Fitch Upgrades $1.42B LACMTA Prop. C Sales Tax Rev. Bonds to 'A+'.

SAN FRANCISCO -- Fitch rates the Los Angeles County Metropolitan Transportation Authority, CA's $180,00,000 Proposition C sales tax revenue bonds, second senior bonds, series 2004-A, 'A+' and upgrades to 'A+' from 'A' $1.22 billion in outstanding parity bonds. The new issue will sell competitively on Oct. 13. Also, Fitch affirms the 'A+' rating on $1.58 billion in Proposition A first tier first senior bonds and the 'A' rating on $11.0 million in Proposition A first tier second senior bonds. The Rating Outlook for all bonds is Stable. The financial advisor for the new issue is Public Financial Management, Inc.

The upgrade reflects high debt service coverage resulting from the continued strong Proposition C sales tax performance, coupled with the Metropolitan Transportation Authority's (MTA, or the authority), as well as the MTA's intent to not to issue debt senior to the second senior bonds. In fact, the MTA is considering closing its Proposition C first senior lien. The ratings on both Proposition A and C bonds also considers the MTA's overall operating and structural characteristics, as well as recent accomplishments and continuing challenges and bond types' lien status and legal features. Challenges include restraining cost growth in light of strong labor unions, managing capital needs and requirements ordered by a special master and consent decree, and increasing ridership and farebox recovery.

The MTA's bus and rail system is extensive, and future capital spending is focused on improving reliability and connectivity rather than system expansion. Financial operations have benefited from growing sales taxes, yet financial pressures continue, with fare increases limited until recently by a consent decree and strong labor pressures. The last two union contract negotiations resulted in strikes, each lasting over one month. The system's farebox recovery ratio remains low (29%) due to passenger fare restrictions, operating expense growth, and interrupted ridership gains. While recent ridership figures show a decline largely resulting from last year's strike, overall growth is evident and the various transportation lines generally recover lost ridership over time.

The new bonds and outstanding proposition C second senior sales tax revenue bonds are secured by a second lien on the MTA's 80% share of the one-half cent Proposition C sales tax. While the current legal documents allow for a lien prior to these bonds', the MTA has never issued first senior debt and does not plan any future sales. The tax is levied countywide and is showing strong growth. Annual sales tax gains have averaged 4.2% since 1992 and declined in only one year. Pledged revenue in fiscal 2004 covers debt service that year at a high 4.9 times (x) and covers maximum annual debt service (MADS), including the new bonds, 4.4x. The additional bonds test is satisfactory, requiring historic pledged revenue to cover MADS, including the new bonds, 1.3x. Assuming the MTA's planned $1.1 billion in additional parity debt is sold as planned through fiscal 2014, coverage falls to a still strong 3.4x using 4.1% annual sales tax gains, and 2.3x based on a very conservative no sales tax growth scenario.

Fitch continues to note several improvements in the MTA's administration and operations over the past several years and also notes remaining challenges. In the past few years, the authority has increased operating efficiency as evidenced in costs per service hour while expanding bus and rail operations. Also, MTA management demonstrates greater stability with several senior members in their positions for at least five years. In addition, the MTA has improved its relationship with the Federal Transit Administration, including securing a full funding grant agreement for the upcoming East Side Light Rail project. Lastly, the Nov. 1, 2003 expiration of the consent decree's prohibition on fare increases gives the MTA greater fare flexibility from a legal standpoint. However, Fitch views the MTA's ridership base as fare sensitive, yielding a practical fare-raising limit.

The authority's remaining challenges are managing labor costs and the mandates of a consent decree stemming from litigation filed in 1996 by a bus riders' group. Labor negotiations now typically require arbitration, and a strike resulted in both 2000 and 2003. While the MTA board showed notable unity in both instances and secured relatively favorable contracts that included work rule changes, the strikes disrupted attempts to increase ridership.

The consent decree, as interpreted by the assigned special master, restricts the MTA's operating and service flexibility by such things as mandating vehicle acquisition levels, required fare discounts, and, through Nov. 1, 2003, limiting fare increases. While the MTA has successfully increased the special master's awareness of the system's needs, constraints, and financial requirements, conflicts between the MTA and the litigants over certain key matters remain unresolved. Some agreement between the parties is needed for compliance with the decree and its eventual dismissal. The lack of resolution on these matters presents uncertainty, and their final determination could be costly.