Fitch Rates Alabama Public School and College Authority Bonds 'AA'

NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA' rating to approximately $145.9 million Alabama Public School and College Authority capital improvement pool qualified school construction bonds, series 2009D (tax credit bonds). The bonds are expected to sell via negotiation on or about Dec. 2, 2009. Fitch also affirms the 'AA' rating on $680 million outstanding capital improvement pool bonds. The Rating Outlook is Stable.

The rating reflects ample coverage of debt service by pledged revenues, the strength of the pledged revenues, which include major state revenue sources, and the core nature of the activities being financed (K-12 and higher education), as well as the strong budget controls exhibited by the state.

The Alabama Public School and College Authority (the Authority) provides capital financing for public education in Alabama, and, with $2.2 billion of debt outstanding, is the most active debt issuer of the several authorities that issue debt in the state. The Authority members are the governor, the state superintendent of education, and the director of finance, indicating the importance of this financing mechanism and the role of the state in education.

The bonds are a limited obligation of the Authority payable from pledged revenues, which include the sales, use, lease, utility gross receipts and utility service use taxes. Pledged revenues not needed for debt service are deposited into the state Treasury to the credit of the Education Trust Fund (ETF), a special fund of the state that is the largest operating fund into which taxes and revenues are deposited. The ETF funds K-12 and higher education as well as smaller education, health, library and other programs. Each bond series has its own separate lien on pledged revenues subordinate to prior issues; once issued, the 2009D bonds will occupy a 12th lien position respecting the pledged revenues. Given the ample coverage of debt service by pledged revenues, discussed further below, the subordinate status is not a rating factor.

While the authority bonds are not general obligations of the state, they do reflect the state's general credit quality as pledged revenues include major state revenue sources and finance a central state responsibility. Alabama has extensive earmarking of taxes and uses special obligations for nearly all of its capital needs. The general fund is minor in state operations as is debt issued against it. State general obligation bonds are rated 'AA' by Fitch based on the state's longer-term trend toward a more diversified economy despite a severe downturn in manufacturing, strong spending controls which contribute to balanced operations, and manageable debt levels.

Pledged revenues provide ample coverage of debt service requirements both on an annual and maximum annual basis. Unaudited fiscal year 2009 revenues of $2.1 billion, while 11% lower than the prior year, provide 8.4 times (x) coverage of maximum annual debt service. State financial operations, including the ETF, benefit from strong spending controls, with a constitutional requirement to make across-the-board appropriation reductions, called 'proration,' when a deficit is projected in one of several funds. Debt service is not subject to proration. This device has been implemented several times, including in fiscal year 2009, when weak revenue performance necessitated a 17.9% reduction in education appropriations. By depleting its education rainy day fund, the state was able to limit the reduction to 11%. With further revenue weakness expected in the fiscal year that began Oct. 1, the Governor has already declared a 7.5% proration of the education appropriation for fiscal year 2010.

The current offering provides new money to be loaned to local school boards for capital projects under a pooled approach that allows capital funds of the state to be leveraged rather than being limited to support pay as you go financing. The Authority also issues capital outlay bonds for capital improvements to public schools and institutions of higher education with proceeds considered grants to recipients.

The Authority remains engaged in litigation regarding swap options entered into in 2002 and amended in 2003. The Authority received up front payments of approximately $12.6 million and granted the counterparty, JP Morgan Chase, an option to require the Authority to enter into fixed rate payer swaps in connection with the variable rate refundings of the bonds. The exercise dates of the swaps coincided with the unprecedented disruptions in the credit markets in the fall of 2008, at which time it would have been difficult, or at least very expensive to obtain liquidity support, for the Authority to access the variable rate market The Authority filed declaratory judgment action in federal district court, requesting the court to determine the rights and obligations of the parties under the swap options. The counterparty terminated the swaps, with the state's termination payment obligation estimated to be between $12.6 million to $122 million. The Authority asserts, among other things, that the swap option does not comply with state statute. A trial date has been set for October 2010.

The Authority maintains that it will make any payments that the court requires and that it has the legislative authority to make a termination payment from ETF revenues. It is also exploring the possibility of issuing bonds to cover a potential payment and will seek legislative authority to issue bonds if that is deemed necessary. The Authority refunded the bonds affected by the swap option in October, freeing up sufficient funds to make termination payments if necessary; however, the Authority has not pledged to set these funds aside or otherwise segregate them to make the termination payment. Although the financial implications of a negative outcome to the litigation are relatively small, the course of events leading into entering the swap option and its disposition reflect negatively on management.

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