Federal transportation infrastructure spending has a long history and serves a critical need both by providing a public good and by leveraging additional investment by state, local, and regional entities. According to the Congressional Budget Office, in 2017, the federal government spent $84 billion on transportation capital or operations and maintenance, in direct investment or through grant programs supporting highway and transit spending. Buoyed by December 2015's $305 billion reauthorization of the U.S. surface transportation program (Fixing America's Surface Transportation [FAST] Act) through September 2020, state, local, and regional entities have issued grant anticipation revenue vehicle (GARVEE) bonds backed by the anticipated federal dollars to support roadway and transit investment. These programs are largely reimbursement or formula-based programs that allow states or local transit providers to leverage federal transportation funding for capital or operating purposes and advance projects earlier than they otherwise would have been completed.

S&P Global Ratings has evaluated the 29 grant programs for highways and transit in 27 states and territories. A primary benefit of federal aid programs in transportation--both for state and local governments, and for bondholders--has been the reliability, relative stability, and predictability of funding. These characteristics provide certainty needed for long-term planning associated with large transportation projects while protecting recipients and bondholders from the risk of Congressional appropriations, thereby advancing projects that might not otherwise proceed for several years. Money in the federal Highway Trust Fund (HTF) secures these grant programs. Issuers have generally had strong coverage levels and liquidity contingency plans, contributing to strong ratings on related bonds. Despite the sector's vulnerability to government shutdowns, we expect this support will continue from all levels of government, so we have a stable outlook on the sector.

How We Rate GARVEE Bonds

S&P Global Ratings evaluates different security structures and additional state support that account for the range of ratings. Our criteria, "Methodology And Assumptions: Rating U.S. Federal Transportation Grant-Secured Obligations" (published May 29, 2009), outlines the analytical approach to the security structure and assessment of the supportive funding and legislative framework. In our view, the highly rated programs have been an efficient and effective financing tool. In addition, we apply our "Federal Future Flow Securitization" criteria (published March 12, 2012), to determine the maximum possible rating level relative to the U.S. sovereign rating (AA+/Stable/A-1+), after factoring in federal entity and project- or program-specific factors.

The ratings on GARVEEs assumes that the supportive legislative framework and Congressional appropriations funding transportation grant programs will continue through multiyear authorizations or continuing temporary extensions. This assumption is based on historical precedent, our view of the political and economic importance of national highway and mass transit systems, the broad historical bipartisan political support for transportation spending programs at all levels of government, and Congress' track record of continuing appropriations and extensions to budget authorizations.

S&P Global Ratings' credit ratings in this sector range from 'A' to 'AA' where only federal funding is pledged, and as high as 'AAA' where state agencies blend the federal funding with an additional pledge of state funding. We base the relatively strong ratings in this sector on the issuer's pledge of the HTF grants from the federal government. Overall, we believe, the FAST Act's signing confirms our views of ongoing and widespread Congressional support for preserving and expanding the national highway system. States and local transportation agencies that receive distributions from the HTF can confidently proceed with complex multiyear transportation projects because the questions surrounding federal funding no longer loom. Nevertheless, we carefully evaluate the risks to state programs that leverage these funds, including the timing of receipts, level of funding, and erosion in dollars due either to lower authorized or appropriated levels or to programmatic changes that negatively affect recipients. We will continue to monitor the sector to evaluate how each individual state issuer might adjust its debt or capital spending plans, given the new law.

Although reauthorization risk cannot be eliminated, it has been minimized through conservative financial structures inherent in all rated GARVEE transactions, which have resulted in the relatively high ratings on these transactions. These include the use of backup credit support, debt service reserves, robust debt service coverage levels, shorter final maturities, and restrictive additional debt provisions. In addition, many nonquantitative credit factors influence the rating, such as funding mechanics and timing; evaluation of state processes for managing and administering the program; history of federal receipts and volatility; each state's donor status, underlying economy, and transportation needs; and each state's respective political representation and Congressional influence.

The Sector Is Particularly Sensitive To Government Actions

As we recently observed, during a government shutdown, transit is the most-affected transportation sector because nearly all employees of the Federal Transit Administration (FTA) are deemed nonessential, including those FTA staff responsible for administering disbursement of grant payments regardless which fiscal year the funds come from. For example, a transit agency requesting payment or reimbursement for a previously approved and appropriated grant--not just the current federal budget year--would be left in the lurch. So transit GARVEEs (that is, bonds secured by reimbursements from the FTA) are exposed to possible nonpayment during a government shutdown.

However, issuers of transit grant-secured bonds (transit GARVEEs) that we rate have liquidity or structural features--such as prefunding principal or interest payments well in advance of due dates--that mitigate delays in receipt to ensure timeliness of debt service payments. For example, some issuers have lines of credit or have fully funded their next principal and interest payments a year in advance. Federal highway grants that support debt service payments of states that have leveraged this reimbursement program are minimally affected by a prolonged shutdown because the Federal Highway Administration has a different nonappropriated funding source and is fully staffed during a shutdown.

Rated GARVEE bonds consistently demonstrate very strong pro forma maximum annual debt service (MADS) coverage. Pro forma MADS coverage across rated bonds ranges from a low of 1.6x to a high above 300x, with most programs producing coverage from obligated authority and actual federal receipts of at least 4.0x. The strong coverage levels remain a key credit strength for the sector. Our pro forma MADS coverage calculation is based on the GARVEE program's actual obligation authority or federal receipts and pro forma MADS, which includes existing debt service plus debt service from planned issues.

In addition to coverage levels and the presence, or lack thereof, of additional security, bond provisions are important in determining GARVEE credit quality. While most GARVEE programs don't have funded debt service reserves, nearly all have tests governing the issuance of additional bonds, and we view these additional bond tests (ABTs) as an important rating factor. ABTs typically compare projected coverage levels from federal apportionments, including the planned additional bonds, to MADS obligations. Because most GARVEE programs issue debt with level debt service, MADS coverage levels are a good indicator of a program's ability to cover its obligations, based on current funding levels. We furthermore consider ABTs that require stronger coverage levels based on historical, rather than projected, federal funding as better than those that allow the inclusion of projected funding levels.

Annual Sector Report Card

As part of its review, S&P Global Ratings affirmed all 29 ratings in the GARVEE sector (see chart and table).

Outlook: Stable

The outlook is stable for 28 out of the 29 GARVEE issuers. The stable outlook reflects our expectation that the longstanding federal aid highway program will continue to receive what we consider significant funding and that the states will continue to receive their historical share of annual distributions to provide very strong MADS coverage. Funding through 2020 is relatively certain following the FAST Act's passage. Grant-secured obligations are based on the assumption that the HTF will remain solvent, from either federal gas and transportation taxes or transfers from the U.S. Treasury, and federal reimbursements will arrive as anticipated. While there is always uncertainty regarding the ultimate Congressional appropriation levels, we believe near-term federal funding will be close to authorization levels in the FAST Act.