SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed Menlo Park Community Development Agency, California's (the agency) bonds as follows:
--$59.8 million outstanding tax allocation refunding bonds (TABs), series 2006 (Las Pulgas Community Development Project) at 'BBB'.
The Rating Outlook has been revised to Positive from Stable.
The TABs are secured by tax increment revenues, net of county administrative fees. The bonds are additionally secured by a cash-funded debt service reserve fund.
KEY RATING DRIVERS
IMPROVING AV CUSHION: The revision in Outlook to Positive from Stable reflects moderate improvement of the TABs assessed value (AV) cushion (defined as the degree of AV loss required to cause debt service coverage to fall to a sum sufficient amount) and expectations of further gains based on a solid city-wide AV expansion in fiscal 2015 as well as a strong real estate market and ongoing development of the project area's largest properties.
VARIABLE RATE VULNERABILITIES: The TABs are in variable-rate mode and are synthetically swapped to fixed. As a result of the debt structure, there are structural vulnerabilities, particularly with regard to the TABs' swap, which is currently subject to a termination event.
CONCENTRATED PROJECT AREA: The small project area is highly concentrated among its top taxpayers and experienced a significant AV loss during the recession. However, the project area is mature, well diversified by land use, and in-fill development is ongoing.
STRONG LOCAL ECONOMY: Menlo Park is a mature and affluent community in the San Jose region's Silicon Valley with low unemployment, extremely high and rising home values, and an expanding employment base.
SATISFACTORY IMPLEMENTATION OF DISSOLUTION PROCEDURES: The agency has obtained a finding of completion from the California Department of Finance (DOF) and is not currently experiencing any cash flow timing issues imposed by dissolution statute.
RISING AV CUSHION: The rating likely will be upgraded if the TABs' AV cushion continues to increase materially.
Menlo Park (general obligation bonds rated 'AAA' by Fitch) is located in the San Francisco Bay Area's peninsula region, benefitting from access to the large and broad employment markets of San Jose and San Francisco.
SOUND DEBT SERVICE COVERAGE LEVELS
The TABs' Fitch-estimated AV cushion increased to a sound 38% in fiscal 2014 from 31% in fiscal 2013 due to a moderate AV gain and a reduced letter of credit (LOC) fee per the conditions of a recent three-year LOC extension. The TABs' AV cushion exceeds the project area's substantial peak to trough AV decline of 18.7% from fiscal years 2009-2012.
Fitch-estimated fiscal 2014 tax increment revenues of $10.4 million cover maximum annual debt service (MADS) 1.70x and annual debt service (ADS) 1.82x. MADS occurs in fiscal 2017 and declines moderately thereafter. Fiscal 2015 AV for the project area has not yet been released by the county assessor. However, city-wide AV is estimated to increase by over 6%. Appeals information from the county was not available for the current credit review, but the prior year's appeals levels were quite low and the property market has continued to strengthen.
ANALYTICAL REFINEMENT CONSIDERS POSITIVE EFFECTS OF DISSOLUTION
On May 1, Fitch refined its California RDA analysis pertaining to the beneficial impact of dissolution legislation (AB 1X 26). Fitch now considers TAB liens to be closed and surplus housing revenues to be available for non-housing TAB debt service. Although Fitch views these factors as positive credit characteristics, they were not sufficiently material to result in a positive rating action. A sizeable portion of the TABs were already payable from the 20% housing set-aside, and the AV cushion is not yet sufficiently robust - with consideration of variable rate structural risks noted below - for the closed lien to warrant positive rating action.
Fitch formerly excluded positive dissolution factors from consideration, reflecting a conservative approach to a dissolution environment marked by legislative, administrative, and judicial uncertainty. Two-and-a-half years and six recognized obligation payments schedule (ROPS) cycles have passed since dissolution, during which the factors have benefitted TAB credit quality with no successful legal challenges to date. Although uncertainties remain, Fitch views the continued presence of closed TAB liens and surplus housing revenue availability as more likely than not to remain a feature of California TABs.
VULNERABLE VARIABLE RATE CHARACTERISTICS
The TABs' sound AV cushion is offset by typical variable rate structural risks. The bonds include liquidity support from a State Street LOC and an interest rate swap with Morgan Stanley. The agency's swap agreement is currently subject to termination based on Moody's below investment grade rating of the TABs. A termination by the counterparty (Morgan Stanley) would expose the agency to interest rate risk. However, the agency's related termination payment would be subordinate to debt service and therefore would not impair debt service.
To date, the counterparty has not terminated the swap, which had a negative termination value of $10.7 million as of June 30, 2013. The counterparty may be reluctant to terminate the swap since repayment would derive from annual surplus tax increment available after payment of debt service and would likely take over two years to pay in full.
The recent three-year extension of the agency's LOC at a reduced fee is viewed by Fitch as a credit positive, mitigating prior concerns related to fee and renewal risks. The new LOC fee was reduced to 2% from 2.75%, but could rise to 2.75% if Fitch or Standard & Poors carry a credit rating on the TABs of 'BB+' or below. Recently positive AV performance, if sustained, makes it more likely that the agency will be able to renew its LOC in three years at a reasonable fee, or refund its TABs with fixed rate debt depending on interest rate conditions, including the termination value of the TABs' interest rate swap.
VERY STRONG CITY-WIDE ECONOMIC CHARACTERISTICS
Menlo Park economic characteristics are extremely strong, with very high educational attainment levels and median per capita incomes at 233% and 247% of state and national levels. Unemployment fell to a very low 3.4% in April from 4.1% the year prior, compared to the state and national rates of 7.4% and 5.9%, respectively.
PROJECT AREA SMALL, CONCENTRATED, VOLATILE
The project area is small at just 857 acres and is highly concentrated among its top 10 taxpayers who make up 37% of AV (41% of incremental value [IV]). Project area AV fell by a substantial 18.7% from fiscal years 2009-2012 owing largely to declines in the project area's commercial real estate values. Many of the project area's largest taxpayers are in the economically cyclical high-tech industries.
The project area's peak-to-trough AV decline compares poorly to the city, which experienced a reduction of growth during the recession but no losses. The project area's fiscal 2014 AV gained a moderate 5.1% (gross of exemptions, which have not yet been released by the county), following a 2.4% increase the year prior.
PROJECT AREA WEAKNESSES MITIGATED BY MATURITY, PROMISING TRENDS
The above-mentioned project area weaknesses are somewhat mitigated by the following:
--The area's largest taxpayers, including Facebook (12% of IV), Menlo Business Park (9%), and AMB Property (8%) have been performing well and are in different stages of expanding or improving their properties.
--The project area's IV to base year value is high at 1076%, resulting in a low degree of revenue sensitivity to AV volatility.
--The project area is well diversified by land use as of fiscal 2013 (the most recent year for which data was available), with significant exposure to industrial (37% of AV), residential (36%), and commercial (25%) properties.
In addition to these strengths, the city's solid housing market has realized significant gains in recent years, with property values up 16.6% year-over-year to January 2014 (Jan. 1, 2014 is the basis upon which fiscal 2015 AV levels will be determined) according to Zillow.
AV in the project area is unlikely to rise by the same degree as home market values for three reasons. First, the project area contains significant commercial and industrial real estate concentration, and changes to commercial values have lagged residential values over the past several years. Second, Proposition 13 limits AV increases to no more than 2% annually (unless property turns over), except for properties subject to a Proposition 8 AV reduction. It is unknown what proportion of properties in the project area is subject to Proposition 8. Last, it is unclear to what extent city-wide residential home value gains apply to the housing stock located within the project area.
Despite these limitations, Fitch believes the project area ultimately will benefit by some positive valuation tailwinds from the broader regional real estate recovery.
SATISFACTORY IMPLEMENTATION OF DISSOLUTION PROCEDURES
Management appears to be acting in conformity with its bond indentures, despite the administrative hurdles imposed by dissolution statute (AB 1X 26), and the agency reportedly is not subject to any related cash flow timing issues.
The agency is not required to produce continuing disclosures, per the TABs' indenture, as long as the bonds are traded in daily or weekly variable rate mode. This weakness is offset by Fitch's expectation that the agency will make available to Fitch on an ongoing basis requested information needed to continue rating the bonds, including data related to AV, top taxpayers, and appeals.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from CreditScope and Zillow.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria