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

SAN FRANCISCO--()--Fitch Ratings affirms the following City of San Luis Obispo, California (the city) ratings:

--$14 million lease revenue bonds series 2006 at 'AA';

--$13.5 million City of San Luis Obispo Capital Improvement Board lease revenue bonds series 2009 and 2012 at 'AA';

--Implied general obligation bonds 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 maintained strong reserves throughout the downturn and has added to fund balance as revenues have recovered. Expenditure pressures are prudently managed and general fund operations are balanced.

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 2013. 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. Employment growth has outpaced the state and nation in the wake of the recession and unemployment rates are below average.

RESILIENT TAX BASE: Assessed value (AV) remained fairly stable in this older, slow growing and more established community during the downturn, and has returned to modest growth.

RATING SENSITIVITIES:

ECONOMICALLY-SENSITIVE REVENUES: The city's reliance on economically-sensitive sales and transient occupancy taxes limits upwards movement of the rating.

CREDIT PROFILE

STRONG FINANCIAL PERFORMANCE

San Luis Obispo faced significant declines in economically sensitive revenues during the recent recession and has benefited from a strong rebound over the last three years. Total general fund revenues increased by almost 16% between 2010 and 2013, and have been bolstered by a robust sales tax recovery. The city has also increased reserves during this period; unrestricted fund balance reached a healthy 28.5% of general fund spending at the end of 2013.

Fitch views the city's strong reserves as an important offset to its reliance on economically sensitive revenues. Sale and transient occupancy taxes account for nearly half of general fund revenues and dropped sharply during the recent downturn. The city drew on reserves to mitigate this funding loss and also made significant reductions in expenditures. Subsequent expenditure increases have generally been limited to capital and other one-time uses, as the city has sought to control labor cost inflation. Notable achievements towards this goal have included the shift of employee pension contributions back to employees, employee responsibility for all health insurance cost increases, and the avoidance of across-the-board pay adjustments.

A local sales tax measure adopted in 2006 supports the city's strong financial position, raising approximately $6.5 million in revenues annually. The measure expires in 2015 and its renewal will be considered by city voters in November 2014. Support for renewal appears strong, but the city has prudently begun contingency planning in the event the tax is not extended.

RISING PENSION COSTS PRESSURE BUDGET

The city participates in the state-sponsored CalPERS defined benefit pension plan and faces ongoing budget pressures from rising contribution rates. Rate increases are expected to accelerate over the next five years to address the plan's sizable unfunded liabilities, and further increases are under consideration. Pension costs in 2013 were equal to a high 28.5% of governmental expenditures and will likely rise as a result of these changes. This figure includes costs borne by the city's enterprise funds, which account for roughly one-third of government-wide operating expenses and are self-supporting.

The city has sought to reduce the impact of pensions upon its general fund through shifting costs to employees, introducing new benefit tiers, and setting aside reserves in anticipation of rate increases. High pension costs are also mitigated by limited long-term obligations in other areas. Overlapping debt is a low 0.8% of AV or $1,093 per capita and both capital needs and OPEB liabilities are limited. Amortization of direct is above average with 72% of bonds 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 46,000 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 experienced strong employment gains after steep losses during the downturn. Its December 2013 unemployment rate of 6.2% was lower than both state and national averages, while employment levels now exceed pre-recession peaks. The city's stability is also reflected in its tax base, which declined by less than 2% in 2011 and 2012 before returning to growth in 2013.

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 and Zillow.com.

Applicable Criteria and Related Research:

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

U.S. Local Government Tax-Supported Rating Criteria

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

Additional Disclosure

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Contacts

Fitch Ratings
Primary Analyst
Stephen Walsh
Director
+1-415-732-7573
Fitch Ratings, Inc.
650 California St., 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Alan Gibson
Director
+1-415-732-7577
or
Committee Chairperson
Karen Ribble
Senior Director
+1-415-732-5611
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Stephen Walsh
Director
+1-415-732-7573
Fitch Ratings, Inc.
650 California St., 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Alan Gibson
Director
+1-415-732-7577
or
Committee Chairperson
Karen Ribble
Senior Director
+1-415-732-5611
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com