OREANDA-NEWS. Fitch Ratings assigns an 'AA' rating to the following City and County of San Francisco, California (the city) general obligation bonds (GOs):

--approximately \$61 million GOs (transportation and road improvement bonds, 2014) series 2015B.

Proceeds will be used to fund street, transportation and related infrastructure improvements in the city. The GOs are expected to be sold via competitive sale on or about June 23.

The Rating Outlook is Positive.

SECURITY

The series 2015B GOs and the outstanding GOs are payable from an ad valorem tax pledge on all taxable property without limit as to rate or amount.

KEY RATING DRIVERS

STRONG RESERVES/FINANCIAL POLICIES SUPPORT POSITIVE OUTLOOK: The Positive Outlook reflects the city's fiscally prudent institutionalized financial policies which, along with strong economic and revenue growth, have resulted in solid rainy day and budgetary reserves. It further reflects Fitch's expectation for continued improvement in the city's financial flexibility as measured by its fund balances and ability to adjust expenditures.

EXCEPTIONALLY STRONG ECONOMIC BASE: San Francisco's large and dynamic economy has seen continued strong labor force and employment growth rates. Taxable assessed valuation (TAV) growth remains robust. Wealth indicators are very strong and the tax and employment bases are very diverse.

SOUND FINANCIAL OPERATIONS: Four years of operating surpluses have resulted from strong economic and revenue growth, moderate expenditure growth and policies to fund reserves with one-time and above-average revenues. Reserves now exceed pre-recession levels and new policies are structured to slow their use during the next downturn.

STRONG FINANCIAL MANAGEMENT, OVERSIGHT: The city's charter requires thorough periodic budget monitoring and gives the independent controller strong expenditure control.

MIXED LONG-TERM LIABILITY PROFILE: The city's overall debt is high on a per capita basis, but Fitch considers it affordable given the city's wealth level and strong tax base. Capital needs are large, but above-average amortization and tax base growth should keep the city's debt levels affordable. Carrying costs including debt service, pension and other post-employment benefit (OPEB) costs are moderate but rising despite recent reforms.

RATING SENSITIVITIES

SUSTAINED POSITIVE OPERATIONS: Continued adherence to adopted fiscal policies to build and maintain reserves and curb expenditure growth resulting in sustained sound financial flexibility would lead to an upgrade.

CREDIT PROFILE

STRONG OVERSIGHT SUPPORTS ENHANCED FINANCIAL FLEXIBILITY

The city's charter features several conservative requirements that promote financial stability. The budget must be based on revenue projections published by the independent controller. The charter also requires periodic budget status reports and permits the controller to freeze appropriations if actual revenues are less than budgeted.

A 2009 voter-approved charter amendment led to the adoption of various financial policies including: two-year budgeting, a biennial five-year forecast with balancing strategies, use of one-time revenues for one-time expenditures, and budgetary reserve funding policies and procedures. Importantly, one of the budgetary reserves, the budget stabilization account, is funded from two of the city's most volatile revenue sources, including real property transfer tax revenues in excess of the five-year average.

The new reserve policies in particular have contributed to the city's improved financial position, helping to rein in expenditure growth during a period of economic expansion. Rainy day and budget stabilization reserves have increased materially since their low point in fiscal 2010; furthermore, the requirement to fund reserves from above-average growth in certain cyclical revenues helps curb the city's historical reliance on unsustainable revenue growth for ongoing expenditures. Although most of the city's new mechanisms remain untested by a severe fiscal shock, in Fitch's view they position the city to better absorb any future economic and revenue uncertainty.

In fiscal 2014, the city added another \$67 million to its rainy day and budget stabilization reserves, raising the balance to \$215.5 million (about 5.9% of general fund spending). This is up from \$39 million at fiscal year-end 2010. Furthermore, voters recently amended the charter to limit the amount of the rainy day reserve available for the separately-managed local school district under the original rainy day fund approved in 2003. Not including the rainy day reserve available to the school district and spending about \$12 million for one-time capital, the city projects ending fiscal 2015 with about \$227 million in its rainy day and budget stabilization reserves.

HOSPITAL OPERATIONS REMAIN HEALTHY

San Francisco's public hospital (SFGH) has maintained sound financial operations since implementation of the Affordable Care Act. To date, increased revenue from newly insured patients has exceeded the reductions in state and federal support and the city's general fund transfers to the hospital remain at historical levels. Nonetheless, continued reductions in state and federal support for indigent care as well as competition for insured patients will be a challenge going forward. Uncertainties remain in the rapidly changing healthcare environment. Fitch believes the city's hospital is well positioned to address these challenges and that its general fund financial exposure is manageable.

DIVERSE REVENUES; GROWING FUND BALANCES

As both a city and county, San Francisco enjoys a relatively diverse revenue base which performed adequately during the national recession and has shown solid growth over the last several years. Locally generated taxes generate more than two-thirds of general fund revenues, resulting in somewhat less exposure to potential state and federal funding shifts than other California counties. Total tax revenues for fiscal 2014 were 13% above prior year levels and 39% above receipts for fiscal 2010. Fiscal 2015 estimates show an 8% increase in tax revenues over the prior year, led by real property transfer tax (16% growth) and hotel tax (14.9% growth).

General fund balances have improved steadily over the past four years culminating in a \$295 million net operating surplus in fiscal 2014 resulting in an unrestricted fund balance of \$728 million, equal to a solid 19.8% of spending. General fund cash balances have also strengthened, rising to over \$1 billion in fiscal 2014, a four-fold increase from 2010 levels.

LONG-TERM BUDGET CHALLENGES REMAIN

The proposed fiscal 2016 budget closed an estimated \$21 million deficit and is structurally balanced though does use some fund balance for capital spending, which Fitch views favorably. The proposed budget adds services including social services for homeless and additional public safety officers, as well as funds a modest cost of doing business increase for its nonprofit service providers. Rainy day and budgetary reserves continue to be funded according to their formulas.

Management's most recent update to its five-year forecast (dated May 1,2015) projects general fund deficits rising to about \$417.9 million in fiscal 2020 (11% of fiscal 2014 spending), largely due to more rapid growth for personnel expenses than revenues. Suggested solutions to close the projected gap include slowing capital spending and department savings, among other options. Fitch believes the city has sufficient expenditure flexibility to address the forecast deficits, though wage pressure could present a challenge. Notably, the five-year forecast includes a recession scenario allowing the city to begin discussing actions which would be needed to address larger deficits.

ECONOMIC GROWTH OUTPACES STATE AND NATION

TAV levels rose by 5.4% in fiscal 2015 and maintained a 4.3% compounded annual growth rate over the past six years. Employment growth has been similarly robust and the city's unemployment rate fell to a very low 3.8% in February 2015, well below state and national averages. Job growth continues to exceed state and national averages and wealth and income levels are high.

PENSION AND OPEB COSTS RISING BUT AFFORDABLE

The city is pre-funding a portion of its OPEB costs, aided by charter-required employee contributions, and expects to reach the full actuarially-required contribution (ARC) in approximately 30 years. The pay-as-you-go amount was about \$166 million in fiscal 2014, or 3.6% of governmental expenditures, and funding at the actuarially required level (\$341 million or 7.5% of governmental expenditures) would be challenging. Further supporting OPEB funding is voters' approval of a 2013 ballot measure to prevent future raids on a recently established OPEB trust.

The city's retirement fund is adequately funded, estimated at 81% as of June 30, 2014 using Fitch's 7% return assumption. Pension contributions are expected to flatten as investment losses have been fully smoothed in. In addition, concerns about pension contribution trends are offset somewhat by the recent pension reforms that require employees to share responsibility for the rising costs and limit COLAs.

Carrying costs, including pension, OPEB and debt service, consumed about 22.6% of fiscal 2014 governmental expenditures, a level Fitch believes is manageable. However, as noted, OPEB annual costs are likely to rise somewhat over the medium term which could pressure operations.

AFFORDABLE DEBT AND LARGE CAPITAL NEEDS

San Francisco's debt burden remains affordable despite sizeable recent issuances. Including overlapping entities, debt totals a high \$6,200 per capita but a moderate 2.8% of taxable market value. Future debt issuance plans are expected as the city addresses needs identified in its 10-year, \$4.7 billion general fund capital improvement plan. Future borrowing could raise debt burden above current levels, depending on the timing of issuances and repayment schedules.