Barcap sees opportunity in Build America Bonds

Bay Area Toll Authority (BATA) is a solid credit that offers opportunity for Build America Bonds investors, says Barclays Capital in a research piece published today. Barcap notes that BATA is the second largest issuer in the BABs index, behind California, with $2.8 billion of bonds outstanding – of which $1.3 billion is senior and $1.5 billion subordinate.

Barcap says the BATA bonds are backed predominantly by the toll revenues of seven Bay Area bridges and contain both toll rate covenants and additional bond tests that require BATA to raise toll rates and prohibit the issuance of new debt if debt service coverage metrics are below certain levels.

Analysts believe BATA’s key credit strengths (its willingness and ability to increase toll rates, strong balance sheet highlighted by $1bn of liquidity, and relatively inelastic demand for its services) more than offset the key credit challenges (earthquake risk and construction risk related to the seismic retrofit program).

BATA’s subordinate bonds currently trade around 85bp wide to the senior bonds given the junior claim on gross revenues, weaker debt service coverage metrics (1.3-1.4x, versus 2.0-2.2x on the senior bonds), weaker covenants (toll rate covenant and additional bonds test), and smaller debt service reserve fund requirement (maximum interest, as opposed to maximum annual debt service).

Given that the BATA subordinate bonds (A1/A+/NR) are approximately 50bp cheap relative to other single-A rated toll-backed BABs and approximately 85bp behind the senior bonds, Barcap thinks there is approximately 40bp-50bp of potential tightening in the medium term. Analysts believe, however, that the expected issuance of up to an additional $2bn of BATA subordinate bonds within the next six months will limit any spread tightening in the near term.

They argue that while the BATA senior bonds are fairly valued versus other toll-backed BABs, they are attractive relative to other index-eligible bonds, as the BATA senior bonds trade 67bp wide to similarly rated long bonds in the credit index.