OREANDA-NEWS. April 13, 2015. Fitch Ratings has affirmed the 'A' rating on Commonwealth of Kentucky State Property and Buildings Commission (SPBC) agency fund revenue bonds, project no. 91 and project no. 105 issued for the Kentucky River Authority (KRA).

The Rating Outlook is Stable.

SECURITY

The project no. 91 and project no. 105 bonds (collectively, the River Authority bonds) are special and limited obligations of the SPBC, payable solely from revenues derived under financing/lease agreements between the commission, as lessor, and the commonwealth's finance and administration cabinet (the cabinet) and the KRA, as lessee. A moral obligation pledge of the commonwealth of Kentucky to restore draws on the debt service reserve provides additional security and is the basis for the rating.

KEY RATING DRIVERS

GENERAL FUND MORAL OBLIGATION (MO): The rating on the bonds issued for the KRA is two notches below that of the commonwealth's implied general obligation (GO) rating('AA-'). The direct linkage reflects that KRA is an entity of the state, serves a broad state purpose of maintaining a key environmental resource, and finances an ongoing program of capital projects. The close oversight of the KRA by Kentucky's finance and administration cabinet and issuance of the bonds through the SPBC, which is a key commonwealth financing mechanism, indicates the further commitment of the MO provider, the commonwealth of Kentucky, to KRA. The MO mechanism and timing meet Fitch's criteria with all requirements related to the MO spelled out in the bond resolutions and lease agreements between the SPBC, the KRA and the cabinet. Under the lease, the cabinet, the commonwealth's financial management organization, has covenanted to request general fund appropriations for replenishment of the reserve fund to its requirement of maximum annual debt service (MADS) upon a draw down.

COMMONWEALTH'S LIMITED OPERATING FLEXIBILITY: The commonwealth's operating flexibility is constrained compared with that of most states with weak depleted reserves and a continuing reliance on nonrecurring revenue sources, though no further deficit bonding is included in the current biennial budget. The last biennium ended with an unexpected revenue shortfall, but current year performance is in line with the budgeted forecast.

COMPARATIVELY HIGH LONG-TERM LIABILITIES: The commonwealth's combined debt plus unfunded pension system liabilities are amongst the highest for U.S. states. Recently adopted pension reform measures, including a commitment to full actuarial funding for one of Kentucky's systems, are a positive step. But significant challenges remain, including a continually underfunded teachers' plan.

STEADY JOBS RECOVERY: Kentucky's economic recovery from the recession has been solid as the commonwealth recently returned to its pre-recession peak employment levels. Other trends including labor force contraction, below-average population growth and low levels of educational attainment pose long-term demographic challenges for Kentucky.

RATING SENSITIVITIES

The rating is sensitive to changes in the commonwealth's implied GO rating of 'AA-', on which this rating is based.

CREDIT PROFILE

The 'A' rating is based on the MO pledge of the commonwealth evidenced through the cabinet's covenant to request general fund appropriations for replenishment of the reserve fund up to its required MADS level as needed, and Kentucky's general credit quality. The legislature created the KRA in 1986 to manage operations of various locks and dams along the Kentucky River which were originally built by the United States Army Corps of Engineers. KRA's mission expanded two years later to include environmental management along the Kentucky River Basin, which serves as a major source of drinking water for commonwealth residents, including the city of Lexington. The bond resolutions authorizing the KRA bonds establish a reserve fund, funded with bond proceeds at MADS. The resolutions obligate the trustee to promptly notify the cabinet of any reserve fund deficiency. In the lease agreement for the bonds, the cabinet covenants to seek general fund appropriations to restore any deficiency in the reserve fund.

Given the close oversight of KRA by the cabinet (the cabinet secretary is an ex-officio member KRA's governing board), Fitch anticipates the cabinet would know well in advance of any shortfalls of KRA's revenues expected to be used for debt service. KRA dedicates its Tier II revenues, levied on certain entities drawing water from the Kentucky River, to support debt service. Fiscal 2014 revenues provided 1.3 times (x) coverage of MADS, which is in line with historical trends.

Kentucky's 'AA-' implied GO rating reflects the commonwealth's limited fund balances following depletion amidst recession-driven revenue shortfalls, continued reliance on one-time measures in the current biennial budget, and a high liability position, including unfunded liabilities for state-supported pension systems. Kentucky continues to face budget balancing challenges despite some economic recovery, indicating a structural problem that goes beyond the impact of cyclical recession and recovery on its financial operations. In each of the past five biennial budgets, beginning in fiscal 2007 as well as for the current biennium which began on July 1, 2014, the commonwealth has relied on one-time solutions to balance its budget, including depletion of reserves, debt restructuring, and borrowing for operations. No deficit bonding is included in the current biennial budget.

For more information on the commonwealth's implied GO rating, please see the Fitch release titled 'Fitch RatesS Kentucky SPBC's \\$388MM Proj. 108 Revenue Bonds 'A+'; Outlook Stable ', dated Jan. 20, 2015 and available at 'www.fitchratings.com'.