Fitch Rates San Francisco, California's $276MM GOs 'AA-'; Outlook Stable

2008-05-09 23:09:15 -

- Fitch Ratings assigns an 'AA-' rating to the following two San Francisco, CA, issues:

--$232 million general obligation (GO) refunding bonds, series 2008-R1;

--$44 million taxable GO refunding bonds, series 2008-R2.

Both issues will sell competitively on May 20, 2008. Fitch also affirms the 'AA-' rating on San Francisco's $1.1 billion in outstanding GO bonds. The Rating Outlook is Stable.

The 'AA-' rating reflects San Francisco's solid financial position aided by a well-disciplined rainy day fund, and a diverse and strong local economy currently performing well despite national weakness owing somewhat to a strong tourism draw. The city's debt ratios are moderate and will remain affordable despite increased future issuance plans. Fitch also notes the city's spending restraint and conservative budgeting in recent years.

Fitch revised the Outlook to Stable from Positive on March 18, reflecting Fitch's expectation for greater financial volatility in the city's operating funds, including fluctuation in reserve levels. Fitch views the city's structural and political characteristics as limiting financial flexibility through dedication of general purpose revenue to specific uses, and pressures to retain certain service levels despite state and federal funding reductions. These factors in turn reduce the city's ability to build and retain above-average reserve levels.

San Francisco's economy has sound underpinnings as a regional center and strong tourism draw. Recent economic activity demonstrates a continued strong tourism draw, moderate employment gains, relative stability in the real estate sector and good sales tax revenue growth. Assessed value growth slowed to 4.6% in fiscal 2008, but since fiscal 2002 has averaged 6.9% per year. Hotel occupancy remains high (79%), and is approaching its previous peak of 81% in fiscal 2000. Jobs in the five-county San Francisco-Oakland-Fremont metropolitan statistical area increased 5.1% since 2004, following four years of losses in the prior recession. A substantial decline in the labor force, though, has reduced unemployment and has contributed to above-average wage increases.

Through fiscal 2007, the city's financial operations have benefited from the economic gains, with property, real estate transfer, payroll, and utility user taxes all rising considerably. Audited results for fiscal 2007 show a moderate general fund surplus and the fourth consecutive year of positive operations, reversing two years of significant operating losses. The year-end unreserved fund balance rose to $141 million, a strong 5.3% of expenditures and transfers out. Adding the $133.6 million in the city's rainy day fund for budget stabilization, the cushion rises to 10.4% of spending. The rainy day fund is prudently structured to build a financial cushion in strong economic years and keep high revenue gains from building unsustainable spending into the budget.

Currently, the city's financial operations for fiscal 2008 as reflected in its nine-month budget status report released on May 5 projects revenues slightly below budget, but would still include a sizeable deficit. The fiscal year-end 2008 fund balance beyond the rainy day fund is projected to be about $41.6 million. This forecast includes lower than budgeted property transfer taxes ($32 million) more than offset by higher than budgeted property taxes ($26 million), business taxes ($13 million) and hotel tax ($15 million). In addition, it reflects lower than budgeted state subventions and grants of about $30 million. The city reports that expenditure savings of about $40 million will help offset some of the reduced state and federal funding. In addition, the city projects a $305 million budget gap for fiscal 2009, the largest gap that has been forecast for the upcoming year in the last few years.

Fitch views the city's long-term financial status as sound but likely to fluctuate given upcoming pressures. These budgetary strains include the potential for slower revenue gains, state funding reductions, the city's tendency to replenish social service programs threatened by state cuts, and a sizable unfunded liability for retiree healthcare. Also, Fitch notes the rising share of the city's previously discretionary revenue that voters, at various times, have authorized to be dedicated to specific uses or required to be used to retain baseline spending amounts for identified purposes. Fitch believes these dedications can compound financial imbalances by not allowing the city to match resources with rising needs. In turn, these restrictions limit the city's ability to retain a financial cushion or enhance existing reserves.

These near- and long-term financial concerns are balanced by the city's diverse revenue base, solid reserve levels going into a strained period, and its well-funded pension system. About 70% of general fund resources come from local sources, thereby reducing the city's exposure to state funding changes.

The city's actuarial report on its post-retirement medical benefits, done in preparation for the fiscal 2008 implementation of Governmental Accounting Standards Board statement 45, shows the city's liability to be sizable at $2.6 billion or $4 billion, depending on whether or not a dedicated trust is set up for this purpose. To fund the cost on an actuarially sound basis, the city's contribution would be $257 million at a minimum, a significant rise over fiscal 2008's $115 million expense, funded on a pay-as-you-go basis. The fiscal 2008 cost also is a substantial increase over the $88 million cost in fiscal 2006. The city currently is considering its options for funding and controlling future costs and discussing actions with labor groups. The city is considering a plan that would reduce post-retirement medical benefits for new employees and enhance pension benefits, an action that would require voter approval.

San Francisco's debt burden remains affordable despite sizable recent issuances. Including overlapping debt, debt per capita totals $4,503 per capita and 2.8% of taxable market value. Future issuance plans are expected to be moderate, but could rise significantly as the city begins to address needs identified in its sizable $19.7 billion capital improvement plan which includes $4.8 billion in general fund supported projects. Funding sources are expected to include general obligation bonds, which require two-thirds voter approval.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Fitch Ratings, San Francisco
Karen Ribble, 415-732-1756
Amy S. Doppelt, 415-732-5612
or
Media Relations:
Cindy Stoller, 212-908-0526, New York