Fitch Rates 2007 Michigan Grant Anticipation Bonds ‘A’; Affirms Outstanding Notes at ‘AA-’
Fitch Ratings has assigned an underlying ‘A’ rating on approximately $477.6 million State of Michigan Grant Anticipation Bonds, series 2007. In addition, Fitch affirms approximately $32 million in outstanding Grant Anticipation Notes (GANs), series 2002, at ‘AA-’. The Rating Outlook is Stable. Bond proceeds will be used to pay a portion of the cost of the Jobs Today program and to pay the cost of issuance. The bonds are expected to sell through negotiation by a Merrill Lynch & Co-led syndicate. The 2002 notes are rated ‘AAA/F1+’ based on a financial guarantee insurance policy provided by FSA (whose claims paying ability is rated ‘AAA’ by Fitch) and a standby bond purchase agreement provided by Dexia Credit Local (which is rated ‘AA+/F1+’ by Fitch).
The ‘A’ rating of Michigan’s grant anticipation program reflects the twenty year final maturity of the bonds which now extends into four federal authorization cycles from the two reauthorization cycles under which 2001 and 2002 GANs were issued. The debt profile is longer and is more heavily back-loaded than any other bond rated by Fitch secured solely by grants received from the Federal Highway Administration (FHWA). The state anticipates issuing another $130 million in parity bonds in 2009.
The underlying ‘AA-’ rating on the series 2002 notes reflects a covenant of the Michigan Department of Transportation (MDOT) in the second supplemental indenture to use its best efforts to redeem the remaining $32 million in outstanding notes in November 2007 once an appropriation providing such authority is enacted. MDOT’s plan is to retire the notes on November 7, 2007, from balances in the state trunkline fund. To the extent that the 2002 notes have not been redeemed Fitch will review the rating on the 2002 notes. The ‘A’ rating on the bonds reflects the long history of federal transportation funding and the strong coverage of maximum annual debt service (MADS) by pledged State Share funds received in fiscal 2006 of 7.7 times (x). The rating also recognizes that the bonds are dependent upon an unprecedented four reauthorization cycles that further increases exposure to potential changes in federal transportation funding policy that could result in reduced funding levels for highways over time. Also, the rating captures significantly back-loaded principal repayment with nearly 80% of total principal retired in the third and fourth reauthorizations, no advance segregation of funds on a cash basis or through a set-aside of obligation authority and no additional structural features such as a back-up security or a debt service reserve fund. The rating also incorporates an additional bonds test that allows for leveraging down to 1.5x MADS.
The bonds are secured by a pledge of State Share funds which represent grants received from the FHWA made pursuant to Title 23 of US Code. Federal grants are received by the Treasurer and deposited into the Federal Grant Proceeds Subfund in the State Trunkline Fund as required by the Resolution of the State Transportation Commission. State Share funds must be appropriated by the Michigan legislature before they are available for use. The State Share represents between 73% and 77% of FHWA reimbursement grant funds as the remaining 23%-27% are dedicated to local jurisdictions pursuant to state statue. While Act 51 establishes debt service as the first priority for use of State Share funds, there is no required set-aside of cash or of obligation authority. Funds are transferred by the Treasurer two business days prior to principal and interest payment dates. Issuance of the bonds is authorized by Act 51 and by resolution of the State Transportation Commission.
In 2001, the state issued $400 million in GANs and another $200 million in 2002, all in a variable rate mode and with eight and seven year maturity profiles, respectively. In 2005, $400 million in outstanding series 2001 GANs were refinanced with state Trunkline bonds which are separately secured by motor fuel taxes and registration taxes. The series 2002 GANs were issued with a 2009 bullet maturity but the state has been prepaying principal so that only $32.1 million remains outstanding. The Michigan Department of Transportation (MDOT) expects to retire the remaining series 2002 principal balance on Nov. 7, 2007.
A key risk for these bonds is the potential for significant changes in federal transportation funding policy with each new authorization period. Interruption in the flow of federal transportation funding is highly unlikely given the broad-based political support for the program. However, the most recent multi-year reauthorization of the federal surface transportation program was significantly delayed. The Transportation Equity Act for the 21st Century (TEA-21) expired on Sept. 30, 2003 without a successor multi-year authorization, although 12 short-term extensions were passed. The Safe, Accountable, Flexible, and Efficient Transportation Equity Act – A Legacy for Users (SAFETEA-LU) took nearly two years to enact.
The bonds extended maturity of 20 years from the date of issuance exacerbates this reauthorization risk. Assuming the continued practice of six-year federal transportation authorization periods, the bonds will typically span four such periods, while similar debt programs with shorter maturities will cover up to two authorization periods. In the near term, federal transportation funding growth may be less than authorized levels under SAFETEA-LU due to highway trust fund resource constraints. In Fitch’s view potential federal transportation funding constraints and reauthorization risk is sufficiently hedged at the current rating level. Continuing federal budget deficits and national security concerns coupled with the possibility of changing federal priorities and/or highway trust fund resource constraints do not guarantee that such federal transportation funding growth will continue during subsequent reauthorization periods.
MDOT was established by constitutional amendment in 1978, replacing the Michigan State Highway Department. It has primary state programmatic and regulatory responsibilities for the development and operation of public transportation facilities, port and harbor facilities, railroad facilities, highways, and airports. MDOT’s highway programs are funded from the state Trunkline fund with revenues that include a portion of the motor vehicle fuels and vehicle registration taxes.
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