SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has upgraded the following ratings of the Successor Agency to the Redevelopment Agency of the City of Pittsburg, California's (the agency) tax allocation bonds (TABs):
--$117.6 million subordinate TABs series 2004A underlying rating to 'BBB-' from 'BB+';
--$142.3 million subordinate TABs (taxable) series 2006B and subordinate refunding TABs series 2006C and 2008A to 'BB+' from 'BB'.
The Rating Outlook is Stable.
The TABs are payable from 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. A supplemental reserve is required per the terms of the 2004A bonds' letter of credit (LOC).
KEY RATING DRIVERS
GROWING ASSESSED VALUE, REDUCED APPEALS: The upgrade is prompted by continued tax base growth and a reduction in outstanding appeals amount, resulting in improved coverage ratios.
TAX BASE WEAKNESS: The low rating levels reflect still weak maximum annual debt service coverage, significant industrial taxpayer concentration, historically high tax base volatility, and frequent appeals.
VARIABLE RATE TABS' HIGH CASH RESERVES: The higher rating on the 2004A variable rate TABs is due to the bonds' extremely strong DSRF levels, sized to $35 million (30% of 2004A par and nearly 3 times MADS). Fitch believes these reserves provide bondholders with a material degree of additional protection against a hypothetical severe AV stress scenario.
VARIABLE RATE RISK: The LOC has been extended for another year, with the expectation that all variable rate bonds will be refinanced and become fixed rate in 2016.
TAX BASE PERFORMANCE: The ratings may change, depending on the performance and sustainability of the project area's tax base.
VARIABLE RATE RISKS: The current rating level assumes the agency can manage its variable rate debt exposure with reasonable costs, including continued renewal of its LOC.
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 2015 AV
IMPROVED COVERAGE, REDUCED APPEALS
The project area's fiscal 2016 AV increased a solid 6.5%, following a 7.9% increase in fiscal 2015. Recent positive AV performance increased MADS coverage to 1.2x, a significant improvement from below 1x in prior years. Similarly, AV cushion (defined as the percentage of one-time AV decline that the tax base is able to withstand while maintaining 1x MADS coverage) rose to a still-low 16% from a barely sufficient 4% in fiscal 2015.
Outstanding appeals dropped to $39 million of potential reduction in value from $126 million last year, as the local real estate market recovers. The estimated AV loss from granted appeals no longer makes a material difference to coverage ratios.
POSITIVE AV TREND
AV levels in the near future are likely to benefit from increased construction levels, which could add 2% to AV per year. New housing construction is proceeding at a pace of about 200 single family homes annually. 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.
Home values are increasing, but growth has slowed, to 11% year-over-year, compared with 20% a year ago, according to the Zillow home price index. AV increases for some of these additions will be limited to the Prop 13 cap (typically 2% annually), but resales and properties subject to temporary Prop 8 reductions will reflect the full appreciation.
TAX BASE WEAKNESS
Despite the positive momentum mentioned above, inherent tax base weakness remains, evidenced by the relatively late start of AV recovery, and significant peak-to-trough decline. AV dropped a cumulative 20% between fiscal 2008 and fiscal 2013.
In addition, the top 10 taxpayers account for 27% of the AV (29% of incremental value) and include Calpine power plants (12% of AV), and industrial properties owned by United Spiral (1%) and Koch (1%). Some of the top taxpayers were successful in reducing their AV through the appeal process.
VARIABLE RATE STRUCTURAL RISKS
The agency is in the process of refinancing almost all of the agency's outstanding tax allocation bonds. The refinancing would eliminate any variable rate debt and related risks. Until the refinancing finalizes, Fitch continues to incorporate variable rate structural risks into its rating.
The 2004A TABs have 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 $16.6 million, which is expected to be paid out from released cash reserve at refinancing.
The agency is also exposed to LOC renewal and fee hike risks. The 2004A TABs have an LOC supported by State Street Bank and the California State Teachers' Retirement System (CalSTRS), which has been recently extended by another year until Dec. 29, 2016. 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, substantially mitigating risks associated with a step-up rate. In addition to the standard indenture-required DSRF (currently $8.1 million), the 2004As have a $26.7 million supplemental reserve as a condition of prior LOC extensions. Combined, these reserve levels equal $34.8 million, or 30% 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.
Historically, the agency only retained one year's worth of debt service payments rather than the indenture-required two years' worth, and is now in the process of reaching compliance 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'.
Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to fewer than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by Jan. 20, 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.
In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from CreditScope, IHS Global Insight, and Zillow Group.
Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
Dodd-Frank Rating Information Disclosure Form