March 1 - Fitch Ratings has affirmed and subsequently removed from Rating Watch Negative its 'A' rating on the following Santa Cruz County Redevelopment Agency (RDA), CA's tax allocation bonds (TABs). --$150.1 million TABs, series 2000, 2000A, 2003, 2005A, 2005B, 2007, and 2007A. The Rating is assigned a Stable Outlook. SECURITY The TABs are secured by a first pledge and lien on net incremental property tax revenues generated by the Soquel/Live Oak project area. The revenues are net of county administration fees, tax-sharing agreements, AB 1290 pass-through obligations, and the statutory 20% housing set-aside, except for the portion of the TABs that financed low- and moderate-income housing qualifying projects. The debt service reserve requirement is satisfied through a combination of cash-funded reserves and surety bonds from Ambac Assurance Corporation and National Public Financial Guarantee Corporation. KEY RATING DRIVERS AB1484 DISPUTE RESOLVED: The Successor Agency (SA) for Santa Cruz County RDA and the state's Department of Finance (DOF) resolved their dispute regarding the SA's AB1484 July 12, 2012 repayment. The legally binding stipulated agreement between the parties eliminates the requirement that the SA repay $11 million in previously received property tax revenue. THIN BUT STABLE COVERAGE: Debt service coverage is estimated at 1.21x in fiscal 2013. The relatively thin coverage levels are mitigated to some extent by the tax base's stability. Stable Project Area: The project area is relatively large at 3,760 acres and almost fully developed. Assessed value (AV) has remained stable with a modest decline in fiscal 2013. The tax base remains diverse. Sound Local Economy: The local economy is somewhat exposed to the tourism and high technology sectors, but remains fundamentally sound with above-average wealth levels and above-average growth in employment and labor force. RATING SENSITIVITY: TAX BASE CONTRACTION: An unexpected contraction in the tax base that reduces coverage levels below historical norms would likely lead to a downgrade. CREDIT PROFILE DISPUTE WITH DOF RESOLVED The SA and DOF reached a formal agreement resolving their dispute over the SA's repayment of property tax revenue that the state believed should have been paid on July 12, 2012 to other taxing entities. Fitch believes this resolution removes a significant potential risk to bondholder repayment. The amount in dispute, approximately $11 million net of the SA's partial payment ($599,079), was not paid by the SA on July 12, 2012 in order to retain sufficient funds to make debt service payments due Sept. 1, 2012. Under the agreement, the SA is no longer required to make any additional payments and the state is prohibited from assessing penalties to obtain the unremitted funds. The agreement also allows the SA to receive a Finding of Completion following DOF's ongoing due diligence review of the SA's funds. The Finding of Completion would allow the SA to expend some stranded bond proceeds and continue with the process of winding down the RDA. THIN DEBT SERVICE COVERAGE The rating reflects the projected reduction in debt service coverage resulting from a modest 1.5% decline in fiscal 2013 AV. Fitch calculated debt service coverage for fiscal 2013 is 1.21x compared to 1.23x in fiscal 2012. Maximum annual debt service coverage (MADS) is projected at 1.18x based on estimated fiscal 2013 revenues. The reduced coverage levels increase the risk posed by potential AV volatility with only a 12% decline necessary to reach 1.0x MADS coverage. While debt service coverage is below average for the rating level, the project area benefits from a sound local economy and a diverse and stable tax base, anchored primarily by residential tax payers in a mature and developed area. STABLE, DEVELOPED TAX BASE The Soquel/Live Oak project area consists of 3,760 acres in unincorporated Santa Cruz County located between the cities of Santa Cruz and Capitola. The incremental value of the project area is approximately 3.6x its base value and has grown at a 6% compounded average rate from fiscal 2003 through fiscal 2013. The tax base is diverse and stable. In fiscal 2011, the top ten taxpayers comprised only 3.8% of total project area AV, or 4.9% of incremental value. The low concentration is likely due to the residential nature of the project area. Project area AV has increased every year since fiscal 2003 with the exception of a 1.7% decline in fiscal 2010 and a 1.5% decline in fiscal 2013. The most recent decline was largely due to the periodic revaluation of certain types of property, the reclassification of some previously taxable property to tax-exempt, and the successful appeal of AV assessments by some commercial operations. The rating reflects Fitch's expectation that significant future AV declines are unlikely, which is supported by a recovering housing market and limited additional development. The project area is largely developed and mature with limited area remaining for new development. Recently completed or currently ongoing development includes a relatively minor residential subdivision consisting of four homes (all sold) and a four-building commercial development. Management reported that Redwood Square, the project area's commercial center, remains stable with Safeway, Best Buy, and Home Depot acting as the principal anchors to the retail center. SOUND ECONOMY Agriculture, tourism, education, technology and the service sector continue to play important economic roles in the area. Large employers include the University of California Santa Cruz, Pajaro Valley Unified School District, Dominican Hospital, Cabrillo College, the Santa Cruz Boardwalk and Seagate Technology. The Santa Cruz-Watsonville MSA unemployment rate of 11% in December 2012 was higher than the corresponding state average of 9.7%. However, both employment growth (5.9% year over year) and labor force growth (4.1%) are significantly above state and national averages. Wealth levels in the MSA are above average with per capita income at 118% of the national average.