Market Overview

Fitch Affirms Class I & II of Pac Beacon LLC (CA) Military Hsg Revs; Upgrades Class III to 'BBB-'

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NEW YORK--(BUSINESS WIRE)--

Fitch Ratings affirms the ratings on the following classes of Pacific Beacon LLC (CA), military housing taxable revenue bonds (Naval Base San Diego Unaccompanied Housing Project), 2006 series A (the bonds):

--$175 million class I bonds at 'AA-';

--$62 million class II bonds at 'A-'.

In addition, Fitch upgrades the following rating:

--$55 million class III bonds to 'BBB-' from 'BB';

The Rating Outlook is Stable.

SECURITY

The bonds are special limited obligations of the issuer primarily secured by pledged revenues from the operation of the unaccompanied housing project known as Pacific Beacon at the San Diego Naval Base. The absence of a cash funded debt service reserve fund limits protections afforded bondholders.

KEY RATING DRIVERS

OCCUPANCY REMAINS HIGH: The project is currently 98% occupied. Management continues to achieve high occupancy levels, despite deployments resulting in a nearly 80% turnover rate per year.

BAH PERCENTAGE INCREASE: For the Pacific Beacon project the U.S. Navy authorized the payment of Basic Allowance for Housing (BAH) for junior enlisted personnel in the paygrades of E-1 to E-4. The increase in the percentage of BAH from 68% to 82% in 2014 for the residents of Pacific Beacon allowed for rental payments increased revenue to the project and in turn increased debt service coverage. The residents of Palmer Hall continue to receive the 68% of BAH in accordance with the business agreement.

IMPROVING DEBT SERVICE COVERAGE: The affirmation of the ratings on the class I and II and the upgrade of the class III bonds with a Stable Outlook are based on the improved debt service coverage ratios (DSCR). The actual third quarter 2015 year-to-date DSCR of 2.22x, 1.66x and 1.36x for the class I, II and III bonds, respectively, compared favorably to the 2014 DSCR of 1.96x, 1.47x and 1.20x, respectively. The 2014 coverage was an improvement on the coverage posted in 2013.

PROPERTY MANAGEMENT ADDS CREDIT STRENGTH: Management's ability to continue to maintain occupancy levels and contain operating expenses even with the persistent apartment turnover is a positive credit factor.

ROBUST RENTAL MARKET: The BAH increased approximately 8% for the E-1 to E-4 rank on average when compared to last year due to San Diego's rental market strength.

RATING SENSITIVITIES

BAH DECREASE: A material decrease in BAH for the San Diego market area in the near term could put negative pressure on the ratings.

DECREASED OCCUPANCY AND/OR INCREASED EXPENSES: Management's inability to maintain high occupancy levels and/or control project operating expenses could negatively impact DSCRs.

CREDIT PROFILE

BASE INFORMATION

Located just south of downtown San Diego and adjacent to National City, CA, Naval Base San Diego has a primary mission of providing shore support, living quarters and pier-side berthing services to the 37 ships of the Naval Surface Force, U.S. Pacific Fleet. It is the largest surface force support installation in the U.S.

The naval base is home to 90 tenant commands, including many fleet vocational schools; employs more than 40,000 military and civilian personnel; houses 6,500 family members of military personnel; and supports 58,000 military retirees.

PROJECT INFORMATION

The project, which is located at Naval Base San Diego, consists of 1,199 units made up of Pacific Beacon (941 units) and Palmer Hall (258 units) and operates under the name Pacific Beacon.

The original scope included upgrading and renovating existing two-bedroom residential units at Palmer Hall and the construction of three new buildings/towers known as Pacific Beacon with two-bedroom units. The project includes multiple fitness facilities, a multiuse area, classrooms and free parking.

PROJECT OCCUPANCY LEVELS

The project is currently 98% occupied and demonstrated 98% average occupancy for the three year period ending December 2015. Management reports that the project experiences high turnover rates every year which is largely driven by the deployment and promotion of existing tenants.

Project occupancy levels play a key role in determining the amount of revenue generated by the project, as BAH amounts vary by rank level. However, rank levels are now less important as currently 86% of the beds are leased to service members with a rank of E4 or below which all receive the same monthly BAH amount.

BAH RATES

One of the keys to the financial health of the project was the Department of Defense changing the percentage of the BAH to the E1-E4 ranks living at Pacific Beacon to 82% of BAH in 2014. This increased the per bedroom revenue (regardless of tenant mix), offset some of the property operating expenses and increased DSCR this year and should continue that trend in the future assuming operating expenses remain stable. Management reports that the project will pay off the balance of deferred management fees that were incurred prior to the increase in the percentage of BAH available for rental payments at the end of the current year well ahead of its prior projections.

PROJECTED DEBT SERVICE COVERAGE LEVELS

The 2016 budget for the property incorporates a 3.3% economic vacancy assumption. In addition, the projection includes the actual 8% increase in BAH with the same tenant mix which demonstrates a 1.44x all in debt service coverage ratio on a year-to-date basis through then end of February 2016.

Debt service remains nearly level throughout the life of the bonds at approximately $20 million.

Fitch continues to view unaccompanied military housing projects as having more risk than other Fitch rated military family housing projects given the varied profile of the respective tenant bases. Unaccompanied housing projects tend to be subject to higher levels of physical wear and much higher annual turnover which leads to higher property operating expenses. Therefore, Fitch expects that the DSCRs for an unaccompanied project will be higher than those of military family housing transactions at the same rating level to account for this dynamic.

PROJECT CONSTRUCTION

Construction for the project was completed ahead of schedule, June 2009.

BRAC RISK

In 2005, the BRAC commission recommended the closure of Naval Station Ingleside, TX and the relocation of its ships, equipment and personnel to Naval Base San Diego. This closure and the consolidation of the Navy Reserve Command's installation management function with Navy Region Southwest at the San Diego base resulted in a gain of nearly 1,100 military personnel and more than 80 civilian employees for Naval Base San Diego.

While the four previous BRAC commission recommendations (1988, 1991, 1993 and 1995) to the President resulted in the loss of some assigned personnel and activities located in San Diego due to realignments within the Navy's organizational structure, none of the recommendations challenged the future of the base as a home port, fleet support facility or training center. On the contrary, the consolidation of the Navy's infrastructure over the past 18 years has increased its reliance on the San Diego base to serve as a home port to the Pacific Fleet, securing its vital role for the foreseeable future.

There has been no additional BRAC information since the 2005 commission.

DEBT SERVICE RESERVE FUND

The transaction maintains a National Public Finance Guarantee surety bond for the debt service reserve fund sized at maximum annual debt service. Fitch does not assign any value to the surety bond and does not rely on its presence in the event of project financial deterioration. In addition, there is an excess collateral agreement in place in the amount of $10 million which acts as a line of credit to the project from Merrill Lynch with a wrap from AIG. As far as the excess collateral agreement, Fitch no longer gives any credit in the analysis to that agreement.

PROJECT MANAGEMENT

The project manager is Clark Realty Capital, LLC. Since taking over the property management in January, 2010, an affiliate of Clark Realty Capital has maintained high occupancy rates and has ably managed operating expenses.

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

In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was additionally informed by information from Trimont Real Estate Advisors.

Applicable Criteria

Military Housing Rating Criteria (pub. 18 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=870678

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1001407

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1001407

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings, Inc.
Primary Analyst
Ronald P. McGovern
Senior Director
+1-212-908-0513
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kasia Reed
Analytical Consultant
+1-646-582-4864
or
Committee Chairperson
Maura McGuigan
Senior Director
+1-212-908-0591
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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