Fitch Affirms Modesto, CA's IDR at 'AA-' and LRBs at 'A+'; Outlook Stable

SAN FRANCISCO--(BUSINESS WIRE)-- Fitch Ratings has affirmed the following city of Modesto, CA ratings:

--Issuer Default Rating (IDR) at 'AA-';

--$58 million lease revenue refunding bonds issued by the Modesto Public Financing Authority series 2008 at 'A+'.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from lease payments from the city to the authority for use of a number of assets, including police headquarters, fire stations and administrative buildings. The city has covenanted to budget and appropriate lease payments, which are subject to abatement risk. The bonds are also secured by swap revenues and a cash-funded debt service reserve fund.

KEY RATING DRIVERS

The 'AA-' IDR reflects the city's low debt burden, solid expenditure control and sound financial management practices within the context of a challenging revenue environment. The 'A+' LRB rating is a notch lower than the IDR, reflecting a slightly higher degree of optionality in appropriation of lease payments.

Economic Resource Base

Modesto is California's 18th-largest city and the fourth-largest in the agricultural Central Valley, with a population of 211,000. Located about 90 miles east of San Francisco, the city is the economic, commercial and cultural hub of Stanislaus County, one of the nation's 10 most productive farm counties by the value of agricultural products sold. The city is home to significant food processing and agribusiness employers, as well as regionally important healthcare, retail and educational institutions.

Revenue Framework: 'a' factor assessment

Revenues have been stagnant over the past decade, failing to keep pace with inflation; however, recent trends suggest acceleration in revenue growth. Fitch expects revenues to grow faster than inflation, reflecting underlying growth in the tax base and longer-term trends. California's tax limitations give policymakers minimal independent legal authority to manage periods of revenue weakness.

Expenditure Framework: 'aa' factor assessment

Underlying expenditure growth is likely to remain inline with expenditure growth, and policymakers have solid expenditure flexibility with moderate fixed costs, strong headcount control and a slightly restrictive collective bargaining environment.

Long-Term Liability Burden: 'aaa' factor assessment

The long-term liability burden is low relative to the economic resource base.

Operating Performance: 'a' factor assessment

The city has rebuilt a solid financial cushion that Fitch believes is sufficient to withstand typical cyclical revenue stresses with only manageable cuts to core services. Budget management in times of recovery is mixed with generally conservative budgeting and some rebuilding of financial cushion in recent years offset by deferral of some required expenses and one-time gap closing measures during a period in which most local governments do not need such measures.

RATING SENSITIVITIES

Balanced Transition Risks: The city of Modesto's gap closing capacity and financial flexibility largely depend on the level of reserves. The rating is sensitive to shifts in unrestricted fund balance in either direction.

CREDIT PROFILE

Revenue Framework

Modesto's revenues are diverse and capture a broad range of local economic activity. The top five revenue sources - motor vehicle license fees, sales taxes, utility user taxes, charges for services and property taxes - provide about three quarters of revenues. No single source predominates.

Growth prospects for revenues are improving. The 10-year compound annual growth rate (CAGR) of general fund revenues has been very weak, increasing more slowly than the rate of inflation at 0.9%. However, the 10-year revenue CAGR appears particularly skewed by the housing bubble years of the last economic expansion, which boosted base-year revenues above their ongoing trend levels for a period. The housing boom and bust were particularly acute in Modesto given its affordability relative to the San Francisco Bay Area.

Longer-term revenue trends show growth significantly above the rate of inflation and closer to 4%. Fitch expects revenue growth rates to move toward this trend over the next several years. Growth has exceeded 5% in the past two years, breaking a six-year period of very weak performance from 2008 to 2013. Management reports positive trends in business investment in the community that should support continued revenue growth, including increasing home values, investments by agribusiness and healthcare employers and downtown revitalization efforts. Home values in Modesto are up 10.5% on the year according to Zillow Group and are forecast to rise by an additional 6.5% over the next 12 months.

The city's main credit weakness is its very limited ability to adjust revenues under California's restrictive Proposition 13 tax limitations. The city may not raise its operating property tax levy, and it must seek a vote of the people to raise other taxes. The city council may raise some fines, fees and charges for services, but its revenue flexibility in these areas is unlikely to be sufficient to offset typical cyclical revenue variations because many fees are limited to cost recovery under initiatives passed by California voters.

Expenditure Framework

Modesto devotes the bulk of its budget to public safety, which accounts for about three-quarters of general fund expenditures. Salaries and benefits for police, firefighters and other public employees account for the vast majority of spending.

Fitch expects expenditure growth to stay in line with to below revenue growth, assuming the emerging trend of improved revenue performance remains intact. The main spending pressures on the city budget are rising pension contributions and increased costs related to public safety. Proximity to large metropolitan areas keeps some pressure on public safety wages, particularly for police officers (who can transfer to higher paying departments in the Sacramento metropolitan area and the Bay Area with relative ease). Public demands for improvements in public safety keep pressure on management to increase staffing.

Expenditure flexibility is solid but not complete, suggesting the city will need to make manageable cuts to core services during economic downturns. The largely fixed carrying costs of debt service, pensions and other post-employment benefits (OPEB) were moderate at 14.4% of governmental funds spending in fiscal 2015 and are expected to remain so despite rising pension costs.

The collective bargaining framework somewhat limits management's ability to adjust wage and benefit costs because the bulk of the workforce (public safety) is subject to binding arbitration. Binding arbitration parameters take into account the city's ability to pay, suggesting awards should be manageable in the rare instances when workers and management cannot agree to a contract. Management's primary budget balancing tool is headcount control with staffing levels largely at the discretion of policymakers. The city made deep cuts in its workforce during the last downturn, and while it has not restored many of the positions cut, it has made significant additions to its workforce, recovering some expenditure flexibility.

Long-Term Liability Burden

The long-term liability burden is low relative to the economic resource base with overall debt and net pension liabilities (NPL) equaling just 6.3% of personal income. The city has been a very sparing user of debt; the long-term liability metric is roughly equally derived from debt of overlapping governments and the NPL (which is about $250 million adjusted by Fitch to assume a 7% rate of return). Amortization of outstanding debt is slow with less than 40% of principal repaid in 10 years, but the city currently has no plan to issue additional tax-supported bonds.

The city has made strong progress in reducing its OPEB liabilities through plan changes. The liability is small at just $31.7 million, or 0.2% of personal income, and does not weigh on the long-term liability assessment.

Operating Performance

Modesto's budget gap closing capacity is strong, but budget balancing may be challenging in a downturn given its limited revenue raising ability. While some reserve drawdowns are likely in downturns, Fitch expects financial flexibility to recover in times of economic recovery as it has in recent years. The city's unrestricted general fund balance of 18.2% at the end of fiscal 2015 was more than three times the 5.1% scenario-estimated revenue loss that Fitch believes the city may experience in a moderate 1% downturn in U.S. GDP.

The level of revenue volatility is above average for a U.S. municipality, requiring higher fund balances at any given rating level. The current level of reserves is consistent with an 'a' operating performance attribute assessment for a government with midrange inherent budget flexibility. Fitch considers inherent budget flexibility 'midrange' largely due to solid expenditure flexibility in the absence of any meaningful revenue flexibility. Fitch expects the city to maintain reserves at the 'a' level or higher through tight expenditure controls and headcount reductions during economic downturns.

Budget management in times of recovery is solid. Financial planning is thorough with a focus on maintaining structural budget balance. Budgeting is generally conservative, and actual results generally outperform the city's projections. Recent budgets have included some non-recurring gap closing measures such as deferring contributions to the city's workers compensation, employee benefit, general liability, information technology and general liability funds. However, the city makes its full actuarially determined pension contributions, has largely addressed its OPEB liabilities and has significantly built up its financial cushion in the current economic expansion.

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

In addition to the sources of information identified in the 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

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1011076

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011076

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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.

View source version on businesswire.com: http://www.businesswire.com/news/home/20160831006547/en/

Fitch Ratings
Primary Analyst
Andrew Ward
Director
+1-415-732-5617
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
Michael Rinaldi
Senior Director
+1-212-908-0833
or
Elizabeth Fogerty, New York, +1 212-908-0526
[email protected]

Source: Fitch Ratings

---

Serious News for Serious Traders! Try StreetInsider.com Premium Free!

---

You May Also Be Interested In

• TotalEnergies Begins Construction of 12 MW Solar Project at New York's JFK Airport
• NetLogistik Named to Inbound Logistics Top 100 Logistics IT Providers Award 2024
• ESGBreaks – EverGen Infrastructure Corp. (TSX.V: EVGN) (OTCQX: EVGIF) Releases Q4, Year-End 2023 Results; Schedules Earnings Call