Fitch Affirms ARC of San Diego Rev Bonds at 'BBB-'; Outlook Stable

Fitch Ratings takes the following rating action on ARC of San Diego, California as part of its continuous surveillance effort:

--Approximately $12.9 million California Statewide Communities Development Authority certificates of participation, series 2008, affirmed at 'BBB-'.

The Rating Outlook is Stable.

RATING RATIONALE:

--ARC provides highly essential services to developmentally disabled and mentally impaired persons in a relatively large service area. It provides federal and state mandated services to a vulnerable population with limited competition. ARC serves about 2,000 persons through five chapters (27 locations) spread throughout San Diego County.

--Strong demand and high occupancy rates. Demand for ARC's services and programs is robust with residential occupancy rates at 94% in fiscal year (FY) 2009 and 93% through the first six months of FY2010. While the number of consumers served in FY2009 was up slightly from FY2008, services are down about 5% in one program in the current fiscal year due to stricter eligibility requirements from state agencies. Other program volumes are up slightly, but overall services are down 1% from prior year levels.

--Multiple revenue sources, but reliance on governmental programs. ARC enjoys some revenue diversity with work contracts from private employers providing about 37% of its revenues. Regardless, a significant portion of its revenues are derived from California state agencies. The Department of Development Services (DDS) accounts for about 44% of revenues, while Medi-Cal provides 12%. This revenue concentration leaves ARC susceptible to program modifications or reimbursement reductions. Rates from DDS were flat in FY2009 and FY2010, but were then cut 3% across the board in February 2009. Medi-Cal rates increased $10.92 per day in FY2009 and only $0.18 per day in FY2010. Moreover, given the state of California's budgetary challenges the outlook for FY2011 is uncertain.

--Marginal operating performance. Given the cost-based nature of most of its governmental reimbursement and employer contracts, ARC is structured to produce break-even operating results. However, operating margins over the past few fiscal years have been softer mostly as a result of the challenging reimbursement environment.

--Manageable debt position. ARC has a manageable debt position, with 1.7 times (x) maximum annual debt service (MADS) coverage, 2.8% MADS as a percent of revenues, and 49% debt to capitalization in FY2009.

--Modest liquidity metrics with about $7.5 million of unrestricted cash and investments amounting to 84 days operating expenses, 8.3x cushion ratio, and 62% of long-term debt.

KEY RATING DRIVERS:

--Maintenance of adequate cash flow and liquidity metrics.

--Sufficiency of reimbursement from California state agencies.

SECURITY:

The certificates are secured by a deed of trust on certain facilities, gross revenue pledge, and a debt service reserve fund.

CREDIT SUMMARY:

The rating reflects ARC's strong service essentiality, excellent demand, diverse revenue sources, and manageable debt position. Offsetting factors include reliance on governmental reimbursement programs, marginal but improving financial performance, and light liquidity measures. Given the cost-based nature of most of its programs, ARC is structured to produce break-even operating results. However, operating margins over the past few fiscal years have been softer mostly as a result of the challenging reimbursement environment. After FY2008's financial performance was bolstered by a $1.36 million gain on a land purchase (producing a 1.4% operating margin), FY2009's results indicate a negative 0.9% operating margin. This is despite a nearly 3% reduction in total operating expenses. FY2008 and FY2009 results were also negatively affected by unrealized investment losses. Through the first six months of FY2010, strict attention to costs controls produced a 4% operating margin. Favorable investment returns and strong fundraising boosted the excess margin to a healthy 5.7%. The cash position remains modest and is affected by $1.06 million of cash that is held in reserve for self-insured worker's compensation insurance coverage. Excluding this amount as of Dec. 31, 2009, $7.5 million of unrestricted cash and investments amounts to 84 days cash on hand or 62% of long-term debt.

ARC is a California non-profit public benefit corporation based in San Diego, CA, that operates facilities and programs for developmentally disabled and mentally impaired persons. Among its facilities and services, ARC operates four community workshops offering vocational programs, provides work for industry contracts with employers, 12 residential group homes, four residential apartment complexes, and seven centers. In FY2009, ARC generated about $33.9 million of total revenues. ARC covenants to provide annual financial and operating statements to the Municipal Securities Rulemaking Board's EMMA system.

Applicable criteria available on Fitch's website at 'www.fitchratings.com' include:

--'Revenue-Supported Rating Criteria' (Dec. 29, 2009).

Additional information is available at 'www.fitchratings.com'.

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