New York’s Metropolitan Transportation Authority (MTA) is the largest public transport authority in the United States, but its budget deficit and lack of liquidity have become a growing crisis for the organization, state and local government and the city’s residents.

High leverage and poor operating results have translated to projections that MTA is $38 billion in debt and may be at risk of further downgrades – thus, bondholders should think twice before buying.

In this article, we will look at the MTA’s current situation, what happened to its credit rating and what these factors mean for municipal bond investors.

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MTA is a public benefit corporation that generates revenue through rider fares and road tolls, but these sources of revenue have never been sufficient to cover expenses. In fact, the organization’s $8.87 billion in anticipated revenue can only cover 65 percent of its $13.72 billion in operating expenses this year. State and local governments have historically helped cover the shortfall, but these funding sources have started to dry up.

In November 2017, the New York Times launched an investigation and found that politicians from both parties at state and local levels had gradually removed $1.5 billion in MTA funding while overspending, overpaying unions, ignoring infrastructure improvements and agreeing to unnecessary high-interest loans. For instance, the newspaper estimates that the East Side Access project will cost about $3.5 billion per mile of track.

The MTA estimates that its cash balances will be depleted by 2019 with a $403 million deficit in 2020 and a $602 million deficit by 2021. Of course, these bond issuances will continue to put a financial strain on the organization as interest payments eat cash flow. Debt service already accounts for about 30 percent of its fare and toll revenue, but that figure is expected to rise to nearly 40 percent by 2021, according to the MTA’s 2018-2021 Financial Plan.

MTA hopes to address these concerns with a four percent fare and toll increase in 2019 and 2021, but these increases have become difficult to justify given the declining rider experience. With a lack of infrastructure expenditures, the MTA has faced severe malfunctions that have led to substantial delays. The move to cut back on the number of running trains has also led to much busier traffic and congestion across the network.

S&P Global Ratings lowered its credit rating for MTA from A+ to AA-, noting that the amount of cash left over after the organization pays operating expenses fell below 1x annual debt-service costs. The downgrade brings S&P’s credit rating in line with Moody’s Investor Service and Fitch Ratings, which have MTA’s popular revenue bond credit rated at A1 and AA-, respectively, so the move was somewhat expected.

“The lowered rating reflects our assessment of MTA’s most recent estimates and forecasts and our calculation of potentially inadequate consolidated net debt service coverage for unaudited fiscal 2017, budgeted fiscal 2018, and forecast 2019, given rising operating expenses and debt service requirements without corresponding growth in gross revenue,” said S&P analyst Paul Dyson in the credit agency’s note on the rating change.

S&P issued a negative outlook and warned that, if fiscal 2017 results or revised estimates for 2018 and 2019 do not improve consolidated net revenue debt service coverage to more than 1.0x, it could lower the rating further – potentially by several notches. The analyst also warned that it may lower ratings over the next two years, potentially by more than a notch, if ridership falls and stays short of forecasts or if liquidity dries up.

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MTA faces numerous headwinds over the coming years. In addition to liquidity concerns, the transit system faces growing competition from ride-sharing services, like Uber and Lyft, and could face competition from self-driving vehicles in the future. Riders have a growing number of alternatives at a time when MTA is pursuing fare increases and continues to experience severe malfunctions and delays associated with its deteriorating infrastructure.

The upshot is that MTA’s $800 million Subway Action Plan could help address some of these issues. Announced last summer, the plan is intended to stabilize subway service in the intermediate-term and prioritize maintenance to ease delays facing consumers. Proponents of the plan insist that the funding will stem the problems while a long-term solution is identified, while opponents argue that the plan does nothing to address systemic problems.

In the end, MTA has historically relied on subsidies and debt to remain solvent, has high capital expenditure requirements and low forecasted operating revenue, which suggest a lot more downside potential in terms of its debt and ability to service it than it does upside potential of becoming operationally efficient and increasing its solvency and liquidity ratios. Investing in MTA bonds could be even riskier than credit agency ratings would suggest.

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Municipal bond investors should look at many factors when conducting due diligence, including operational profitability, high debt-service coverage, low reliance on subsidies, high asset-to-liability ratios and consistently declining short- and long-term debt liabilities. Unfortunately, MTA has none of these attributes and bond holders should be weary of future issuances as they may be taking on substantial risk without increased reward.

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