Fitch Affirms $173MM Forest City Southern Group, LLC Class I Bonds 'AA-'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'AA-' rating on the Forest City Southern Group, LLC. (SGLLC), Taxable Military Housing Revenue Class I Bonds which includes the following two series:

$127.9 million - 2011 Series A-1 bonds;

$ 45.0 million - 2011 Series A-2 bonds.

The Rating Outlook is Stable.

SECURITY

The security for the rating is all rental receipts of the project. Those receipts are predominantly derived from the basic allowance for housing (BAH) after payment of operating expenses, from U. S. military service members stationed at Keesler (MS), Shaw (SC), Arnold (TN) and Charleston (SC) Air Force Bases (AFBs) throughout four states in the southern part of the U.S. Additionally, security is provided by the first lien on all improvements to the family housing and a servicing advancing structure from a rated servicer.

KEY RATING DRIVERS

DEBT SERVICE COVERAGE RATIO: The audited debt service coverage ratio (DSCR) is 1.97x for the combined A-1 and A-2 bonds for the year ending 2014. The Series A-2 bonds will be paid off on or prior to April 2016 with the proceeds of the Government Direct Loan (GDL) funds. Fitch approximates that the DSCR will demonstrate coverage of no less than 1.40x when the ratio calculation excludes estimated revenues and expenses associated with non debt sized units (NDSUs) and maximum annual debt service is included.

REMOTE BASE CLOSURE RISK: Fitch draws comfort from remote base closure risk of Keesler, Shaw, Charleston and Arnold AFBs.

BASIC HOUSING ALLOWANCE: Current and projected basic allowance for housing (BAH) experienced both cumulative increases and decreases at various ranks over the last four years but in aggregate BAH rates are lower than what was projected at initial underwriting, especially at Shaw and Keesler. However, at Charleston BAH rates were more in line with original assumptions and the property manager at Keesler has been able to increase occupancy above 93% while the original underwriting proforma assumed less than 85% occupancy somewhat mitigating the negative impact of lower BAH rates on revenue. Additionally, at this time, approximately 507 units of additional units add to the aggregate revenues.

IDP: The Initial Development Period (IDP) is almost complete and construction of the units is expected to be delivered on time in the fourth quarter of 2015.

OTHER FINANCIAL PROTECTIONS: The contribution in the form of a $45.0 million Guaranteed Direct Loan (GDL) from the Air Force is projected to be funded on or prior to the April 2016 A-2 bond takeout.

RATING SENSITIVITIES

CONSTRUCTION COMPLETION: The inability of Forest City Southern Group to deliver new and rehab units on time under the original four year plan would negatively pressure the rating.

UNIT DEMOLITION/USAGE: Since the additional Non Debt Support Units (NDSUs) contribute to the net operating income of the project, the continued rental of these units that were originally slated for demolition will continue to have a positive impact on the project.

ABILITY TO MANAGE ALL PROPERTIES: Property management's ability to maintain high occupancy and control operating expenses for the properties over the life of the Southern Group bonds.

BAH RATE FLUCTUATION: Annual basic allowance for housing (BAH) rate changes at the four different locations can have a negative impact on debt service coverage and put negative pressure on the rating.

CREDIT PROFILE

BASE INFORMATION

Located in south central Tennessee, a few miles east of Tullahoma, Arnold AFB is home to the Arnold Engineering Development Center (AEDC), a component to the USAF's material command. Charleston AFB is a USAF Air Mobility Command (AMC) installation located in northern Charleston, SC and is located at Charleston International Airport. Located 83 miles west of New Orleans on the Gulf Coast in Biloxi, MS, Keesler AFB is one of five USAF installations where technical training is conducted by elements of the 2nd Air Force. Shaw AFB is home to the 20th Fighter Wing (20 FW) and is located 8.5 miles northwest of Sumter, SC.

PROJECT INFORMATION

Bond proceeds will be used to fund the construction, maintenance and replacement of housing units at the four military bases and pay costs of issuance. Upon completion, the project is expected to have approximately 1,855 residential housing units.

The credit is also influenced by a base essentiality analysis and the strength of the property manager's experience developing and managing similar types of military housing projects. Fitch's opinion also takes into account the debt structure and contributions from the developer and the U. S. armed services. In this transaction, there was a substantial commitment from the Air Force by providing a $111 million GDL as specific milestones were met. The last installment of the GDL will be made on or prior to April 2016. In addition, Forest City contributed $9.2 million in equity at closing in 2011.

This bond financing includes fully amortizing debt with a final maturity of thirty seven years. The underlying ground lease is for a term of 50 years.

DEBT SERVICE COVERAGE

Project cash flow is a main driver of the Fitch analysis. The cash flow centers on a project's debt service coverage ratio (DSCR) throughout the life of the transaction. The DSCR is calculated after deducting the operating expenses and reserve deposits from the rental revenues. This transaction's current cash flow is considered to be strong with a compliance certificate showing 2.04x based on the trailing 12 months actual, an audited 1.97x at December 2014 and a Fitch projected DSCR of approximately no less than 1.40x when the ratio calculation excludes estimated revenues and expenses associated with 330 non debt sized units (NDSUs) and 218 additional units at Charleston and maximum annual debt service is included.

PROJECT OCCUPANCY LEVELS

Current occupancy (May 2015) at each base is as follows: Arnold 20/22 or 90.9%, Charleston 515/522 or 98.7%, Keesler 805/858 or 93.8% and Shaw 555/630 or 87.3%.

BAH RATES

The original proforma projected a 2% increase in revenue each year for the 4 year IDP. Using current BAH rates, Fitch calculated a combined average monthly unit revenue using the rank mix for each base to arrive at an estimate for overall revenue for the transaction. The combined average unit rents at Shaw and Keesler were less than the 8% that was used at underwriting (2% per year for 4 years). Shaw experienced a 4% decline in revenue relative to original BAH projections and Keesler experienced a 9% decline while Charleston experienced an increase of less than 1% relative to original projections. On a combined basis, current BAH in aggregate is 5.5% less than what was projected at underwriting assuming all units eventually experience turnover.

BRAC RISK

Arnold Air Force Base has not been the subject of any BRAC comment since the first base closure and realignment recommendations where made under the Base Realignment and Closure Act was passed in 1988.

Charleston AFB has not been impacted by any of the BRAC recommendations. The lack of BRAC action and its ranking as 4th out of 154 AFBs in terms of military value give an indication that Charleston will remain as an important base to the Air Force.

The only BRAC action relating to Keesler was the 2005 recommendation to downgrade the base hospital to a clinic. The Air Force rebuilt much of the Keesler AFB after Hurricane Katrina which point to the viability of Keesler.

Shaw has been a net gainer from the BRAC process. None of the past BRAC actions have indicated that the base's core mission is at risk and, with the consolidation of CENTCOM elements at Shaw, it is reasonable to conclude Shaw will remain a part of the Air Force's domestic infrastructure well into the future.

OTHER FINANCIAL PROTECTIONS

In lieu of a cash funded debt service reserve fund (DSRF), a servicing agreement with a rated servicer is in place from Pacific Life, which has a Fitch rated primary servicer rating of 'CPS1' and special servicer rating of 'CSS2'. This servicing structure is not typical in other Fitch rated military housing issues. This servicing agreement which is commonly used in commercial mortgage transactions covers timing shortfalls and there is a special servicing agreement for any workout arrangements. If Pacific Life does not make any needed advance under the agreement, Wells Fargo, the trustee (Corporate rating 'AA-/F1+'), will make any required advance per the servicing agreement.

While the master servicing agreement structure is strong, the structure is not viewed by Fitch to be as strong as a cash funded DSRF of one year's maximum annual debt service. Based on the Indenture, the servicer may not make an advance under certain circumstances where the servicer may deem the advance as non-recoverable. Additionally, the servicer's advances are limited to 12 months.

PROJECT MANAGEMENT

Forest City has developed and managed over 13,800 units at military installations, and all are performing well. The limited liability corporation, SGLLC, was set up to finance, build, manage and maintain 1,855 military housing units for a 50 year period at the four different military installations.

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

Applicable Criteria

Military Housing Rating Criteria (pub. 22 Sep 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=774288

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=988708

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988708

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst:
Charles Giordano, +1-212-908-0607
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Ryan Pami, +1-212-908-0803
Associate Director
or
Committee Chairperson:
Maura McGuigan, +1-212-908-0591
Senior Director
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Charles Giordano, +1-212-908-0607
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Ryan Pami, +1-212-908-0803
Associate Director
or
Committee Chairperson:
Maura McGuigan, +1-212-908-0591
Senior Director
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
alyssa.castelli@fitchratings.com