Fitch Affirms Oakland, CA's POBs & JPFA Revs at 'A'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the following Oakland, CA (the city) ratings:

--$93 million pension obligation refunding bonds, series 2001 at 'A';

--$86 million Oakland Joint Powers Financing Authority (Oakland Administration Buildings) refunding revenue bonds, 2008 series A-1 and B at 'A'.

Fitch has also affirmed the city's Issuer Default Rating (IDR) at 'A+'.

The Rating Outlook is Stable.

SECURITY

The pension obligations bonds are payable from the city's pledge to make annual payments from dedicated tax override revenues and any other legally available source of city revenues; the city's obligation is imposed by law.

The Oakland Joint Powers Financing Authority refunding revenue bonds, 2008 series A-1 are repaid from lease payments for use and occupancy of certain sewer pipelines, subject to abatement. In addition, the city has pledged tax override revenues on a subordinate basis to rental repayments.

The Oakland Joint Powers Financing Authority (Oakland Administration Buildings) refunding revenue bonds, 2008B are repaid from lease payments for use and occupancy of certain administrative buildings, subject to abatement.

KEY RATING DRIVERS

The 'A+' IDR reflects the city's strong operating performance despite revenue performance only in line with inflation. The city has limited independent legal ability to raise operating revenues, is somewhat constrained by high carrying costs, and typically requires one-time monies to balance its general fund budget. Nevertheless, it achieves solid general fund balances and has very strong gap-closing capacity. The 'A' rating for the pension obligation bonds and refunding revenue bonds is one notch lower than the IDR reflecting the slightly higher degree of optionality associated with payment of appropriation debt.

Economic Resource Base

Oakland is the largest of the San Francisco Bay Area's East Bay cities, an economic center of its own, and a central transportation and transit hub with one of the largest container-ship ports in the nation and an international airport. The economy continues to diversify from a historically industrial city to a commercial, service, and governmental center, with a number of large hospitals and a restaurant and entertainment sector that continues to grow. Post-recession, the city has benefited from increasing assessed valuation, numerous development projects, and declining unemployment.

Revenue Framework: 'bbb' factor assessment

The city's general fund revenue performance over the past decade has been in line with inflation, in part reflecting the city's limited independent legal ability to increase operating revenues.

Expenditure Framework: 'a' factor assessment

During the recession, the city demonstrated its ability to work productively with bargaining units to achieve labor concessions. This was an important offset to the city's otherwise limited expenditure flexibility given its high carrying costs.

Long-Term Liability Burden: 'aa' factor assessment

Fitch expects the city's long-term liabilities to remain moderate relative to its resource base, particularly since future growth in pension and OPEB liabilities has been somewhat moderated by pension reform and increased employee contributions. Future debt issuances will likely be offset at least partially by current debt rolling off.

Operating Performance: 'aa' factor assessment

Achieving general fund structural balance is an ongoing challenge for the city given rising service costs, infrastructure and capital equipment needs, and the large proportion of expenses that are non-discretionary. However, the city has very strong gap-closing capacity given its solid reserves over the near term.

RATING SENSITIVITIES

IDR Sensitive to Financial Performance: The 'A+' IDR could come under downward pressure if the city's current level of financial performance, reserves, debt profile, or tax base deteriorated. The Stable Outlook reflects Fitch's expectation that such deterioration is unlikely.

CREDIT PROFILE

The city's tax base rebounded by 33% between fiscal years 2011 and 2017, and will continue to benefit from a strong development pipeline. Based on issued permits and current construction, the city is projecting 20,000 more residential units, 700,000 square feet of new retail space, 4 million square feet of new office space, and 400 new hotel rooms. While the city expects the recent high level of annual AV growth (9% in fiscal 2016, 8% in fiscal 2017) to flatten from fiscal 2018 onwards, considerable stored value under Proposition 13 is being released as long-held properties are released to the market.

The city's unemployment rate has dropped dramatically since the recession, to less than 6% in June 2016, down from a recessionary peak of 17%. However, it remains above-average compared to the Bay Area, state, and nation. While income metrics are largely below Bay Area and state averages, they exceed the national average, likely reflecting city residents' higher educational attainment.

Revenue Framework

The city benefits from diverse general fund revenue sources, broadly capturing economic activity within the city but also has quite high exposure to economically sensitive revenue streams. The fiscal 2017 general fund budget anticipates that property taxes will be 29% of total general fund revenues, remaining the largest and least volatile revenue source. Other revenue sources are much more economically sensitive, most notably business license taxes (13%), real estate transfer taxes (13%), utility consumption taxes (9%), and service charges (9%). The remaining 27% of projected general fund revenues are derived from a variety of sources, including a 5% transfer from fund balance.

Following a recessionary dip in fiscal years 2009 and 2010, general fund revenues rebounded by 20% through fiscal 2015 as both property and economically sensitive revenue streams grew. Nevertheless, the city's cumulative annual revenue growth rate was only in line with inflation. The city projects its general fund revenue growth will level off from fiscal 2018 onwards. Therefore, Fitch assumes future general fund revenue growth will remain slow in line with inflation.

State law requires voter approval for tax increases, limiting the city's ability to control its revenues. In particular, property tax growth is constrained by an annual limit on taxable AV increases absent a change in ownership. Fees, charges for services, and fines can be raised only to recover the costs of providing related services. The city undertakes an annual review to ensure full cost recovery and expansion where possible. Given the cost-recovery cap, the city's revenue raising ability is judged to be limited.

Expenditure Framework

The city provides a full range of municipal services with public safety accounting for a significant 61% of projected fiscal 2017 general fund expenditures.

Based on the city's recent spending profile, high carrying costs, service restoration pressures, and significant infrastructure and capital equipment needs, general fund spending growth is likely to be at least marginally higher than revenue growth over time.

The city's areas of greatest expenditure flexibility are vacant positions (typically 8%-10%) and non-core services. Faced with an economic downturn, the city advises that it would again negotiate with its bargaining units to achieve labor concessions (for example, furloughs, fire apparatus rolling brown-outs, and increased employees' retirement contributions). Certain reforms, including the 2014 Measure Z parcel tax and parking tax for police staffing and community violence prevention programs, mean the city can now declare a fiscal emergency and take council action to modify expenditure allocation decisions rather than having to return to the voters for approval (as would have been required under Measure Z's predecessor).

However, spending flexibility is constrained by the city's high carrying costs (28% of governmental expenditures). Fitch expects that fixed costs for debt service and retiree benefits will remain high relative to the resource base. The city's employer contributions towards the adequately funded state pension plan will increase over time (although local and state pension reforms have moderated the expected rate of growth) and its contributions towards the closed police and fire retirement system resume in fiscal 2018. The city expects that its future PFRS contributions will be covered fully by pledged tax override revenues (including unspent reserves).

There are some limitations on the city's labor flexibility. The city must collectively bargain the suspension or elimination of contracted salary and wage increases, the current multiyear contracts do not include salary reopeners, and both the police and fire agreements provide for binding arbitration. However while reductions in force are subject to meet and confer provisions, the city can ultimately impose reductions if necessary. The city will next negotiate with its civilian and fire bargaining units in 2017 and with its police bargaining units in 2019.

Long-Term Liability Burden

The city's long-term liability burden is moderate. In fiscal 2015, the combined overall debt, pension, and OPEB liabilities were equivalent to a moderately high 19% of personal income. However, given the city's strong tax base, they represented less than 3% of market valuation. Furthermore, the city's direct debt amortizes swiftly and future debt issuance plans are manageable. In late 2016 or early 2017, the city anticipates issuing $23 million in general obligation (GO) bonds under an existing $62 million authorization. In November 2016, the city will seek voter approval for $600 million in GO bonds for streets, roads, facilities, and affordable housing projects. If authorized, the city anticipates that the resulting bonds would be issued over a 10 year period, allowing the new debt to be issued as existing debt rolls off.

The city makes full actuarially-determined annual contributions to state-funded CalPERS retirement plans for public safety and miscellaneous personnel. CalPERS is mandating increasing employer contributions over the next few years to improve its funded ratio. As of June 30, 2014, the city's proportionate share of CalPERS' net pension liabilities for governmental employees only was $949 million (assuming a 7.5% discount rate). Using Fitch's more conservative 7% discount rate, the city's proportionate share increases to an estimated $1.1 billion (but remains less than 1% of market valuation).

The city also operates the Police and fire Retirement System (PFRS), closed since 1976. PFRS has a net pension liability of $216 million (assuming a 6.75% discount rate). Since 1981, PFRS has been funded by an ad valorem tax override which is charged at the maximum allowable rate. In 2012, the city issued pension obligation bonds to relieve pressure on the general fund by temporarily reducing the annual employer contributions and sizing them to match available tax override revenues through maturity in 2026 (when the tax override expires). As previously noted, the city's PRFS contributions resume in fiscal 2018. The city has built up a tax override revenue excess reserve which it plans to use in conjunction with future years' tax override revenues to repay the pension obligation bonds by 2026. This strategy should avoid renewed pressure on the general fund.

In 2015, the city transferred the liability related to a second closed city-operated pension plan, the Oakland Municipal Employees Retirement System (OMERS), to a third party insurance provider by means of a group annuity contract. The city retains a trust fund for any unanticipated OMERS costs.

To begin addressing its $464 million net OPEB liability, the city established a California Employer's Retirement Benefit Trust to set aside funding specifically for its unfunded OPEB obligations. The trust's balance is currently $4 million.

Operating Performance

The city's 'aa' operating performance assessment incorporates challenged revenue and expenditure flexibility, balanced against health reserve levels and sound gap closing ability. The city achieved significant labor concessions during the recession and following dissolution of the Oakland Redevelopment Agency (which had provided financial support for city operations). When necessary, the city has eliminated civilian and sworn positions, and instituted various additional spending reductions. Most labor concessions made during the recession have since been restored with the exception of increased employee contributions for pensions. However, not all services have been restored to previous levels, and the city has identified sizeable infrastructure and capital equipment needs.

Since the recession, the city has been steadily rebuilding its unrestricted general fund balance, enhancing its financial management policies, and appropriating monies to a new vital services stabilization fund. Excluding the pension override set-aside (which will be needed for future debt repayment), the unrestricted general fund balance in fiscal 2015 was a solid $80 million or 13% of spending, up from $51 million or 9% of spending in fiscal 2011. The unrestricted general fund balance is projected to grow to almost $98 million at fiscal 2016 year-end (a 22% increase). These revenues, along with internally borrowable funds, should enable the city to weather an economic downturn with limited deferral of required spending or erosion of overall flexibility.

The updated fiscal 2017 budget still reflects structural imbalance resulting from using one-time funds for ongoing expenses. There is ongoing pressure to increase spending on public safety, support for job and housing creation, and infrastructure and capital equipment. The relative paucity of truly discretionary expenditures makes budget balancing challenging. Despite these constraints, the city expects to achieve general fund structural balance in fiscal 2018 onwards and to eliminate its $11 million facilities fund deficit by fiscal 2019.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/879478

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Contacts

Fitch Ratings
Primary Analyst
Alan Gibson
Director
+1-415-732-7577
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Stephen Walsh
Director
+1-415-732-7573
or
Committee Chairperson
Steve Murray
Senior Director
+1-512-215-3729
or
Media Relations
Elizabeth Fogerty
+1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Alan Gibson
Director
+1-415-732-7577
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Stephen Walsh
Director
+1-415-732-7573
or
Committee Chairperson
Steve Murray
Senior Director
+1-512-215-3729
or
Media Relations
Elizabeth Fogerty
+1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com