Fitch Affirms Massachusetts Federal Hwy Grant Anticipation Notes at 'AA'.

NEW YORK -- Fitch Ratings affirms its 'AA' rating on $1.7 billion in outstanding Commonwealth of Massachusetts special obligation notes (federal highway grant anticipation note program). The Rating Outlook is Stable.

The $1.3 billion in outstanding 1998 series A, 1998 series B and 2000 series A notes are primarily payable from federal highway reimbursements received by the commonwealth. If certain covenants are not met regarding annual federal highway funding, a back-up pledge of 10 cents per gallon of commonwealth gasoline excise tax receipts also secures the notes. The $408 million in outstanding 2003 series A refunding notes are secured exclusively and payable from an escrow account until the applicable Dec. 15, 2008 and Dec. 15, 2010 crossover dates. If the commonwealth certifies conditions for issuing the refunding notes on the crossover dates, then the escrow account will also pay principal and redemption premium for the refunded notes. Otherwise, the 2003 series A refunding notes will be subject to mandatory redemption from the escrow account. After the crossover dates, the refunding notes will be subject to the lien of the trust agreement and will be secured on a parity basis with the 1998 series A, 1998 series B and 2000 series A notes.

Credit strengths for the notes include the long history of federal transportation funding in the commonwealth, strong debt service coverage provided by the pledge of all federal highway reimbursements, the 10 cents per gallon gas tax back-up pledge, and structural features that protect noteholders from an unlikely significant decline in, or suspension of federal highway reimbursements. Additional strengths include covenants that limit debt issuance and protect the flow of pledged federal highway reimbursements from remaining issues associated with the completion of the Central Artery/Tunnel Project (CA/T). The rating also considers a condition for the 2003 series A refunding notes is the verification by an independent certified public accountant of the adequacy of escrow investments to meet the account's payout requirements.

A key risk for these notes 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, Efficient Transportation Equity Act -- A Legacy for Users (SAFETEA-LU) took nearly two years to enact. Based on the 17 year maturity profile when the notes were initially sold, the notes transcend a total of three authorization periods, including one remaining future multi-year period. However, the commonwealth's back-up pledge of 10 cents of the gasoline excise tax, while subject to appropriation, provides an important offset to this reauthorization risk.

In the near term, federal transportation funding growth may be less than authorized levels under SAFETEA-LU due to highway trust fund resource constraints. While Massachusetts may be less susceptible to changes in federal transportation funding policy given its status as a donor state, where it receives about $0.92 in federal surface transportation funds for each $1 the commonwealth contributes in federal motor fuel tax revenues, federal transportation funding growth prospects may be more limited given prior significant federal commitments for the CA/T. In Fitch's view, potential federal transportation funding constraints are sufficiently hedged at the 'AA' rating level, by note payment coverage of maximum annual debt service (MADS) of 2.4 times (x) against federal fiscal 2006 federal highway reimbursements and MADS coverage of 3.8x by combined federal highway reimbursements and gasoline excise tax revenues. In addition, the commonwealth's covenant to maintain its advance construction balance of federal transportation funds at least equal to the notes outstanding provides additional protection.

While substantially complete, the CA/T continues to be subject to construction and costs risks including last year's closure, inspection and repair of tunnel segments following the collapse of a segment of the I-90 connector tunnel's ceiling which followed highly publicized events concerning certain slurry wall construction and waterproofing needs for the I-93 portion of the project. Primarily reflecting additional construction and repair expenses, the CA/T's cost estimate increased earlier this year by $210 million to $14.8 billion. The commonwealth expects to cover the additional costs primarily through its transportation infrastructure fund with these amounts reimbursed by the Massachusetts Turnpike Authority through insurance proceeds, cost recoveries and property sales. Noteholders are sufficiently protected from remaining CA/T project and cost issues given since the notes are secured by all federal highway reimbursements, not just those related to the CA/T project. Any funding that may potentially be withheld for the CA/T project would be available for any other eligible project within the commonwealth. Further, federal legislation provides that federal funds will not be withheld if such moneys are needed to pay outstanding notes.

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