Rating agencies had some good news and bad news for San Francisco this week.
S&P Global Ratings Monday put a negative outlook on the joint city and county’s underlying AAA general obligation bond rating, which means there is a one-in-three chance the rating could be downgraded over the next two years.
But the city also laid claim to triple-A ratings across the board as Fitch Ratings, also on Monday, raised San Francisco’s GO and issuer default ratings to AAA from AA-plus, though the action comes with an asterisk — it was driven by new rating criteria at Fitch.
Moody’s Ratings assigned a negative outlook to its Aaa issuer rating in July, which it confirmed April 17.
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The rating actions come ahead of a $216.5 million
All three rating agencies rate the COPs one notch lower than the GO and issuer rating.
The deal will be senior managed by RBC Capital Markets with Stifel as co-manager. KNN Public Finance and NHA Advisors are municipal advisors; Squire Patton Boggs and Husch Blackwell are bond counsel.
Post-sale, the city will have roughly $1.5 billion in lease obligation debt, according to Moody’s.
As it markets the COPs, the finance team hasn’t received any direct investor inquiries about the rating changes, said Anna Van Degna, director of the San Francisco Controller’s Office of Public Finance.
The “market has historically had a strong appetite for San Francisco’s debt at various rating categories,” Van Degna said.
Challenges driving those negative outlooks are multi-year deficits forecast in the combined city-county government’s five-year financial plan projected to reduce its substantial reserves, equal to 48% of the general fund, to 14% by 2028; and historically high office and retail vacancy rates with office workers
In 2023 the city experienced highly publicized closures of its
The city’s point-in-time homeless count from 2022, the most recent of the two-year reports, showed a 3.5% decrease to 7,754 people experiencing homelessness, of that 3,357 were staying in shelters, even with the decline.
The San Francisco office market closes first quarter 2024 with an overall vacancy rate of 36.7% and net absorption of negative 856,000 square feet, according to national real estate brokerage firm CBRE’s Bay Area
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Fitch assigns a stable outlook to its new AAA rating for San Francisco.
Fitch’s new criteria, which it began using April 2, as it reviewed ratings ahead of bond sales or did annual in-depth surveillance on whatever ratings were up for review, doesn’t equal upgrades for everyone.
Fitch has upgraded four ratings, affirmed two and downgraded two as of April 19, said Karen Ribble, a Fitch senior director. Those running counts, however, don’t cover anything that occurred this week, including the San Francisco upgrade, Ribble said.
“The new criteria recognize revenue, economic and institutional strengths in a way that the old criteria did not,” Ribble said. “The last two are more explicitly recognized, which indicates more resilience to cyclical changes.”
Fitch’s San Francisco ratings report, penned by Ribble; Graham Schnaars, a director; and Michael Rinaldi, a senior director; said the rating reflects the city’s role as the center of an important and growing metropolitan statistical area with a vital role in the national economy.
The San Francisco-Oakland-Berkeley MSA comprises 3.3% of the national economy’s gross domestic product, which is a signifier of the economy’s strength and a sign it’s likely to become more resilient over time, she said.
Though the city is projecting multiple-year deficits that could lower its reserves below the 15% Fitch requires for a triple-A rating, Ribble said, the good governance aspects the rating agency sees in San Francisco make it likely that the city will course correct before it hits 2028.
“They have a formula-based rainy day reserve, and then a budget stabilization reserve,” Ribble said.
Using that formula a portion of the money from San Francisco’s most volatile revenue streams goes into reserves to protect the city from cyclical ups and downs, she said.
“It also contributes to the city not spending all the revenue it has coming in,” Ribble said. “It’s two-year budgeting requires that it balance the budget over a two-year period, which means it can’t turn to one-time solutions as easily.”
The multi-year planning also enables it to see what trajectory it’s on, so it can course correct, so it doesn’t expand expenses beyond what revenues can bear, she said.
“It’s debt policies also limit the amount of general obligation bond and lease revenue bond debt it issues, which keeps their carrying costs affordable,” she said.
Some of the positives Fitch highlighted in the ratings upgrade were also mentioned by Moody’s and S&P.
In its report S&P pointed to high office vacancies and slow-to-recover tourism post-pandemic for the new negative outlook, but analysts also said the city has an extraordinarily strong income profile and resilient residential market.
“The city is currently facing a number of issues,” said Li Yang, an S&P director. “The biggest is its revenue growth is very sluggish and slow.”
Property tax revenues are expected to grow around 1% over the next couple of years, which Yang largely attributed to the high office vacancy rate contributing to lower valuations on commercial property.
He added that costs are also growing faster than revenues.
“Increases in salaries and benefits are outpacing growth in revenues as we saw in the city’s five-year forecast,” Yang said. “That is why they are forecasting deficits for the next five years.”
But with all that, the city still has extremely high wealth and income levels, Yang said. And while assessed values may be slow to grow, partly because of the office vacancies, the state’s Proposition 13, not only slows growth in property taxes, but also prevents big swings on the way down, Ribble said.
The city’s high reserve levels also give it breathing room.
Currently the city has $2.6 billion in reserves, equal to 48% of the general fund, Yang said. Prior to the pandemic, in 2019, it had $2.7 billion in reserves, because it had “really good performance in the years prior to the pandemic,” Yang said.
“They need the reserves to weather what they are forecasting,” Yang said. “We view [the high level of reserves] as a positive.”
S&P analysts said the city has spent — and will continue to spend money — to tackle social problems like crime and homelessness that are affecting the economy.
The proposed budget includes spending on crime and homelessness, which are budget priorities, said Sarah Sullivant, an S&P managing director.
If the city taps reserves to close the $236 million deficit in the fiscal 2025 budget, it will reduce reserves to $2.2 billion or 42% of the general fund, Yang said.
“If the forecast comes to fruition in fiscal 2027 or 2028, reserves could fall to $740 million, and they would then only be 14% of the budget,” Yang said. “They have time, but toward the end, reserves start to get pretty thin.”
Positives, such as the strong income levels and reserves have helped to maintain the triple-A credit rating, despite the challenges cited in the negative outlook, Yang said.
“But some of the pressures, we started to see with the 2023 audit and shortfall, led us to assign a negative outlook,” Yang said. “If they do have consecutive deficits during the next two years, then we could be looking at a weaker profile.”