SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the following San Jose Redevelopment Agency, CA tax allocation bonds (TABs):
--$217.2 million housing set aside TABs at 'A'.
The Rating Outlook is revised to Positive from Stable.
SECURITY
The merged area housing set aside TABs are secured by the 20% housing set aside of tax increment derived from the merged area.
KEY RATING DRIVERS
IMPROVED DEBT SERVICE COVERAGE/ECONOMIC STRENGTHENING: The revision of the Outlook to Positive primarily reflects material growth in debt service coverage (DSC) resulting from assessed valuation (AV) gains. The Positive Outlook also reflects Fitch's expectation for continuing AV gains in the project area over near term which are likely to push DSC to levels more consistent with an 'A+'.
ANALYTICAL REFINEMENT: In addition, the rating and Positive Outlook reflect Fitch's analytical refinement of California TABs in light of dissolution legislation (AB1x26). Fitch now considers TAB liens to be closed and the Positive Outlook is supported by the inability to dilute DSC through issuance of additional bonds.
APPEALS REMAIN ELEVATED: Pending appeals have declined substantially but remain elevated. Fitch expects underlying AV gains and new development to largely offset granted tax appeals. However, an unexpectedly large decline in AV due to appeals could result in a Revision of the Outlook to Stable.
HIGHLY CONCENTRATED, VOLATILE TAX BASE: Taxpayer and industry concentration in the volatile technology sector remains a concern, though the industry is currently in an expansion phase. Fitch expects real estate trends will continue over the short term, adding to solid AV cushion (52%).
RATING SENSITIVITIES
AV GAINS: Fitch may take positive rating action if AV growth results in strong tax base gains, increased DSC and an AV cushion of around 60%.
CREDIT PROFILE
San Jose, with a population of about one million is located in the center of Silicon Valley, about 55 miles south of San Francisco. The agency's large merged project area covers over 8,000 acres or roughly 7% of the city acreage.
SAN JOSE ECONOMY, SOLID RECOVERY FOLLOWING VOLATILITY
Recent project area AV performance has been positive but highlights its inherent volatility. Fiscal 2015 AV increased a solid 7.2%, resulting in an aggregate trough to peak increase of about 22%. The merged area's largest AV decline was from fiscal 2003-2006 when AV dropped an aggregate 21%. The more recent recession resulted in more moderate AV decline of about 9% between fiscal 2010 and 2012.
Current AV trends mirror the general economic expansion. San Jose's job growth continues to accelerate, posting 3.9% gain from November 2013 to November 2014. The city and agency benefit from above-average economic indicators, including median household income at 134% and 154% of the state and national averages, respectively, and a poverty rate about 80% of the national average.
January 2015 home values increased 10% year-over-year, according to Zillow. The local employment and residential real estate markets' strength are likely to translate into a fourth consecutive year of AV gains. Fiscal 2016 AV will be determined by real estate values as of Jan. 1, 2015. The assessor preliminarily estimates an underlying 1.89% AV gain on existing properties, which Fitch believes to be reasonable to conservative given recent home price gains and downward trends in commercial property vacancy rates.
LARGE PROJECT AREA; HIGHLY CONCENTRATED
The merged project area is mature, sizeable (covering 28 noncontiguous square miles and spanning 20 miles north to south) and highly concentrated. The incremental AV (IV) equals over 19x the base year value, reducing somewhat the volatility in pledged revenues relative to declines in AV. The project area tax base is highly concentrated in its top 10 taxpayers, which make up 31.5% of IV, and in the high technology sector. Top taxpayers include companies such as Cisco Systems Inc., eBay, Hitachi and Adobe and other major technology concerns. This sector has a long history of cyclicality and Fitch expects the current expansion to be followed at some point by a contraction.
The high personal property & equipment (PP&E) component of the merged area's AV exacerbates the volatility of the property market. The PP&E and unsecured property component currently accounts for a smaller share of merged area AV, likely due to some diversification in the merged area as multifamily housing has increased and R&D (research & development) space decreased as a share of overall AV. PP&E and unsecured property account for an estimated 13.5% and 17.7% of fiscal 2015 AV, respectively, down from peaks of 18.6% and 23.2%, in fiscal 2012.
SOLID COVERAGE NET OF GRANTED APPEALS
The solid fiscal 2015 AV gain resulted in a roughly $3 million increase in pledged revenues, after consideration of granted appeals. This raises Fitch-estimated fiscal 2015 coverage of $19.8 million maximum annual debt service (MADS) to 2.10x from 1.75x in fiscal 2013. Fitch estimates AV could fall a high 51.5% from current levels before coverage would drop to 1.0x.
Although MADS coverage has improved markedly compared to recent fiscal years, Fitch believes that the elevated amount of pending appeals noted below and the volatility of the project area's tax increment revenues could reverse this trend. However, additional solid gains in AV and pledged revenues resulting in an AV cushion of around 60% would provide sufficient cushion to upgrade the TABs to 'A+' despite these weaknesses.
IMPROVING BUT STILL LARGE BACKLOG OF APPEALS REMAINS
Fitch believes long-term prospects for economic growth in the city and project area are favorable, but appeals may result in a somewhat uneven AV and pledged revenue recovery over the medium term. The number of appeals filed for fiscal 2014 (the latest date available) is about half of its fiscal 2011 peak. However, the number and value of appeals outstanding remains elevated. The combined disputed value of all outstanding appeals is about $7.3 billion (32.6% of fiscal 2015 AV), down from $9.4 billion as of March 2012.
Since 2008 the assessor has granted an average of 13% of disputed amounts, which would equate to approximately 4.3% of fiscal 2015 AV based on current conditions, if granted in a single year. The rating conservatively assumes this rate of appeals.
OVERRIDE LAWSUIT RULED IN AGENCY'S FAVOR, BUT APPEALED
The successor agency (SA) filed a lawsuit in superior court against the county and the court ruled in favor of the agency in June. The lawsuit would require that the county stop withholding an estimated $9.4 million (for fiscal 2015) in annual tax revenue derived from voter-approved tax overrides the agency contends is pledged to bondholders. $1.9 million of this would be pledged revenues of the housing set-aside TABs.
Fitch has conservatively excluded override revenues in its DSC calculations. If the SA does receive the $9.4 million ($1.9 million for the housing set-aside TABs) for fiscal 2016, Fitch estimates debt service coverage would rise to 2.24x and require a 53% decline to reach 1.0x MADS DSC.
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 and Zillow.com
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=979734
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