Fitch Ratings has assigned an 'AA-' rating to the following City and County of San Francisco, California (the city) general obligation (GO) bonds:
-- $251.2 million GO bonds, series 2012D;
-- $38.3 million GO bonds, series 2012E.
The series 2012D bonds will be used to rebuild and make seismic improvements to the city's general hospital and trauma center and the series 2012E bonds will be used to finance improvements to fire, earthquake and emergency response systems and facilities. Bonds are scheduled to sell competitively on or about August 14, 2012.
In addition, Fitch affirms the following ratings:
-- $1.5 billion GO bonds at 'AA-';
-- $1.21 billion various city, corporation, San Francisco Parking Authority and San Francisco Redevelopment Agency lease obligations at 'A+';
-- $58 million corporation open-space fund lease revenue bonds at 'AA-'.
The Rating Outlook is Stable.
The GO bonds are secured by an unlimited ad valorem tax on all taxable property in the city.
Lease obligations are secured by the city's covenant to budget and appropriate, subject to abatement, for use and occupancy of various essential and non-essential city assets. The city covenants to maintain 24 months' rental interruption insurance.
The corporation's lease revenue bonds (open-space fund), series 2006 and 2007, are secured by the city's covenant to budget and appropriate for use and occupancy of city parks and open space. Such lease payments are payable from a dedicated property tax set aside by charter for park and recreational services and facilities.
KEY RATING DRIVERS
LARGE, DIVERSE AND GROWING ECONOMY: San Francisco's large and dynamic economy has returned to good growth, as evidenced by solid increases to employment, reduced unemployment and increasing tax revenues. The city's tax structure captures most of the economic activity in the city, and sales, hotel, business and real property transfer taxes all returned to solid growth levels in fiscal 2012.
STRONG CITY POLICIES AND CONTROLLER OVERSIGHT: A voter-approved measure adopted in November 2009 required the city, with guidance from the controller's office, to adopt numerous budgetary and reserve policies and procedures. These practices should help to improve the city's operating margin and help it retain adequate reserve levels through economic cycles. Budget monitoring continues to be a strength.
LARGE UNFUNDED RETIREE COSTS: The city's sizeable retiree costs and its large unfunded retiree health benefit liability ($4.4 billion) contribute to budgetary pressure. A recently adopted voter initiative is expected to reduce these costs somewhat and help contain their growth. Nonetheless, required annual appropriations related to retiree costs will likely continue to rise as a share of general fund spending.
AFFORDABLE DEBT, SIZEABLE CAPITAL NEEDS: The city's outstanding debt is high on a per capita basis but Fitch considers it affordable given the city's wealth levels; however, capital needs are large, including a sizeable amount of repair and replacement of aging facilities, roads and other infrastructure. Modestly above-average amortization should keep the city's direct debt levels affordable.
DIVERSE REVENUES; STABLE TAX BASE
As both a city and county, San Francisco enjoys a relatively diverse revenue base which performed adequately during the national recession and has showed solid growth in fiscal 2012. Local taxes generated two-thirds of general fund revenues in fiscal 2011, resulting in somewhat less exposure to state and federal funding (combined at 22% of fiscal 2011 revenue) than other counties. The recession had a comparatively modest impact on the city's economy.
Business, sales and hotel taxes all returned to growth in fiscal 2011 and continued to improve through fiscal 2012. As of the fiscal 2012 nine-month budget status report, the controller's office estimated business taxes would be up 9.5% over fiscal 2011 levels, sales taxes by 7.5%, and hotel taxes by 14%. The unemployment rate also improved in the 12 months ending May 2012 to 7.4% from 8.4%, as employment increased a strong 3.6%.
Taxable assessed valuation (TAV) increased at a strong rate into fiscal 2011 (up 5.1%) but was essentially unchanged for fiscal 2012 (up 0.5%). Exact data is not yet available, but the city is forecasting a moderate increase in TAV for fiscal 2013. The continued growth despite moderate declines in some property values is reportedly due in part to a large backlog of supplemental assessments for commercial properties sold at the height of property values. Offsetting this benefit, however, there is still a large but declining amount of appeals. As of June 1, 2012, the difference in value between the assessor and taxpayer opinion of open appeals was a high $33 billion (20% of TAV.) Appeals granted have historically been well below the requested reduction; however, the large amount of appeals may suppress TAV growth over the medium term.
BUDGET CHALLENGES REMAIN DESPITE IMPROVED REVENUE
Despite the relatively modest recessionary impact on revenues, the city has faced sizeable fiscal imbalances. Large budget gaps were solved for several years with temporary or one-time measures, including use of reserves. An operating surplus of $136 million in fiscal 2011 brought the unrestricted/assigned general fund balance to a sound $240 million, or 8.2% of expenditures and transfers out. This gain followed three consecutive years of drawdowns exceeding $100 million, which had reduced the available general fund balance (including the rainy day reserve) to $37.5 million at fiscal year-end 2010. This amount represented just 1.2% of expenditures and transfers out, down from $274 million (10.9%) in fiscal 2007.
The city estimates ending fiscal 2012 with about $200 million in higher than budgeted revenues. GAAP-based estimates are not yet available, but this should result in a solid net surplus after transfers. Starting in fiscal 2013, the city has adopted two-year rolling budgets. The city's initial estimated budget gap for fiscal 2013 was $170 million, and for fiscal 2014 was $312 million. The budget gaps were closed largely with higher revenue forecast based on improved actual collections and lower than anticipated salary costs. Most labor agreements expired June 30, 2012. The city negotiated no salary increases for fiscal 2013 but agreed to salary increases of about 3% for fiscal 2014. If revenue growth does not continue, salary and other cost increases may pressure future budgets. Additional budget pressure continues from increasing retiree costs, estimated to total 9.6% of fiscal 2011 spending.
AFFORDABLE DEBT OFFSET BY LARGE CAPITAL NEEDS
San Francisco's debt burden remains affordable despite sizeable recent issuances. Including overlapping entities, debt totals a high $6,771 per capita but a moderate 3.3% of taxable market value, reflecting the large amount of commercial property in the city. Future debt issuance plans are expected as the city addresses needs identified in its 10-year $4.9 billion general fund capital improvement plan.
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, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors.
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
U.S. State Government Tax-Supported Rating Criteria
Karen Ribble, +1-415-732-5611
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San Francisco, CA 94108
Stephen Walsh, +1-415-732-7573
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