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

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

--$7.3 million San Luis Obispo Public Financing Authority lease revenue bonds series 2014 at 'AA'.

The bonds are scheduled to sell competitively on or about Oct. 15, 2014. The proceeds will fund the expansion of Los Osos Valley Road Interchange Project on U.S. Highway 101, a major interstate freeway.

In addition, Fitch affirms the following ratings:

--City of San Luis Obispo implied general obligation bonds at 'AA+';

--$26.4 million City of San Luis Obispo Capital Improvement Board lease revenue bonds series 2006, 2009 and 2012 at 'AA'.

The Rating Outlook is Stable.

SECURITY

The lease revenue bonds are secured by lease payments made by the city to the authority and the board. The city has covenanted to budget and appropriate the lease payments, subject to abatement. There is no debt service reserve fund for the 2014 bonds.

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, RISING PENSION COSTS: The city's sparing use of bond 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. Other post-employment benefit (OPEB) liabilities are 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 the state average. The city's property tax base is mature, diverse and growing at a moderate pace after suffering small declines during the recession.

LEASE NOTCHED FROM GO: The 2014 lease revenue bonds are rated one notch below the city's GO rating. Lease provisions are typical with a covenant to budget and appropriate debt service annually subject to risk of abatement. The leased asset is a parking garage in the city's central business district with a significantly higher insured value than the par amount on the bonds.

RATING SENSITIVITIES

ECONOMICALLY-SENSITIVE REVENUES: The city's reliance on economically-sensitive sales and transient occupancy taxes limits upward movement of the rating. The rating could come under downward pressure if the city fails to maintain structural budget balance and compliance with its reserve policies.

CREDIT PROFILE

San Luis Obispo is a city of about 46,000 people on the California coast located just south of the midway point between San Francisco and Los Angeles. The city is home to California Polytechnic State University with about 20,000 students.

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 fiscals 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 strong 28.5% of general fund spending at the end of fiscal 2013.

Fitch views the city's strong reserves as an important offset to its reliance on economically sensitive revenues. Sales 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 March 2015 and its renewal will be considered by city voters in November 2014. Support for renewal appears strong and the city has prudently begun contingency planning in the event the tax is not extended. Nonetheless, failure of the measure could pressure the city's strong financial operations.

LOW DEBT, MOVES TO ADDRESS RISING PENSION COSTS

Long-term liabilities are manageable with rising pension costs offset by a modest bond debt and limited OPEB liabilities. Total carrying costs for pensions, OPEB and debt service equaled a moderate 19.8% of governmental funds spending in fiscal 2013. Rising pension costs are likely to increase this fixed cost burden, but total carrying costs are likely to remain in a range that Fitch considers moderate and affordable.

Pension costs are rising as the city works to address unfunded pension liabilities. The city reported that its pension funds were 71.4% funded as of June 30, 2012. That's equal to an estimated 67.7% funded ratio using Fitch's standard 7% rate of return assumptions. 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 update actuarial assumptions. Pension costs in fiscal 2013 were equal to a moderate 14.3% of governmental expenditures, but 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.

OPEB liabilities are less of a concern for San Luis Obispo than most municipalities due to relatively modest benefit offerings and some prefunding of future liabilities. The city's unfunded OPEB liability equaled just $4.5 million as of June 30, 2011. The city's annual required contribution (ARC) for OPEB was a very modest $558,000, or 0.9% of governmental funds spending in fiscal 2013, and the city paid its full ARC.

Total direct and overlapping debt will remain quite low at 1% of AV or $1,372 per capita after the current issue. Debt service accounted for just 4.6% of governmental funds expenditures in fiscal 2013. The city's debt structure is uncomplicated and composed entirely of fully amortizing, fixed-rate lease revenue bonds. Amortization will slow with the addition of the current 30-year bond issue, but remain moderate with about 42% of debt repaid over 10 years. The city's capital needs are limited and largely funded by pay-go capital spending. The city currently has no further plans to issue tax-supported debt.

STRONG 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 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 economic downturn. Its July 2014 unemployment rate of 6.6% was close to the national average and well below the state California. Employment levels now exceed pre-recession peaks.

The city's tax base proved quite stable and resilient during the recent housing downturn. Taxable assessed value (TAV) declined by less than 2% in 2011 and 2012 before returning to growth in 2013. TAV grew a moderate 3.3% to $6.5 billion in fiscal 2014. Taxpayer concentration is low with the top 10 taxpayers representing just 6.3% of TAV.

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).

--'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

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=890494

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Contacts

Fitch Ratings
Primary Analyst
Andrew Ward
Director
+1-415-732-5617
Fitch Ratings, Inc.
650 California St., 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble
Senior Director
+1-415-732-5611
or
Committee Chairperson
Karen Krop
Senior Director
+1-212-908-0661
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Andrew Ward
Director
+1-415-732-5617
Fitch Ratings, Inc.
650 California St., 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble
Senior Director
+1-415-732-5611
or
Committee Chairperson
Karen Krop
Senior Director
+1-212-908-0661
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com