SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA' rating to the following Los Angeles County Metropolitan Authority (Metro), California bonds:
--$62.1 million Proposition C sales tax revenue bonds, senior bonds, series 2014-A.
The series 2014-A bonds are scheduled to be sold competitively on June 11. Proceeds will be used to refund the remaining outstanding series 2004A bonds for savings and fund a debt service reserve fund with cash.
In addition, Fitch affirms the following ratings:
--$453.4 million Proposition C sales tax revenue bonds senior bonds, series 2004-A (to be refunded), 2013-B and 2013-C at 'AA'.
The Rating Outlook is Stable.
Proposition C senior sales tax revenue bonds are secured by a first lien on the Proposition C 1/2 cent sales tax applied to all taxable sales within Los Angeles County (the county), net of an administrative fee paid to the State Board of Equalization and net of the 20% allocated to local jurisdictions for local transit. The State Board of Equalization remits the net Proposition C sales tax revenues directly to the trustee each month.
KEY RATING DRIVERS
SOUND DEBT SERVICE COVERAGE: Estimated maximum annual debt service (MADS) coverage for fiscal 2014 remains strong at 4.2 times (x) despite historical volatility in pledged revenues. Fitch anticipates that sizeable future debt issuance will be structured to ensure continued strong debt service coverage for the medium to long term.
HUGE, DIVERSE ECONOMY AND TAX BASE: Metro's tax base and service area enjoy fundamental long-term strengths, including modest population growth, a huge and diverse economic base, and a resilient tax base. These factors counterbalance a stubbornly high unemployment rate and mixed socio-economic indicators.
SOUND DEBT PROFILE: Metro demonstrates sound gross and net leverage on its existing debt portfolio. Nonetheless, Metro will need to balance its sizeable future debt repayment obligations with its expanding operational funding requirements.
WAGE AND RETIREE COST PRESSURE: Metro's pension and OPEB systems will likely generate additional funding pressure in the future given their weak funded ratios. In addition, recently contracted multi-year salary increases for one of five transit unions points to additional operating cost pressures.
STRONG FINANCIAL MANAGEMENT: The 'AA' rating reflects Metro's ability, as an expanding transportation system, to balance the public's demand for expanded transit service with construction and operating expense growth, given the realities of sales tax revenue fluctuation and significant competition for state and federal funding.
The rating is sensitive to shifts in fundamental credit characteristics including strong debt service coverage by Proposition C sales tax revenues and maintenance of significant available funds for transit operations. The Stable Outlook reflects Fitch's expectation that such shifts are unlikely.
Metro is coterminous with Los Angeles County, covering 1,433 square miles and serving almost 10 million residents. Metro operates the nation's second largest transportation system. It carries an estimated 1.6 million passengers per weekday on its bus and rail services, and funds 40 municipal operators providing fixed-route services and more than 100 local agencies providing community-based transportation. Metro is also responsible for some highway construction funding and traffic flow management.
SOUND DEBT SERVICE COVERAGE
Debt service coverage remained strong at its recent low of 3.3x MADS in fiscal 2010 after Proposition C sales tax revenues dropped a cumulative 18% during fiscal 2007 to fiscal 2010. Since then, Proposition C sales tax revenues have rebounded strongly, increasing 26% through fiscal 2014 (estimated) and more than offsetting the prior decline. Fiscal 2013 debt service coverage was a strong 4.0x MADS. Sales tax revenues are forecast to grow a further 4% in fiscal 2014 and Metro is assuming an average of 3% annual growth through fiscal 2039 which seems slightly optimistic given an average growth rate of 2.5% during fiscal years 2001-2013.
Proposition C sales tax revenues stand up well to severe loss scenarios. They would need to decline by an unprecedented 80.6% to drop to 1.0x MADS. More likely is a slight reduction in debt service coverage as additional debt comes online. Metro is planning to issue $4.4 billion of additional debt through fiscal 2040. Fitch anticipates that this sizeable future debt issuance will be structured to ensure a level of debt service coverage that is still commensurate with the 'AA' rating category over the medium to long term.
While the additional bonds test (ABT) for the Proposition C sales tax revenue bonds is weak at 1.3x MADS, historic and projected leverage are much lower than the ABT would permit. This reflects certain constraints. The Proposition C tax ordinance contains strict allocation requirements as to how the monies can be spent, Metro debt policy caps the use of its revenues for debt service at 35%, and transit system operating requirements effectively limit the level of future borrowing.
The Proposition C bonds have a standard-sized, fully cash-funded debt service reserve currently funded with about $144 million in cash and investments.
HUGE, DIVERSE ECONOMY AND TAX BASE
Metro's economic and tax bases are huge, mature, and highly diversified, demonstrating both revenue strength (particularly with regard to sales tax revenues) and tax base resiliency. Relatively minor TAV losses in fiscal years 2010 (-0.5%) and 2011 (-1.9%) subsequently have been more than offset by gains in fiscal years 2012 (1.4%), 2013 (2.2%), 2014 (4.7%) with a further 5.1% TAV increase anticipated for fiscal 2015.
The county's diverse economy is vulnerable to significant cyclicality as evidenced its above average unemployment rate. Nonetheless, strong employment growth and modest labor force growth year over year ending Dec 2013 brought the jobless rate down to 8.8% from 10.2% in June 2013. The county's income and wealth indicators are below state levels and mixed relative to the nation, reflecting some highly urbanized and low income areas and an above-average immigrant population. Population growth continues to be slow and manageable, averaging 0.3% per year over the last decade.
SOUND DEBT PROFILE
The need to fund the vast operating and capital needs of the transit system from residual tax revenues limits the likelihood that Metro will issue to levels approaching the ABT. Fitch estimates net debt to revenues after payment of operating expenses at 4.0x in fiscal 2014. This calculation nets from gross debt unrestricted cash and investments and cash-funded debt service reserves, and divides that number by net revenues of the governmental and enterprise funds. Fitch will monitor the risk that leverage materially increases as Metro executes its future capital program, particularly those projects funded from significant issuances backed by Measure R sales tax revenues.
Metro expects to issue considerable additional debt through fiscal 2040: $2 billion secured by Proposition A sales tax revenues, $4.4 billion secured by Proposition C sales tax revenues, and $5.5 billion secured by Measure R sales tax revenues. Since this debt will be issued in tandem with ongoing expansion of Metro's transit services, it will be important for Metro to balance its future debt repayment obligations with its expanding operational funding requirements.
Since the recession, Metro has eliminated nearly one-third of its variable rate and swap counterparty exposure. There are now no swaps associated with outstanding Proposition C sales tax revenue bonds.
WAGE AND RETIREE COST PRESSURE
Metro operates a single-employer public employee retirement system that includes five defined benefit plans covering most employees. As of Dec. 31, 2012, Metro calculated that these plans had a weak funded ratio of 64.7%. By contrast, a small subset of Metro employees participate in a defined pension plan administered by CalPERS that has a strong funding ratio of 92.6%. Whereas Metro funds fully the actuarially required contributions (ARC) for all its pension plans, it funds its other post-employment benefit (OPEB) obligations only on a pay-as-you-go basis plus 5% of ARC or $5 million. As of Jan. 1, 2013, its OPEB funded ratio was an extremely weak 19.7%. Given these weak funded ratios, Fitch expects that Metro's pension and OPEB systems will generate additional funding pressure in the future.
STRONG FINANCIAL MANAGEMENT
Financial operations are currently sound but remain vulnerable to concentration in volatile sales tax revenues. The low farebox recovery ratio of about 26% provides limited diversity to Metro's revenue base. Reflective of adequate operating performance is Metro's sound average coverage of all current debt service net of operating expenses, which Fitch estimates at 1.89x (between fiscals 2014 and 2018). Fitch calculates that this figure might decline to 1.20x based on conservative future debt issuance assumptions and Metro's prudent expense management during the recession. Metro responded to shrinking revenues by cutting costs, reducing service hours, raising fares, and significantly scaling back capital and debt plans.
In the near term, Metro will need to manage wage pressure as evidenced by its recent four-year agreement with one of its transit workers' unions which includes 3% annual raises. In the longer term, future leverage will be taken on, particularly on the Measure R lien to fund rail expansion projects. The continued ability to balance both rising debt service payments and the increasingly costly operating needs of an expanding system will be crucial to maintaining the rating.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, and National Association of Realtors.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria