Fitch Rates Kentucky Asset/Liability Commission GARVEES 'AA-'.

NEW YORK -- Fitch Ratings assigns an 'AA-' rating to the following issue for the Kentucky Asset/Liability Commission (ALCO):

--$139.6 million project notes, 2005 Federal Highway Trust Fund, first series.

The notes are expected to sell through negotiation with a Citigroup-led syndicate on or about May 25. The notes will pay interest each March 1 and Sept. 1, beginning Sept. 1, 2005, and will mature Sept. 1, 2005-2017. Note proceeds will be used to fund three interstate widening and rehabilitation projects, including: I-65 from Bowling Green to the Tennessee state line; I-75 from the existing 6-lane facility in Scott County, north to the existing 6-lane facility in Grant County; and, I-64 extending east from I-265 toward Simpsonville. Proceeds will also be used for cost of issuance.

The notes are ALCO's first issuance of debt secured by financing payments made from federal transportation funds, which are subject to appropriation by the commonwealth. A memorandum of agreement (MOA) between the Federal Highway Administration (FHWA), the Kentucky Transportation Cabinet (KYTC), ALCO, and the Finance and Administration Cabinet (the cabinet) -- in conjunction with a financing/lease agreement among ALCO, the cabinet, and the KYTC -- establish debt service as a first priority in the flow of federal funds and provides a sum sufficient debt service payment stream of FHWA grant funds.

Fitch's 'AA-' rating reflects the long-established track record of federal transportation funding, KYTC's covenant that it will convert advanced construction funds necessary to cover debt service at the beginning of each federal fiscal year, and the notes' 12-year maturity, which helps limit future federal surface transportation program reauthorization risk. The rating also incorporates the protection of the additional notes test, which allows for additional note issuance only if FHWA grants received during the most recent federal fiscal year exceed maximum annual debt service on outstanding and proposed notes by 4.0 times. While many of the structural protections seen in the bond documents of other direct payment grant anticipation revenue vehicle (GARVEE) transactions are not specified in the indenture, Fitch believes that the covenants in the MOA and the financing/lease agreement and administrative flexibility of KYTC tie together sufficiently to provide similar protections.

Two events worth noting have occurred in Kentucky in the last week. First, recent news reports indicated the potential withholding of grant funds by FHWA due to KYTC's failure to meet affirmative action plan goals. A subsequent letter from FHWA to KYTC stated that FHWA believes that joint FHWA/KYTC efforts to address these issues have been successful and that there will be no adverse effects to the availability of federal funds in Kentucky. As a result Fitch does not view this as an immediate credit concern. Other states have experienced clean-air act and project delivery issues resulting in the potential withholding of FHWA funds. However, given the major role FHWA funding plays in state transportation budgets, solutions have always been found.

Second, following two successive biennia of delayed budget enactments and government operation by executive order, the Kentucky Supreme Court ruled on May 19 that public expenditure in the absence of an enacted budget is unconstitutional except for that required by broad "statutory, constitutional, and federal mandates." At least some forms of "bonded indebtedness" were mentioned as such a mandate. Fitch's ratings consider the importance of appropriation debt to the state and its historical track record.

Pursuant to the MOA, the KYTC covenants that at the beginning of each new federal fiscal year, it will convert the amount of advanced construction funds necessary to pay the scheduled debt service costs for each of the bond financed projects based on the project's share of debt service costs for that federal fiscal year. The conversion of advanced construction funds will be the first authorization in that federal fiscal year of funds legally available for that purpose. KYTC also covenants that if only a portion of the obligational authority is provided by the federal government, KYTC will reserve the same pro-rata share of that portion of the obligational authority for debt service for that year until the full amount is provided.

Similar to other debt programs' leveraging of federal transportation funds, there is no debt service reserve fund. However, this is offset to some degree by KYTC's covenant to convert advanced construction funds in the amount of debt service at the beginning of each federal fiscal year, and that such conversion will be the first authorization of funds legally available. This in effect establishes debt service as the first priority in the flow of federal funds. Principal payment dates on the notes occur on Sept. 1, while the federal fiscal year begins on Oct. 1, providing nearly a year of cushion between the obligation of funds and the principal payment date and six months of cushion between the obligation of funds and the March interest payment date.

A key risk for all GARVEE-backed debt is the potential for significant changes in federal transportation funding policy with each new authorization period. While an interruption in the flow of federal transportation funding is highly unlikely given the broad-based political support for the program, reauthorization of the Transportation Equity Act for the 21st Century (TEA-21), which expired on Sept. 30, 2003, has been significantly delayed. However, the federal government has put in place several short-term extensions, with the latest running through May 31, 2005.

Both the House and Senate have now passed a reauthorization bill. The Senate bill includes an additional $11 billion in funding over the House-passed bill. The Administration has issued a policy statement indicating that it would not support the additional funding. Next steps will probably include a compromise in a conference committee followed by a vote on a conference report by both the House and Senate before a bill is sent to the President. Given the threat of a veto another short-term extension cannot be ruled out.

ALCO was established in 1997 and exists as an independent agency and constituted authority of the Commonwealth of Kentucky. ALCO is authorized to issue tax and revenue anticipation notes, project notes and funding notes. Project notes are to be used for authorized projects upon request of the cabinet, to be repaid through financing agreements or alternative agreements. KYTC is responsible for the construction, reconstruction and maintenance of the Commonwealth's primary road system.