TEXT-Fitch cuts Fresno, Calif. implied go rating to 'BBB+'
Nov 9 - Fitch Ratings has downgraded the following city of Fresno, California (the city) bonds: --Implied general obligation bond (GO) rating to 'BBB+' from 'A-'; --$47.6 million Fresno Joint Powers Finance Authority (Fresno JPA or the authority) lease revenue bonds, series 2006A and series 2009A, to 'BBB' from 'BBB+'; --$120 million Fresno JPA lease revenue bonds, series 2004 (A, B, and C) and series 2008 (A, C, E and F), to 'BBB-' from 'BBB+'. The Rating Outlook remains Negative. SECURITY The lease revenue bonds are secured by lease rental payments made by the city to authority for use and occupancy of a variety of governmental assets. The city has covenanted to budget and appropriate lease rental payments annually. KEY RATING DRIVERS WEAK FINANCIAL POSITION: The downgrade reflects continued concerns about the city's weak financial position and severely limited flexibility in the near to medium term. The city's general fund has minimal reserves, and the city plans to bridge a small deficit in the current budget year (fiscal 2013) by borrowing from its sewer fund. Unrestricted general fund balances are expected to fall below zero for several years. ACCESS TO SIGNIFICANT LIQUIDITY: The city's deficit spending plans are small relative to significant internal borrowable resources in its utility funds, and the city's financial strategy appears reasonable, given limited revenue and expenditure flexibility. However, even temporary deficit spending for operations is a sign of significant budget stress. RISK TO FORECAST: The city's long-term financial forecast shows the general fund returning to balanced operations in fiscal 2014, but that would require modest improvements in sales and property tax revenues and successful privatization of the city's residential solid waste enterprise. While the forecast tax growth assumptions appear plausible, any revenue shortfall would likely yield further deficit spending and could weigh on the rating if significant. OTHER NEGATIVE FUND BALANCES: Several city enterprise funds developed negative fund balances in recent years. Management has moved to address this issue, but resolving these negative fund balances will delay efforts to rebuild healthy general fund reserves for several years. MANAGEMENT WORKS TOWARD BALANCE: The city's current management appears to have a good understanding of the city's financial challenges and has developed a clear plan to withstand the current period stress while working to restore long-term structural budget balance. Willingness-to-pay therefore appears solid. WEAK ECONOMY, LATE RECOVERY BEGINNING: Fresno is the second-largest city in California's agricultural Central Valley and the regional economic hub. The city was hard hit by the housing downturn and recession. It continues to suffer high unemployment at 12.3% in September, but job growth has resumed. TAX BASE EROSION: The tax base is large and diverse, but assessed value (AV) has declined 12.1% from its peak in 2009 and continues to slide. The pace of declines has slowed in recent years, and increases in new construction suggest that the real estate market is in the early, fragile stages of a recovery. Continued population gains should support the tax base over time. MANAGEABLE LONG-TERM LIABILITIES: The direct and overlapping debt burden is somewhat above average compared to the size of the tax base at 5.7% of assessed value but moderate at $3,000 per capita. While debt service is somewhat high as a percentage of general fund spending, pension and other post-employment liabilities compare favorably to other large cities. LEASES NOTCHED: The lease revenue bond ratings are notched from the implied GO rating by one notch for essential or highly over-collateralized leases and by two notches for non-essential assets. WHAT COULD TRIGGER A RATING ACTION UNEXPECTED DEFICIT SPENDING: Deficit spending meaningfully in excess of current expectations or beyond the current budget year could put downward pressure on the rating. ECONOMIC, REVENUE RISKS: Revenues and the local economy appear to be recovering, but the city's lack of reserves leave it particularly vulnerable to an economic shock. A reversal of recent improvements in revenues and the local economy would put downward pressure on the rating. NEGATIVE FUND BALANCES: Failure to make progress on resolving negative fund balances outside the general fund could put downward pressure on the rating. CREDIT PROFILE WEAK FINANCIAL POSITION Fresno's financial position deteriorated rapidly during the recent recession and has not yet begun to recover. The city largely depleted its reserves during the economic downturn, ending fiscal 2011 with an unrestricted general fund balance (the sum of assigned, unassigned and committed balances under GASB 54) equal to just 0.5% of expenditures and transfers out. The balance is expected to rise slightly when the 2012 audit is released, but reserves remain very low and inadequate for even the current well-below-average rating level. General fund revenues declined 16% from fiscal 2008 to 2010, led by double-digit declines in property and sales taxes, the city's two biggest revenue sources. Recovery has been painfully slow due to lingering property tax weakness. Total operating revenues rose 2.5% in 2011 and appear to have risen by a similar amount in 2012. Sales taxes have been recovering handily, jumping 14% in 2012, but property taxes unexpectedly dropped 3.4%, weighing heavily on overall revenue performance. Like other California cities, the city has very little revenue raising flexibility due to the property tax limitations of Proposition 13, forcing it to balance budgets primarily on the expenditure side of the ledger. The city failed to fully realign expenditures with decreased revenues due to rising debt service costs and long-term labor contracts that limited expenditure flexibility. Debt service rose 38% from 2008 to 2013, forcing the general fund to absorb significant additional expenses as revenues declined. The general fund was forced to absorb ongoing non-general fund debt service expenses and to cure negative fund balances outside the general fund due to weakness in a number of other funds, including the zoo, parking, development services and convention center funds. The city has adjusted operations in these funds to prevent further deficit spending and has a 10-year plan to gradually resolve $26 million of remaining negative balances with transfers from the general fund. The city has made significant cuts to both its payrolls and public services, suggesting a strong willingness to make painful decisions to restore budgetary balance. Operating expenditures declined 23% between 2009 and 2011. The city has been unable to reduce public safety spending as much as desired due to a long-term contract for police officers, which runs through 2015. The contract locks in pay rates at a level that the city believes it can no longer afford and limits layoffs. The city successfully renegotiated its other labor contracts, achieving significant savings, but it has not been able to reach an agreement with its police officers. Police salaries and benefits equaled about half of budgeted general fund expenditures for 2013. Police offered the city a sizeable salary reduction in exchange for an extension of its contract to 2016, which management rejected. The two sides appear to be at an impasse. The city's decision to reject a contract extension, which would extend very long-term contracts in an uncertain revenue environment, suggests that management is determined to realign compensation costs with reduced resources, but it leaves the city with a structurally imbalanced budget as it waits out the contract. DEFICIT SPENDING IN 2013, STRESS TO LINGER The failure to reduce police compensation for the current budget year leaves the city with a $4.2 million budget gap in a 2013 budget of about $250 million. The city plans to borrow from its sewer fund to finance the deficit and appears to have adequate liquidity to withstand this period of stress. Fresno had $232.7 million of unrestricted cash and investments in various accounts government-wide at the end of fiscal 2011. Much of this liquidity is in the city's water and sewer funds. The funds cannot be permanently transferred to the general fund due to state law, but they do provide a significant source of internal cash flow funding for short-term borrowing. Management believes the city will require just one year of deficit financing, but future budgets will remain vulnerable until the city sees a more convincingly positive revenue trend and rebuilds reserves. The city engages in a thorough financial planning process. Its long-term financial forecast shows the general fund returning to balance in fiscal 2013, but this assumes a modest increase in sales and property taxes, as well as significant revenues from the privatization of the city's residential solid waste franchise. The privatization appears to be progressing and likely to provide more revenue than budgeted in the current year, reducing the expected deficit by as much as $1.5 million. While the tax growth assumptions are very conservative compared to historic growth, the current outlook for resumed property tax growth appears particularly uncertain. If the economy continues to recover as expected, the city should be able to avoid further deficit spending after 2013, but the city could face significant deficits if the U.S. economy sustains further shocks that push the economy back into recession. Even in the base case scenario of a gradual recovery, the city does not expect to meaningfully rebuild its reserves for several years. ECONOMIC RECOVERY BEGINS Fresno is the cultural, commercial and healthcare hub of the San Joaquin Valley, one of the world's most productive farming regions. It benefits from a large and increasingly diverse economy that is currently recovering from a deep cyclical downturn. Fresno's economy is largely driven by agriculture-related activity. As such, unemployment has tended to be somewhat higher than the national and state averages over time. The unemployment rate was 12.3% in September 2012, down from 14.1% a year earlier. Job growth has resumed with employment rising a solid 2.3% in the past year. Socioeconomic indicators are below average. Median household income was 83.1% of the national level and the poverty rate was 24.9% in 2010. The city experienced significant population and job gains over the last two decades, which led to a diversification of the economy and to a significant expansion of the tax base and housing stock. The tax base is diverse and large with AV of $26.6 billion in fiscal 2013. AV has declined 12.1% since peaking in 2009. AV fell 1.3% in fiscal 2013. Construction is beginning to resume at a subdued pace. The city issued 534 single family home construction permits in the first nine months of calendar 2012, which is 22% higher than total for all of 2011. While the city's housing market and economy remain weak, Fresno appears to be participating in the national economic recovery after several years of lagging. MANAGEABLE DEBT BURDEN Fresno's direct debt burden (excluding fully self-supporting debt) was $694 million as of June 30, 2012. Debt service equaled an elevated 12.7% of general fund expenditures and transfers out for fiscal 2012. Amortization is somewhat below average with 22% of debt repaid in five years and 44% in 10 years. However, gradual amortization should reduce the debt burden over the next five years because the city has no plans to issue new general fund-supported debt. Pension and other post-employment liabilities are somewhat less of a concern for Fresno than for many other local governments because the city's two pension plans have funded ratios above 100%, and the city's other post-employment benefit obligations are modest at $84 million, or 0.3% of AV, as of June 30, 2010. Retirement contributions equalled 10.2% of general fund spending in 2012. The combined carrying costs of debt and retiree liabilities was significant at 22.9% of general fund spending but in-line with peers. NOTCHING FROM GO The lease revenue bonds are notched downward from the implied GO rating by one notch for essential assets (series 2009) or two notches for largely non-essential assets (series 2004 and 2008). The assets securing series 2006 (a convention center exhibit hall and theater) are judged to be non-essential, but they are rated only one notch from the GO rating because the leased assets significantly over-collateralize the debt with a value almost three times the amount of the outstanding bonds. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com, National Association of Realtors, Underwriter, Bond Counsel, and Underwriter Counsel. Applicable Criteria and(New York Ratings Team)
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