CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A-' rating on the approximately $16.6 million series 2007 bonds issued by North Carolina Medical Care Commission on behalf of Arbor Acres United Methodist Retirement Community (Arbor Acres).
The Rating Outlook is revised to Negative from Stable.
The bonds are secured by gross revenues, a first mortgage, a security interest in the residency agreements, and a debt service reserve fund.
KEY RATING DRIVERS
CONTINUED CAPITAL SPENDING: The Negative Outlook is based on Arbor Acres' continued robust capital spending, which has resulted in liquidity metrics that have not improved in line with Fitch's expectations during the last review. Further, management indicated that there are additional capital projects in the near term, which will likely suppress improvement in liquidity. At June 30, 2013, unrestricted cash and investments totaled $17.7 million, down from a peak of $20.2 million in 2010. Liquidity metrics are weak with 301.7 days cash on hand, 6.0x cushion ratio and 39.1% cash to debt at June 30, 2013.
IMPROVED ENTRANCE FEE RECEIPTS: Cash flow has improved through the six months ended June 30, 2013 (interim period) as Arbor Acres brought an additional 19 independent living units (ILUs) on line since fiscal 2011 (Dec. 31 fiscal year end). Turnover entrance fee receipts and resident revenue growth has been solid. Turnover entrance fee receipts totaled $3.2 million in the interim period compared to $4 million in fiscal 2012 and $2.9 million in fiscal 2011. Sustaining strong cash flow will be imperative to maintaining the current rating level.
SOLID OCCUPANCY: Arbor Acres occupancy continues to be a credit strength, remaining solid despite additional units brought on line over the past three years. Average occupancy of ILUs was 94.7%, assisted living units (ALUs) was 99% and skilled nursing facility (SNF) was 97.8% at June 30, 2013.
HIGH DEBT BURDEN: Arbor Acres' debt burden is high and there is no additional debt capacity at the current rating level given its weak liquidity position. Maximum annual debt service (MADS) coverage has historically been light for the 'A' category median at 1.9x for fiscal 2012 compared to the 'A' category median of 2.7x, but improved through the interim period given strong turnover entrance fees with coverage at 3.1x and solid revenue only MADS coverage of 1.0x. Strong debt service coverage will be needed to offset weak liquidity metrics and future capital plans.
HEAVY INVESTMENT IN PLANT: Capital spending as a percent of depreciation expense has continued to be very high, averaging 538.4% over the last three years (2010-2012), which is significantly above the 'A' category median of 95.6%. Although this spending has suppressed liquidity, Fitch views the investment in plant favorably as it helps to maintain the marketability of the community resulting in sustained strong occupancy levels.
SUSTAINED STRONG CASH FLOW EXPECTED: With its additional revenue generating units on line, Fitch expects Arbor Acres to sustain the strong cash flow exhibited in the interim period. Arbor Acres has limited financial flexibility at its current rating level given its liquidity position, therefore, the failure to sustain strong cash flow is likely to result in negative rating pressure.
FUTURE CAPITAL SPENDING: Arbor Acres is contemplating several projects including the expansion of its SNF and construction of new ILUs but plans have not been finalized. A further increase in debt burden or deterioration in liquidity would likely result in negative rating action.
Arbor Acres is a Type C (fee for service) continuing care retirement community located on 82 acres in Winston-Salem, North Carolina. Arbor Acres has a total of 430 units, up from 393 in 2011. The unit mix includes 263 ILUs (133 cottages, 104 apartments and 26 studios), 102 ALUs (72 ALU and 30 dementia/memory care) and 65 SNF beds. The SNF beds are 100% private pay, which Fitch views positively.
Continued Capital Spending
A negative effect of the focus on renovation and expansion has been the drain on Arbor Acres' cash position, both in absolute dollar terms and relative to expenses and debt. Fitch expected an improvement in liquidity from the last review in September 2011. However, at June 30, 2013, unrestricted cash and investments totaled $17.7 million, down from a peak of $20.2 million in 2010. Liquidity metrics have dropped as well, with days cash on hand (DCOH) at 301.7 days down from 442 in fiscal 2010 and below the 'A' category median of 494.8 days. Cushion ratio was a very light 6.0x in fiscal 2012 compared to the median of 14.4x; and cash-to-debt was 39.1%, significantly below the 'A' rating category median of 120.2%.
The majority of the expansions and renovations were funded with the proceeds of a $28 million direct bank loan issued in 2010, and the balance, $11 million, was funded from operating cash flow. As a result of this investment, net property plant and equipment has doubled since 2009, to $85.2 million from $41.9 million, while the average age of plant has been brought down to 10.8 years, close to the 'A' rating category median of 10.5 years, from the former high of 13.4. Capital spending as a percent of depreciation expense has continued to be extremely strong (685% in 2011, 369.6% in 2012, and 223.8% for the six months ended June 30, 2013), and significantly above the 'A' category median of 95.6%.
Fitch expects Arbor Acres to generate sufficient cash flow going forward to cover future capital needs and to rebuild the balance sheet. A further deterioration in liquidity metrics would likely result in negative rating pressure.
Arbor Acres has consistently maintained very solid occupancy across the continuum of care, even as an additional 37 residential units were brought on line over the past two and a half years. This project, undertaken to maintain the marketability of the campus, also included renovations to existing units and expansion of common areas, and was funded with a combination of debt and operating cash flow. Management continues to consider additional expansion and renovation projects to maintain strong demand. Through the first six months of fiscal 2013, ending June 30, average occupancy of ILUs was 88.8% for the cottages, 93.7% for apartments, and 84.6% for studios. ALUs were 98.6% occupied, dementia/memory care units 98.4%, and SNF beds 97.8% occupied.
Historically, Arbor Acres had produced operating metrics in line with the rating category, but profitability has declined since the last review due to the recent construction. From a five year average operating ratio of 94.9%, favorable to the 'A' category median of 95.2%, the operating ratio rose to 99.3% in 2012. The decline in profitability can be attributed to several one-time items in fiscal 2012 including moving residents to the new ALU building, new fitness center and investment in electronic medical records. Profitability improved through the six months ended June 30, 2013 with 0.9% operating margin and 26.5% adjusted net operating margin. Management attributes the improvement in performance to the effects of the newly renovated ILUs which came on line beginning in January 2013, boosting 2013 revenues over 2012. Fitch expects sustained improved cash flow going forward to support capital spending and rebuilding of liquidity.
Uncommitted Capital Structure
Arbor Acres has $45 million of debt outstanding, of which $28 million is a direct bank loan (series 2010) with BB&T that is at an indexed floating rate. The series 2010 bonds have a mandatory put date of June 10, 2017 and the bank has to give Arbor Acres six months notice of a put. Arbor Acres has no swaps outstanding.
Arbor Acres covenants to provide annual audited financial statements within 120 days of its fiscal year end and unaudited financial statements within 30 days of each fiscal quarter.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating Criteria for Not-for-Profit Continuing Care Retirement Communities', July 10, 2013.
Applicable Criteria and Related Research:
Not-for-Profit Continuing Care Retirement Communities Rating Criteria