Fitch Rates San Luis Obispo, CA's Lease Rev Bonds 'AA'; Outlook Stable

Fitch Ratings assigns an 'AA' rating to the following City of San Luis Obispo Capital Improvement Board, CA (the board) bonds issued on behalf of the city of San Luis Obispo, California (the city):

--$5.4 million refunding lease revenue bonds, series 2012.

The bonds are scheduled to sell via competition on or about May 24. The proceeds will refinance the board's 2001C lease revenue bonds.

In addition, Fitch affirms the following ratings:

--Implied general obligation rating at 'AA+';

--$30 million (pre-refunding) of outstanding lease revenue bonds, series 2001C, 2006 and 2009 at 'AA'.

The Rating Outlook is Stable.

SECURITY

The lease revenue bonds are secured by lease payments made by the city to the board. The city has covenanted to budget and appropriate the lease payments, subject to abatement.

KEY RATING DRIVERS

STRONG FINANCIAL POSITION: The city has maintained a strong reserve position in the face of declining revenues through disciplined expenditure cuts that have largely restored structural budget balance to the general fund. Revenues have begun to recover from a sharp downturn, helping offset the pressure of rising pension costs.

REVENUE CYCLICALITY: Revenues are somewhat volatile due to reliance on economically sensitive sales and transient occupancy taxes, which accounted for about one-half of general fund revenues in fiscal 2011. This concern is offset by the city's ample reserves and history of expenditure discipline.

EXCELLENT FINANCIAL MANAGEMENT: Active budget monitoring, comprehensive financial policies and the use of long-term budget planning provide a strong framework for managing through unexpected budgetary problems. The city has regularly met its policy of maintaining reserves equal to at least 20% of general fund spending.

LOW DEBT BURDEN, HIGH PENSION COSTS: The city's sparing use of bonded debt is a credit positive, although San Luis Obispo does have meaningful unfunded pension obligations that require increasing annual benefit contributions from the city's operating budgets. The other post employment benefit (OPEB) liability is modest.

FUNDAMENTALLY SOUND ECONOMY: San Luis Obispo is the economic center of California's Central Coast region with a tourism-, education- and government-driven economy. The local unemployment rate remains elevated after a deep recession, but has begun to decline and has outperformed the state over a long period of time.

RESILIENT TAX BASE: Assessed value (AV) remained fairly stable in this older, slow growing and more established community despite the deep housing downturn affecting California and the nation.

CREDIT PROFILE

STRONG FINANCIAL PERFORMANCE

San Luis Obispo managed through the significant declines in economically sensitive revenues during the recent recession by spending excess reserves (above the city's 20% policy target) and cutting spending. Total general fund revenues fell 9% from fiscals 2008 to 2010 before beginning to recover with a 2.3% increase in fiscal 2011. Sales tax revenues, the city's biggest revenue source, fell 18% during the downturn but began to recover with a nearly an 11% gain in fiscal 2011 and gains have continued so far in fiscal 2012.

The city has made significant reductions in expenditures despite the bulk of the city's costs being labor-related and subject to collective bargaining negotiations. Overall, expenditures dropped 4.2% in fiscal 2010 and 3.1% in 2011. These cuts allowed the city to end fiscal 2011 with a surplus after four years of spending down its fund balance. Management continues to negotiate to achieve a city council-mandated 6.8% reduction in compensation costs that would return the city's budget to ongoing structural budget balance.

The city added $1.8 million (or 4% of expenditures) to fund balance in fiscal 2011, bringing the unrestricted general fund balance (the sum of assigned, unassigned and committed fund balances) to a healthy $12.7 million, or 25.2% of expenditures. Despite the previous three years of fund balance drawdowns, the city maintained compliance with its strong fund balance policy throughout the period.

RISING PENSION COSTS PRESSURE BUDGET

While the city's revenues have begun to recover, the city will continue to face budget pressures over the next several years from rising pension contributions following market losses of recent years. Annual required pension contributions are expected to increase to $9 million in fiscal 2015 from an already high $7.5 million, or 17% of general fund spending. The city's 2012 budget includes $1.3 million of unspecified labor concessions that are still to be negotiated with public employee unions. These savings are unlikely to fully materialize this year, which may require about $1 million of reserve spending this year. However, management continues to believe it will achieve substantial reductions in compensation costs by requiring greater pension contributions from employees and shifting new employees to a less generous pension plan.

San Luis Obispo voters approved charter amendments last year that eliminated binding arbitration provisions that previously limited management's ability to control its public safety spending. Voters also approved a measure that would allow elected policymakers to reduce pension benefits without voter approval. Together the two measures suggest strong community support for realigning the city's cost structure to match available revenues, and the city's fire fighters have recently agreed to concessions that would reduce city pension cost significantly and meet the city council's labor cost savings targets.

The city's debt burden is low and expected to remain so. Direct debt is a modest 0.4% of AV or $619 per capita, while combined direct and overlapping debt is just at 1% of AV or $1,340 per capita. Amortization is about average with 25% of bonds repaid in five years, and 46% repaid in 10 years.

NOTABLE FISCAL OVERSIGHT

San Luis Obispo's financial management is particularly strong. Financial management and elected officials actively monitor budget performance across the city's biennial budget cycle and have made adjustments to reduce expenditures in the face of revenue declines. While the need to negotiate major spending reductions with labor can lead to a lag in rebalancing budgets, the city's budget process includes long-term budget planning that focuses policymakers' attention on the need to align on-going revenues and expenditures to achieve structural balance.

ECONOMIC HUB; STABLE ECONOMY

San Luis Obispo, a city of about 45,100 people, is the economic center of California's Central Coast region. The city's biggest industries are tourism, higher education and government. The city is also a regional retail hub and is home to the California Polytechnic State University with about 20,000 students. The city benefits from slow, steady population growth and has generally experienced unemployment rates below the state average. The city saw a sharp rise in joblessness during the recent recession, peaking at 11.4% in January 2010. Unemployment has been declining over the past year and fell to 9.5% in February 2012, which was about 2 percentage points below the state rate.

The tax base has proven resilient in the face of the national housing downturn. AV grew through fiscal 2010 and has declined by less than 2% over the past two fiscal years. The relative stability of the tax base is likely due to the fact that the city is an older, more established community that did not experience rapid building during the housing boom. Overall, the city's economy and tax base appears fundamentally sound, despite recent current cyclical weakness.

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, University Financial Associates, the S&P/Case-Shiller Home Price Index, IHS Global Insight, the National Association of Realtors, bond counsel and the financial advisor.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 15, 2011);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 15, 2011).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648842

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