SAN FRANCISCO--()--Fitch Ratings affirms the following San Jose Redevelopment Agency tax allocation bonds (TABs):
--$233 million housing set-aside TABs at 'A'.
The Rating Outlook is Stable.
In addition, Fitch maintains the Rating Watch Negative on the following TABs with the following ratings:
--$232 million merged area redevelopment projects TABs, series 2003, 2008A and 2008B, rated 'BB';
--$1.4 billion merged area redevelopment projects TABs, series 1993, 1997, 1999, 2002, 2004A, 2005A, 2005B, 2006A-T, 2006B, 2006C, 2006D, 2007A-T, 2007B rated 'BB-'.
The merged area TABs are secured by gross tax increment revenue from the project area net of certain senior pass-throughs and the 20% set-aside for housing. The housing TABs are secured by the 20% housing set-aside. All TABs are also secured by debt service reserve funds; however, only the merged area redevelopment project TABs, series 2003 and 2008A and 2008B, benefit from a cash-funded reserve.
KEY RATING DRIVERS
DOWNSIDE REVENUE RISK REMAINS: The maintenance of the Negative Rating Watch reflects continued short-term rating risk to non-housing bonds, associated with pressured pledged revenues and already low debt service coverage. The San Jose Redevelopment Agency (SA or the agency) and the county continue to dispute whether certain revenues (impounded by the county until resolved) are pledged to bondholders. In addition, an increase in appeals for fiscal 2013 (appeals information available in the coming weeks) could indicate increased short- and longer-term debt service coverage pressure.
HOUSING BONDS STABLE: The Stable Outlook on the housing set-aside bonds reflects the strong debt service coverage which would only be marginally affected by a judgment against the SA or by appeals granted.
DISPUTE WITH COUNTY: Fitch expresses concern that the dispute between the SA and the county could impede progress on current and future issues that may arise.
HIGHLY CONCENTRATED, VOLATILE TAX BASE: Taxpayer and industry concentration remains a concern. Fiscal year 2012 top 10 taxpayers represent 32% of assessed value (AV) with the largest taxpayer at 15%. Furthermore, the concentration in the volatile technology sector poses additional risk, though the industry is currently in an expansion phase.
BIFURCATION OF RATINGS DUE TO RESERVES: The lower rating on the merged project area TABs without cash-funded debt service reserve funds reflects the minimal value Fitch places on debt service reserve fund surety policies.
ADVERSE OPINION ON LAWSUIT WITH COUNTY: Absent a timely resolution over the disputed revenue or if the lawsuit is decided in favor of the county, already narrow debt service coverage would be reduced and could result in a downgrade.
INCREASE IN APPEALS: An increase in appeals for fiscal 2013 to increase the outstanding appeals amount compared to fiscal 2012 could result in a downgrade. Even a lower level of appeals would continue to pressure the credit given the low debt service coverage.
San Jose, with a population of about 970,000, is located in the center of Silicon Valley, about 55 miles south of San Francisco. The agency's merged project area covers over 8,000 acres or roughly 7% of the city acreage.
COUNTY LAWSUIT COULD REDUCE DEBT SERVICE COVERAGE; DISPUTE WITH STATE RESOLVED IN AGENCY'S FAVOR
The county is withholding about $7.8 million in annual tax revenue derived from voter-approved tax overrides the agency contends is pledged to bondholders. The SA has filed a lawsuit in superior court which is expected to be heard in April 2013. In the meantime, these funds will be kept in escrow as they are received semi-annually. If the SA loses the $7.8 million, debt service coverage on the merged project area TABs would drop to about 1.05x in fiscal 2013 before AV adjustments and appeals and a very narrow 1.01x after granted refunds.
The SA did prevail in the dispute with the state Department of Finance (DoF) regarding certain AB 1484 payments totaling about $39 million, which Fitch views as a credit positive. A stipulated judgment was received in December 2012 absolving the SA of any obligation to make such payment.
UNDERLYING CREDIT PRESSURED BUT IMPROVING
San Jose's economy continues to improve markedly. Job growth is among the fastest in the country and was an impressive 3.5% from December 2011 to December 2012. The city benefits from above-average economic indicators, including median household income and per capita income at 153% and 121% of the national averages, respectively, and a poverty rate about 77% of the national average.
According to information provided by the county, fiscal 2013 AV increased about 2.1% over fiscal 2012. This is better than the 1.7% previously forecast. Despite this improvement, AV remains under pressure due to appeals. In fiscal 2013, adjustments and appeals to fiscal 2012 resulted in a 3.1% decline in revenues. This follows a similar sized adjustment the prior year. The number and value of unresolved appeals in the project area increased steeply in fiscal 2012 (fiscal 2013 appeals are not yet available). There were over 1,200 pending appeals for the 2011 and 2012 tax years with a combined disputed value of $5.6 billion.
Total disputed value for all outstanding appeals for fiscal years 2007-2012 totaled $9.4 billion, up from $7.7 billion as of January 2011 (for fiscal years 2007-2010). Fitch believes long-term prospects for economic growth in the city and project area are favorable, but the appeals may result in a somewhat uneven AV recovery in the tax base.
LARGE PROJECT AREA; HIGHLY CONCENTRATED
The merged project area is sizeable, covering 28 non-contiguous square miles and spanning 20 miles north to south. It encompasses 21 component areas including industrial, downtown, and neighborhood business districts. The commercial/industrial component is the largest and includes companies such as Cisco Systems Inc., eBay, Hitachi and Adobe and others which are a vital part of the regional, state and national economy.
Despite its large size, the project area tax base is highly concentrated in its top taxpayers and in the high technology sector. This sector has experienced significant volatility in recent years. The tax base also includes high levels of personal property & equipment (PP&E), whose AV tends to be more volatile: increasing steeply with an up-cycle as investments in business equipment are made and then declining in a down-cycle as the equipment is depreciated and not replaced or becomes obsolete.
The vast majority of total project area AV is for industrial - primarily research and development - and commercial uses, with a moderate residential component. In addition, unsecured property, mostly personal property, accounts for a large amount of project area AV.
Taxpayer concentration remains above average with fiscal 2012 top 10 taxpayers representing 32% of AV and 34% of incremental AV (IV). The largest taxpayer, Cisco, constitutes 15.1% of the project area's IV. Total PP&E represents a high 23% of fiscal 2012 total AV, but this is down substantially from a high of 30.1% in fiscal 2002.
VOLATILE AV; NARROW COVERAGE; MINIMAL ADDITIONAL RESOURCES
Along with AV and IV, pledged revenue trends have been volatile in recent years, ranging from a gain of 32.6% in fiscal 2002 to 14% and 12% losses in fiscal years 2004 and 2005, respectively. The bulk of the AV losses stemmed from reductions in AV for PP&E, which can fall steeply during economic downturns. After increasing in fiscal years 2007 through 2010, AV declined in fiscal 2011 and 2012 by 7.5% and 1.8%, respectively.
Fiscal 2013 AV increased 2.1%. Given ongoing development in the project area and the economic growth in the technology industry, Fitch expects AV growth to continue over the medium term. However, the potential for outstanding appeals from previous years constraining AV and revenue gains remains a risk.
For fiscal 2013, including a $5.4 million negative revenue adjustment for appeals granted for previous years, pledged revenues of about $134.8 million cover $133 million in debt service by a low 1.01x, or 1.06x assuming the SA prevails in the county lawsuit.
A Fitch base case assumes underlying AV increases 1% in fiscal 2014 but is partially offset by appeals, resulting in a 0.8% AV decline. This would bring debt service coverage to 1.03x without consideration of the disputed tax override revenue and 1.08x with the disputed revenue.
For the housing bonds, projected fiscal 2013 revenue of $34.2 million covers senior maximum annual debt service ($19.8 million) about 1.80x. If the SA prevails in the lawsuit, coverage would increase to 1.88x. The Fitch base case discussed above would result in still solid debt service coverage of 1.68x if the agency does not prevail in the lawsuit.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
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, S&P/Case-Shiller Home Price Index.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).