May 12, 2016 - 4:41 PM EDT
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Fitch Affirms San Antonio, TX Limited Tax Bonds; Upgrades PFC Lease Rev Bonds; Outlook Stable

Fitch Ratings has affirmed the following San Antonio, TX obligations:

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

--$1.595 billion limited tax bonds 'AAA';

--$31.3 million municipal facilities corporation lease revenue bonds at 'AA+';

In addition, Fitch upgrades the following lease revenue bonds:

--$550.4 million public facilities corporation (PFC) lease revenue bonds upgraded to 'AA+ from 'AA'';

The Rating Outlook is Stable.

SECURITY

The GO bonds are supported by the taxing power of the city, limited to $2.50 per $100 assessed valuation (AV).

The lease revenue bonds are payable from annual appropriations by the city.

KEY RATING DRIVERS

The 'AAA' IDR and GO ratings reflect the city's strong revenue flexibility and growth prospects, minimal revenue volatility, and superior financial resilience. These metrics offset the more moderate assessment of the city's expenditure framework that's driven by rapidly rising public safety spending.

Economic Resource Base: San Antonio is the second largest city in the state and seventh largest in the U.S. Prominent sectors include: military and government, domestic and international trade, convention and tourism, medical and healthcare, and telecommunications. Employment gains remain steady despite the contraction of the energy sector that services the nearby Eagle Ford Shale. Steady population growth is fueled by affordable housing prices and ample developable land.

PFC Leased Asset: The upgrade of the PFC lease revenue bonds to 'AA+' from 'AA' reflects application of Fitch's revised criteria for U.S. state and local governments, which was released on April 18. The revised criteria include more focused consideration of project factors in ratings for appropriation-backed debt. The PFC lease revenue bonds do not carry any of the additional risk features that Fitch identifies for rating more than one notch below the IDR.

Revenue Framework: 'aaa' factor assessment

The diverse basket comprised of utility revenues, property taxes, and sales taxes that support the city are expected to yield continued solid and steady gains due to rapid population growth. The city's independent legal ability to raise property tax revenues provides ample flexibility.

Expenditure Framework: 'aa' factor assessment

The city's solid expenditure flexibility is derived from management's prudent budgeting practices and moderate carrying costs, balanced against rapidly growing public safety spending driven by costly benefits. The city has demonstrated a solid ability to cut spending during times of economic and revenue decline.

Long-Term Liability Burden: 'aa' factor assessment

Addressing the city's sizeable deferred capital needs may cause an increase in the liability burden but Fitch expects it to remain manageable. The city's unfunded pension liability is moderate and consistent funding of pensions at actuarially determined levels should keep it at this level.

Operating Performance: 'aaa' factor assessment

The combination of the city's expenditure cutting flexibility, revenue raising authority, and minimal revenue volatility leaves it well positioned to address cyclical downturns. The city has demonstrated a commitment to prudent fiscal practices.

RATING SENSITIVITIES

Shift in Fundamentals: The Issuer Default Rating, General Obligation, and lease revenue bond ratings are sensitive to materials change in the city of San Antonio's strong revenue and expenditure flexibility and operating performance, which Fitch expects the city to maintain throughout economic cycles.

CREDIT PROFILE

The local economy continues to expand rapidly with continued sector development in high technology, medical and healthcare, higher education, and financial services, providing diversity beyond the military which remains a major economic factor. Lackland Air Force Base, Randolph Air Force Base, and Fort Sam Houston account for over 90,000 military and civilian personnel. These facilities benefited from very large investments and additions to troop strength in past base realignments and include high-value missions such as the sole medical school for all military medical personnel.

Corporate headquarters located within the city include United Services Automobile Association (17,000 employees), Valero (IDR rated 'BBB'), and Rackspace. The expansive employment base remains resilient in the face of low oil prices and stalled exploration activity within the nearby Eagle Ford Shale. The city's unemployment rate remained unchanged at a low 3.5% in March 2016 from a year prior, aided by a 2.9% gain in employment.

Revenue Framework

The city relies on a combination of utility revenues (33% of general fund revenues), property taxes (25%), and sales taxes (24%). Utility revenues are primarily from City Public Service (CPS; senior lien bonds rated 'AA+') plus a modest amount from San Antonio Water System (SAWS; senior lien bonds rated 'AA+'). CPS revenues have trended upward but are subject to some volatility due to swings in weather and natural gas prices. The relative stability of AV during downturns has provided steady property tax revenues. Sales tax revenues perform in line with the overall economy. Overall general fund revenues have exhibited minimal volatility.

Historical revenue growth has been above the level of inflation and U.S. GDP growth. The city's revenues are projected to continue this trend given the rapidly expanding employment base and strong demographic trends. The city's AV increased by strong 13.5% in fiscal 2016 due primarily to reappraisal gains. A 6.6% gain in median home values over the last 12 months will likely lead to additional AV growth in the near term.

Ample taxing margin remains under the $2.50 per $100 AV property tax cap for operations and debt service.

Utility revenue raising flexibility is limited as CPS payments are set at 14% of CPS' gross revenues per city ordinance and CPS' master indenture. City council does, however, approve rate increases. Under the flow of funds for CPS utility revenue bonds, distribution of the 14% of gross revenues is the fifth priority, preceded by operations and maintenance expenses, payment of parity bonds and reserves, payment of inferior lien obligations and a distribution to the repair and replacement account.

Expenditure Framework

Public safety is the city's primary responsibility (66% of general fund spending). It is the city's goal to cap public safety spending at this level in order to avoid the crowd-out of other services.

The pace of spending growth absent policy actions is likely to be moderate but pressured by a growing population and costly public safety health insurance benefits. Public safety spending is exceeding general revenue growth.

The city's fixed cost burden is moderate, with carrying costs for debt, pensions and OPEB equaling 18.5% of governmental expenditures.

The framework for collective bargaining agreements (CBA) in Texas gives management control over police/fire hiring and firing and staffing patterns but requires that pay hikes and benefit levels be determined via CBAs. The CBAs for police/fire expired in Sept. 2014, causing both groups to operate under an evergreen clause whereby the terms of the expired agreement (excluding pay hikes) are automatically renewed through Sep. 2024. Talks with the police and fire associations stalled as the city attempted to realign the costly benefits for police/fire employees and their dependents. Subsequently, the city filed a lawsuit claiming the expired CBA's 10-year evergreen clause is unconstitutional due its long term. The city lost at the local level but it has appealed to the district court of appeals. No wage hikes are awarded during the evergreen period but all else remains the same including health benefits. The lack of wage hikes in fiscal years 2015 & 2016 nearly offset the cost of the contested health insurance benefits.

Long-Term Liability Burden

The long-term liability burden, including overall debt and unfunded pension liabilities, is moderate at 17.1% of personal income. Given the city's goal to maintain a flat debt service tax rate, Fitch expects the liability burden to remain moderate as the city addresses its large deferred capital needs with measured debt issuances. The city has $54 million of authorized but unissued bonds and plans to seek voter authorization of about $750 million of GO bonds in 2017.

Civilian and certain public safety employees participate in an agent multiple employer defined benefit pension plan administered by the Texas Municipal Retirement System (TMRS). Fire fighters and police participate in a single-employer defined benefit pension plan.

Annual pension payments consistently meet the actuarially required contribution.

Operating Performance

The city's financial resilience is derived from a combination of revenue and expenditure flexibility and minimal revenue volatility. These credit strengths are expected to keep the issuer's reserve levels well above the 'aaa' financial resilience assessment during an economic downturn.

In the wake of the last downturn, the city gradually increased its formal fund balance policy from 9% to 10% of spending and increased its two-year budget reserve from 3% to 5% of spending. The fiscal 2016 budget is balanced, reduced the O&M rate by 0.75 cents, and is based on conservative utility revenue and sales tax growth of 2% and 4.5%, respectively, over fiscal 2015 budget levels.

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/creditdesk/reports/report_frame.cfm?rpt_id=879478

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1004421

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1004421

Endorsement Policy

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

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Fitch Ratings
Primary Analyst
Jose Acosta
Senior Director
+1-512-215-3726
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst
Rebecca Moses
Director
+1-512-215-3739
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-1568
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
[email protected]


Source: Business Wire (May 12, 2016 - 4:41 PM EDT)

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