Fitch Ratings has affirmed the following Hayward, California (the city) ratings:

--$72.5 million certificates of participation (COPs) (Capital Projects) at 'AA';

--$21.8 million 2007 refunding COPs (Civic Center and Capital Projects) at 'AA';

--Issuer Default Rating (IDR) at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The COPs are repaid by the city's lease rental payments under a covenant to budget and appropriate annually. The lease rental payments are subject to abatement. The bonds are rated one notch below the city's IDR, reflecting the appropriation requirement.

KEY RATING DRIVERS

The 'AA+' IDR reflects the city's strong operating performance, moderate long-term liability burden, moderate fixed costs, and solid reserves. The city's productive labor relations provide the city with budgetary flexibility, particularly in terms of increased benefit cost sharing.

Economic Resource Base

The 63 square mile city is located in Alameda County on Interstate 880 between Oakland (14 miles north) and San Jose (26 miles south). The city has experienced modest population growth over the last decade, to about 158,000 in 2015, and its residents have good access to various San Francisco Bay Area employment centers. The city's economic characteristics are mixed, particularly in relation to the wealthy region, but residents are benefitting from lower unemployment and the strengthened local tax base.

Revenue Framework: 'a' factor assessment

Fitch expects continued strong revenue growth without tax increases or other revenue enhancements. The city's legal ability to raise revenues is constrained by state propositions which require voter approval for tax increases.

Expenditure Framework: 'aa' factor assessment

The city has a moderate fixed cost burden and a demonstrated ability to manage spending in response to economic and revenue decline. On average, spending growth is likely to be in line with, to marginally above, revenue growth over time.

Long-Term Liability Burden: 'aa' factor assessment

The city's long-term liabilities are moderate relative to its resource base.

Operating Performance: 'aaa' factor assessment

The city has exceptionally strong gap-closing capacity. Its solid revenue base, demonstrated budget flexibility and sound reserves would offset moderate recessionary revenue decline.

RATING SENSITIVITIES

IDR Sensitive to Financial Performance: The 'AA+' IDR could come under downward pressure if the city fails to maintain satisfactory financial flexibility, including reserves sufficient to address periodic economic volatility.

CREDIT PROFILE

While the city benefits from its participation in the San Francisco Bay Area's diverse employment opportunities, its own employment base is somewhat narrow. Large city employers include government, California State University-East Bay, and midsize manufacturing firms, with newer bio-science and information technology firms somewhat offsetting the presence of traditional manufacturers. The city's tax base has grown by almost 26% since its recessionary low in fiscal 2011 and development prospects are good.

Revenue Framework

The fiscal 2017 budget assumes 37% of its general fund revenues will come from property and transfer taxes, 23% from sales tax, 11% from the utility users' tax, 8% from changes for services, 7% from franchise fees, and 14% from other sources. Furthermore, in November 2014, 67% of voters approved a new 20-year, 0.5% sales tax (Measure C) which is projected to generate around $14 million annually for the city in new revenue (approximately 10% of projected fiscal 2016 total general fund revenues). Measure C revenues will be used for a variety of purposes and the city council has complete discretion on how to expend the monies.

Fitch expects future revenue growth to be strong and in line with historical performance, above national GDP and inflation, because the city benefits from a reasonably diverse revenue structure. During the past 20 years, there have been only four years with general fund revenue declines which were relatively small. Consequently, the city has experienced strong 172% general fund revenue growth between fiscal years 1995-2015, with a further small increase projected for fiscal 2016. Part of this revenue growth is attributable to the introduction of a utility users' tax in fiscal 2010 which was scheduled to expire in fiscal year (FY) 2019, but which 73% of voters have already approved for a 20-year extension. This generates about $17 million annually (a material contribution to fiscal 2016's projected total general fund revenues of $143 million).

The city's revenue raising ability is limited. State law requires voter approval for tax increases, limiting the city's ability to control its revenues. In particular, property tax growth is constrained by an annual limit on taxable assessed value (AV) increases absent a change in ownership. Fees, charges for services, and fines can be raised only to recover the costs of providing related services. The city is undertaking a comprehensive update to its user fee schedule that will likely generate increases to those revenues.

Expenditure Framework

The city provides a full range of municipal services. The city's options with regard to cutting or reallocating services are somewhat limited given the high level of public safety spending (72% of the proposed fiscal 2017 general fund budget) which is a community priority.

Based on the city's current spending profile, solid revenue growth and managed service cost increases should result in spending growth in line with, to marginally above, revenue growth over time. The proposed fiscal 2017 budget indicates 4% growth in general fund expenses. Coming out of the recession, the city demonstrated its ability to modulate spending increases by freezing salaries for five years and having employees pick up a greater share of their benefit costs.

Fixed costs for debt service and retiree benefits are moderate relative to the resource base. While the city's employer contributions towards the adequately funded state pension plan will increase over time, this will be partially offset by employees' increased contributions to their benefit costs. Staffing resources have been restored throughout the city since the recession. A retraction of these restored positions would result in annual savings of between $1 million and $2 million.

Long-Term Liability Burden

The long-term liability burden is likely to remain moderate. The city does not have immediate future debt issuance plans apart from refundings for interest savings (the bulk of the overall debt burden is generated by other governmental entities) and it makes full actuarially-based annual pension contributions to the state pension system.

The city is about to refund via private placement its 2007 refunding COPs (Civic Center and Capital Projects) for interest savings, and will be seeking state approval to refund all of the redevelopment successor agency's tax allocation bonds for interest savings. For the longer term, the city is examining how best to fund replacement of its main police station, jail, and 911 dispatch center.

Operating Performance

The city's exceptionally strong financial resilience is based on Fitch's expectation that the city would use a combination of its solid budget flexibility and reserves to offset recessionary revenue declines. Growth prospects for revenues are strong and subject to limited volatility, as evidenced by data from the Fitch Analytical Sensitivity Tool (FAST) that estimates a 2.1% revenue decline given a 1% drop in national GDP based on the city's historical revenue performance.

Since the recession, the city has held its unrestricted general fund balance at between 18% and 25% of spending, thereby ensuring a solid financial cushion ($30 million, or 22% of spending, at fiscal 2015 year - end). The city's current projection is that there will be a small general fund drawdown in fiscal 2016 ($1 million maximum) due to salary increases; this would not greatly affect the fund balance as a percentage of spending. In the event of a general fund emergency, the city could temporarily access $46 million in borrowable funds from outside the general fund.

The city's conservative multiyear projections show a general fund structural imbalance from fiscal 2020 onwards, driven in part by rising personnel costs. After five years of no increases, employees are receiving 3% increases in each of fiscal years 2016-2018. Further, there are increased general fund transfers to the capital projects fund and other post-employment benefits (OPEB) prefunding from fiscal 2019 onwards. If increased OPEB prefunding is phased in as currently planned (by $1 million annual increments), the city estimates that it could achieve the actuarially required OPEB contribution by fiscal 2020.

To address any future structural imbalance, management advises that it will be focusing on additional benefit cost sharing with labor, expenditure reductions, and the application of Measure C revenues to appropriate expenses. However, based on the city's performance coming out of the last recession, plus its historical outperformance of its multiyear budget projections, Fitch anticipates that the city will maintain breakeven to positive operations going forward.