OREANDA-NEWS. Fitch Ratings has affirmed Modesto Public Financing Authority (PFA), California's (the authority) bonds as follows:

--\$58 million lease revenue refunding bonds, series 2008 at 'A+'.

In addition, Fitch affirms the following rating:

--City of Modesto, California (the city) implied general obligation (GO) rating at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by lease payments from the city to the authority for use of a number of mostly essential leased assets, subject to abatement. The bonds additionally are secured by a cash-funded debt service reserve fund.

KEY RATING DRIVERS

CONSTRAINED ECONOMY, RECOVERY UNDERWAY: The city's economy continues to demonstrate growing tax revenues and a rebounding tax base with improved real estate values and new development. Nevertheless, it remains somewhat constrained by the agriculture-dominated regional economy and above-average unemployment rate.

SOUND FINANCIAL PROFILE: Proactive and conservative financial management is keeping general fund reserves at satisfactory levels. However, the city recognizes that it needs to grow its revenue base if it is to meet community service expectations.

LOW DEBT BURDEN: Overall debt is low and debt, pension, and other post-employment benefit (OPEB) carrying costs are manageable.

LEASE REVENUE RATING NOTCHED FROM IMPLIED GO: The lease revenue bonds are rated one notch below the implied GO bond rating reflecting the essentiality of most of the leased assets and a covenant to budget and appropriate.

RATING SENSITIVITIES

The ratings are sensitive to fundamental changes in financial management and performance. The Stable Outlook indicates Fitch's expectation that the city will not alter its current conservative approach. The city's somewhat limited economy limits its implied GO rating.

CREDIT PROFILE

Modesto is the seat of Stanislaus County, located in the northern San Joaquin Valley. It encompasses 36 square miles and serves approximately 205,000 residents.

CONSTRAINED ECONOMY, RECOVERY UNDERWAY

The city is a governmental, medical, and retail hub for the surrounding region. Nevertheless, the local economy remains significantly concentrated in agriculture, despite regional diversification efforts. Consequently, the city's below-average socioeconomic characteristics are somewhat shaped by the high percentage of seasonal agricultural jobs in the local employment market. Unemployment is declining gradually but remained elevated at 9.2% in November 2014, compared with the state and national averages of 7.1% and 5.5% respectively.

Economic recovery is underway, as evidenced by increasing tax revenues and tax base valuation increases. After a cumulative assessed valuation (AV) decrease of 30.4% between fiscal years 2008 and 2013, there was a strong rebound of 5.9% in fiscal 2014 and 10.5% in fiscal 2015. This has resulted in meaningful increases in the city's property tax receipts. The county assessor is projecting a further 4%-5% AV increase for the city in fiscal 2016. This appears to be justified given the current construction pipeline of new distribution warehouses, commercial/retail properties, and medical facilities. Residential properties are recovering some of their lost value but are not expected to return to pre-recession prices. While foreclosures remain an issue, the number of foreclosure filings and proceedings are declining.

The city is expecting an upswing in single family dwelling construction in fiscal 2016 based on subdivision map approvals and the commencement of grading for a new subdivision. However, future large scale residential development will likely be constrained by two factors: growth limitations, which are expected to be strengthened by a voter-initiated city limit ordinance on the November 2015 ballot, and the difficulty developers have in assembling large parcels of land given the diverse ownership of properties surrounding the city.

SOUND FINANCIAL PROFILE, CONSERVATIVE MANAGEMENT

The city ended fiscal 2014 with an unrestricted general fund balance of \$16.1 million, a satisfactory 14.7% of spending. It achieved a fourth year of surplus operations (\$3.5 million net operating surplus after transfers) and continued to exceed its \$10 million minimum unrestricted general fund reserve policy (equivalent to 9.1% of fiscal 2014 general fund expenditures and transfers out). This was made possible by growth in the city's well diversified revenues, significant labor concessions (including pension and OPEB reform), tight expenditure controls, and recent structural reorganization.

Now that the economy is improving and tax revenues are growing, the city has been able to provide labor with salary and wage increases, and provide the community with some service restorations. It anticipates ending fiscal 2015 with a \$3.6 million general fund balance drawdown in order to fund a number of one-time council priorities including salary incentives for employees. This would still leave a total general fund balance of approximately \$16.3 million or 14.5% of spending.

The city anticipates returning to balanced operations in fiscal 2016. Thereafter, its conservative multiyear projections through fiscal 2023 show a small but persistent structural imbalance largely due to increases in annually required CalPERS contributions. The city has identified almost \$8 million in current general fund expenditure flexibility to address future budget shortfalls. However, it recognizes that it needs to grow its revenue base in order to maintain existing service levels and fund service expansions desired by the community (for example, greater public safety services and maintenance of all existing fire stations). To that end, the city is working with the community on proposals for excess property sales, creation of a downtown benefit district, a surcharge on water customers outside the city limits, and a 0.5 cent general sales tax measure.

Fiscal 2014 general fund liquidity was adequate. As part of the fiscal 2015 budget, the city established a \$3 million general fund reserve for unanticipated contingencies. In an emergency, the city could access \$42.1 million in cash from its internal service funds and \$164.4 million from its enterprise funds (for short-term loans subject to city council approval).

LOW DEBT BURDEN

The city's overall debt burden is low at \$1,225 per capita or 1.9% of market valuation. Amortization is average with 42% of principal retiring in 10 years. The 2008 lease revenue bonds, which represent approximately 95% of the city's debt, are variable-rate debt supported by a letter of credit which will next need to be extended in March 2017. A sizeable negative swap value (negative \$10.3 million) remains associated with this variable-rate debt.

In fiscal 2014, combined debt repayment, annually required pension contribution, and OPEB pay-as-you-go carrying costs were manageable at 17.4% of total governmental spending. The pension component of the city's carrying costs will continue to grow due to increases in the annually required CalPERS contributions. However, these increases are somewhat offset by savings from the city's pension and OPEB reforms which significantly reduced entitlements and increased employee contributions. The city expects an upcoming OPEB actuarial study to show its unfunded OPEB liabilities to be greatly reduced.