OREANDA-NEWS.  Fitch Ratings affirms its ratings on the following classes of Pacific Beacon LLC, 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-'
--\$55 million class III bonds at 'BB'

The Rating is Outlook 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: The increase in the percentage of the basic allowance for housing (BAH) from 68% to 82% in 2014 allowed for rental revenue increases to the project for the rank of E-1 to E-4 and in turn increased debt service coverage.

IMPROVING DEBT SERVICE COVERAGE: The ratings on the class I, II and III bonds are being affirmed with a Stable Outlook based on the actual 2014 debt service coverage ratios (DSCR)of 1.96x, 1.47x and 1.20x, compared to 2013 DSCR of 1.83x, 1.37x and 1.12x, respectively.

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.

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

DSCR STABILITY: After several years of DSCR stability, a positive rating change could materialize.

BAH DECREASE: Although unlikely, a material decrease in BAH for the San Diego market area in the near term could put negative pressure on the rating.

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

PAYMENT OF DEFERRED FEES: To the extent that deferred fees are not paid off in the next few years, it could result in long-term credit implications.

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 (1,715 beds) and Palmer Hall (516 beds) 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 a fitness facility, a multi-use area, classrooms and free parking.

PROJECT OCCUPANCY LEVELS

The project is currently 98% occupied and demonstrated 97% average occupancy for the three-year period ending December 2014. Management reports that the project experiences high turnover rates every year which is largely driven by the deployment 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 79% of the beds are leased to service members with a rank of E4 or below, which all receive the same monthly BAH amount. Management reports that it expects that by year-end 2015 90% of the units will be leased to this segment of the service member population.

BAH RATES

One of the keys to the current financial health of the project was the Department of Defense changing the percentage of the BAH to the E1-E4 ranks 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. The Project is currently accruing approximately \$12.4 million in deferred fees and is expected to pay these fees off over the next few years (projected payoff by 2018).

PROJECTED DEBT SERVICE COVERAGE LEVELS

The 2015 budget for the property incorporates a 4.6% economic vacancy assumption. In addition, the projection includes the actual 8% increase in BAH along with 90% allocation for the E-1 to E-4 tenants and demonstrates the following expectation for debt service coverage ratios for 2015:

--Class I bonds: 2.18x
--Class II bonds: 1.64x
--Class III bonds: 1.33x

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, November 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 an MBIA surety bond for the (DSRF sized at maximum annual debt service. Fitch does not assign any value to the MBIA 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 (rated 'A/F1'; Negative Outlook by Fitch) with a wrap from AIG (rated 'A-'; Positive Outlook). At this time, the surety bond provider has had its creditworthiness downgraded since the issuance of the bonds. Fitch does not include either the surety bond or the excess collateral agreement as factors in its analysis.

PROJECT MANAGEMENT

The original project manager, Pinnacle Realty Management, was replaced by Clark Realty Capital, LLC on Jan. 1, 2010. Since taking over the property management, the project has maintained occupancy over 95% and has been able to manage operating expenses.