Fitch Ratings has downgraded the rating on approximately $215 million of Casino Reinvestment Development Authority, New Jersey (CRDA or the authority) luxury tax revenue bonds, series 2014 to ‘BBB’ from ‘BBB+’.
The Rating Outlook remains Negative.
Luxury tax receipts consist of a 9% hotel room tax, 9% tax on ticket purchases at theaters, exhibitions and other places of amusement, and 3% tax on alcoholic beverages, all levied in the city of Atlantic City.
ANALYTICAL CONCLUSION
Likely slow trajectory of the recovery for casino and other entertainment activity in Atlantic City and thus luxury tax receipts, and the resulting higher vulnerability of the structure to revenue volatility in the near term, relative to our pre-pandemic expectations.
The Negative Outlook reflects heightened uncertainty about the strength of taxable activity through the recovery period and the vulnerability of receipts to further pressures, including those posed by prolonged public health concerns.
WEAK REVENUE GROWTH PROSPECTS: Long-term growth of pledged receipts have long been viewed as weak by Fitch given historical demand and revenue trends over time, and influenced by the impact of competing gaming options from nearby regional casinos outside New Jersey, online gambling and sports betting.
RATING SENSITIVITIES
Evidence of a lengthy or excessively delayed recovery, suggesting a more permanent shift in demand for gaming and entertainment activity in Atlantic City and further reducing Fitch’s growth expectations for luxury tax receipts.
Luxury tax revenue collections and bond debt service coverage have experienced a severe shock as a result of the pandemic-related closure of Atlantic City’s casinos. The shutdown, which lasted from March 17 to July 3, 2020, and other social distancing measures curtailed virtually all taxable activity for the period. Casinos reopened beginning in July and a nascent rebound in visitors and taxable activity has been underway. However, the continuation of the public health crisis will continue to affect tax receipts.
State public health restrictions remain in effect, including limiting the number of casino patrons to 25% of total occupancy limits.
Shows, meetings and conventions have not resumed to any significant degree.
ECONOMIC RESOURCE BASE
Atlantic City is currently home to nine casino resorts and a large number of other hotel accommodations, in addition to being a shopping, meeting and entertainment destination. Two new casinos that opened in 2018, Hard Rock and Ocean Resort, marginally grew the overall gaming market from 2017 but also cannibalized market share from neighboring casinos.
Other gaming options within New Jersey expanded with legalization of internet gambling in 2013 and sports betting in 2018. Online options have become important revenue generators for casinos, although only the on-site portion of sports betting marginally increases foot traffic at the casinos, as most occurs online. On-site gaming activity, particularly table games, poker and slot machines, has historically tracked collection experience for luxury tax collections more closely.
CRDA is an instrumentality of the state of New Jersey, created in 1977 to fund various capital improvements from its dedicated revenue sources, including grants for the construction and renovation of the Atlantic City convention center properties, and to promote casino gaming and tourism as a means to provide for economic development and eradicate blight in Atlantic City. CRDA has issued debt under several user fee-supported securities, as well as the tax-supported series 2014 luxury tax revenue bonds, of which $216 remain outstanding following the Nov. 1, 2020 principal payment.
State statute requires that luxury tax revenues be applied to pay debt service on the bonds before they may be used to pay CRDA operating expenses. While levied by the city, the tax revenue is structured to not be treated as city property in the event of a bankruptcy filing by the city and would not be drawn into its estate, according to bond counsel. At the time of the original bond sale, in 2014, bond counsel also opined that CRDA is ineligible to file for bankruptcy protection under the federal code. Bondholders have a first lien on the revenue stream prior to its being available to fund operations of the convention center. Under applicable state law, the city may not reduce or abolish the tax as long as any bonds secured by the tax are outstanding. Atlantic City has never physically collected this revenue. The state has also agreed to non-impairment of bondholder rights.
LUXURY TAX REVENUE DESCRIPTION
Pledged luxury tax revenues consist of a 9% room tax on all hotel accommodations in Atlantic City, including nine casino hotels; a 9% tax on purchases of tickets at theaters, exhibitions and other places of amusement; and a 3% tax on purchases of liquor by the drink. Hotel rooms, drinks and tickets provided on a complimentary basis are not subject to the tax. About three-quarters of total luxury taxes revenues have historically come from the hotel tax, which are influenced primarily by occupancy over time, as well as by room rates. Tax receipts are also highly seasonal, with summer visitors generating most economic activity. In fiscal 2019, luxury tax receipts in the June-August summer season represented 36% of annual collections.
Revenues are pledged on a gross basis. However, once sufficient funds have been set aside for semiannual debt service payments, the remaining revenue, up until six months prior to the next semiannual debt service payment date, is available to fund operations, maintenance and capital expense of the convention center properties located in the city (Boardwalk Hall, the West Hall and the new convention center) and other permitted uses of luxury tax revenue under applicable New Jersey law. Such net luxury tax revenues remain subject to the lien of the indenture until spent.
GROWTH PROSPECTS WEAK
Fitch views gaming revenues in Atlantic City having relatively weak long-term growth prospects.
a view which applies to related revenue streams, including the luxury taxes. Longstanding challenges to more robust growth of gaming-related receipts in Atlantic City include competition from regional casinos and online gaming options, the viability over time of individual casinos, changing demographics, and national and regional economic conditions. These factors influenced recent historical experience for the luxury taxes, including a cumulative 21% revenue decline during the 2014-2017 period, which was reversed in 2018 with the opening of two new casinos and the expansion of entertainment options; revenues rose 38% in that year.
Fitch’s expectations for the recovery of Atlantic City point to a rebound in 2021, although the mix of gaming receipts may shift further toward online options, signaling a potentially slower recovery for on-site activity, including those that support luxury taxes. For further information, please see “What Investors Want to Know: U.S. Gaming” (October 2020), at www.fitchratings.com.
NARROWER COVERAGE REDUCES RESILIENCE
Based on annual disclosure and more recent data from CRDA, Fitch calculates that 2020 YTD luxury tax revenues through August equaled $9.9 million, about 66% below the equivalent period in 2019, reflecting the 14-week casino shutdown. However, August 2020 revenues alone were 31% below the August 2019 figure, attesting to the rebound underway following the reopening of casinos; September data is not yet available.
On-site casino activity, measured by casino winnings from table games, poker and slot machines at Atlantic City’s nine casino resorts is one proxy for tourism activity in Atlantic City. As with luxury tax receipts, August 2020 on-site winnings were 31% below the August 2019 level, while September 2020 on-site winnings were only 15% below September 2019, suggesting that tourism continued to close the gap in September and that luxury tax receipts may follow suit. Assuming luxury tax collections through the remainder of 2020 remain 15% below the prior year based on the September casino winnings figures, annual revenues will have fallen 51% from the 2019 level. This would lower coverage of MADS to a slim 1.26x.