SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings assigns the following underlying rating to the Successor Agency to the Redevelopment Agency of the City of Pittsburg, CA's (the agency) tax allocation bonds (TABs):
--$109.7 million subordinate TABs series 2004A at 'BB' on Rating Watch Positive.
In addition, Fitch has placed the following bonds issued by the former Pittsburg Redevelopment Agency (former RDA) on Rating Watch Positive:
--$245.4 million subordinate TABs (taxable) series 2006B and subordinate refunding TABs series 2006C and 2008A 'BB-'.
Prior to today's rating actions the Rating Outlook on the TABs was Stable.
The TABs are secured by a subordinate lien on non-housing tax increment revenues, net of county administrative fees, and are payable per statute from former housing revenues on a subordinate basis to housing TABs. The TABs are additionally secured by cash-funded debt service reserve funds (DSRF) sized to the IRS maximum and supplemental DSRFs required per the terms of the 2004A bonds' letter of credit (LOC) sized to varying amounts by bond series.
KEY RATING DRIVERS
RATING WATCH POSITIVE: The Rating Watch Positive reflects Fitch's expectation for continued improved performance from the project area tax base and debt service coverage over the intermediate term. This expectation is tempered by the uncertainty surrounding the agency's renewal of a letter of credit (LOC) expiring in December 2014, as materially higher costs for liquidity could negatively impact projected debt service coverage levels.
LOW COVERAGE, VARIABLE RISKS: The low rating levels reflect weak debt service coverage and variable rate structural risks. Although tax increment revenues now fully cover maximum annual debt service (MADS) and seem poised for further growth, the project area's AV historically has exhibited high volatility, and has been subject to frequent appeals from its highly concentrated industrial taxpayers.
VARIABLE TABS' HIGH CASH RESERVES: The 2004A variable rate TABs' positive one-notch distinction is due to their extremely strong DSRF levels, sized to $34.4 million (31% of 2004A par and 305% of MADS). Fitch believes these reserves provide bondholders with a material degree of additional protection against a hypothetically severe AV stress scenario.
GROWTH LIKELY DESPITE APPEALS: The project area enjoys good intermediate-term growth prospects due to the city's availability of vacant land, large-scale residential construction in progress, rising home values, and major infrastructure projects that could lead to auxiliary growth. However, a backlog of pending appeals could dampen growth over the near-term.
LOC RENEWAL: Fitch likely will upgrade the bonds if the agency renews its LOC, expiring in December, with an affordable related fee that does not materially and negatively affect projected debt service coverage levels.
TAX BASE PERFORMANCE: The ratings may change, depending on the performance and sustainability of the project area's tax base.
Pittsburg is located in Contra Costa County and benefits from its location within the large and diverse San Francisco Bay Area employment market and the presence of several large industrial enterprises. Most local economic indicators are weak despite the city's geographic advantages.
The project area comprises a large 5,750 acres, making up over 70% of the city's fiscal 2014 AV. Although the project area's tax base contains a fair degree of diversification by property type, there is high concentration among the top 10 payers who make up 33% of incremental value (IV) (30% of AV).
FY15 AV SIGNIFICANTLY HIGHER THAN EXPECTED
The project area's fiscal 2015 AV increased a solid 7.9%, rising to levels not seen since before fiscal 2010. The gain significantly out-performed Fitch's prior base case assumption of a 1.8% AV loss, which had been conservatively crafted in light of a large overhang of pending appeals, a granted appeal of $49 million, and a low CPI adjustment of 0.45%. Although the latter two factors are included in fiscal 2015 AV, the former is not, and may weigh somewhat on fiscal 2016 AV performance.
Fiscal 2015 AV performance increased MADS coverage to 1.03x from 0.95x and 0.93x in fiscal years 2014 and 2013, respectively. Fiscal 2015 MADS coverage would have been 1.05x if not for a one-time $2 million deferred LOC fee payable on Dec. 31, 2014, of which $1 million is recurring at current rating levels. Coverage would improve further if not for Fitch's conservative coverage methodology, which excludes $333,000 in annual loan repayments, $1.5 million of interest earnings, and any supplemental property tax revenues, which are highly variable.
The agency's semi-annual cash flow projections show a cash flow surplus of $8 million in calendar 2015 growing to $15 million in 2016, based on a reasonable 2% AV growth assumption. The agency will be able to retain cash surpluses for some time as it builds up its debt service funds, as noted below.
OUT-YEAR AV GROWTH POISED TO BENEFIT FROM NEW CONSTRUCTION
AV levels in fiscal 2016 and beyond are likely to benefit from elevated construction levels. New housing construction is proceeding at a pace of about 200 single family homes annually, with an approximate annual value of $68.8 million (2.8% of fiscal 2014 AV) based on agency-reported median sales values of $534,500. Multi-family construction is also expected to boost AV, but the timing of such developments is difficult to predict.
The city has approved over 2,500 new housing units within the project area, and expects thousands more given the availability of vacant land and in-fill development opportunities. A portion of anticipated projects are related to a planned Bay Area Rapid Transit rail extension into the project area.
Rising real estate prices also bode well for out-year AV growth. City home values are up 11% through June, according to Zillow. Property values as of January 1, 2015 will form the basis for fiscal 2016 AV.
VARIABLE RATE STRUCTURAL RISKS
The 2004A TABs are variable rate with a variable-to-fixed interest rate swap and make up 45% of subordinate debt by par value. Because the variable rate TABs are secured on a parity lien with the agency's fixed rate subordinate TABs, the variable rate structure exposes all subordinate debt to interest rate risk and a potential termination payment if the swap is terminated. The swap counterparty may terminate the swap if the agency's debt is downgraded to below 'BBB-' by S&P, which is the current rating level. Management estimates the termination payment at roughly $14 million.
The termination payment would be subordinate to subordinate debt service and all pass-through payments and likely could not be paid rapidly, if at all, based on current debt service coverage levels and other agency obligations. As a result, the swap counterparty may not be incentivized to terminate the swap if the option becomes available. Further, given its subordination to debt service, Fitch would not expect failure to make a termination payment to result in a TAB default.
The agency is also exposed to LOC renewal and fee hike risks, with the LOC scheduled to expire in December 2014. An inability to extend or replace the agency's LOC would result in conversion of the variable rate TABs to bank bonds, which could raise interest costs to as high as 12%, adding substantially to annual interest costs. Fitch estimates fixed rate TAB debt service reserves could last approximately four years under these conditions before depletion, assuming no AV growth. Due to the 2004As' out-sized reserve levels and declining projected LOC costs as the bonds are paid down, these bonds could avoid reserve depletion through maturity under the same severe conditions.
2004A TABs BENEFIT FROM HIGH RESERVE LEVELS
The 2004A TABs benefit from atypically high cash reserves that Fitch believes provides bondholders with materially higher credit quality than the fixed rate reserve levels, which are nonetheless good overall. In addition to the standard indenture-required DSRF (currently $7.9 million), the 2004As have a $26.5 million supplemental reserve as a condition of prior LOC extensions. Combined, these reserve levels equal $34.4 million, or 31% of the 2004A TABs' outstanding par value. The fixed rate TABs also have an LOC-required reserve, but it is significantly smaller at $5.5 million, and it must be used to replenish any hypothetical draw-down of the 2004A TAB reserves, providing limited benefit to the non-2004A TABs.
Per the TABs' indentures the agency must retain two years' worth of debt service payments in the TABs' debt service funds, which is on top of the above-mentioned reserves. Historically the agency only retained one year's worth, and is now in the process of reaching compliance with the indenture requirement by retaining surplus tax increment that otherwise would have been distributed to overlapping taxing entities or subordinate pass-through payees. As a result, the agency projects that already high cash levels will grow further.
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