SAN FRANCISCO--(BUSINESS WIRE)-- As part of its continuous surveillance effort, Fitch Ratings takes the following rating actions on East Palo Alto Redevelopment Agency, California (the agency) bonds:

--$8.2 million tax allocation bonds (TABs) series 2003A and 2003B affirmed at 'A-'.

In addition, Fitch takes the following rating action on East Palo Alto Public Financing Authority's bonds:

--$18 million revenue bonds series 2005A affirmed at 'A-'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a pledge of and first lien on incremental property tax revenues in two project areas, less amounts due to overlapping jurisdictions. The three series of bonds listed above are on parity. Additional bondholder security is provided by a cash-funded debt service reserve at the least of 125% of average annual debt service, 100% of maximum annual debt service (MADS), or 10% of outstanding principal.

KEY RATING DRIVERS

Strong Coverage Levels: The bonds are supported by a strong property tax base that experienced substantial assessed value (AV) growth since inception, contributing to robust coverage of 3.01 times (x) MADS based on fiscal year 2010 audited revenues, which is resistant to Fitch's stress scenarios.

Highly Concentrated Tax Base: The underlying tax base for the bonds is highly concentrated, with a single taxpayer accounting for 43% of incremental assessed value (IV) and the top 10 taxpayers accounting for 78%.

Stable AV: Property values in the project areas have remained stable despite the recent economic downturn and widespread declines in real estate values nationally.

Weak City Economy: The economic strengths of the project areas stand in contrast to those of the city, which is subject to very high unemployment levels and low household incomes.

CREDIT PROFILE

The East Palo Alto Redevelopment Agency benefits from its location amidst Silicon Valley in the San Francisco Bay Area, allowing it to draw upon the substantial wealth of surrounding communities. However, the city of East Palo Alto itself is relatively impoverished, with an unemployment rate of nearly 20% as of June 2011 and median incomes well below national averages.

The East Palo Redevelopment Agency's TABs are supported by property tax increment from two project areas that have experienced substantial development since issuance. The IV of the merged project area is close to 30x its base value. Annual growth in AV reached a peak of 55% in 2007, but has slowed with the build-out of the areas and the decline in real estate values nationally. AV declined by 2% in fiscal 2010 and was nearly flat in fiscal 2011 and 2012.

Coverage levels for the bonds are robust as a result of this strong growth in AV. 2010 audited revenues provided coverage of 3.01x MADS. Under Fitch's base case of no further growth and a loss of AV equivalent to 50% of the value of outstanding assessment appeals, tax increment coverage would remain 2.85x MADS through maturity. Under a stress scenario of a 2% annual decline in AV for five years, plus a loss of AV equivalent to 50% of the value of outstanding assessment appeals, tax increment coverage drops to a still healthy 2.56x MADS. The additional loss of AV equivalent to 50% of the value of the top 10 taxpayers would lower coverage to an adequate 1.48x MADS. A reduction in coverage to 1.0x MADS would require the loss of 65% of AV.

The credit strength provided by the bonds' strong coverage levels is partially offset by high taxpayer concentration. The agency's largest taxpayer, a real estate investment trust, accounted for 43% of the tax base for the bonds in 2010, and the top 10 taxpayers represented a very high 78% of IV. Such concentration exposes bondholders to the risk that debt service could be impaired by a large reduction in AV or tax payments for a very small number of taxpayers. A cash-funded debt service reserve provides some protection against this risk.

Project areas supporting the bonds are strategically located to take advantage of demand from the city's wealthier neighbors, and major tenants include class-A office developments, a luxury hotel, and big box retailers. Residential properties represent a minority of the project areas' AV due to the relocation of homes outside the project area as part of the agency's redevelopment plans and the substantial growth in commercial AV. The combined size of the two project areas is 169 acres, representing 11% of the city's total area but more than one-third of AV.

The agency's financial position is strong, with unreserved fund balance at 19% of spending at the end of fiscal 2010 and consistently positive operating margins. Most of the agency's redevelopment plans for the two project areas have already been completed, and it has no near-term plans to issue new debt at parity, which would be subject to an additional bonds test of 1.35x MADS, or 1.25x MADS upon a decrease in the largest taxpayer's share of IV below 20%. Debt amortization is below average, with 37% of outstanding principal repaid in 10 years.

Recently adopted state legislation provides for the dissolution of redevelopment agencies in California unless they agree to make specific ongoing payments of tax increment revenue to the state. The East Palo Alto Redevelopment Agency intends to make all payments required to continue operations under the new legislation, which is currently under review by the state supreme court. Transfers of tax revenue to the state, should they be upheld, are expected to remain subordinate to debt service.

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, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com, and National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 15, 2011);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 15, 2011).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648842

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