Feb 22 - 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
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
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).