its historical purposes of funding educational facilities for grades K-12 to include educational facilities at state colleges and universities. The 2012 legislature approved $100 million in capital projects at various state colleges and universities to be funded with the current offering. The division of bond finance, the state's central debt issuing entity, provides debt issuance oversight.
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 additional bonds test; 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 additional bonds test (ABT) of at least 3x MADS to offset the discretionary nature of the revenue stream, amortization within 20 years, and historically sustained, solid lottery revenues.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria', dated Aug. 14, 2012;
--'U.S. State Government Tax-Supported Rating Criteria', dated Aug. 14, 2012.
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria
One State Street Plaza
New York, NY 10004
Elizabeth Fogerty, +1-212-908-0526 (New York)