OREANDA-NEWS. Fitch Ratings has affirmed the 'AA-' rating on the following Gilroy, California (the city) bonds:

--$9.5 million general obligation (GO) bonds, series 2009;
--$21.6 million GO bonds, series 2010.

The Rating Outlook is Stable.

SECURITY

The bonds are payable by the city's unlimited ad valorem tax pledge.

KEY RATING DRIVERS

SOLID FINANCES: General fund financial operations feature strong fund balances, conservative reserve policies, and active management to align expenses with revenues.

ECONOMIC IMPROVEMENT: The city's declining unemployment rate is below the state and national rate, but lags the regional rate. Taxable assessed value (TAV) has shown three years of growth since fiscal 2014 after previous year declines. Sales tax revenues continued their improvement, indicative of local economic growth, and surpassed their pre-recession high for the first time.

HIGH DEBT LEVELS: The city's overall debt levels are above average, reflecting significant overlapping school district debt, and debt amortization is slow. Carrying costs of debt service, pension, and other post-employment benefit (OPEB) costs are manageable.

RATING SENSITIVITIES

SHIFTS IN FUNDAMENTALS: The rating is sensitive to shifts in fundamental credit characteristics including the city's strong financial management practices. The city's history of maintaining solid reserves while addressing operating and capital needs indicates continued rating stability.

IMPROVED ECONOMIC INDICATORS: Sustained and significant improvement in TAV and sales tax collections, which signify robust economic growth, partnered with continued sound financial practices, could improve credit quality.

CREDIT PROFILE

Gilroy is located in Santa Clara County, about 30 miles south of San Jose. The 2014 population estimate of 52,533 is a 7.6% increase from 2010.

SOLID FINANCIAL POSITION

Financial operations have benefited from strong reserve policies, requiring a minimum unrestricted balance reserve of 25% of expenditures and an additional economic stability reserve of 15% of expenditures. In addition, management has been active in aligning spending with revenues during the latest economic downturn in order to offset revenue declines. Substantial expenditure cuts included reduced headcount and delayed/reduced capital spending. A portion of both have been recently reinstated, underlying Fitch's belief that the city retains expenditure flexibility. Fiscal 2015 general fund revenues were above the original budget by nearly $3 million and expenditures were $1.7 million below. However, the city used a portion of its fund balance to cover the cost of fleet and equipment purchases, resulting in a $953,000 reduction in general fund balance. Fiscal 2015 unrestricted general fund balance remains strong at 43.4% of expenditures and transfers out.

The fiscal 2016 budget is balanced without the appropriation of fund balance and management reports performance mainly in line with budget, with revenues slightly above. Out-year projections show structurally balanced operations with general fund balances in compliance with policy goals.

The general fund faces moderate contingent liabilities related to inter-fund borrowing, which are currently paid from developer impact fees. Given recent strong performance of these revenues, Fitch does not expect that general fund support will be needed.

ECONOMIC INDICATORS IMPROVING

The local economy has been diversifying in recent years, but still has a large agricultural base. The area is home to three large retail outlet complexes and benefits from its location within the San Jose employment market. City unemployment (4.9% in January 2016) continues its decline but remains above the Santa Clara County rate (3.9%) while moving below state (5.8%) and national (5.3%) rates. Per capita income indicators are lower than regional and state averages, but exceed national averages.

The city's residential real estate market has stabilized recently. Following annual declines and flat performance since fiscal 2009, TAV rebounded in fiscal 2014 (7.5%), fiscal 2015 (7.7%), and fiscal 2016 (6%). The city expects continued growth in the near term.

Overall economic stabilization and growth is also evident in sales tax revenue (33% of fiscal 2015 general fund revenue). Sales tax revenue grew for the fifth straight year (10% growth in fiscal 2015), to surpass its pre-recession peak. The city forecasts a modest 2% increase in fiscal 2017.

HIGH DEBT LEVELS

The city's overall debt levels are above average, reflecting significant overlapping debt, largely related to school district issuance. Debt is $6,052 per capita and 4.7% of assessed value. Principal amortization is slow, with 36.5% retired in 10 years. The city is not contemplating debt issuance in the near term, opting to implement its $98.5 million fiscal 2016-2021 capital plan with pay-as-you-go spending.

Most city employees are covered under the California Public Employees' Retirement System (CalPERS), with those ineligible to participate covered by a separate defined contribution plan. The funded level for the CalPERS plan is 72.3%, based on Fitch's estimated 7% rate of return. The city's total carrying costs, including debt service costs, actuarially required pension contributions, and OPEB pay-as-you-go payments are manageable at about 20% of governmental spending.