OREANDA-NEWS. Fitch Ratings affirms the following Prescott, AZ ratings at 'AA':

--$355,000 general obligation (GO) bonds series 2007;
--$18.7 million Prescott Municipal Property Corporation (MPC) excise tax revenue bonds series 2007 and 2010;
--Issuer Default Rating (IDR).

The Rating Outlook is Stable.

SECURITY
The GO bonds are payable from an unlimited ad valorem tax levied on all taxable property in the city.

The excise tax revenue bonds are special obligations of the MPC payable from payments made by the city. The bonds carry a pledge of and first lien on the city's excise tax and state shared revenues.

KEY RATING DRIVERS

Analytical Conclusion
The 'AA' IDR and GO rating reflect solid expenditure flexibility and prudent budgeting, factors that have supported maintenance of stable financial operations, including sound reserves, even in periods of economic weakening, and despite limited revenue raising ability. Carrying costs related to long-term liabilities are moderate and are expected to remain so, though they will be pressured by increased pension costs due to retirement system underfunding.

The 'AA' MPC excise tax revenue bond rating reflects the expectation for a strong coverage cushion during periods of economic decline and an additional bonds test of 3x maximum annual debt service (MADS).

Economic Resource Base
Prescott, AZ is located approximately 95 miles northwest of Phoenix and 90 miles south of Flagstaff, and is the Yavapai County seat. The city (population of about 41,000) serves as a regional retail and commercial center. Major economic sectors include government, healthcare, trade and tourism.

Revenue Framework: 'bbb' factor assessment
Prescott's 10-year general fund revenue growth rate is modestly above the national inflation rate but lower than national GDP growth. Recent performance has been positive, and continued revenue growth is expected, given economic improvement and ongoing development plans. The city has very limited independent ability to offset operating revenue volatility for operating purposes with tax rate or other revenue adjustments.

Expenditure Framework: 'aa' factor assessment
The city's solid expenditure flexibility reflects moderate carrying costs and full control over headcount, wages, benefits, and work rules given the absence of labor contracts. This flexibility should allow the city to address spending pressures related to operating and capital needs while maintaining stable finances.

Long-Term Liability Burden: 'aa' factor assessment
The city's total long-term debt and pension liability burden is moderate at about 11% of personal income, largely related to the unfunded pension liabilities. No additional governmental funds debt issuance is currently contemplated.

Operating Performance: 'aaa' factor assessment
Fitch expects continued strong operating performance given the city's history of prudent budgeting and expenditure flexibility, with maintenance of reserves adequate to address potential economic downturns.

RATING SENSITIVITIES
Maintenance of Financial Position: The ratings are sensitive to shifts in the city's strong financial management practices and capabilities. These include solid expenditure flexibility and maintenance of adequate reserves.

Debt Service Coverage Cushion: The excise tax revenue bond rating is additionally sensitive to shifts in debt service coverage, with significant coverage declines (not expected) potentially resulting in negative rating pressure. The rating on excise tax revenue bonds is capped at the city's IDR.

CREDIT PROFILE

Prescott's economic base includes government, healthcare, trade and tourism, with the city acting as a center for regional trade. A moderate climate and scenic surroundings contribute to the city's tourism and growing retirement sectors. Top 10 taxpayers (about 8% of taxable assessed value [TAV]) are largely utility and retail-related, with some manufacturing. Arizona Public Service, a utility, is the largest taxpayer at about 2.5% of TAV, followed by Sturm Ruger (firearms manufacturing) at about 1.4%. TAV returned to growth in 2014 (fiscal 2015) following multi-year annual declines. City unemployment has decreased but remains above state and national levels.

Revenue Framework
General fund revenues are made up largely of economically sensitive local sales and state shared revenues (income, sales, and vehicle license taxes). Local sales taxes made up about 43% of fiscal 2015 general fund revenues, followed by intergovernmental revenues (34%). Property tax revenues represented a low 5%. Reflecting general revenue volatility and the impact of the economic downturn, the city's general fund 10-year revenue compounded annual growth rate (CAGR) was below the national GDP growth rate, though modestly above the national inflation rate. Independent revenue raising ability is very limited due to legal caps, voter requirements, and reliance on intergovernmental revenues.

Revenue performance has been positive in recent years, and continued growth is expected due to an improving economy and ongoing economic development projects.

Primary property tax levies used for operations are limited to a 2% annual increase over the prior year plus taxes on any property not previously subject to taxes. There is no limitation on annual secondary levies, used for voter-approved bond indebtedness. Voter approval is required for a sales tax rate increase.

Expenditure Framework
The city's largest general fund expenditure area is public safety. Public safety expenditures represented about 70% of fiscal 2015 spending.

The natural pace of spending is expected to remain in line to marginally above revenue growth. The city's history of prudent budgeting has resulted in operating surpluses in recent years and adequate reserves even in periods of economic weakening.

Solid expenditure flexibility is supported by manageable carrying costs (about 18% of fiscal 2015 governmental spending), control over headcount, and the absence of labor contracts. This flexibility should allow the city to address spending pressures, including increases in public safety pension costs due to retirement system underfunding, while maintaining stable financial operations.

A recently approved state-wide Arizona Public Safety Retirement System (PSPRS) ballot measure providing for new hire benefit adjustments and eliminating automatic cost of living adjustments could lessen pension spending pressures. In addition, there is currently a citizen initiated sales tax rate increase proposal (proceeds to cover public safety costs, including pensions), which may be put before voters. A similar city proposal that would have dedicated proceeds from a sales tax rate increase to pension costs was rejected by voters in 2015.

Long-Term Liability Burden
City debt levels are moderate, and no additional near-term governmental funds debt issuance is expected. The city's long-term liability burden, largely related to its unfunded pension liability, is moderate at about 11% of personal income. The city contributes to two pension plans: the Arizona State Retirement System (ASRS), a cost sharing, multiple employer plan; and the significantly underfunded PSPRS, an agent, multiple employer plan. The city reports a fiscal 2015 ASRS net pension liability (NPL) of $30.3 million, with fiduciary assets covering 69.5% of total pension liabilities at the plan's 8% investment return assumption (approximately 62.6%, adjusted by Fitch to assume a lower 7% investment rate assumption). The NPLs for the city's PSPRS police and fire plans are $34.8 million and $36 million, respectively, with fiduciary assets covering 25.3% and 31.4% of total pension liabilities at the plans' 7.85% investment return assumption (approximately 23.1% and 28.7%, adjusted by Fitch to assume a lower 7% investment rate assumption).

The city has made 100% of its actuarially determined contributions in recent fiscal years for all retirement plans. For fiscal 2016, due to increased contribution requirements, PSPRS offered an additional 'phase-in' contribution option that allowed for the impact of the increases to be spread across three years. The city chose the 'phase-in' option for fiscal 2016 but will return to the 'before phase-in' option for fiscal 2017.

Operating Performance
The city's strong budget flexibility supports a high level of financial resilience allowing for the maintenance of strong reserves through economic cycles.

Prudent budgeting has resulted in operating surpluses and increased reserves in recent years. Fiscal 2015 operations yielded a budget surplus that increased the general fund unrestricted balance to $22.8 million or 72.6% of spending. The initial fiscal 2016 budget assumed a deficit of about $1.2 million. Due to better than budget revenue performance and lower expenditures, current estimates indicate a surplus of about $1.6 million.

MPC Excise Tax Revenue Bonds

The 'AA' rating for the excise tax revenue bonds reflects an adequate financial cushion despite historic volatility of pledged revenues, a strong additional bonds test of 3x MADS, reliance on excess pledged revenue for city operating needs, and solid performance expectations for pledged revenues. In evaluating the sensitivity of the pledged revenues to cyclical decline, Fitch considers both revenue sensitivity results under a 1% national GDP decline scenario and the largest decline in revenues over the period covered by the revenue sensitivity analysis. Based on a 15-year pledged revenue history, Fitch's analytical sensitivity tool (FAST) generates a 6% scenario decline in pledged revenues. The largest actual consecutive cumulative decline in historical revenues is about 20% from fiscal 2008 to fiscal 2010.

Revenues pledged to the excise tax revenue bonds include excise taxes and state shared revenues. Excise taxes include locally levied 1% transaction privilege (sales) taxes (46% of fiscal 2015 pledged revenues), franchise taxes, licenses and permits, charges for services, and fines and forfeitures. State shared revenues (35% of pledged revenues) consist of state shared sales taxes and state revenue sharing distributed to localities based on population. Following strong declines in fiscal 2009 and 2010, pledged revenues have seen annual growth since fiscal 2011, with continued growth estimated for fiscal 2016 and 2017. Pledged revenues have increased at a CAGR of 2.6% from fiscal 2005-2014. Fiscal 2015 pledged revenues of $31.1 million provide strong MADS coverage of about 8.9x.

The rating on the MPC excise tax revenue bonds is capped at the city's IDR, as pledged revenues are closely linked with city operations and are not viewed as special revenues under section 902(2)(B) of the bankruptcy code.