OREANDA-NEWS. Fitch Ratings has assigned an 'A+' rating to the commonwealth of Kentucky State Property and Building Commission's (SPBC) $4.365 million road fund revenue bonds project no. 111.

The bonds are expected to be offered through negotiated sale on or about the week of Nov. 16, 2015.

The Rating Outlook is Stable.

SECURITY

The bonds are a special and limited obligation of the SPBC, payable solely from revenues derived under a financing/lease agreement between SPBC, as lessor, and the commonwealth's transportation cabinet, as lessee. The bonds are paid from appropriations made to the transportation cabinet by the legislature, 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. Fitch rates appropriation-backed debt supported by the general fund and road fund one notch below the commonwealth's implied GO rating of 'AA-'.

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 fund revenue bonds. Biennial legislative appropriation is required for the transportation cabinet to have sufficient resources to make lease payments, and therefore, for SPBC to make debt service payments. Accordingly, the rating on SBPC'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 compared with that of most states, with weak reserves and a continuing reliance on nonrecurring revenue sources. Fiscal 2014 ended with an unexpected revenue shortfall, but fiscal 2015 performance was $165.4 million ahead of the budgeted forecast.

COMPARATIVELY HIGH LONG-TERM LIABILITIES: The commonwealth's combined debt plus unfunded pension system liabilities are amongst the highest for U.S. states. Pension reform measures in 2013, including a commitment to full actuarial funding for one of Kentucky's systems, are a positive step, but significant challenges remain, including a consistently underfunded teachers' plan.

STEADY JOBS RECOVERY: Kentucky's economic recovery from the recession has been solid as the commonwealth returned to its pre-recession peak employment levels last summer. Other trends including labor force contraction, below-average population growth and low levels of educational attainment pose long-term demographic challenges.

RATING SENSITIVITIES

LINKED TO IMPLIED GO RATING: The rating on the commonwealth of Kentucky's appropriation-backed debt is linked to changes in the commonwealth's implied GO rating of 'AA-', on which the rating is based.

CREDIT PROFILE

Kentucky's 'AA-' implied GO rating reflects the commonwealth's limited fund balances following depletion amid recession-driven revenue shortfalls, continued reliance on one-time measures in the current biennial budget, and a high liability position, including unfunded liabilities for state-supported pension systems. Kentucky continues to face budget-balancing challenges despite economic recovery, indicating a structural problem that goes beyond the impact of economic cyclicality on its financial operations. Each of the past five biennial budgets relied on one-time solutions to achieve balance, including use of reserves, debt restructuring, or borrowing for operations.

ROAD FUND AND APPROPRIATION RISK

Road fund revenue bonds are rated equivalent to general fund-supported appropriation debt of the commonwealth due to appropriation risk. While road fund revenues are constitutionally dedicated to transportation uses, there is no lien on road fund revenues in favor of bondholders. Neither the indenture nor the lease agreement includes non-impairment language requiring the commonwealth to maintain road fund taxes and fees at levels sufficient to pay debt service on road fund revenue bonds.

Road fund revenue 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 (41% of FY 2015 road fund revenues available for lease payments) 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 (37.9% of fiscal 2015 available revenues) is a 6% tax levied on the sale or transfer of motor vehicles. FY 2015 available road fund revenues were down 1.5% year over year (yoy.)

Total road fund receipts, including various revenues not available for lease payments, declined 2.2% yoy in FY 2015, and were 1.3% below the commonwealth Consensus Forecasting Group's (CFG) budgeted estimate. The decline in gasoline prices drove the shortfall as the variable component of the motor fuel tax is tied to the average wholesale price of gasoline. In response, the Transportation cabinet made corresponding expenditure reductions. In 2015, the legislature changed the statute governing the fuel tax to set a higher floor and adjust the mechanism used to calculate the variable rate portion to reduce volatility.

For more information on the commonwealth, see Fitch's press release 'Fitch Rates Kentucky SPBC's $111MM Project 110 Revenue Bonds 'A+'; Outlook Stable', dated Nov. 9, 2015 and available at fitchratings.com.