Fitch Affirms Fresno, CA's Implied GO Rating at 'BBB+'; Outlook Revised to Stable

Fitch Ratings has affirmed the following city of Fresno, California (the city) bonds:

--Implied general obligation bond (GO) rating at 'BBB+'.

--$44.8 million Fresno Joint Powers Financing Authority (Fresno JPFA) lease revenue bonds series 2006A and series 2009A, at 'BBB';

--$107.4 million Fresno JPFA lease revenue bonds (LRBs) series 2004 (A and C) and series 2008 (A, C, E and F) at 'BBB-'.

The Rating Outlook is revised to Stable from Negative.

SECURITY

The LRBs are payable from lease rental payments made by the city to the Fresno JPFA for use and occupancy of a variety of governmental assets subject to abatement. The city has covenanted to budget and appropriate lease payments annually.

KEY RATING DRIVERS

STABLE ON FINANCIAL GAINS: The revision to a Stable Outlook reflects improving financial performance. The rating remains quite low compared to peer municipalities due to weak general fund reserves that give the city more limited flexibility to respond to shocks in the near term.

BUDGET BALANCE RESTORED: Revenue gains and very large expenditure cuts have helped move the budget back into balance. The renegotiation of burdensome police contracts (50% of general fund spending) has decreased expenditure pressures.

FUND BALANCE DEFICIT CLOSED: The city has repaid interfund borrowing it used to withstand the recent recession several years ahead of schedule and is beginning a multi-year process of restoring reserves to more typical levels.

WEAK ECONOMY, RECOVERY ACCELERATING: Fresno's economy is growing at a healthy pace, but remains a fundamental weakness due to chronically high unemployment and weak incomes.

TAX BASE RECOVERS: The tax base is large and diverse. Taxable assessed value (AV) has nearly recovered the significant declines experienced during the recession and appears poised for continued growth.

MANAGEABLE LONG-TERM LIABILITIES: The overall debt burden is moderate. Pension and other post-employment benefit (OPEB) liabilities compare favorably to other large cities, although combined carrying costs are sizable and have created general fund expenditure pressures in recent years.

LEASES NOTCHED: The LRBs are rated below the implied GO rating by one notch for essential or highly over-collateralized leases and by two notches for non-essential assets.

RATING SENSITIVITIES

REVERSAL OF FINANCIAL GAINS: The rating could come under downward pressure if the budget slips back into structural imbalance.

IMPROVEMENTS IN FUND BALANCE: The rating could move higher if the city maintains structural balance and rebuilds a reasonable reserve position.

CREDIT PROFILE

Fresno is California's fifth-largest city with about 510,000 residents. It is located about 250 miles north of Los Angeles in the heart of the agricultural San Joaquin Valley.

WEAK FINANCIAL POSITION

Financial performance is beginning to improve after a period of extreme weakness. Fresno's financial position deteriorated rapidly during the recent recession, posting net operating deficits after transfers in five of the six fiscal years through June 30, 2013. The combination of declining revenues and limited ability to cut spending due to long-term collective bargaining agreements depleted city reserves at the same time that ailing enterprises (including parking, convention center, community development funds) required general fund support. Like other California municipalities, Fresno 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's unrestricted general fund balance fell to negative $6.4 million, or 2.4% of spending, in fiscal 2013 due to the merger of enterprise funds with chronic deficits into the main operating fund. Ongoing general fund operations were close to balance and Fitch's expectations in 2013 excluding fund consolidation.

GRADUAL RESERVE BUILDING EXPECTED

The city appears poised to return to a positive general fund reserve position in fiscal 2014. Unaudited actual results for the year show a net operating surplus of $19 million (7.1% of spending), suggesting a positive unrestricted fund balance in 2014. The fiscal 2015 budget is balanced with an addition to fund balance possible if revenue gains are sustained. The city's budget assumes essentially flat revenue from actual 2014 levels and appears well positioned for outperformance, given significant gains in AV. Fresno fully repaid internal water and commercial solid waste fund loans that it used to carry negative fund balances in July 2014.

The city has recently renegotiated the last of the long-term police contracts that limited its ability to fully realign expenditures with revenues during the downturn. Fresno's police officers agreed to a new labor contract that increases worker pension and healthcare contributions by more than it increases pay, saving the city about $4.3 million over the three years through fiscal 2017. General fund payments under the police contract represent about 50% of spending.

The city's financial cushion remains quite low as a percentage of expenditures, but it has improved faster than expected. A reasonably conservative city financial forecast shows the reserves hitting its policy target of 10% of expenditures by 2019, assuming continued gradual revenue gains. Fitch is unlikely to raise the rating to a level that is more typical for a large U.S. city until Fresno has made significant and sustained progress toward reaching the reserve target.

Fitch believes the city's recently implemented policies should reduce the likelihood of a return to previous levels of financial weakness if followed. The changes include a limitation on the term of labor contracts, policies that aim to identify and cure non-general fund deficits before they become problematic, a reasonable general fund reserve policy and the matching of one-time revenues and expenses.

The city's large and liquid balance sheet remains the main protection against economic uncertainty and near-term budget misses, given the low level of general fund reserves. Fresno had $293.3 million of unrestricted cash and investments in various accounts government-wide at the end of fiscal 2013. Much of this liquidity is in the city's water and sewer funds. (See 'Fitch Affirms Fresno, CA's Subordinate Lien Sewer Revenue Bonds at 'AA-'; Outlook Revised to Stable' and 'Fitch Affirms Fresno, CA's Subordinate Water Revenue Bonds at 'A+'; Outlook Revised to Stable' - both published today.) 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.

WEAK ECONOMY IN CYCLICAL RECOVERY

Fresno is the cultural, commercial and healthcare hub of the San Joaquin Valley, one of the world's most productive farming regions. Its large and increasingly diverse economy is currently recovering from a deep cyclical downturn. Fresno's economy remains largely driven by low-wage agriculture-related activity. Unemployment has tended to be somewhat higher than the national and state averages over time. The unemployment rate was 9.4% in August 2014, down more than six percentage points from its recessionary peak. Job growth has resumed with employment rising 2.3% over the past 12 months and having surpassed its pre-recession peak in 2013. Socioeconomic indicators are below average. Median household income was 79.7% of the national level and the poverty rate was almost twice the national rate at 27.5% in 2012.

The tax base is large, diverse and growing once again. Total AV rose 4.6% to $28.2 billion in fiscal 2014. A preliminary estimate of a 6.8% gain in 2015 would push AV close to pre-recession levels. The recent gains likely reflect some bounce-back in values after a deep housing market crash. AV is likely to grow at a more moderate pace going forward, but continued growth will be supported by ongoing population gains, ample land available for development, and increasing building permit requests.

MANAGEABLE LONG-TERM LIABILITIES

Total direct and overlapping debt was moderate at 4.5% of AV or $2,505 per capita as of June 30, 2014. Amortization is moderate with 24.2% of debt repaid in 5 years and 51.1% in 10 years. 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 OPEB liabilities are less of a concern for Fresno than for many other local governments because the city's two pension plans have funded ratios at or near 100%, and the city's OPEB obligations are modest at $115.5 million, or 0.4% of AV, as of June 30, 2012. The combined carrying costs of debt and retiree liabilities was on the high side of the moderate range at 22.6% of governmental fund spending in fiscal 2013.

NOTCHING FROM GO

The LRBs are rated below the implied GO rating by one notch for essential assets (series 2009) and 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'.

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 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

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=912354

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