Financial risks to the ST3 plan have grown

Compared to expectations in 2016, capital costs are likely to be much higher as inflation in capital expenditures and right of way acquisition have run far ahead of general inflation (image: Sound Transit)

By the time most ST3 projects are delivered in the mid-2030s, Sound Transit is projected to accumulate over $17 billion in debt. Managing that debt load is critical to delivering the program on time.

Sound Transit's debt capacity is limited in several ways. There is a statutory limit that total debt cannot exceed 1.5% of the property tax base within the RTA district. There are other constraints, contained within financial policies and bond covenants, that limit bond servicing costs relative to available cash flow. Sound Transit monitors all of these so the future debt load remains financially sustainable and within legal limits. If future projections indicated any of these limits would be exceeded, it would become necessary to delay projects or reduce operations.

The analysis that informed the development of the ST3 program in 2016 suggested a prudently low risk of breaching the statutory debt limits. Other risks relating to bond servicing costs appeared near zero. A recent analysis shows appreciably larger risks on all dimensions. Estimates for costs and revenues have increased since the 2016 projections, but the increase in costs is outpacing revenues. The capital program remains affordable at this time, but the margin of error has narrowed.

One way to think about risks is to recognize how every component of the 25-year forecasts has a range of uncertainty. Three years into the ST3 program, we know more than we did in 2016 and that narrows the range of estimates. But estimates through 2041 can still change by billions of dollars in a year. It's not a question of whether Sound Transit is on target (the median estimate still says yes), but how likely Sound Transit is to end up in the unhappy tail of the distribution of possible outcomes.

There are three key metrics to watch:

Legal limits on debt: Sound Transit faces a statutory limit that non-voted debt must not exceed 1.5% of the assessed value of property within the RTA, unless approved by 60% of voters. Earlier projections were for a 'pinch point' in the early 2030s as several major projects are completed about the same time. The more recent analysis shows a more extended window of elevated risks, though the probability Sound Transit would get too close to the limit remains under 20%.

Risks of exceeding the statutory limit remain manageable, but are significantly higher than estimated in 2016 (image: Sound Transit)

More early risk is worrying as it leaves less time to react. In a recession, we could see more debt and a lower ceiling because the statutory cap is tied to property valuations which would fall. Projections in 2018 showed that even a small near-term recession could place Sound Transit on a lower trajectory that breaches the debt limit later in the program.

Financial Policy: Sound Transit's financial policies specify revenues should cover operating costs plus debt servicing 1.5 times (net coverage ratio). This ensures enough cash to meet bond commitments and to operate the trains and buses. While it's possible to alter this policy, too low a net coverage ratio would signal higher risk to the bond markets, raising Sound Transit's cost of cost of borrowing.

Above inflation growth in operations costs mean much higher risk of exceeding the allowed net coverage ratio (image: Sound Transit)

The net coverage ratio has been under pressure because operating costs are growing ahead of inflation. Just in the Fall 2018 update to the financial plan, Sound Transit added $2.1 billion in expected operating costs. Two-thirds of the increase in forecast operating costs is in services bought from other providers, and makes clear why Sound Transit went looking for cheaper alternatives to relying on the local agencies.

Unlike most capital costs, operating costs are forever, so the management challenge extends beyond the life of the ST3 program. As major projects are completed, operations and state-of-good-repair costs grow steadily as a share of tax revenues. The recent analysis indicates risks to the net coverage ratio policy grow continuously over the life of the program, reaching 49% by 2041, the last year in the analysis.

Debt Covenants: Sound Transit's bond agreements require revenues to cover bond debt servicing at least 1.6 times (gross coverage ratio). This measure too shows increased risks over the entire program window, though less than the net coverage measure because gross coverage doesn't include operating costs where much of the downside risk lies. Bond holders don't need to worry about operations because they get paid first.

Risk of breaching bond covenants have increased in the outer years of the program (image: Sound Transit)

The analysis considers only forecast risk. It does not include large external events such as passage of I-976 that would push the ST3 plan far off course, or a major change in future federal grant policies. It does clarify the caution regularly expressed by suburban board members about scope creep in Seattle, and their insistence on identifying third-party funding soon. Cost discipline in the next few years remains essential to delivering projects on schedule in the 2030s.