Fitch Ratings has affirmed the ‘AA’ rating on $593.3 million of outstanding senior lien Port of Long Beach harbor revenue bonds and the ‘AA-‘ rating on the $498.9 million of outstanding subordinated lien TIFIA loan. The Rating Outlook on all bonds is Stable.
RATING RATIONALE
The ratings reflect the port’s strong market position in a large and economically diverse region, with resilient revenues from long-term contractual guarantees that are sufficient to cover both the port’s outstanding senior debt obligations and the subordinate TIFIA loan. Contractual guarantees should continue to provide revenue stability as the port proceeds with its long-term capital improvement plan (CIP), focused on ensuring the port’s competitive position and enhancing capacity to meet growth going forward.
The port continues to maintain strong financial metrics and considerable liquidity in line with management’s guidelines of 2.0x minimum debt service coverage ratio (DSCR) and 600 days cash on hand (DCOH) despite moderating throughput levels following congestion, supply chain and labor challenges affecting the industry. The one-notch differential on the TIFIA loan reflects its subordinate claim on revenues.
KEY RATING DRIVERS
Revenue Risk – Volume – High Stronger
Strong Market Position: Fitch has revised its assessment of Revenue Risk (Volume) to ‘High Stronger’ from ‘Stronger’ following the publication of its new Transportation Infrastructure Rating Criteria, which assesses volume risk on a five-point scale.
The Port of Long Beach is the nation’s second-largest container port, located on the West Coast. Together with the neighboring Port of Los Angeles, it constitutes the San Pedro Bay Port Complex — the ninth-largest port complex in the world. The port’s ability to handle larger ships, sizable local market share and strong representation across shipping alliances continues to position the port favorably.
The port remains exposed to fluctuations in international trade along with labor risks, with throughput levels largely dependent on East Asian imports. The port has benefited from record high cargo volumes in the post-pandemic period, but throughput moderation is expected in the near term due to ongoing operational disruptions related to labor uncertainty and economic challenges.
Revenue Risk – Price – Stronger
Resilient Revenues: With a large majority of operating revenues coming from the container business (approximately 73% of operating revenues), the port is exposed to fluctuations in international trade and competitive pressures, which can lead to volume volatility. However, the port’s revenues have proven to be largely insulated from trade-related revenue volatility due to the high percentage of long-term guaranteed contracts in place with most tenants.
Minimal annual guarantees account for roughly 85% of operating revenues, and counterparties honor their agreements through periods of volatility. Guaranteed annual minimums are scheduled to rise in the medium term, reflecting contractual step-ups related to the Middle Harbor Redevelopment project.
Infrastructure Dev. & Renewal – Stronger
Modern Facilities, Manageable Capital Program: The port benefits from modern facilities and have excellent access to intermodal transportation facilities. With several sizable projects now completed, the port’s five-year capital improvement plan (CIP) (2023-2027) is sized at $1.4 billion with a focus on rail improvements and supply chain efficiency.
The current capital plan is expected to be almost entirely funded with port revenues, existing bond proceeds, and grants with conservative budgeting for modest additional borrowing in the medium term. Ongoing rail improvements are expected to extend beyond the CIP period. Careful management of CIP scope and cost relative to business demand so as to maintain the port’s strong financial profile is important to rating maintenance.
Debt Structure – 1 – Stronger; Debt Structure – 2 – Midrange
1 – Senior Debt; 2 – Sub/TIFIA Loan
Fixed-Rate, Amortizing Debt: The senior bonds are all fixed-rate and benefit from strong covenants, although Fitch notes that outstanding debt does not benefit from a cash-funded DSRF. The lack of DSRF is not viewed as a credit negative given the robust current and anticipated levels of unrestricted reserves.
The port manages its financial profile to a minimum of 2.0x net coverage and 600 DCOH, per an ordinance adopted by the Board of Harbor Commissioners in 2011. Fitch views this policy as providing liquidity stability for bondholders and sees continued management to these levels as important to maintenance of credit quality as the port continues to issue debt without cash-funded DSRFs for future issuances. The subordinate TIFIA loan is fixed-rate, and benefits from a fixed amortization profile, but has a junior claim to revenues.
Financial Profile
The port has a healthy balance sheet, maintaining strong liquidity levels while drawing upon cash to fund the ongoing CIP. Liquidity at fiscal year-end 2022 represented over 1,300 DCOH. Historically, the port has maintained high DSCRs, with net coverage on all obligations in the 3.0x range both prior to the recession and since fiscal 2011. Senior DSCR increased to 3.9x in fiscal 2022 with leverage remaining modest at 1.7x net debt to cash flow available for debt service (CFADS) on all obligations. Fitch’s rating case anticipates DSCRs for all obligations at or above 3.5x with coverages improving as the port’s debt service profile steps down in coming years.
Financial metrics under Fitch’s rating case are appropriate overall for the ‘AA’ rating category, although cash flows are susceptible to periodic contract renegotiations with tenants as well as continued effects of ongoing congestion and supply chain disruptions.
PEER GROUP
Among peers in the ‘AA’ rating category, such as Port of Los Angeles (AA/Stable) and the Hawaii Department of Transportation (AA-/ Stable), Port of Long Beach demonstrates comparably strong cargo activity and robust coverage metrics. Leverage for all three ports is consistent with the ‘AA’ rating category. LA and Long Beach share the San Pedro Bay and access to the Alameda Corridor.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
–Higher than anticipated volatility or a steady downward trend in port container volumes;
–Financial forecasts indicating inability to meet management’s policy of maintaining 2.0x DSCR on all obligations and liquidity equivalent to 600 DCOH;
–Upward revisions to the capital program, a higher dependence on debt funding, and/or a material depletion of port liquidity resulting in weaker leverage metrics above 6.0x.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
–Given POLB’s already high rating level and sector-wide risks inherent to ports, upward rating action is unlikely.
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.
CREDIT UPDATE
As the nation’s second largest container port, POLB’s operational performance has remained strong despite pressures from recent disruptions related to supply chain bottlenecks and labor uncertainty. In fiscal 2022, the port handled record high volumes of approximately 9.6 million twenty-foot equivalent units (TEUs), a slight 1.7% increase from the prior year, reflecting pandemic related build-ups. Fiscal YTD 2023 TEU volumes through February 2023 are down 25.2% relative to the same period in 2022 and 6.7% below pre-pandemic levels for the same period in 2020. Near-term adjustments are expected to continue in 2023, with ongoing uncertainty around labor contract negotiations contributing to a shift of volumes from West to East and Gulf coast ports. Management expects the post pandemic shift from goods to services will also contribute to a decline in volumes for the remainder of the year.
Fitch continues to monitor labor relations as negotiations around the contract agreement between the International Longshore and Warehouse Union (ILWU) and the Pacific Maritime Association (PMA) that expired on July 1, 2022 are still ongoing. Organized labor actions during previous ILWU contract negotiations caused delays in processing cargo and resulted in fluctuations in port volumes; however, material work stoppages are unlikely given the significant stakeholder and political involvement. It remains to be seen if there will be a reversal in volumes back to West Coast ports with the resolution of talks, the timing of which is also unclear.
Total operating revenues for fiscal 2022 were $479.6 million, representing an increase of 10.3% over fiscal 2021 and 5.2% above management’s projections. This increase is primarily driven by growth in container throughput, which represents 73% of revenues. In addition, contribution from rental property revenues grew from 5.3% in fiscal 2021 to 7.7% in fiscal 2022 due to continued strong demand for land leasing for container storage, helping to alleviate congestion at the port. Operating expenses for 2022 were 23.6% higher than prior year, mostly due to the increase in pension and postretirement healthcare benefit expenses. This increase was anticipated by management and remained well below the port’s budget by approximately 17%. Operating expenses are expected to trend higher in coming years from increased costs for infrastructure maintenance, labor and environmental projects. The port’s cost profile continues to be well managed, with overall five-year CAGR for operating expenses at 3.1%.
Fitch notes that declines and recoveries in volumes have had a limited impact on the port’s rating, largely due to the revenue stabilizing nature of the port’s long-term leases with its largest tenants, that account for roughly 85% of operating revenues and they are more than sufficient to cover annual debt service on the port’s outstanding senior debt obligations and the subordinate TIFIA loan. Even during periods of volume fluctuation (due to the pandemic, tenant bankruptcy, labor unrest and supply chain disruptions) the port has a track record of minimum guarantees being honored with key tenants maintaining long-term operations at the port. As such, despite weaker expected volumes, management has indicated that 2023 operating revenues is on track to reach another strong watermark for the port.
Debt service coverage for all obligations in fiscal 2022 has remained strong at 3.9x, well above the rate covenant of 1.25x and the board’s policy of 2.0x. The port had $606.2 million in unrestricted funds in fiscal 2022, translating to over 1,300 DCOH and far exceeds the board’s cash requirement policy of 600 DCOH.
Post the completion of the port’s key projects (Port Headquarters, the Gerald Desmond Bridge replacement and the Middle Harbor redevelopment program), the port’s ongoing CIP is focused on supply chain efficiency via rail infrastructure improvements. The five-year CIP is manageable at $1.4 billion and is expected to be majority funded by grants and surplus cash. The port conservatively budgets new debt funding of $100 million in fiscal 2027.
Whilst historically the port has underspent on its CIP and has demonstrated flexibility in the plan’s roll-out, Fitch views this conservative budgeting as proactive given the current high inflationary environment. Management has also indicated the port continues to pursue additional federal and state grants to support its capital investments as well as consider other debt management strategies, including strategic refunding opportunities to capture interest savings in the medium term.
FINANCIAL ANALYSIS
Fitch’s base case reflects the port’s conservative expectations of future performance through 2027, followed by modest assumptions through the 10-year projection period. Operating revenues are assumed to grow at a 10-year CAGR of 1.8%, reflecting a normalization in operations as volumes stabilize from congestion pressures caused by supply chain disruptions and other factors. The base case assumes longer term operating expense grow at 0.5% higher than management budgeted projections with a CAGR of 6.0% through 2032.
The port’s debt service profile gradually declines in coming years which supports stronger future coverages with large step downs of approximately $9 million and $16 million in fiscal 2025 and 2028, respectively. Out of conservatism and in light of the current high inflation environment, Fitch has included $100 million of additional borrowing in fiscal 2027 to support ongoing capital projects in the case analysis. Under these assumptions, total DSCR averages a robust 4.1x through 2027 (4.8x through 2032) and leverage is modest at 2.0x in 2027.
Fitch’s rating case considers a hypothetical recessionary stress in fiscal 2026 that results in a 7.5% decrease in operating revenues, followed by a modest two-year recovery period before growing at 1.0% per year thereafter, resulting in a very modest 10-year CAGR of 0.7%. Historically, the port’s operating revenues have shown a 10-year CAGR of 2.9%, which supports the conservatism in Fitch’s rating case assumptions. Operating expenses are stressed by 1.0% above management’s long-term assumptions and grow at a 6.4% CAGR through 2032. The same additional borrowing assumptions are factored in the rating case. Under this scenario, rating case metrics remain strong even contemplating additional borrowing, reflecting the flexibility of the port’s financial profile. Total DSCR averages 3.8x through 2027 (4.1x through 2032) and leverage is at 2.4x in 2027.
Overall financial metrics under both cases are consistent with the ‘AA’ category as reflected in Fitch’s indicative rating guidance in its port criteria. As considered in POLB’s rating, any potential severity of downside volume risk is largely mitigated by strong lease terms with tenants, which generally feature minimum revenue guarantees. A majority of the port’s tenants operate under long-term lease contracts that collectively contain minimum payment provisions that can cover annual debt service requirements.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Long Beach (CA) [Port Facilities] has an ESG Relevance Score of ‘4’ for Labor Relations & Practices due to follow-on impacts of labor relations between port tenants and longshoremen during periods of contract negotiations, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
Other than the score for Labor Relations and Practices, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
Source: Fitch Ratings