July 2 - Fitch Ratings has downgraded the following bonds for the city of Fresno, CA (the city): Implied general obligation (GO) bond rating to 'A-' from 'A'. Fresno Joint Powers Finance Authority --$167.5 million lease revenue bonds (series 2004A, B, & C; 2006 A; 2008 A, C, E & F; and 2009A) to 'BBB+' from 'A-'. Fitch has also revised the city's Rating Outlook to Negative from Stable. SECURITY The lease revenue bonds are secured by lease rental payments made by the city of Fresno to the Fresno Joint Powers Financing Authority for use and occupancy of essential assets, subject to annual appropriation and abatement. KEY RATING DRIVERS FAILURE TO BALANCE BUDGET: The downgrade reflects Fitch's heightened concerns about the city's ability to achieve fiscal stabilization given the adoption of a fiscal 2013 budget that failed to achieve important cost saving measures. ACTIVE FISCAL MANAGEMENT; CONTRACTS KEY: Fitch notes as a key rating driver the city's active management of fiscal performance through interim reporting and fervent public stance on reaching a solution that restores fiscal balance. However, management believes its only practical options for achieving budget balance are through reductions in public employee compensation. This is a significant challenge given that the largest existing contract offers raises and job protection through 2015 with no formal re-openers. LACK OF RESERVES: The city depleted its unrestricted general fund balance in fiscal 2012 and continues to struggle to close ongoing fund balance deficits outside the general fund. The city has a plan to adequately manage cash flow over the next fiscal year and does not anticipate the need for external borrowing. It has significant resources in enterprise funds that can be used for liquidity. However, these funds cannot be permanently transferred to governmental funds under California law. LIMITED REVENUE OPTIONS: The adopted fiscal 2013 budget continues the city's reliance on one time revenues as it has little revenue raising flexibility. MANAGEABLE LONG-TERM LIABILITIES: Overall debt is moderate at about 4.9% of assessed value (AV) and is expected to decline gradually as the city has no additional borrowing plans. Other long-term liabilities are manageable and compare favorably to other large cities with fully-funded pensions and an unfunded other post-employment benefit liability equal to about 0.3% of AV. WHAT COULD TRIGGER A RATING ACTION FURTHER FINANCIAL WEAKENING: Worsening budget imbalance during fiscal 2013 or inability to achieve balanced operations in fiscal 2014 would put downward pressure on the city's rating. CREDIT PROFILE UNBALANCED BUDGET The Fresno City Council passed a budget on Thursday that closed an estimated $16 million budget gap for the upcoming budget year. The budget includes one-time revenues, an increase in its sales tax revenue forecast that could prove optimistic in an uncertain economy, and assumed labor concessions that have not been agreed to by employee groups. The city believed employees would agree to compensation cuts, but it failed to secure them in time for its budget deadline. The city also missed budget projections in fiscal 2012 because it did not secure desired concessions. LIMITED EXPENDITURE FLEXIBILITY The city has made deep cuts in expenditures since the recent recession began, including elimination of a third of its general fund positions. However, long-term labor contracts with its police union have locked in compensation costs at a level that no longer appears sustainable amid weak revenue performance. The city's police contract precludes layoffs, and holds compensation constant in 2013 and 2014 before raising pay about 4% in 2015. STALLED NEGOTIATIONS The city asked employees to accept a 6% pay reduction this year to rebalance its budget, but police employees did not agree to the concessions. Police offered the city a sizeable salary reduction in exchange for an extension of its contract to 2016, which management rejected. The two sides appear to be at an impasse. The city's decision to reject a contract extension -- which would extend very long-term contracts in an uncertain revenue environment -- suggests that management is determined to realign compensation costs with reduced resources. But the enacted budget assumes $4.1 million of concessions from police that appear unlikely to occur. The existing contract and practical public safety concerns preclude policymakers from balancing the budget through significant staffing reductions. NEGATIVE FUND BALANCE The city is likely to run negative fund balance for a period of time if the city cannot reach an agreement on concessions. The lack of financial reserves leaves the city vulnerable to expense and revenue shocks in an uncertain economic environment. While municipalities with other internal resources can sustain negative fund balances for a period, negative fund balances are uncommon and a sign of financial distress. Continued deficit borrowing, albeit from internal resources, would put further downward pressure on the rating.