SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned a rating to Menlo Park Community Development Agency, California's (the agency) bonds as follows:
--$63.7 million outstanding tax allocation refunding bonds (TABs), series 2006 at 'BBB'.
The Rating Outlook is Stable.
SECURITY
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
SOUND DEBT SERVICE COVERAGE: Fitch estimates fiscal 2013 tax increment revenues cover maximum annual debt service (MADS) by a sound 1.52x. Coverage holds up well under severe Fitch-designed stress tests.
VARIABLE RATE VULNERABILITIES: The TABs were issued as variable rate and include a letter of credit (LOC) whose fee has climbed substantially, and an interest rate swap that is currently subject to a termination event by the agency's counterparty.
CONCENTRATED PROJECT AREA: The small project area is highly concentrated among its top taxpayers and it experienced a significant AV loss during the recession. However, the project area is mature, well diversified by land use, and its top taxpayers are in expansion mode.
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 exposed to any cash flow timing issues imposed by dissolution statute.
RATING SENSITIVITIES
ASSESSED VALUES AND COVERAGE: The rating is sensitive to shifts in fundamental credit characteristics including the project areas' assessed value (AV) performance and debt service coverage levels.
VARIABLE RATE ISSUES: Variable rate complications could pressure the rating, including termination of the interest rate swap, or an inability to renew or replace the agency's LOC under reasonable terms.
CREDIT PROFILE
Menlo Park (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 'BBB' rating largely reflects sound debt service coverage. Fitch estimates fiscal 2013 net revenues available for debt service at $9.9 million, which covers MADS 1.52x (ADS coverage is 1.59x). Debt service includes remarketing and LOC fees, which are on parity with principal and interest payments.
Debt service coverage stands up well to severe Fitch-designed stress testing. MADS coverage falls to 1.20x MADS (1.27x ADS) under a scenario where fiscal 2014 AV falls by its peak-to-trough AV decline of 18.7% and reported appeals are granted at their appellants' opinion of value. Fitch estimates AV could fall a substantial 31% from fiscal 2013 levels before MADS coverage would reach 1.0x.
VULNERABLE VARIABLE RATE CHARACTERISTICS
The TABs were issued as variable rate, with liquidity support from a State Street LOC and an interest rate swap with Morgan Stanley. The LOC expires May 25, 2014. Fitch assumes that the agency would be able to replace its existing LOC with at least similar costs as its existing contract. An inability to do so could lead to a downgrade.
The LOC fee is dependent upon the lowest of the TABs' underlying ratings. The fee increased to a high 2.75% (the maximum allowed under the current contract) from 1.25% when Moodys downgraded its underlying rating to non-investment grade in 2012. The agency's swap agreement is currently subject to termination based on the downgrade. 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 $10.8 million as of June 28, 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 several years to pay in full.
VERY STRONG CITY-WIDE ECONOMIC CHARACTERISTICS
City 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 3.9% in May from 5.4% the year prior, compared to the state and national rates of 8.1% and 7.3%, 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 35% of AV (38% 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 through at least fiscal 2012. The project area's fiscal 2013 AV gained a modest 2.8%, ending three years of consecutive losses. Preliminary data suggests AV may rise by approximately 5% in fiscal 2014.
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 (8%), 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 1024%, resulting in a low degree of revenue sensitivity to AV volatility.
--The project area is well diversified by land use, 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 recently with a year-to-date 10% value increase according to Zillow. January 2013 values were up an impressive 25% year-over-year and are the basis upon which fiscal 2014 AV levels will be determined.
AV in the project area is unlikely to rise by the same degree as home market values for three reasons. First, the project areas contain 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's 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. Fitch conservatively includes 2% AV gains in its base case coverage scenarios through fiscal 2015 and 1% gains thereafter. To the extent the project area realizes growth in excess of these estimates, there could be positive credit implications assuming these gains appear likely to hold or expand in future years.
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). Dissolution law did not impose a cash flow timing issue on the agency, and management has confirmed that obligations previously deemed subordinate to debt service will remain so. The agency recently received its finding of completion from DOF.
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, Bond Counsel, 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
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=799678
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