Fitch Affirms Los Angeles County MTA, CA's Prop. C Sales Tax Rev Bonds at 'AA'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the following bonds issued by the Los Angeles County Metropolitan Transportation Authority (MTA), CA (LA Metro) at 'AA':

--$412 million senior Proposition C sales tax revenue bonds series 2013-B, 2013-C, and 2014-A.

In addition, Fitch has assigned an Issuer Default Rating (IDR) of 'AA' to LA Metro .

The Rating Outlook is Stable.

SECURITY

The Proposition C senior sales tax revenue bonds are payable from a first lien on the Proposition C 1/2 cent sales tax applied to all taxable sales within Los Angeles 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

The 'AA' IDR reflects LA Metro's strong operating performance, moderate long-term liability burden, solid expenditure control, and strong economic growth prospects, which offset the authority's limited independent legal ability to raise revenues. The rating on the Prop C sales tax bonds, which is capped at the level of the authority's IDR, is supported by solid growth prospects and strong debt service coverage.

Economic Resource Base

The economic resource base is exceptionally large and diverse and growing at a solid pace. Los Angeles County is the largest in the U.S., with a population of over 10 million people. The county accounts for more than a quarter of the state of California's population and economic output.

Revenue Framework: 'a' factor assessment

Growth prospects for revenues are strong, but the authority has limited independent legal ability to raise revenues due to tax limitations.

Expenditure Framework: 'aa' factor assessment

Fitch expects expenditure growth to track revenue growth and believes the authority has solid flexibility to adjust spending throughout the economic cycle.

Long-Term Liability Burden: 'aa' factor assessment

The long-term liability burden is very low relative to the large economic resource base, but moderate relative to cash flows and net plant assets.

Operating Performance: 'aaa' factor assessment

The authority has exceptionally strong gap closing capacity, reflecting a sizeable reserve cushion. Fitch believes the authority is likely to use its solid expenditure flexibility to maintain a high level of financial flexibility across business cycles. Near-term prospects for financial performance are quite strong due to voter approval of new taxes to fund increased transportation investments in the county.

RATING SENSITIVITIES

REVENUE PERFORMANCE, LEVERAGE: The IDR could come under downward pressure in the event of a weakening in Fitch's expectations for the authority's economic and revenue base or unexpected deterioration in fundamental financial flexibility. The rating is unlikely to rise in the outlook period due to limitations on the independent legal ability to raise revenues and expected increases in the long-term liability burden.

LEVERAGE RISKS: The sales tax revenue bond rating could come under downward pressure if the authority leverages the revenue streams more than currently expected. The rating is also sensitive to movement in the authority's IDR, which serves as a rating cap.

CREDIT PROFILE

Los Angeles County, with a population that would rank it among the 10 largest U.S. states, is home to both a manufacturing center and a broad and diverse service economy. The county economy includes major entertainment, tourism, healthcare, higher education, trade and transport, and governmental sectors. Despite these strong economic and tax base characteristics, the unemployment rate is typically higher than the nation's. Wealth indicators are below the state's and mixed relative to the nation, reflecting some highly urbanized and low-income areas.

The authority is the largest public transit operator west of Chicago with light rail, heavy rail and bus services that carry about 1.4 million passengers a day. The authority also provides highway construction funding, traffic flow management and transit funding assistance to local communities across its vast 1,433 square mile service area. The authority has been aggressively expanding subway and rail transit in the highly congested county and recently received voter approval for an additional sales tax that the authority estimates will provide more than $60 billion in additional transit funding over the next 40 years. Average weekday ridership equaled about 30% of payroll employment in 2015.

Revenue Framework

Voter-approved sales taxes provide about two thirds of total revenues. Local voters have approved four separate half-cent sales tax measures. Federal and state capital and operating support provides about a quarter of revenues. Fares and other operating revenues are a relatively minor revenue stream at about 10% of revenues.

Growth prospects for revenues are strong. The dominant sales tax revenue stream is somewhat volatile, but tracks economic activity well over time. The 4% 10-year compound annual growth rate of revenues was above both the rate of U.S. GDP growth and inflation through 2015. Fitch attempts to adjust for policy changes (such as the approval of new taxes) to analyze the underlying growth trajectory of revenues. For LA Metro, the figure excludes volatile capital grants that cannot be used for operations and estimates sales taxes at current tax rates across the period.

The authority has very limited independent legal ability to raise revenues due to strict state tax limitations that require a vote of the people to approve tax increases. The authority has gotten strong voter support for tax measures, but the its board of directors cannot increase taxes independently. State and federal grant funding is decided by outside bodies. The main independent revenue flexibility available to the board is the ability to adjust fares, but fares and other operating revenues are a small part of the overall budget.

LA Metro has significant exposure to outside funding that is beyond the control of the authority, including significant funding for capital from the state of California and the federal government. This is not unusual for transit agencies, but Fitch's assessment of the revenue framework could be reduced if the authority's access to intergovernmental aid declined on a sustained basis.

Expenditure Framework

LA Metro's expenditure framework is typical for a fast-growing U.S. transit agency, with primary spending driven by labor, fuel and capital costs.

Fitch expects the agency's spending to remain in-line with its healthy revenue growth. The authority faces demand for increased services and greater capital investments, but such demands have generally been matched with rising revenues. Management negotiates compensation to keep adjustments in total compensation in line with revenue growth.

Expenditure flexibility is solid. The authority's board has strong control over service levels and headcount and has demonstrated an ability and willingness to adjust spending in past economic downturns. The authority also benefits from significant spending flexibility due to the ability to temporarily defer pay-go capital spending during downturns or to shift funding strategies from pay-go to debt financing during periods of stress. The authority's 2017 to 2021 capital improvement plan includes an average of about $420 million a year in pay-go capital spending.

The relatively fixed carrying costs of debt service, pensions and other post-employment benefits (OPEB) were moderate at about 13% of expenditures in fiscal 2015. The district has some (but not complete) control of labor costs. It must negotiate pay and benefits levels with its five employee unions. Management ultimately controls headcount and may ultimately impose terms after an impasse, but district employees retain the ability to strike.

Long-Term Liability Burden

The authority's long-term liability burden is low relative to its large economic base and composed primarily of sales tax revenue bonds. The long-term liability burden (including estimated unfunded pension liabilities of about $372 million based on Fitch's standard 7% rate of return assumption) equaled $4.8 billion, or 1% of personal income, in 2015. Long-term liabilities appear higher but still moderate by other measures, such as debt-to-funds available for debt service at 4.8x and debt-to-net plant assets at 42%.

Debt is likely to increase over the next decade as the authority continues to invest heavily in its capital infrastructure and begins to leverage new revenues recently approved by voters. The authority's $7.1 billion 2017 to 2021 capital improvement plan includes about $2.5 billion of new borrowing. The authority will amortize about $1.1 billion of debt over the period, increasing its overall long-term liability burden by more than a third including debt already issued in fiscal 2016. Fitch expects debt to remain low relative to personal income and moderate relative to cash flows even with the additional borrowing. Cash flows are expected to rise substantially over the next five years, as newly authorized taxes increase the dominant sales tax revenue stream by about a quarter, somewhat softening but not fully offsetting the impact of new borrowing on debt ratios.

A variation from the referenced criteria was applied in this analysis. The committee assessed the long-term liability burden via a modification to the debt metrics supporting the long-term liability assessment. The district is a local, tax supported government enterprise. Fitch's credit opinion is that the district debt burden is best analyzed by combining measurement methods typically used in self-supporting enterprises and the approach usually applied to local governments.

The authority's $1.1 billion unfunded OPEB liability is modest relative to the economic resource base at 0.2% of personal income.

Operating Performance

The authority is very well positioned to withstand typical cyclical revenue variability. Unrestricted cash and investments equaled $1.4 billion, or a strong 50% of operating expenses (184 days cash) at the end of fiscal 2015. The authority has posted positive margins in recent years, and net revenues after payment of operating and maintenance expenses provided solid all-in debt service coverage of about 1.7x in fiscal 2015. The reserve cushion equals almost 15x the 3.4% revenue loss that the Fitch Analytical Sensitivity Tool (FAST) suggests the authority may experience in Fitch's standard moderate economic downturn scenario (a 1% decline in U.S. GDP). The FAST estimate is based on an analysis of the authority's long-term revenue performance across economic cycles.

Fitch expects the authority to adjust service levels, fares and capital spending to maintain a healthy financial cushion and cash balances through a downturn. The authority may also increase debt funding of capital for a period in downturns, which is typical for capital intensive enterprises and would not materially affect Fitch's long-term liability assessment for the authority. The ability to shift between capital funding sources (locally generated pay-go, grants from higher levels of government and use of debt) is a key source of financial flexibility.

Budget management in times of recovery is very strong. The authority maintains solid reserves across business cycles and engages in thorough long-term financial and capital planning. It has also secured funding to support ongoing investments to maintain a state of good repair for existing assets even as it rapidly expands the system. The authority also fully funds actuarially required pension contributions.

Sales Tax Revenue Bonds

The Proposition C revenue bonds are backed by a first lien on sales taxes collected on a broad and diverse revenue base.The sales tax revenue bond rating is capped at the authority's IDR because Fitch believes debt service payments may be subject to an automatic stay in the unlikely event of a bankruptcy by LA Metro. The 'AA' sales tax revenue bond rating reflects the IDR cap. The underlying sales tax revenues have solid growth and a high degree of resilience to modelled revenue declines at assumed leverage levels.

Sales tax revenue growth generally outpaces inflation but not U.S. GDP growth. The 10-year compound annual growth rate of pledged revenues was 3% in 2014 and 1.9% in 2015. The 2015 reading was distorted by a decline in 2015 that reflects a one-time accrual adjustment, not underlying growth prospects. Fitch expects the key metric to exceed inflation in future years.

To evaluate the sensitivity of the dedicated revenue stream to cyclical decline, Fitch analyzes the degree of coverage cushion that current revenues provide at maximum annual debt service (MADS). Fitch measures the coverage relative to both modelled recessionary revenue declines (using the same 1% decline in GDP economic scenario used in the IDR framework) and the largest decline in revenues over the period covered by the revenue sensitivity analysis. The FAST model generates a 6.5% decline in pledged sales tax revenues in a recession, reflecting a moderately high degree of economic cyclicality in the revenue stream. The largest consecutive decline was a 17.6% decline during the Great Recession.

Assuming issuance up to the 1.3x additional bonds test (ABT), the structure could tolerate a 23% drop in revenues. Fitch does not expect the authority to leverage to the ABT. Fitch expects the authority to comply with voter approved spending allocations and board policies that require much of the pledged sales tax revenue to be spent on operations and uses other than debt service, limiting leveraging of the revenue stream. Given limits on use of revenues, Fitch believes the authority is unlikely to leverage the revenue stream beyond 2.3x debt service coverage on an all-in basis. At 2.3x coverage, pledged revenues could fall 57% before reaching 1x debt service coverage. The 57% coverage cushion is 9x the recessionary decline scenario produced by the FAST model and 3x the largest consecutive decline in the analyzed revenue history. Actual debt service coverage was much stronger at 4.4x coverage in 2015.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/879478

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or
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+1-415-732-5611
or
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or
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Contacts

Fitch Ratings, Inc.
Primary Analyst
Andrew Ward
Director
+1-415-732-5617
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble
Senior Director
+1-415-732-5611
or
Committee Chairperson
Laura Porter
Managing Director
+1-212-908-0575
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com