OREANDA-NEWS. Fitch Ratings assigns an 'A' rating to the following bonds:

--Approximately $282 million Sacramento Public Financing Authority (SPFA) lease revenue bonds, series 2015 (Sacramento Entertainment and Sports Center - ESC) (federally taxable).

The proceeds will fund the city of Sacramento's (city) contribution to the construction of a new home for the Sacramento Kings basketball team at the Sacramento Entertainment and Sports Center (the arena), finance a debt service reserve fund and pay costs of issuance.

The city plans to sell the series 2015 bonds in floating rate mode to Goldman Sachs & Co. as underwriter in August 2015 if a trial court rules in its favour. The city expects to publicly remarket the bonds in fixed rate mode if the appellate court rules in its favour but in any event in advance of the mandatory tender date of October 2, 2017. (See the end of this release for more information on the litigation.)

In addition, Fitch affirms the city's implied general obligation (GO) bond rating at 'AA-'.

The Rating Outlook is Stable.

SECURITY
The bonds are payable from lease rental payments from the city to SPFA for use and occupancy of the arena. The city has covenanted to budget and appropriate lease rental payments from any legally available resource. The lease is subject to abatement risk, and bondholders lack the right to foreclose on the property in a default.

KEY RATING DRIVERS

NOTCHING ON ESSENTIALITY: The two notch distinction for the arena financing reflects the non-essential nature of the project. The 'AA-' implied GO rating reflects the city's elevated and rising debt burden, somewhat concentrated economy, strong management and positive recent financial performance.

IMPROVING FINANCIAL POSITION: Recent financial performance has been very strong with significant reserve building, but the city experienced an extended period of deficits during the last recession. The turnaround reflects large expenditure cuts, underlying revenue recovery and voter approved tax increases. Financial reserves remained healthy throughout the recession and are currently quite strong.

BUDGET PRESSURES CONTINUE: The city's financial forecast shows significant out-year deficits, driven by rising pension costs and expiration of a temporary sales tax. City policymakers recognize that services restored with a temporary sales tax are likely to be rolled back if voters do not extend the sales tax.

PARKING MODERNIZATION KEY TO ARENA PLAN: The city plans to rely on new parking modernization and rental payments from ArenaCo, as representatives of the Sacramento Kings to fund arena debt service. The plan appears reasonable but remains speculative.

FUNDAMENTALLY SOUND ECONOMY: Sacramento's economy has solid fundamental underpinnings due to a large governmental sector. Unemployment has declined rapidly in recent years amid solid job creation. The tax base is diverse and shows clear signs of recovery. Incomes are somewhat below average.

HIGH DEBT BURDEN: Overall debt levels are above average and expected to climb with the arena financing. Combined carrying costs of debt service and retiree benefits are also projected to increase to above average levels with the new debt. Pensions are adequately funded, but pension contributions are rising.

WELL MANAGED CITY: Management engages in thorough financial and capital planning processes within a solid financial policy framework. Elected policymakers have shown strong expenditure discipline and received significant public support for efforts to restore budget balance after a period of painful service reductions.

RATING SENSITIVITIES

MAINTENANCE OF OPERATING BALANCE: The rating is sensitive to the city's ability to maintain operating balance in the face of ongoing cost pressures and limited revenue flexibility. The Stable Outlook reflects Fitch's expectation that the city will continue to make budget adjustments as necessary to maintain balance.

CREDIT PROFILE
Sacramento is the capital of the state of California and the sixth most populous city in the state with about 475,000 residents. The city is located about 85 miles northeast of San Francisco.

IMPROVING FINANCIAL POSITION
The city's financial position continues to recover after a deep recession. The city has posted net operating surpluses after transfers since fiscal 2012, ending a six-year period of fund balance spending. The city had an operating surplus after transfers of $18.9 million, or 5% of expenditures and transfers out, in the fiscal year ended June 30, 2014. Unrestricted fund balance increased to a strong $95.4 million, or 25.2% of spending. Budgets for fiscal 2015 and 2016 suggest continued balanced or surplus operations.

The city's revenues dipped sharply in the recession, but policymakers showed strong expenditure discipline in returning the city's finances to balance. Total spending reductions equaled 20% over the fiscal 2008-12 period compared to revenue declines of 8.5%. The city closed current services budget gaps of about $40 million a year over this period, largely by trimming positions. The city maintained healthy reserves across the period, with unreserved fund balance bottoming out as a percentage of spending at 12.4% in fiscal 2010.

Like all California governments, Sacramento has limited revenue flexibility due to state constitutional tax limitations. The city cannot increase property taxes and must secure voter approval for other tax increases. The lack of revenue flexibility forces the city to make most budget adjustments through expenditure changes, and the city must negotiate with organized labor to fully adjust expenditures to match revenues.

RISKS TO FINANCIAL OUTLOOK
Sacramento's general fund budget has returned to structural balance since the recession, but the city faces a number of spending and revenue risks. Pension costs are climbing rapidly, while a temporary sales tax increase approved in 2012 expires in fiscal 2019. The city's five-year financial forecast shows budget gaps equal to a high of 5% spending in fiscal 2020 if the city continues to spend at its current pace and voters do not extend the sales tax. Management would expect to cut recently restored services to regain budgetary balance, but the looming sales tax expiration remains a financial risk.

The city's budget could also come under pressure if the city's plan to pay debt service on the new bonds using team rental payments and the proceeds of an ambitious parking modernization plan prove overly optimistic. Fitch believes the city's funding plan is reasonable but remains speculative until fully implemented.

The parking modernization plan relies on increased enforcement activities, expansion of parking meter system and technology improvements that have the potential to provide significant additional revenues to the city. The city has prudently planned for a third less revenue than parking consultants forecast, and has also begun funding a liquidity reserve with a budgeted balance at fiscal year-end 2016 of $7 million and expected to grow to about $18 million in fiscal 2017. The liquidity reserve should protect the general fund from the most likely near-term pressures as the parking modernization plan is implemented.

The city plans to issue the bonds as general appropriation-backed debt that it will be obligated to pay regardless of the underlying debt service funding plans. Any shortfalls in planned payment sources would put pressure on a general fund that appears relatively tightly balanced at the moment and would likely require painful budget reductions if called upon for repayment of the arena debt.

ECONOMIC RECOVERY GAINS SPEED
Sacramento's large, government-dominated economy has picked up significantly over the past three years after being hard hit by the housing downturn and a late recovery from the recent recession. The city's non-seasonally adjusted unemployment rate of 6.1% in May 2015 was down significantly and was in line with the state (6.2%) and above the national (5.3%) rates. Job growth has outpaced the state and nation at 2.4% over the past year. The city benefits from a large, relatively stable employment base as the state capital, and it is a regional economic center with growing technology, healthcare and professional services sectors.

The city's tax base has begun recovery from a 14.5% decline during the housing downturn with a 3.9% increase in fiscal 2014 and a 5.7% jump to $39.5 billion in fiscal 2015. The tax base is diverse, and concentration is not a concern with the top 10 taxpayers accounting for just 4.1% of current AV. Recent gains in home price indexes suggest that AV gains are likely to continue.

The city's tax-base could also benefit from significant (albeit still tentative) development projects in the pipeline, including the Kings arena project, the redevelopment of the city's downtown rail yards and the end of a development moratorium in the formerly fast growing Natomas neighborhood. Natomas added significantly to the city's growth during the housing boom, but development was halted by FEMA for flood levee repairs. The lifting of the moratorium opens a large swath of undeveloped land for building near the urban core.

City socioeconomic indicators are mixed, but typical for a large urban area. Median household income is somewhat weak at 93.8% of the national and 81.4% of the state median. The individual poverty rate is elevated at 21.9%.

ABOVE-AVERAGE DEBT BURDEN
The city's debt and pension liabilities are large. The direct and overlapping debt burden will be above average at 6.4% of assessed value and $5,281 per capita after the current offerings. Carrying costs for debt service and retirement benefits were moderate at 20.1% of governmental funds expenditures in fiscal 2014 but are expected to jump to over 25% of spending due to increases in debt service and pension contributions.

2015 BOND LITIGATION
The sale and delivery of the 2015 bonds are the subject of a lawsuit challenging the validity of the bonds and related indenture and lease documents. The plaintiffs assert (among other claims) that the expenditures and participation by the city in the project are: (1) a waste of public funds and unlikely to serve the city's various stated public purposes; (2) illegal (because they allegedly violate certain local, state and constitutional limitations); and (3) the byproduct of alleged fraud and concealment. A trial court decision is expected by the end of July 2015.

If the trial court rules against the city, the bonds will not be sold and the rating will be withdrawn. If the trial court rules in favor of the city, the city would proceed with the sale of the bonds to the underwriters.

If the plaintiffs then file an appeal with the state court of appeals and the state court of appeals were to rule in favor of the city, the city would proceed with the public remarketing of the bonds. In the event the state court of appeals decides against the city, the city would likely appeal to the state supreme court. Subsequently, if the state supreme court rules in the plaintiffs' favor, the series 2015 bonds and related indenture and lease documents would be invalid.

Under that scenario, purchasers of the series 2015 bonds would not be entitled to repayment and could lose their entire investment. The city would not be obligated to make, and might be precluded from making, lease rental payments, thereby adversely affecting bondholders. Bondholders also could be required to repay to the authority any previous principal and interest payments made on the series 2015 bonds.

It is unclear what remedies, if any, bondholders would have. If they were to file a suit for damages or recovery against the city in this situation, they would be unsecured creditors. In the event the city is unable or unwilling to make a timely payment of bond principal and interest as a result of the state supreme court ruling, Fitch would indicate that a default had taken place and withdraw the rating.

Fitch has reviewed an opinion of Greenberg Traurig, LLP, counsel retained by the underwriter, which states that the allegations against the city are without merit and that the plaintiffs should not prevail on any of their proffered causes of action. The city is proceeding with the borrowing now to avoid additional capital-related expenses in an environment of increasing construction costs and interest rates.