Fitch Rates San Diego, CA Lease Revs 'A+'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has assigned the following ratings to San Diego, California lease revenue bonds:

--Approximately $71 million San Diego Public Facilities Financing Authority (SDPFFA) lease revenue bonds, series 2012A (Capital Improvement Projects) at 'A+';

--Approximately $18 million SDPFFA lease revenue refunding bonds, series 2012B (Fire and Life Safety Facilities Refunding) at 'A+';

--$140.9 million Convention Center Expansion Financing Authority (CCEFA) lease revenue refunding bonds, series 2012A at 'A+'.

The SDPFFA lease revenue bonds, series 2012A and B will be sold via negotiation during the week of June 18. The CCEFA lease revenue refunding bonds, series 2012A will be sold via negotiation during the week of June 4.

In addition, Fitch affirms the following ratings:

--Implied San Diego unlimited tax general obligation (GO) bond rating of 'AA-';

--$7.7 million San Diego certificates of participation (COPs) (1993 Balboa Park/Mission Bay Park Refunding), series 2003 at 'A+';

--$330.9 million SDPFFA lease revenue bonds, series 2002B, 2007A, and 2010A (Master Refunding Project) at 'A+';

--$10.7 million San Diego Metropolitan Transit Development Board (CA) lease revenue refunding bonds, series 2003 at 'A+';

--$156.8 million CCEFA lease revenue bonds, series 1998A at 'A+'.

The SDPFFA lease revenue bonds, series 2002B will be refunded by the SDPFFA's new lease revenue refunding bonds, series 2012B. The CCEFA lease revenue bonds, series 1998A will be refunded by the CCEFA's new lease revenue refunding bonds, series 2012A.

The Rating Outlook is Stable.

SECURITY

The COPs and lease revenue bonds are secured by the city's lease rental payments which the city covenants to budget and appropriate annually. Lease rental payments are subject to abatement which is mitigated by standard rental interruption insurance provisions.

KEY RATING DRIVERS

FUNDAMENTAL CREDIT STRENGTHS: The city benefits from a diverse economy, a variety of revenue streams, and its desirable location as a place to live and work or visit. While taxable assessed valuation (TAV) trends have performed relatively well compared to other CA localities, Fitch expects relatively stagnant performance over the near term given the shadow housing inventory which has yet to work its way into the market; depressing both home prices and new construction.

ELEVATED UNEMPLOYMENT RATE: While the city's largest employers are in the traditionally stable military, education, government, and health care sectors, the city's unemployment rate rose significantly during the economic downturn and remains elevated.

SOLID FINANCIAL OPERATIONS: The city ended fiscal 2011 essentially breaking even and maintaining an adequate unrestricted general fund balance. The city projects similar performance for fiscal 2012. Recent city forecasts allude to measured progress in addressing the city's structural imbalance, with some continued vulnerability to economic volatility.

PRUDENT POLICIES: The city continues to demonstrate its commitment to conservative financial management policies, multiyear budget planning, and general fund balance and reserves preservation.

ADMINISTRATIVE CHALLENGES REMAIN: Fitch expresses some reservations about the city's ability to fully implement disclosure initiatives, given recent system implementation problems which delayed audits. The city's plan to resume timely audit reporting in November 2012 is an important positive step.

SIGNIFICANT LIABILITIES GOING FORWARD: The overall debt burden is moderate and expected to remain so despite planned debt issuances to address what the city reports as significant unmet infrastructure maintenance needs. Pension and other post-employment benefit (OPEB) liabilities exert pressure on the overall credit profile despite the city's prudent approach to funding.

WHAT COULD TRIGGER A RATING ACTION

POTENTIAL AREAS OF GENERAL FUND EXPOSURE: Additional general fund support for debt currently reimbursed by redevelopment monies, the city's storm water program, and construction projects if state funding ceases due to possible voter approval of a ban on project labor agreements, could place downward pressure on the city's bond ratings.

CREDIT PROFILE

San Diego is the second largest city in California, with a population of approximately 1.3 million. While the city has diverse employment and tax revenue bases, and significant ongoing economic development, its socio-economic characteristics are somewhat mixed and its unemployment rate was still elevated at 9.5% in March 2012.

RELATIVELY MILD TAX BASE FLUCTUATIONS

The city's tax base has survived in relatively good shape despite the pressures on the wider county's property market during the economic downturn. Two years of small TAV declines (0.6% in fiscal 2010 and 2.1% in fiscal 2011) were followed by a slight rebound in fiscal 2012 (up 0.8%). The city recently adjusted its projection for fiscal 2013 TAV to a 1.1% decline from the 2.3% increase estimated earlier this year. The change reflects the county's revised projections in light of unexpected further median house price declines. The county's ongoing elevated levels of appeals, foreclosures, and delinquencies suggest that the city's tax base could continue to experience stress despite ongoing construction and a positive housing price trend.

SOLID FINANCIAL OPERATIONS

The city ended fiscal 2011 with a solid unrestricted general fund balance (the sum of committed, assigned, and unassigned general fund balances under GASB 54) of $99.9 million, equaling 8.9% of spending. Excluding an $87.3 million transfer to the general fund of RDA cash for projects not yet started (held in a separate trust account and subject to potential state claw back), fiscal 2011 operations were essentially break even.

The city is projecting a $17.8 million budget surplus for fiscal 2012 due to modest increases in property, sales, and hotel tax revenues, savings from previously implemented expenditure reduction measures, additional personnel savings from a higher than anticipated number of retirements, and lower energy and utility expenses. No use of the projected $17.8 million is being recommended for the remainder of fiscal 2012. Instead, $12.8 million is included in the fiscal 2013 proposed budget (comprising $3.7 million for delayed expenses, $8.3 million for deferred capital projects, and $0.8 million for the general fund reserve), and $5.0 million is recommended to be added to reserves available for unforeseen circumstances or to mitigate the potential impact of the state denying redevelopment support for city debt. The city plans to adopt a final budget by June 15.

In addition to consistently exceeding its 8% general fund reserve goal, the city recognizes the need to bolster reserves for its public liability, workers' compensation, long-term disability, and enterprise funds and has concrete plans to incrementally build them up.

The city's five-year forecast shows general fund revenues offsetting known costs increases and benefitting from continued economic improvement, as well as decreased annual pension contributions as a result of prior reforms. If realized, general fund operations would break even in fiscal 2013 and net surpluses after transfers would grow annually thereafter, gradually improving to a net surplus after transfers of $67 million in fiscal 2017. Given the recent adjustment of TAV projections to negative from positive, and mixed economic indicators, Fitch believes certain revenue assumptions might prove aggressive but notes that projected overall revenue growth is modest.

REESTABLISHMENT OF TIMELY AUDITS

Following pension disclosure failures which significantly delayed its audits for fiscal years 2003-2008, the city has made significant investments in its financial reporting and accounting systems. However, after issuing its fiscal 2009 audit on a timely basis, problematic implementation of a new enterprise resource planning system delayed the fiscal 2010 audit by nine months and the fiscal 2011 audit by one month.

From a management and administration perspective, Fitch notes with concern the training weaknesses and inadequate management controls that led to the initial inaccurate data entry problem, the length of time taken to resolve the problem, and the failure to risk manage the implementation more successfully. The city expects to issue its fiscal 2012 CAFR on a timely basis (November 2012, ahead of the industry standard of December 2012).

MODERATE DEBT BURDEN BUT SIGNIFICANT PENSION & OPEB LIABILITIES

Due to past market access impediments, the city's overall debt burden is moderate at $3,894 per capita, or 3.2% of fiscal 2011 market valuation. Debt amortization is average. In fiscal years 2011 and 2012, the city issued an elevated $161 - $163 million in short-term TRANs annually because of significant increases in the pension ARCs for those years. However, fiscal 2013 TRANs will be lower at approximately $130 million due to improved fiscal 2012 year end balances and earlier timing of interfund transfers.

The city emphasizes its continued focus on funding its capital backlog of $898 million (excluding water and wastewater system needs). The city is considering issuing between $80 - $90 million annually during fiscal years 2013 - 2017. The city might also act as conduit issuer for $520 million in bonds to expand its convention center, if all the required project approvals are granted, but it would be responsible for repayment of only a small portion of that debt.

Fitch believes the capital plan is manageable and should not dramatically alter the city's overall debt profile from both a tax base and budget burden perspective. However, in terms of overall funding for the city's capital needs, Fitch notes that voter approval of a June 5, 2012 ballot measure to prohibit project labor agreements could adversely impact the city's receipt of capital grant funding from the state ($194 million over the last two years), thereby creating more need for general fund support of capital projects.

Fitch expresses concern regarding the general fund's potential exposure to additional debt burden (starting at up to $7 million in fiscal 2013 and $14 million annually thereafter) if the general fund has to pay for debt previously intended to be repaid by the now dissolved RDA. City officials advise that the impact on the general fund should be minimal, offset by projected property tax share revenue growth and monies set aside to mitigate near-term impacts. Fitch believes that the city will likely be able to manage the additional exposure but remains concerned about potential negative financial impacts as the RDA exposure represents approximately 80% of the projected fiscal 2012 $17.8 million net operating surplus after transfers.

San Diego City Employees Retirement System (SDCERS) is 68.5% funded using the city's 7.5% discount rate and 64.9% funded using Fitch's more conservative 7% discount rate, levels that Fitch views as less than adequate. The city has already worked to stem the growth in its pension costs by establishing second tier pension benefits for new hires starting in 2009-2012 (depending on job classification), reducing the rate of return for its deferred retirement option plan, and eliminating its contributions on behalf of employees.

On June 5, 2012 the electorate will also be asked to vote on further pension reform. A conservative analysis prepared by the city's independent budget analyst suggests that if successful, the considerable potential net savings from this reform ($963 million over 30 years) would come not from the proposed pension system changes that actually increase pension costs. Rather, the savings would result from proposed restraints to employee remuneration growth so long as they are not rescinded by majority city council vote. Nevertheless, in terms of the pension system, the ballot measure would benefit the city in the long-term by shifting investment and longevity risks to future city employees.

In terms of OPEB, the city still has an unfunded accrued actuarial liability of roughly $567 million, or a low 0.4% of fiscal 2012 TAV, when including the benefit of recent reforms. The city negotiated a new city retiree health plan in 2012 which is projected to save $714 million in health care costs over 25 years and caps the city's annual OPEB contribution at $57.8 million (5.1% of budgeted fiscal 2012 spending) in fiscal years 2012-2015, with annual increases of up to 2.5% thereafter.

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, Zillow.com, and 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

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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Contacts

Fitch Ratings
Primary Analyst
Alan Gibson, +1-415-732-7577
Director
Fitch, Inc.
650 California Street 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Stephen Walsh, +1-415-732-7573
Director
or
Committee Chairperson
Jessalynn Moro, +1-212-908-0608
Managing Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Alan Gibson, +1-415-732-7577
Director
Fitch, Inc.
650 California Street 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Stephen Walsh, +1-415-732-7573
Director
or
Committee Chairperson
Jessalynn Moro, +1-212-908-0608
Managing Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com