Fitch Downgrades Penn Turnpike Commission Long-Term Revs to 'A+', Stable Outlook.

NEW YORK -- Fitch Ratings downgrades the rating on the outstanding $2.1 billion of Pennsylvania Turnpike Commission (PTC or the Commission) turnpike revenue bonds (senior lien) to 'A+' from 'AA-' and affirms the 'F1+' on approximately $535 million in bond anticipation notes. The Rating Outlook on the turnpike revenue bonds (senior lien) is Stable. Fitch has not been asked to rate the series A of 2008 subordinate revenue bonds that will be used by the PTC to meet a portion its fiscal-year (FY) 2008 obligations under Pennsylvania State Legislature HB 1590, titled Act 44.

Fitch's downgrade of the PTC's (senior lien) revenue bonds to 'A+' reflects the higher overall leverage of the turnpike system which, on a combined basis could reach between $13 and $14 billion (across all liens) over the next 12 years. The downgrade also reflects the fact that senior lien revenue bondholders are not fully insulated from parity debt being issued to meet obligations under Act 44, which could result in deterioration of historically robust debt service coverage levels.

The rating reflects the high likelihood that under any reasonable scenario senior lien revenue bond debt service coverage would be robust. The downgrade also takes into consideration the mission change of the PTC from a self supporting entity to one subsidizing state-wide functions and the associated lower levels of financial flexibility as excess toll revenues will now flow out to meet Act 44 payments. Given the significant increase in financial obligations and overall leverage the PTC is now dependent upon regular toll increases for obligations outside of the preservation of the turnpike system. Prior to this change, excess toll revenues were maintained within the PTC, mitigating the lack of structured operating and capital reserves. With no covenant requiring specific cash set-asides for necessary rehabilitation efforts there is the potential that capital projects can be deferred to meet Act 44 obligations, resulting in delayed and more expensive capital projects in the medium-to-long-term.

The long-term rating reflects PTC's vital role in serving the state's major population centers as well as its stable historical traffic and revenue growth, its financial performance, which is expected to continue covering all operating and current capital needs of the existing mainline facilities, and its economic ratemaking flexibility. The rating also incorporates the additional $3 billion in senior lien debt needed to fund the PTC's proposed $4.7 billion mainline capital improvement plan (CIP) and increasing leverage to subsidize highway and bridge projects across the commonwealth as well as subsidize transit operations under Act 44. Furthermore, the rating incorporates the senior lien additional bonds test of 1.75 times (x) annual debt service or 1.30x maximum annual debt service and the expectation that the majority of bonds issued to meet Act 44 obligations will be issued on the subordinate lien. The rating also incorporates the rate covenants, though weak, on the subordinate and proposed subordinate guaranteed bonds at 1.15x and 1.0x, respectively, as they provide another floor of protection.

The subordinate indenture allows for two liens of debt in the form of subordinate lien revenue bonds and further subordinated bonds with a guaranty from the Commonwealth of Pennsylvania's Motor License Fund (MLF). The PTC and the Commonwealth are currently negotiating the terms of the guarantee agreement including the priority of payments and timing of payments. Fitch notes that there is no cross default or acceleration between the subordinate and senior indenture.

Under Act 44 PTC is obligated to transfer a total of $750 million in FY2008 (FY end May 31), which was partially funded through the issuance of senior lien PTC Bond Anticipation Notes issued in September 2007. The annual obligation increases to $900 million in FY2010 if a lease for I-80 is entered into, with a 2.5% annual escalator built-in post FY2010. In the event that PTC is unable to place tolls on I-80, the annual obligations to PennDOT would drop to $450 million annually through the term of the lease. An important consideration is that the PTC is required to meet the higher level of payments until a decision or ability to toll I-80 has been reached, which could be up to six years, and the PTC will not likely be reimbursed from PennDOT for the higher payment levels and associated debt issued to make such payments in the event that I-80 is not tolled. The PTC Act 44 payments will be used by PennDOT to supplement its highway and bridge program and fund a Public Transportation Trust Fund to support the capital and operating needs of the commonwealth's transit agencies.

At this time, PTC and (PennDOT) have applied to the US Department of Transportation (USDOT) to convert the portion of I-80 running through Pennsylvania to a toll road. Pursuant to the lease between PTC and PennDOT, the turnpike would operate and maintain I-80, charge and collect tolls and make lease payments to PennDOT for a 50 year term. The current plan for I-80 contemplates surplus I-80 revenues being used to support subordinate debt service and Act 44 obligations, providing no credit enhancement to the senior debt. Toll rates/mile on I-80 will likely be comparable to the mainline and would follow a similar 3% annual rate adjustment schedule once established.

Reflecting its mission change the PTC anticipates meeting its significantly increased annual obligations in the near- to medium-term through the combination of a 25% toll increase on the mainline turnpike in 2009, 3% annual toll increases thereafter and the potential issuance of nearly $9 billion in debt. Without both debt and toll increases the PTC could not meet Act 44 obligations for the next 10-15 years. After a thorough analysis of the PTC's plan, using PTC assumptions, Fitch believes that there are reasonable scenarios under which planned toll increases may be insufficient to meet the annual obligations under Act 44 in the medium term and additional leveraging and/or higher toll rates may be needed.

Furthermore, Fitch's base and stress case scenarios indicate that both significantly higher leveraging and toll increases above 3% annually may be needed earlier to meet debt service coverage and its obligations under Act 44. This could exacerbate political risks. Fitch notes that while missing an Act 44 payment would not trigger an I-80 lease termination, the commonwealth is anticipating the availability of this revenue stream for its wider transportation program.

The PTC is taking on its new obligations in an uncertain political environment. Legislation has been introduced in Congress that could prohibit tolls on I-80. In response to such proposals, Pennsylvania's Governor has reopened consideration for a long-term lease of the Pennsylvania Turnpike to a private operator to generate sufficient funds for the Commonwealth's aforementioned transportation needs. While these alternative initiatives at the state and federal levels raised the level of political risk, Fitch expects the PTC's financial exposure to be limited given its lower level of obligations in the event I-80 is not tolled and the expectation that the commission's obligations would be assumed or taken out under a scenario where the turnpike would be leased to a concessionaire.

PTC has maintained strong debt service coverage of 3.9x and 3.4x in 2006 and 2007 respectively. While coverage levels have been strong, Fitch expects debt service coverage to fall as the PTC manages both existing obligations on the mainline facilities and capital projects contained in its 10-year capital program but also new obligations under Act 44. Revenue growth for FY2005 and FY2006 was strong, increasing 33% and 8%, respectively, to $545 million and $588 million, reflecting the toll increase in August 2004 (FY2005). Revenue growth moderated in 2007, increasing to $592 million, or slightly less than 1%, reflecting minimal traffic growth and no toll increase. Operating and maintenance expenses grew by 5.6% and 5.4%, respectively in fiscal 2006 and 2007, consistent with historical growth rates since 2002. Through the first six months of FY2008, traffic and revenue are tracking slightly higher than 1% as compared to FY2007.

The Pennsylvania Turnpike is the nation's oldest turnpike. It serves Pennsylvania's mature economy, including the cities of Philadelphia and Pittsburgh, which anchor each end of the state. The turnpike also provides a strategic link in the system of turnpikes that stretches from Chicago to Boston. Not surprisingly, toll revenues benefit from a high proportion of commercial traffic. While this introduces some susceptibility of commercial revenues to economic cycles, the sizable boost to revenues in up-cycles softens the negative financial impact in down-cycles. Interstate 80 extends through northern Pennsylvania for roughly 311 miles from the Delaware Water Gap Bridge over the Delaware River on the Commonwealth's eastern boundary to the Ohio-Pennsylvania state line on its western boundary.

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