Fitch Affirms Hayward, CA COPS AT 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the following city of Hayward, California (the city) ratings:

--$24.5 million 2007 refunding certificates of participation (COPs) (Civic Center and Capital Projects) at 'AA'.

In addition, Fitch affirms the following ratings:

--Implied general obligation at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The COPs are secured by lease rental payments made by the city for use of the civic center and are subject to annual appropriation and abatement.

KEY RATING DRIVERS

RESOLVING STRUCTURAL IMBALANCE; SOUND RESERVES: The city continues to conservatively manage operations to maintain consistently solid general fund reserves and liquidity. Ongoing labor concessions and other expenditure cuts, coupled with improved revenues and voter-approved revenue enhancements have been largely effective in closing the gap.

STRONG REGIONAL ECONOMY PROVIDES DIVERSITY: The local economy benefits from the broader San Francisco Bay area, providing diversity to the city's historically narrow manufacturing-centered employment base. Socio-economic indicators are in line with national averages but somewhat below the more affluent county and region.

WELL-MANAGED LIABILITY BURDEN: Overall debt levels are moderately low with currently manageable carrying costs, and capital plans include modest future borrowing. Rising pension costs have the potential to pressure the credit, though this is somewhat mitigated by management's successful negotiation of pension cost sharing among all employees.

LEASE REVENUE COPs: The one-notch rating distinction on the lease revenue COPs reflects the city's general credit quality as well as covenant to budget and appropriate sufficiently for lease rental payments, a requirement for rental interruption insurance, and the use of essential city property as security.

RATING SENSITIVITIES

FAILURE TO MAINTAIN STRUCTURAL BALANCE: Failure to maintain structural balance would indicate pressured financial flexibility inconsistent with the current rating, given the city's limited level of expenditure flexibility.

DETERIORATION OF RESERVES: Near-term fund balance use above current projections could compromise the city's currently ample financial flexibility.

CREDIT PROFILE

The city is located in Alameda County at the intersection of Interstate 880 and route 92 approximately 14 miles south of Oakland and 27 miles north of San Jose. The city's population of 151,574 in 2013 has experienced modest growth over the last decade.

STABILIZING STRUCTURAL BALANCE; CHALLENGES REMAIN

The city's financial operations have stabilized in recent years, with prudent management offsetting budgetary imbalances. Voter-approved revenue increases have supplemented conservative revenue forecasting and substantial expenditure reductions to allow the city to maintain solid reserves. The city's liquidity position is consistently healthy, with general fund cash exceeding liabilities by approximately four times for at least the past five fiscal years.

The city's fiscal 2013 unrestricted fund balance of $28.4 million equaled a solid 22.8% of spending, consistent with the prior year's results. General fund revenues increased by 4.4% to $121 million, due to improved property and sales tax receipts. Expenditures, dominated by public safety spending (72.6% of general fund spending), remained essentially flat in fiscal 2013. Prudent revenue forecasting and non-recurring revenues of approximately $1.9 million drove a modest surplus of $455 thousand in fiscal 2013, in contrast to a budgeted deficit of $4.2 million. The city achieved the surplus despite the use of $3.8 million for capital projects and equipment.

The city has actively managed operations to maintain balance, despite ongoing challenges. Total city revenues have increased since the economic downturn, with revenue enhancements and prudent cost controls offsetting property and sales tax declines. The city successfully implemented voter-approved utility user tax and sales tax increases along with stringent negotiated cost-sharing for employee pension liabilities.

The fiscal 2014 budget calls for a use of $3.8 million (3% of budgeted general fund spending) of fund balance, driven by approximately $3.2 million in capital spending and rising employee benefit costs. Management reports that fiscal 2014 is tracking better than budget, and that fund balance use will be lower at approximately $1.5 million.

Management expressed commitment to maintain balanced fiscal 2015 operations despite projections for continued budget deficits. The city and its employees have agreed upon stringent cost containment measures, including negotiated cost-sharing for employee pension liabilities, in response to projected budget imbalances. Management stated that service cuts would be considered to achieve balance; however, Fitch considers the city's level of expenditure flexibility to be limited, given the city's high level of public safety spending.

VOTER-APPROVED REVENUE INCREASES

The city secured voter approval for a twenty year half-cent sales tax measure which is projected to augment general fund revenues by approximately $10 million annually beginning in October, 2014. The revenues will be designated for necessary capital improvements but are legally available for any purpose. Fiscal 2015 revenues are pro-rated to approximately $4.5 million, and were not factored into the city's fiscal 2015 budget, which Fitch considers prudent.

Current budget plans call for a $4.8 million use of reserves; however, given the city's history of outperforming its budget as well as the unbudgeted revenues, Fitch believes final results will be substantially better than budget. The fiscal 2015 budget provides operating forecasts through fiscal 2023, which project significant structural imbalance in the out-years. These projections are principally driven by the city's conservative budgeting assumptions. Projections do not include the benefit of the voter approved half-cent sales tax measure, hold certain revenue sources flat and assume a level of employee benefit cost increases off of a higher than actual base.

BROAD REGIONAL EMPLOYMENT OPPORTUNITIES, NARROW LOCAL COMMERCIAL BASE

The city is located 14 miles south of Oakland and benefits from its participation in the San Francisco Bay Area's diverse employment opportunities. The city's own employment base is somewhat narrow. Large city employers include government, California State University-East Bay, and Kaiser Permanente. Other large employers include mid-size manufacturing firms, with bio-science firms somewhat offsetting the presence of traditional manufacturers.

The city has largely recovered from the economic downturn, with both housing prices and assessed value showing strong growth in recent years, increasing the city's tax base by 13% since fiscal 2012. With 10% growth in fiscal 2014, taxable assessed value now exceeds the fiscal 2009 level. The April 2014 6.4% unemployment rate declined 20% on a year-over-year basis, remaining below the state (7.3%) and above the nation (5.9%). Resident employment has rebounded above pre-recessionary levels, and resident wealth and income approximate state and national averages, trailing the more affluent county and region.

LIMITED DEBT PRESSURES

Overall debt ratios are moderately low at $3,119 per capita and 2.8% of market value, driven mainly by county and school debt. Amortization of direct debt is rapid with 74% of principal retired within 10 years. Debt service requirements equal a low 2.3% of governmental fund spending. The city expects to issue debt within the next year, leveraging the half-cent sales tax revenues secured through 2034. The borrowing would fund the construction of a new library as well as improvements to police and fire safety facilities.

Rising pension costs have the potential to pressure the credit. Substantially all city employees participate in the California Public Employees' Retirement System (CalPERS). Fiscal 2013 city contributions equaled 8.9% of governmental fund spending. Although the city's annual required contribution (ARC) is expected to increase steeply in the near term, recently negotiated labor concessions include employees sharing a greater portion of the burden.

Near term cost growth is contained as a result of the city's reduced workforce and negotiated cost sharing measures. Pension costs will increase by a relatively modest $903,000 (6%)in fiscal 2014, relative to the $4.1 million increase prescribed in the June 30, 2011 CalPERS calculation.

The city's OPEB contribution was a modest 1.4% of governmental fund spending in fiscal 2013, with full ARC funding by fiscal 2019 incorporated into the fiscal 2015 budget. Total carrying costs, including debt service, pension ARC, and OPEB contributions, equaled a low 12.67% of governmental fund spending in fiscal 2013, despite the city's rapid principal amortization rate and pension cost increases.

TYPICAL LEASE STRUCTURE

The city has covenanted to budget and appropriate lease rental payments for the use of the civic center, home to the city's primary municipal function and city council chambers. The city may substitute other property for the leased civic center, although the substituted property must have comparable appraised value, essentiality, and useful life.

The lease requires the city to provide rental interruption insurance equal to at least the maximum payment payable in any two consecutive fiscal years in the remaining term of the lease. Lease payments would be abated proportionately during any period where there is substantial interference with the city's use and occupancy of the property, although not if insurance proceeds or reserve fund amounts are available to pay the lease. The city waives its right to terminate the lease in the event of damage or destruction.

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, University Financial Associates.

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=836977

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Contacts

Fitch Ratings
Primary Analyst
George M. Stimola
Analyst
+1 212-908-0770
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Karen Ribble
Senior Director
+1 415-732-5611
or
Committee Chairperson
Jessalynn Moro
Managing Director
+1 212-908-0608
or
Media Relations, New York
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
George M. Stimola
Analyst
+1 212-908-0770
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Karen Ribble
Senior Director
+1 415-732-5611
or
Committee Chairperson
Jessalynn Moro
Managing Director
+1 212-908-0608
or
Media Relations, New York
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com