Fitch Affirms North Dakota Dept of Transportation Grant & Rev Anticipation Bonds at 'AA'

Fitch Ratings affirms its 'AA' rating on the approximately $48.3 million North Dakota Department of Transportation (NDDOT) grant and revenue anticipation bonds, series 2005. The bonds pay interest each December 1 and June 1, and reach final maturity in June of 2020. The Rating Outlook is Stable.

The 'AA' rating reflects the dual pledge of federal transportation funds and state highway funds, which provide multiples of debt service coverage; the long and established history of federal transportation funding; NDDOT's covenant to convert advanced construction funds necessary to cover debt service at the beginning of each federal fiscal year; and a 5 times (x) additional bonds test that moderates the potential for future issuance. Credit concerns include bond maturity which extends through three federal funding periods; the risk of changes in federal transportation funding policy through upcoming reauthorization periods; and the absence of a specific tax pledge to the state highway fund, as revenues credited to the state highway fund and flowing through to NDDOT are subject to legislative actions.

The Stable Outlook reflects the fact that the NDDOT's back-up pledge of available state highway funds, which provides 23.1x maximum annual debt service (MADS) coverage based on 2008 receipts, and no expectation for additional leverage somewhat offsets federal surface transportation program reauthorization risk and cash shortfalls in the near to medium term.

On Sept. 15, 2008 President Bush signed a bill that transferred $8.017 billion from the general fund to the highway trust fund (HTF). The transfer is clearly a positive action for state DOTs and for GARVEE bondholders that both solves the near-term cash crunch and underscores the relative importance of the highway program in the Federal budget, which is a key credit factor. However, the transfer is a very short-term fix that provides policymakers up to a year to find a longer term solution. Absent such an emergency transfer the Federal Highway Administration (FHWA) was anticipating the need to implement a significant slow-down in reimbursement rates to state departments of transportation (DOTs) as the HTF balance has evaporated due to a combination of past spending increases and lower collections. The $8 billion transfer allowed the FHWA to reinstate daily reimbursements, meaning that state DOTs could resume the normal billing process. Fitch expects that a supplemental transfer will need to be made by the end of Federal fiscal 2009 to allow the program to continue to operate without reducing reimbursement rates.

The bonds are secured by both federal transportation funds and state highway fund revenues. A memorandum of agreement (MOA) between the Federal Highway Administration (FHWA) and NDDOT establishes as the first priority in the flow of federal transportation funds a sum-sufficient payment stream equal to no less than an 80% annual federal share of debt service. However, the pledge of federal transportation funds under the indenture is more broadly defined to provide coverage in the unlikely event the programmed obligation authority results in a deficiency.

The annual state share, which is equal to the remaining annual debt service and is subject to biennial legislative appropriation, is backed by pledged state highway funds. These funds consist mainly of NDDOT's share of the highway tax distribution fund, which is from motor fuel sales and motor vehicle registration fees (about 60% of pledged highway fund revenues); additional vehicle registration fees; licenses, fees and permits; fleet and miscellaneous revenues; and reimbursements from political subdivisions. As additional bondholder protection, pledged state highway funds are available to cover the annual federal share of debt service in the event federal transportation funds are insufficient and to the extent pledged state highway funds have been appropriated.

Furthermore, in addition to the funds pledged above, the legislature has provided the NDDOT with additional funding from the state's motor vehicle excise tax (after deduction for the state aid distribution fund share). For the biennium ending June 30, 2009, NDDOT will receive additional state funds equivalent to 10% of the state's motor vehicle excise tax, providing approximately $12.6 million in additional revenue. For the biennium ending June 30, 2011, NDDOT will receive funds equivalent to 25% of the state's motor vehicle excise tax, providing an additional $30.5 million of state revenue to the NDDOT during that time period. These additional revenue streams available to bondholders provide a mitigant to potential shortfalls or changes in federal transportation funds.

The key risk for these bonds, similar to other bonds secured by federal surface transportation funds, is the potential for significant changes in federal policy at the end of each surface transportation funding authorization period. While interruption in the flow of funding is highly unlikely given broad-based political support for the program, the most recent multi-year reauthorization was significantly delayed. The Transportation Equity Act for the 21st Century (TEA-21) expired in 2003 without a successor program in place. Short-term extensions were passed 12 times, but nearly two years elapsed before enactment of The Safe, Accountable, Flexible, and Efficient Transportation Equity Act - A Legacy for Users (SAFETEA-LU) in 2005. SAFETEA-LU expires on Sept. 30, 2009.

The remaining 11-year maturity for the 2005 series bonds exposes bondholders to a moderate level of reauthorization risk compared other bonds of the same type. Assuming the continued practice of six-year federal transportation authorization periods, the outstanding bonds will likely span two such periods, while similar debt programs with longer maturities generally span up to four authorization periods. The absence of other debt leveraging against federal highway revenues, the stability of this revenue source to NDDOT, and an additional bonds test requiring 5x MADS coverage for issuance of additional debt ensure that pledged revenues will remain at levels providing adequate security for bondholders. Increased reauthorization risk is largely mitigated by the back-up pledge of state highway funds.

The next authorization will likely prove challenging given the need to make tough decisions on gas tax levels, the federal role in funding surface transportation, and the role of the private sector. Should the gas tax remain at its current level the program will not likely achieve the increases seen over the past 12 years. In fact, given the recent shift to public transportation there could be political pressure to provide a larger allocation to the transit account.

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