Fitch Downgrades Hampton Roads PPV, LLC 2007 Series A Military Housing Tax Revs; Outlook Negative

NEW YORK--()--Fitch Ratings has downgraded the ratings on the following classes of Hampton Roads PPV, LLC military housing taxable revenue bonds (Hampton Roads Unaccompanied Housing Project), 2007 series A (the bonds):

-- Approximately $210 million class I to 'A-' from 'A+';

-- Approximately $58 million class II to 'BB' from 'BBB-';

-- Approximately $9 million class III to 'B+' from 'BB'.

The Rating Outlook on the bonds is Negative.

SECURITY

The bonds are special limited obligations of the issuer and are primarily secured by a first lien on all receipts from the operation of the unaccompanied housing project known as Hampton Roads, located at Norfolk Naval Complex. The absence of a cash funded debt service reserve fund limits protections afforded bondholders.

KEY RATING DRIVERS

DECLINE IN REVENUE AND PROJECTED COVERAGE: The rating downgrade and Negative Outlook reflect the anticipation of weaker revenue and debt service coverage (DSC) in 2014, driven largely by a 5.8% decline in the Basic Allowance for Housing (BAH) from 2013 to 2014. While 2013 DSC ratios of 1.47x, 1.14x and 1.07x, respectively for each series, are adequate, projected 2014 coverages are not expected to exceed 1.31x, 1.01 and .95x, respectively.

PROJECT OPERATION VOLATILITY: The downgraded ratings further reflect Fitch's expectation that project operations will continue to exhibit a degree of volatility consistent with historical operations and higher than initial expectations.

BATTLESHIP LEAVES BASE: The U.S. Navy is in the process of redistributing ships and plans to move the USS New York from its Hampton Roads berth to Jacksonville, Florida. Approximately 3,000 sailors will be impacted in relation to the move.

HIGH TURNOVER LEVELS: The project has been experiencing high turnover levels in January and February 2014 due to the aircraft carrier USS George Bush deployment which puts negative pressure on operating expenses. The project also experienced a dip in occupancy in early 2014 due to ship deployment with over 900 service member move outs. The average occupancy for January 2013 - February 2014 was 90.8%, which is down from 96% in late 2013.

ABSENCE OF CASH RESERVE: While there are operational and capital reserves that are available to support the project, the absence of cash funded debt service reserve fund detracts from bond holder security for all classes of bonds. Class III bonds are most vulnerable.

RATING SENSITIVITIES

BAH REVENUE: Future annual fluctuations in BAH rates for the Norfolk area will continue to drive revenues and could impact DSCRs. Any weakness attributable to lower BAH rates could be offset by an increase in the percentage of BAH for the project, as determined by the Department of Defense.

DECREASED OCCUPANCY AND/OR INCREASED EXPENSES: Management's ability to maintain high occupancy levels and control operating expenses could potentially offset the effect of lower revenue.

UNPLANNED DEPLOYMENTS: Deployments that may occur outside of the planned schedule may put negative pressure on net operating income and DSCRs due to high turnover beyond what is normally experienced.

CREDIT PROFILE

BASE INFORMATION

Hampton Roads/Norfolk Naval Complex (HRNC), located in Southeastern Virginia about 90 miles from Richmond and 185 miles from Washington, D.C., is the largest naval base in the world. It covers approximately 4,631 acres. HRNC consists of a number of installations primarily located in the Norfolk and Sewells Point areas and extends to sites in Norfolk, Virginia Beach, Suffolk, Chesapeake, Portsmouth, Hampton, and Newport News. HRNC is surrounded by many navy installations such as Naval Weapons Station Yorktown/Cheatham Annex, Little Creek Naval Amphibious Base, Norfolk Naval Shipyard, Naval Air Station Oceana/Dam Neck Annex, and Naval Security Group Activity Northwest.

PROJECT OVERVIEW

The housing project located on Norfolk Naval Complex base in Virginia (known as Hampton Roads) is providing apartment residences for single (i.e., unaccompanied) U.S. Navy enlisted personnel. Hampton Roads is providing 1,189 two-bedroom, two-bath apartments, each with a kitchen and living room. In addition to the new units, existing housing facilities were renovated to provide another 39 units.

DEBT SERVICE COVERAGE

While the project's 2013 respective debt service coverage ratios of 1.47x, 1.14x and 1.07x are adequate and in line with management expectations for the year, projections for 2014 which incorporate the new BAH amount show coverage not exceeding 1.31x, 1.01 and .95x, respectively. When reserve and replacement deposits which are paid after debt service are included those ratios decline further to 1.27x, .98x and .92x. Debt service, as originally planned, increased to $19.3 million in 2013 and will remain level throughout the life of the bonds.

These projected ratios will only be achieved if there are no increases in aggregate operating expenses and the property maintains occupancy at a minimum of 92.5% for the remainder of the year. Property management reports that the project continues to experience operating expenses that are approximately 20% higher than what was originally anticipated.

Fitch views unaccompanied military housing projects as having more risk than military family housing projects given the varied profile of the respective tenant bases. Unaccompanied housing projects tend to be subject to higher levels of physical wear and higher annual turnover which leads to higher operating expenses. Therefore, Fitch expects that the DSCRs for an unaccompanied project will be higher than those of military family housing transactions at the same rating level to account for this dynamic.

PROJECT OCCUPANCY LEVELS

The project experienced a dip in occupancy during the first two months of 2014 due to a ship deployment with over 900 service member move outs. The average occupancy for Jan 2013 - Feb 2014 was 90.8% which is down from 96% in late 2013. Management reports that occupancy improved in April to 98%.

Additionally, the Navy is in the process of redistributing ships and plans to move the USS New York from its Hampton Roads berth to Jacksonville, Florida. Approximately 3,000 sailors will be impacted in relation to the move.

Fitch believes that project management will continue to be challenged by the potential for future deployments and the need to reoccupy units.

BAH RATES

There was a 5.8% decline in BAH rates from 2013 to 2014. This followed a 5.25% increase in 2013 which followed declines of 1.36% and 0.81% in 2012 and 2011, respectively. BAH has increased by 8.6%, in aggregate, since the bond origination (2008-2014). However, original projections assumed a 2% increase annually, which would have resulted in a 10.3% increase to date. The difference between the expected 10.3% increase and the actual 8.6% increase will cause debt service coverage to decline if the BAH does not increase in the future.

Based on third party REIS data for the Norfolk/Hampton Roads area, there is uncertainty as to what will be the effect of the U.S. defense budget cuts on the rental market.

BRAC RISK

The first Base Realignment and Closure Commission recommendations were made in 1988, and U.S. Navy facilities in and around Hampton Roads were not included in any of the commission's recommendations. However, since the second BRAC review in 1991 and recommendations made in 1993, 1995, and 2005, the BRAC Commission has proposed to relocate Navy activities, ships, personnel, operations, and infrastructure to HRNC.

It is clear from a review of the Navy's recommendations to the BRAC Commission and the BRAC Commission's recommendations to the President since 1988 that the HRNC, including the Naval Shipyard, Norfolk, Naval Station, Norfolk, Naval Air Station, Oceana, Naval Amphibious Base, Little Creek, Naval Weapons Station, Yorktown, and the related operations and infrastructure in around them are vital to the U.S. Navy. None of these key facilities have been recommended for closure by the Navy. Consequently, Fitch expects that HRNC will continue to serve the U.S. Navy and retain its status as the largest naval complex in the world for the foreseeable future.

It is unclear if the recent movement of the USS New York is an indicator for future BRAC recommendations.

DEBT SERVICE RESERVE FUND

The bonds have a debt service reserve fund whereby AMBAC serves as the surety bond provider sized at maximum annual debt service. Fitch does not assign any value to the AMBAC surety bond and does not rely on its presence in the event of project financial deterioration. In addition, there is an excess collateral agreement in place in the amount of $6.5 million which acts as a line of credit to the project from Merrill Lynch (rated 'A/F1'; Outlook Negative by Fitch) with a wrap from AIG (rated 'A-'; Outlook Stable). At this time the surety bond and excess collateral agreement providers have had their creditworthiness downgraded or withdrawn completely since the issuance of the bonds. As a result, Fitch no longer gives any credit in the analysis to those agreements.

PROJECT MANAGEMENT

Hampton Roads LLC is managed by American Campus Communities, Inc. (ACC). ACC has traditionally managed student housing properties and currently has 53 properties with approximately 32,000 student housing beds under its management. The Hampton Roads properties are the first arrangement where ACC is acting as manager for a military housing project.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information in the Revenue-Supported Rating Criteria, this action was additionally informed by information from Hunt Companies.

Applicable Criteria and Related Research:

-- 'Revenue-Supported Rating Criteria' (June 3, 2013);

-- 'Rating Criteria for Military Housing' (Sept. 17, 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

Military Housing Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=717957

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=827336

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Maura McGuigan, +1-212-908-0591
Senior Director
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Charles Giordano, +1-212-908-0607
Senior Director
or
Committee Chairperson
Mario Civico, +1-212-908-0796
Senior Director
or
Media Relations, New York
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Maura McGuigan, +1-212-908-0591
Senior Director
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Charles Giordano, +1-212-908-0607
Senior Director
or
Committee Chairperson
Mario Civico, +1-212-908-0796
Senior Director
or
Media Relations, New York
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com