OREANDA-NEWS. Fitch Ratings has assigned an 'A+' rating to approximately \$300 million of series 2015 grant anticipation revenue bonds (GARVEEs) and affirms \$478.8 million of existing GARVEE bonds. The Rating Outlook is Stable.

KEY RATING DRIVERS

The 'A+' rating is driven primarily by the strength of the federal transportation funding program. Although the program has become more dependent on transfers from the general fund and is no longer funded on a multiyear basis, it continues to be essential for the federal government. The 'A+' rating also reflects North Carolina Department of Transportation's (NCDOT or the department) pledge of federal transportation funding which provides strong debt service coverage ratios (DSCRs) to mitigate risk of a potential reduction in federal revenues. Strong additional debt limitations and resources of the department to manage any interruptions in federal funding further support the rating.

Uncertainty of the Federal Program: The federal program, which was once funded on a multiyear basis, has now morphed into a program where future policy is less certain and funding levels are less predictable. The program is more dependent on frequent action to extend authorization and on continued transfers from the general fund that will likely need to be continued indefinitely barring an increase in the federal gas-tax or a significant reduction in spending. While future policy is uncertain, the federal program remains essential in funding the maintenance of the nation's highway system and is distributed by a formulaic method.

Strong Protection against Leverage: The indenture limits additional parity bonds so that pledged federal transportation funds are to be at least 3.0x maximum annual debt service (MADS). The GARVEE Act adopted by the state further limits debt issuance so that total principal outstanding cannot exceed federal transportation funds received in prior year or MADS cannot be more than 15% of average annual federal transportation funds expected to be received over the seven-year period for the state transportation improvement program (STIP).

Strong DSCRs: Federal funds authorized provided strong DSCRs of 11.0x in 2014 and are projected to remain above 8.5x under the department's forecast. Similar to other GARVEE programs, there is no debt service reserve fund. However, this is offset by NCDOT's covenant to obligate federal funds in each federal fiscal year for debt service before any other purpose. Additionally, NCDOT has approximately \$85 million in cash in the set-aside account to mitigate any delays or interruptions in federal funding.

Peer Comparison: Fitch's standalone highway GARVEE bonds, all of which are rated 'A+', tend to have strong additional leverage limitations of at least 3.0x current receipts to pay debt service. In contrast standalone transit GARVEE bonds have materially lower leverage limitations of 1.5x, giving them less financial flexibility to protect against declines in federal program revenues and are thus rated 'BBB'.

RATING SENSITIVITIES

Negative or Positive - A material change in Fitch's view of the strength of the Federal program.

TRANSACTION SUMMARY

The state of North Carolina is expected to issue \$300 million of series 2015 GARVEE bonds to price the week of May 20. The bond proceeds will be used to finance in part various projects identified in NCDOT's STIP that are eligible for federal funding. In addition to the series 2015 bonds, the department is also proposing to issue an additional \$300 million of GARVEE bonds in the spring of 2016, which has been considered in Fitch's forecast.

The Highway Trust Fund (HTF) continues to be on an unstable trajectory with expenditures exceeding revenues. The most recent legislative authorization, Moving Ahead for Progess in the 21st Century Act (MAP-21), relied on \$10.8 billion of transfers from the general fund and did not address the long-term structural imbalance in the HTF. An interim measure passed in early August 2014 keeps the program running through May 2015. Given that the larger debate on ways to fund the HTF is expected to continue, it is unlikely that Congress will approve a longer-term reauthorization within the next month and will require more short-term fixes. Fitch will continue to monitor legislative developments as they unfold. In the event that the discussions may lead to delays in federal aid distribution, the department has \$85 million of cash in the set-aside account, equivalent to one year of debt service, to mitigate this risk.

Future funding levels will be 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. Further complicating matters is the increase in corporate fuel economy standards approved in August 2012 that could adversely impact gas tax revenues which support the HTF going forward. The risk of potential reduction in federal funding is offset by the department's DSCR which remains strong at 11x in 2014.

Fitch's sensitivity analysis assumes a 26% decrease in federal transportation funds to match the amount of receipts coming into the HTF. Under this scenario, debt service coverage is expected to remain strong, above 6.3x through 2019 and then improving to 9.5x by 2024 as a result of declining debt service.