SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings takes the following rating action on Pittsburg Redevelopment Agency, California (the agency) as part of its continuous surveillance effort:
--$139.9 million tax allocation bonds (TABs) downgraded to 'A' from 'A+';
--$153.1 million subordinate TABs downgraded to 'BB+' from 'A';
--$27.6 million housing set-aside TABs downgraded to 'BBB' from 'A'.
The Rating Outlook for the subordinate TABs is revised to Negative from Stable. The Rating Outlook for the senior TABs and housing set-aside TABs is Stable.
RATING RATIONALE:
--The downgrade of the subordinate bonds to 'BB+' reflects the bonds' inadequate debt service coverage levels resulting from a substantial three-year AV loss, a severe slow-down in new construction activity, and a very weak economy that may continue to weigh on the housing market and AV levels.
--The Negative Outlook reflects concerns about the agency's ability to extend or replace its letter of credit (LOC) that expires in December 2011. It also reflects concerns that an early termination event could be triggered on the agency's swap, which would expose the variable rate subordinate TABs to interest rate risk, and trigger a substantial termination fee that would nevertheless be subordinate to subordinate TAB debt service.
--The downgrade of the housing bonds to 'BBB' reflects the aforementioned weakening of the project area's tax base and the narrowing of debt service coverage levels that nonetheless remain adequate overall.
--The downgrade of the senior bonds to 'A' reflects the aforementioned weakening of the project area's tax base. However, coverage remains solid, even under a severe Fitch-designed stress scenario.
--Bondholders benefit from supplemental revenue streams and a standard cash-funded debt service reserve fund. Additionally, subordinate bondholders benefit from a large supplemental cash-funded debt service reserve fund required for the duration of the agency's LOC agreement.
--The project area benefits from its proximity to Bay Area employment centers, its large size, and sound long-term growth prospects in spite of currently substantial economic weakness.
--The local economy is stressed, exhibited by very high unemployment levels, a weak tax base, low income levels, and vulnerable housing characteristics.
--The agency's deferral of its Supplemental Educational Revenue Augmentation Fund (SERAF) payment will cause the agency to become dormant once current projects are completed. While the tax base may suffer from the cessation of reinvestment activities, the agency will be unable to further leverage its tax base if growth returns until it makes its SERAF payment.
--The governor's proposed fiscal 2012 budget, which seeks to eliminate redevelopment agencies statewide, was not a factor in the rating, as under the proposed plan the existing debt and other contractual obligations would be repaid as they come due.
WHAT COULD TRIGGER AN DOWNGRADE? (Subordinate TABs):
--The inability to renew or replace the agency's expiring LOC, or the prohibitive cost of doing so.
--The release of supplemental debt service reserves now required under the outstanding LOC as the result of a modified or replaced LOC agreement.
--Material depletion of available reserves to pay both outstanding and contingent liabilities including potential swap termination payments.
KEY RATING DRIVERS (TABs & Housing Set-Aside TABs):
--Current coverage levels are adequate considering the TABs' respective rating levels, and Fitch believes they will remain adequate even if short-term AV declines somewhat from present levels.
--The local economy and housing market are pressured by very high unemployment. Their eventual recovery likely will be influenced by the timing and degree of employment normalization.
SECURITY:
The senior TABs are secured by all tax revenues allocable to the agency, minus a 20% housing set-aside, and a county administrative fee. Subordinate TABs are secured by a first lien on subordinate pledged tax revenues, which are net tax increment minus senior debt service. The subordinate bonds additionally are secured by a $33.4 million supplemental reserve, required for the life of the LOC. The housing TABs are secured a first lien on the 20% housing set-aside from gross tax increment. All bonds are also secured by standard cash-funded debt service reserves.
CREDIT SUMMARY:
Pittsburg is located in the northeastern portion of Contra Costa County and situated along the Sacramento-San Joaquin River Delta. Moderate population growth has been driven by the area's affordability, availability of developable land, and proximity to major Bay Area employment centers with good transportation options. Nonetheless, the city has been severely affected by the economic recession. October unemployment registered a very high 17.1%, and the housing market has been under considerable pressure. Reportedly average home prices have lost over half their peak value, foreclosures make up approximately two-thirds of homes available for sale, and about 41% of total properties by assessed valuation (AV) have had their (AV) reduced under Proposition 8, which will cause AV to be more volatile as market values fluctuate. According to Fitch data, over half of non-agency mortgages are subprime or negatively amortizing, foreclosure rates remain high, and even higher delinquency rates suggest continued weakness over the short to intermediate term.
The redevelopment agency's merged project area is a large 5,750 acres, encompassing more than half the city of Pittsburg and about 70% of its AV. About three-quarters of the project area's AV consists of residential properties, with the remainder split commercial and industrial properties, including a major power plant. AV is concentrated in the top 10 payers, but concentration concerns are somewhat mitigated by the essentiality of the top payer, which is an electricity generator. Consistent with the ailing local property market, AV fell by a substantial 15.6% cumulatively from fiscal 2009-2011, though the rate of decline slowed to 1.5% in fiscal 2011.
Recent AV losses have lowered Fitch-estimated subordinate debt service coverage to 1.28 times (x) annual debt service (ADS) in fiscal 2011. Subordinate coverage is calculated on the basis of secured net revenues' (net revenues minus senior TAB debt service) ability to meet subordinate TAB debt service. Due to rising senior debt service costs, Fitch estimates that subordinate coverage would drop to 0.99x in fiscal 2013, assuming no AV growth. Although subordinate debt service coverage is expected to drop to about 1.0x, under a no-growth scenario, housing bonds' coverage would fall to a still-adequate 1.34x ADS in fiscal 2013 from 1.61x in fiscal 2009. Senior debt service coverage, though lower than anticipated, remains quite strong at 2.66x in fiscal 2013 when coverage would hit a five-year trough.
Under a more onerous stress scenario, whereby AV declines 20% in 2012, is flat through 2016, and grows 2% annually thereafter, annual senior TABs coverage would exceed 2.0x. However, annual coverage on the subordinate TABs from tax revenues would fall to .65x in fiscal 2013 and furthermore would exhaust all pledged reserves by 2020, without consideration of certain supplemental revenues and non-pledged cash reserves that management could use to meet debt service. These non-pledged cash reserves include a $5 million capital reserve cushion, and a $7.5 million operating reserve. Under the same stress provisions, annual coverage for the housing set-aside TABs would be at least 1.06x. Given the general state of the local economy and the high percentage of nonconforming and distressed properties within the community, there is a real possibility at least a variation of the stress scenario could materialize. Furthermore, it is unclear to what extent non-pledged cash resources would be employed to satisfy pass-thru payments, which in turn, would reduce available resources to subsidize subordinate debt service.
For fiscal 2011, absent supplemental tax increment, Fitch estimates that tax increment will be insufficient to pay both bond debt service and subordinate pass-through payments, necessitating the use of fund balance or other revenues to honor pass-through agreements. Additionally, the agency did not make its fiscal 2010 and 2011 state-mandated SERAF payments of $17.4 million and $3.5 million respectively. As a result, the agency must become dormant subsequent to spend-down of bond funds for existing capital projects. Until the SERAF payments are made, the agency cannot issue additional debt or begin new capital projects; however, the agency will continue to pay debt service on outstanding bonds. Also, the 20% housing set-aside requirement will rise to 25%, though the additional 5% will be subordinated to debt service.
Fitch believes Pittsburg house prices could continue to fall moderately from present levels, thus placing additional pressure on AV and pledged revenues. If AV continues its descent, debt service reserves may have to be tapped in spite of other large cash reserves because major capital expenditures will deplete the majority of non-debt service reserve funds, and pass-through payments may necessitate the use of the remainder. Nonetheless, it would take a significant AV decline followed by a long period of below-average AV growth to deplete all debt service reserves. Currently the subordinate bonds have a $22.6 million standard debt service reserve and, as a condition of the issuance of an LOC (backed by State Street and CalSTRS), the agency is required to hold a supplemental debt service reserve amount of $33.4 million as long as the LOC is outstanding. The LOC expires in late 2011.
The agency's debt structure poses a significant credit vulnerability. A quarter of subordinate debt ($117 million) is variable rate, supported by the LOC and hedged by an interest rate swap. An inability to extend or replace the agency's LOC likely would result in conversion of the variable rate bonds to bank bonds which could raise interest costs on the variable rate debt to as high as 12%. At the maximum rate, Fitch estimates annual debt service costs would rise a net $8.1 million. Nonetheless, the absence of accelerated payout provisions in the LOC agreement means the debt service reserve fund could tolerate drawdowns for some time, assuming no additional and substantial AV declines. Fitch will closely monitor developments with regard to the extension and terms of a renewed or replaced LOC.
Management reported on Jan. 6, 2011 that the agency's interest rate swap (Piper Jaffray is the counterparty) recently had a negative value of $12 million and may be terminated if Standard & Poors or Moodys downgrade the agency's debt to below 'BBB-' or 'Baa3', respectively. Upon termination, the agency would owe the termination value (which fluctuates based on interest rates) on a subordinated basis to debt service. If forced to pay the termination value, management noted that cash in project funds could be used.
Management is considering purchasing subordinate bonds with approximately $10 million from the supplemental reserve required by the LOC. The proposed purchases would include a provision to replenish the reserve with any excess revenues resulting from lowered debt service levels. The intent of the program would be to increase all-in debt service coverage levels to 1.12x, 1.12x, and 1.05x in fiscal years 2012, 2013, and 2014, respectively, assuming no AV growth. Fitch believes the structure would be credit-neutral, as the ability to replenish cash reserves could be impaired if AV declines, resulting in a similar cash drawdown of reserves upon completion of the bond purchase program as would have occurred if such a program had not been used.
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, University Financial Associates, LoanPerformance, Inc., and Financial Advisor.
Applicable Criteria and Related Research:
'Tax-Supported Rating Criteria', dated Aug. 16, 2010;
'U.S. Local Government Tax-Supported Rating Criteria', dated Oct. 8, 2010.
For information on Build America Bonds, visit www.fitchratings.com/BABs.
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548605
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564566
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.