NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'A+' rating to the Turnpike Authority of Kentucky's (TAK) $186.85 million economic development road revenue bonds (revitalization projects), 2013 series A revenue bonds.
The bonds are expected to be offered through negotiation on or about Sept. 11, 2013.
Fitch also affirms the 'A+' rating on approximately $6.4 billion in appropriation backed debt issued by the State Property and Buildings Commission, the Kentucky Infrastructure Authority, TAK, the Kentucky Asset/Liability Commission, and the Lexington-Fayette Urban County Government Public Facilities Corp.
The Rating Outlook is Stable.
The bonds are a special and limited obligation of TAK, payable solely from revenues derived under a financing/lease agreement between TAK, as lessor, and the commonwealth's transportation cabinet, as lessee. The bonds are paid from appropriations made to the transportation cabinet, primarily from the Road Fund, which receives various transportation-related fees and taxes.
KEY RATING DRIVERS
MOST STATE DEBT IS APPROPRIATION BACKED: Kentucky's debt is primarily in the form of lease rental bonds requiring appropriation for debt service. The commonwealth's lease financing mechanism is well established, highlighted by automatically renewable leases and covenants to seek appropriation for debt service.
APPROPRIATION RISK LIMITS RATING: Road fund revenues, which are the primary sources of revenues for debt service, are constitutionally dedicated to highway purposes, though not necessarily for debt service on road revenue bonds. Biennial legislative appropriation is required for the transportation cabinet to have sufficient resources to make lease payments, and therefore, for TAK to make debt service payments. Accordingly, the rating on TAK's road fund revenue bonds is equivalent to the commonwealth's general-fund supported appropriation debt.
LIMITED OPERATING FLEXIBILITY: The commonwealth's operating flexibility is constrained with depleted reserves and a continuing reliance on nonrecurring budget items, including debt issuance for operating purposes, despite evidence of economic and revenue recovery.
HIGH LONG-TERM LIABILITIES: Commonwealth debt levels are at the higher end of the moderate range, and other long-term liabilities are well above average for a U.S. state. Recently adopted pension reform measures could improve the commonwealth's long-term liability position but will also increase scheduled pension funding demands on the budget.
ECONOMY SLOWLY REBOUNDING: Kentucky's economy is recovering from the recession, though growth continues to lag national trends. Manufacturing had been showing strong yoy employment gains, but that trend has slowed.
The rating is sensitive to changes in the commonwealth's fundamental credit quality, on which this rating is based.
Kentucky's 'A+' lease rating reflects the commonwealth's limited fund balances following depletion amidst recession-driven revenue shortfalls, continued reliance on one-time measures in the current biennial budget, and high liabilities, including for the poorly funded pension systems.
ROAD FUND AND APPROPRIATION RISK
Road fund bonds are secured by lease payments from the transportation cabinet to the authority, with revenues derived from biennial legislative appropriations. The bonds are paid mainly from resources of the road fund, principally motor fuel and vehicle usage taxes. The motor fuel tax (approximately 38% of unaudited FY 2013 road fund revenues) includes a fixed component (5 cents) and a variable rate component equal to 9% of the average wholesale price, subject to a floor. The tax is levied on gasoline, liquefied petroleum gas and special fuels (e.g. diesel). The vehicle usage tax (approximately 41% of unaudited FY 2013 revenues) is a 6% tax levied on the sale or transfer of motor vehicles. Unaudited FY 2013 road fund revenues were up 3.3% yoy, and very slightly (0.5%) below the commonwealth Consensus Forecasting Group's (CFG) budgeted estimate. Unaudited FY 2013 net revenues of the road fund covered pro forma maximum annual debt service of $175.3 million (inclusive of a planned $200 million issuance in summer 2015) by a solid 3.3 times (excluding a Build America Bonds subsidy).
Road fund bonds are rated equivalent to general fund-supported appropriations debt of the commonwealth due to appropriation risk. While road fund revenues are constitutionally dedicated to transportation uses, there is no lien on all road fund revenues in favor of bondholders. Statutorily, in the event of non-appropriation, a portion of motor fuel taxes and surtaxes is dedicated to repayment of road fund revenue bonds. These dedicated revenues are not anticipated to be sufficient to pay debt service on outstanding road revenue bonds. Further, neither the indenture nor the lease agreement includes non-impairment language requiring the commonwealth to maintain motor fuel tax rates at levels sufficient to pay debt service.
PRESSURED FINANCIAL PROFILE
Kentucky continues to face budget balancing challenges despite recovery in the economy, indicating a structural problem that goes beyond the impact of cyclical recession and recovery on its financial operations. In each of the past four biennial budgets, beginning in fiscal 2007 and including the biennium that began July 1, 2012, the commonwealth has relied on one-time solutions to balance its budget, including depletion of reserves, debt restructuring, and borrowing for operations, specifically to pay Kentucky Teacher Retirement Systems (KTRS) non-pension retirement benefits (OPEB). Although the structural gap and use of one-time items has been reduced in the current biennium, this practice has continued despite economic recovery and growing revenues.
The commonwealth began to rebuild its rainy day fund at the end of the last biennium (ended June 30, 2012) with a deposit of approximately $122 million; however, the enacted budget for the current biennium, again draws upon the budget stabilization fund to achieve balance, using $49 million of the balance in fiscal 2014. The budget, which assumed modest revenue growth of 2.4% in fiscal 2013 and 2.3% in fiscal 2014, required aggressive measures to close an estimated gap of $742 million. Priority areas such as education and Medicaid were protected from budget reductions but most areas of the budget were reduced. The budget authorized continued borrowing to pay a portion of KTRS retiree health benefits, albeit in a smaller amount than in the prior biennium. Legislation passed in 2010 phases in additional KTRS OPEB contributions by both employees and the state.
For FY 2013 (ended June 30), the commonwealth reported general fund revenue growth of 2.8% yoy, as strong individual income tax growth offset lackluster sales and use tax revenues. Final general fund collections of $9.348 billion were in line with the CFG's Dec. 2011 forecast of $9.307 billion used in developing the current biennial budget. Individual income tax revenues increased 6% yoy to $3.7 billion, which Fitch believes could be partially attributable to income acceleration into calendar year 2012 to avoid recent federal tax increases. At its Aug. 15 meeting, the CFG adopted a preliminary estimate of more modest 1.8% yoy growth in FY 2014. Sales and use tax revenues were down 1% in FY 2013 to $3 billion after a sharp 5.4% gain in FY 2012. For FY 2014, the preliminary CFG forecast is for a modest rebound with 1.4% yoy growth. Fitch views these revenue forecasts as achievable, and will more fully evaluate the final CFG forecasts adopted in December in preparation for the FY 2015-16 biennial budget.
Despite a decade of contraction, Kentucky continues to have an oversized manufacturing sector relative to the national economy. This sector had been recovering since bottoming out in early 2010, but growth has plateaued with narrowing yoy employment gains since February and a 0.6% yoy decline in July 2013. While gains in automotive-related employment had been a key factor in the recovery, the state reports nondurable goods sectors like plastics and chemicals have been somewhat unsteady. Overall, the commonwealth's non-farm employment is up 1% yoy as of July 2013, below the national rate (1.7%) for the ninth consecutive month. Kentucky's July 2013 unemployment rate of 8.4% remains above the 7.4% U.S. rate, reflecting lagging economic growth. Kentucky's per capita personal income for more than three decades has approximated 80% of the U.S. average and currently ranks the commonwealth a low 47th among the states for this measure.
DEBT AND OTHER LONG-TERM LIABILITIES
Kentucky's liabilities are high for a U.S. state with the combined ratio of debt and unfunded pension liabilities representing 21.4% of 2012 personal income. This ranks it among the highest of U.S. states rated by Fitch. Net tax-supported debt alone, of approximately $9.1 billion, represents an above-average 5.9% of 2012 personal income. This includes the $186.85 million of new money in the series 2013A TAK revenue bonds being sold, other general and road fund-supported appropriation debt, and debt paid from other state agency funds. Kentucky has long used state agencies for its capital financings, which depend on biennial legislative appropriations for security, and has well established policies and procedures that recognize such obligations as debt. Although payment is subject to legislative biennial appropriations, the securing financing agreements are automatically renewable.
The funding level for the state-supported portion of the Kentucky Retirement System (KRS, and excluding the County Employees Retirement System) was only 30.2% as of June 30, 2012, down from nearly fully-funded just 10 years ago. Using Fitch's more conservative 7% discount rate assumption, funding of the pension plan declines to 27.9%. Funding levels for the commonwealth's other state-supported retirement systems, including the Kentucky Teachers Retirement System (Fitch adjusted funded ratio of 51.6% as of June 30, 2012), have deteriorated as well partially due to investment losses and the failure to fully fund actuarially calculated annually required contributions (ARCs).
In April, the state adopted the latest in a series of pension reform measures which could improve the state's long-term liability position. Changes in the 2013 legislation (Senate Bill 2) include requiring any future cost of living allowances to be fully pre-funded by the general assembly, closing the current defined benefit plan to new employees and establishing a hybrid cash-balance plan for new hires as of Jan. 1, 2014, and requiring the general assembly to fully fund the ARC as of fiscal 2015. The state also adopted a companion revenue bill (House Bill 440) which included provisions estimated to provide $100 million in revenue to fund the general fund portion of the full ARC. The changes do not apply to the Kentucky Teachers Retirement System.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from IHS Global Insight.
Applicable Criteria and Related Research:
--'U.S. State Government Tax-Supported Rating Criteria', dated Aug. 14, 2012.
Applicable Criteria and Related Research:
U.S. State Government Tax-Supported Rating Criteria