SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the following city of Fresno, California (the city) bonds:

--Implied general obligation bond (GO) rating at 'BBB+'.

--$46.2 million Fresno Joint Powers Financing Authority (Fresno JPA or the authority) lease revenue bonds series 2006A and series 2009A, at 'BBB';

--$113.7 million Fresno JPA lease revenue bonds series 2004 (A, B, and C) and series 2008 (A, C, E and F) at 'BBB-'.

The Rating Outlook remains Negative.

SECURITY

The lease revenue bonds are secured by lease rental payments made by the city to the authority for use and occupancy of a variety of governmental assets. The city has covenanted to budget and appropriate lease rental payments annually.

KEY RATING DRIVERS

NEGATIVE ON FINANCES: The Negative Outlook reflects continuing concern about the city's weak financial position and severely limited flexibility to respond to shocks in the near-term.

WEAK FUND BALANCE: The city's general fund has minimal reserves, but revenue gains and very large expenditure cuts have helped move the budget closer to structural balance. The city's 2013 and 2014 budgets appear balanced, albeit with some one-time revenues.

LACK OF EXPENDITURE FLEXIBILITY: Long-term labor contracts limited the city's ability to respond to revenue declines during the recent downturn. The majority of the long-term contracts have expired and been replaced by short-term contracts with significant cost savings. But the city's police contract (50% of general fund spending) runs through fiscal 2015, significantly limiting flexibility in the near term.

ACCESS TO SIGNIFICANT LIQUIDITY: The city's large and liquid balance sheet remains the main protection against economic uncertainty. The city no longer expects to draw its fund balance to below zero, which would have necessitated some inter-year borrowing from enterprise funds. The city's water and sewer funds have very large reserve balances that could be tapped if general fund pressures re-emerge.

OTHER NEGATIVE FUND BALANCES: Several city enterprise funds developed negative fund balances during and before the recession. Management has moved to address this issue, but resolving these negative fund balances will delay efforts to rebuild healthy general fund reserves by several years.

MANAGEMENT WORKS TOWARD BALANCE: The city's current management appears to have a good understanding of the city's financial challenges and has developed a clear plan to withstand the current period stress while working to restore long-term structural budget balance. Willingness-to-pay appears solid.

WEAK ECONOMY, RECOVERY BEGINNING: Fresno is the largest city in California's Central Valley and the regional economic hub. The city was hard hit by the housing downturn and recession, but the economy has begun to show clear signs of recovery with solid job growth and declining unemployment.

TAX BASE EROSION: The tax base is large and diverse, but assessed value (AV) declined 10.9% from its peak in 2009 to 2013. Increases in new construction suggest that the real estate market is recovering. Fitch is cautiously optimistic regarding the county assessor's expectation for the tax base to recoup about half its accumulated losses in the current fiscal year.

MANAGEABLE LONG-TERM LIABILITIES: The direct and overlapping debt burden is elevated. Pension and other post-employment benefit (OPEB) liabilities compare favorably to other large cities. Still, combined carrying costs are somewhat elevated.

LEASES NOTCHED: The lease revenue bond ratings are notched from the implied GO rating by one notch for essential or highly over-collateralized leases and by two notches for non-essential assets.

RATING SENSITIVITIES

WEAK RESERVE POSITION: Fitch is likely to downgrade the rating if the city's revenue recovery is not sustained.

NEGATIVE FUND BALANCES: Failure to maintain progress on resolving negative fund balances outside the general fund could put downward pressure on the rating.

SLIPPING EXPENDITURE DISCIPLINE: City policymakers are under pressure to restore services after a period of severe cuts. Fitch is likely to downgrade the rating if the city's historically strong expenditure discipline slips, allowing budget gaps to reopen.

CREDIT PROFILE

Fresno is California's fifth-largest city with about 500,000 residents. It is located about 250 miles north of Los Angeles in the heart of the agricultural San Joaquin Valley.

WEAK FINANCIAL POSITION

Fresno's financial position deteriorated rapidly during the recent recession. Long-term labor contracts and declining revenues created a budget mismatch that depleted city reserves at the same time general fund support to ailing enterprise funds with negative fund balances was needed. The city posted net operating deficits after transfers in four of the past five audited fiscal years.

The city's reserve position appears to be improving, but remains very weak. Fresno drew its unrestricted general fund balance down to $1.4 million (0.5% of spending) in fiscal 2011 from an unreserved fund balance of $30.6 million (11.7% of spending) in 2008. Conservative revenue forecasts and spending cuts supported growth in the unrestricted general fund balance to $2.4 million, or 1% of expenditures as of June 30, 2012. The city's 2013 and 2014 budgets appear roughly balanced, albeit with some use of one-time revenues.

Fitch expects fund balance to increase slightly in 2013 and 2014, given conservative budgeting. Levels will likely remain inadequate relative to the financial and operational risks faced by the city, forcing most budget adjustments to be made through expenditure control. Expectations for fund balance have improved from Fitch's last review in November 2012, when general fund balance was expected to fall into slightly negative territory for several years.

REVENUE RECOVERING GRADUALLY

General fund tax revenues declined 13.8% from fiscal 2008 to 2010, led by double-digit declines in property and sales taxes, the city's two biggest revenue sources. Tax revenues have begun to rise again, but are only expected to surpass 2008 levels in the current fiscal year. Tax revenues rose 3.8% in 2012 and a solid 7% in 2013 (estimated, unaudited results). Like other California cities, the city has very little revenue raising flexibility due to the property tax limitations of Proposition 13, forcing it to balance budgets primarily on the expenditure side of the ledger.

LIMITED EXPENDITURE FLEXIBILITY FOLLOWING DEEP CUTS

The city failed to fully realign expenditures with decreased revenues due to rising debt service costs and long-term labor contracts that limited expenditure flexibility. Debt service rose 38% from fiscal 2008 to 2013. The general fund absorbed ongoing non-general fund debt service expenses and spent reserves to cure negative fund balances that had developed outside the general fund.

The city has adjusted operations in these funds to prevent further deficit operations (assuming continued general fund support for debt service) and has made considerable progress in reducing accrued deficits. About $16 million of the original non-general fund deficit problem remains, down from $36 million in 2010. The remaining problem equals a significant but manageable 5% of governmental funds spending. The city plans to pay off the remaining deficits (which are largely financed by a loan from the city's water utility) over five years.

The city has made significant cuts to both its payrolls and public services where it had discretion. General fund expenditures declined 23% between 2009 and 2011. The city has trimmed total non-enterprise payrolls by 940 full-time equivalent positions, or 31.6% of its workforce from 2008 to 2012.

The city could not reduce public safety spending as much as management desired due to a long-term contract for police officers, which runs through 2015. The contract locks in pay rates at a level that the city believes it can no longer afford over the long term and limits layoffs. The city successfully renegotiated its other labor contracts and achieved significant savings.

General fund payments under the police contract represent 50% of spending and with no re-openers. Management plans to push for compensation reductions that would re-align spending with revenues when the contract is open again and the City Council can impose terms in fiscal 2016. Fitch views management's ability to impose cuts following the contract's expiration as a key credit strength that puts the city in a position to regain a more convincing fiscal balance in fiscal 2016 and beyond. Fitch also recognizes the political difficulty of such a tactic and will continue to monitor labor relations closely to determine the impact of contracts on financial performance and credit quality. In the meantime, expenditure flexibility is judged to be quite limited.

The city has traditionally had good expenditure discipline, making cuts through the downturn that would have been unthinkable in many communities (cutting police staffing 25.8% in a community with a significantly above average crime rate). Fitch believes budget discipline may be slipping amid a slight improvement in revenues and fatigue over service level reductions.

The city council significantly reduced the number of layoffs in the 2014 budget in favor of assuming higher property tax receipts. The new property tax assumptions are not unreasonable (4.7% growth versus an assessor estimate of a 5.5% to 6% increase in AV countywide), but the adopted budget is now less likely to outperform estimates in a way that would return fund balance to a more healthy level. Similarly, local voters rejected the privatization of city garbage services, which would have lowered bills and increased city franchise fees significantly.

Fitch will continue to monitor the city's budgeting performance and may further reduce the rating if policymakers hesitate to make necessary cuts or begin to restore services at a pace the city cannot afford.

NO BORROWING FOR GENERAL FUND OPERATIONS

The city expected to cover a projected $4.2 million budget gap in its $250 million 2013 budget with borrowing from its sewer fund. The operating deficit would have pushed the city's unrestricted fund balance into negative territory. The city did not need the loan because 2013 revenues came in above conservative expectations.

The city's large and liquid balance sheet remains the main protection against economic uncertainty, given the unusual lack of general fund reserves. Fresno had $232.7 million of unrestricted cash and investments in various accounts government-wide at the end of fiscal 2011. Much of this liquidity is in the city's water and sewer funds. The funds cannot be permanently transferred to the general fund due to state law, but they do provide a significant source of internal cash flow funding for short-term borrowing.

ECONOMIC RECOVERY BEGINS

Fresno is the cultural, commercial and healthcare hub of the San Joaquin Valley, one of the world's most productive farming regions. It benefits from a large and increasingly diverse economy that is currently recovering from a deep cyclical downturn. Fresno's economy is largely driven by agriculture-related activity. As such, unemployment has tended to be somewhat higher than the national and state averages over time. The unemployment rate was 11.1% in August 2013, down from 13.3% a year earlier. Job growth has resumed with employment rising at about 2% a year. Socioeconomic indicators are below average. Median household income was 83.1% of the national level and the poverty rate was 24.9% in 2010.

The tax base is diverse and large with AV of $27 billion in fiscal 2013. AV has declined 10.9% from its peak in 2009 to 2013. AV is projected to rise 4.7% in fiscal 2014 (based on values as of Jan. 1, 2013). A single year of estimated valuation increases is not a trend, but the estimate appears plausible, given that the assessor is an independent county (not city) official and the conclusions make sense in light of available housing market data.

Construction is beginning to resume at a reasonable pace. The value of building permits issued in the city has increased 62% from its trough in 2011 with $463 million of permits issued in 2013. Home prices are up about 12%) from a year ago, according to the Standard & Poor's/Case-Shiller Home price index.

MANAGEABLE LONG-TERM LIABILITIES

Fresno's direct debt burden (excluding fully self-supporting debt) was $693.8 million as of June 30, 2012. Total direct and overlapping debt was elevated at 5.8% of assessed value and $3,116 per capita. The debt structure is typical with no variable rate debt, swaps or capital appreciation bonds. Amortization is moderate with 22.8% of debt repaid in 5 years and 47.6% in 10 years. Gradual amortization should reduce the debt burden meaningfully over the next five years because the city has no plans to issue new general fund-supported debt.

Pension and other post-employment liabilities are less of a concern for Fresno than for many other local governments because the city's two pension plans have funded ratios above 100%, and the city's other post-employment benefit obligations are modest at $115.5 million, or 0.4% of AV, as of June 30, 2012.

The combined carrying costs of debt and retiree liabilities were somewhat elevated at 26.5% of governmental fund spending in fiscal 2012. Carrying costs are likely somewhat overstated due to significant enterprise fund pension costs that are not borne by government funds. The carrying costs do reflect a high debt service burden and significant ongoing payments to maintain a 100% pension funding. Considering the general fund alone, debt service and retirement contributions equaled 22.9% of general fund spending in 2012.

NOTCHING FROM GO

The lease revenue bonds are notched downward from the implied GO rating by one notch for essential assets (series 2009) or two notches for largely non-essential assets (series 2004 and 2008). The assets securing series 2006 (a convention center exhibit hall and theater) are judged to be non-essential, but they are rated only one notch from the GO rating because the leased assets significantly over-collateralize the debt with a value almost three times the amount of the outstanding bonds.

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, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com, National Association of Realtors, Underwriter, Bond Counsel, and Underwriter Counsel.

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=807256

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.