Fitch Affirms Arizona State Board of Transportation's GANs at 'AA'; Outlook Stable

CHICAGO--()--Fitch Ratings affirms the 'AA' rating on the Arizona State Board of Transportation's (the board) approximately $248 million in outstanding grant anticipation notes (GANs). The Rating Outlook remains Stable.

RATING RATIONALE

The rating is driven by a strong subordinate pledge on the monies in the Arizona Department of Transportation State Highway Fund (SHF) and Maricopa County Regional Area Road Fund (RARF). The bonds are also secured by the state's future federal highway grants.

Fitch will generally assign a rating consistent with the higher of the federal grant or the subordinate liens. Currently, the highest rating that Fitch has assigned to standalone GARVEE bonds for which Highway Trust Fund (HTF) revenues are the only pledged revenue source is 'A+', reflecting Fitch's view of the strength of the Federal program. The 'AA' rating on the Arizona federal reimbursement bonds reflects Fitch's view of the strong enhancement provided by the balance from the State Highway Fund and the Regional Area Road Fund.

KEY RATING DRIVERS

--Dual Pledge: Arizona Department of Transportation's (ADOT) bonds are secured by the first lien on Arizona's federal highway funds and the subordinate lien on monies in the SHF and Maricopa County RARF (for eligible RARF projects), which helps offset reauthorization risk.

--Historically Stable Federal Transportation Funding: Fitch notes that changes in federal funding policy with each new authorization period could result in reduced funding levels for highways.

--Strong Covenants and Timing Mechanisms: Additional leverage is limited by a strong additional bonds test of 3.0 times (x) maximum annual debt service (MADS). ADOT has an administrative covenant to deposit all federal aid into the Grant Anticipation Note Fund if projected coverage is insufficient.

--Additional Leverage Not Anticipated: ADOT does not plan to issue GANs in the current or fiscal year 2016.

RATING SENSITIVITIES

Negative:

--Significant reduction in federal funding, a lapse in federal gas tax collections, or a change in budgetary treatment of the federal highway trust fund;

--A decline in the SHF and RARF fund balances and/or excessive leveraging of highway revenue bonds and transportation excise tax revenue bonds could put pressure on the rating.

SECURITY

The notes are secured by future federal aid under grant agreements between the ADOT and the Federal Highway Administration (FHWA). Funds deposited in the SHF and the RARF provide back-up security.

CREDIT UPDATE

The unsustainable trajectory of HTF expenditures exceeding receipts over the past several years was not addressed by the interim measure congress passed in early August. Instead the recent legislation relies on $10.8 billion of general fund transfers to keep the program afloat through May 2015. While the continued general fund transfers have underscored the relative importance of transportation funding within the federal budget, they do not guarantee future commitments. The future of the program beyond May 2015 is hard to predict, but it is Fitch's view that significant changes are needed either on the expenditure side or on the revenue side to put the program on a sustainable trajectory. In addition, complicating matters is the increase in corporate average fuel economy (CAFE) standards from the current 29 miles per gallon (mpg) to 54.5 mpg by 2025 that was approved on Aug. 28, 2012. Such a standard puts further pressure on HTF receipts from taxes imposed on passenger cars, leading to an estimated 13% reduction from today's levels by 2032. In Fitch's view, the unsustainable trajectory of the HTF may lead to policy changes that could affect bondholders.

The pledge of subordinate funds provides an important offset to reauthorization risk and supports the current rating level. ADOT operates and administers the state highway system under the policy directives and debt-issuing authority of the board. Debt service on the notes is payable from federal aid revenues paid to ADOT under grant agreements with the FHWA related to each GANs series. Since the grant agreements establish only a sum sufficient payment stream, the board has broadened the definition of pledged revenues to include all federal aid revenues received by ADOT and, to the extent necessary, certain SHF and RARF resources. The SHF is funded by statewide fuel taxes and user fees via the Highway User Revenue Fund (HURF). As of Nov. 4, 2014, the SHF had a balance of $356.9 million. The RARF is funded by the Maricopa County transportation excise tax. As of Nov. 4, 2014, the RARF had a balance of $502.6 million. Excluding federal funds, these HURF and RARF balances provide approximately 13x MADS coverage.

The Fitch rating case analysis assumes a 22% reduction in federal receipts in 2016 which is consistent with Fitch's view of the gap between receipts and outlays in the HTF. Coverage remains sufficient for the rating level of over 9x on a federal revenue basis and 15x with the state's back-up pledge revenues.

ADOT has entered into grant agreements with the FHWA relating to the outstanding GANs. Under the grant agreements, the FHWA has agreed to make payments to ADOT for eligible project costs, to the extent federal funds are available, in amounts equal to GAN debt service. ADOT bills the FHWA for the amount of debt service in advance of the debt service payment date. All grant revenues under any grant agreement relating to the outstanding GANs are deposited with the State Treasurer who is required to deposit such grant revenues directly into the Grant Anticipation Note Fund.

The Arizona Highway Department's mission is to provide a safe, efficient and cost-effective transportation system for Arizona. The department is responsible for more than 6,700 miles of highways and 4,000 bridges across the State of Arizona.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. State Government Tax- Supported Rating Criteria' (Aug. 14, 2012);

--'Leveraging Federal Transportation Grants: Rating Criteria for GARVEE Bonds' (Aug. 15, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. State Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033

Leveraging Federal Transportation Grants: Rating Criteria for GARVEE Bonds

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685504

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=926055

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Contacts

Fitch Ratings
Primary Analyst
Daniel Adelman
Analyst
+1-312-368-2082
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Scott Zuchorski
Director
+1-212-908-0659
or
Karen Krop (State Analyst)
Senior Director
+1-212-908-0661
or
Tertiary Analyst
Samuel Marsico
Analyst
+1-212-612-7810
or
Committee Chairperson
Gregory Remec
Senior Director
+1-312-606-2339
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Daniel Adelman
Analyst
+1-312-368-2082
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Scott Zuchorski
Director
+1-212-908-0659
or
Karen Krop (State Analyst)
Senior Director
+1-212-908-0661
or
Tertiary Analyst
Samuel Marsico
Analyst
+1-212-612-7810
or
Committee Chairperson
Gregory Remec
Senior Director
+1-312-606-2339
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com