NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'B+' rating on approximately $29 million series 2010A bonds issued by the city of Alhambra, CA, on behalf of Atherton Baptist Homes (Atherton).
The Rating Outlook is Stable.
The bonds are secured by gross revenue pledge, mortgage, and debt service reserve fund.
KEY RATING DRIVERS
WEAK GOVERNANCE AND MANAGEMENT PRACTICES ADDRESSED: Since Fitch's last review in February 2014, several changes have been implemented which are expected to correct Atherton's weak governance and management practices. These changes include a new CEO, a new Chairman of the board, and restated bylaws to broaden the breadth and diversity of board members. While positive in intent, Fitch will monitor the effectiveness of these changes on operations and management oversight practices.
POOR FINANCIAL PROFILE: The affirmation of the 'B+' rating reflects Atherton's weak financial profile with low liquidity, poor operating performance, and thin debt service coverage. Operating ratio remains high, especially for a Type C facility, with 122.6% in fiscal 2014 (unaudited) and 122.3% in fiscal 2013 compared to Fitch's Type C median of 93.6%. Poor profitability has been driven by lower than budgeted revenue and higher expenses, especially related to workers' compensation. Atherton generated debt service coverage of just 1.3x in fiscal 2014 and fiscal 2013; just above its covenant requirement of 1.2x.
WEAK LIQUIDITY: Atherton's liquidity position is weak with $7.9 million unrestricted cash and investments at Dec. 31, 2014, which translated to 158.3 days cash on hand (DCOH) and 27.2% cash to debt. Atherton has a liquidity covenant of 180 DCOH beginning June 30, 2015, which is not expected to be met but will not trigger an event of default assuming a consultant call in. Currently, there is a management consultant engaged, who is expected to remain on board until all bond covenants are met. Fitch notes that the redemption of the remaining series 2010B bonds during fiscal 2014 drove a decline in liquidity from the prior year since initial entrance fee receipts were part of unrestricted cash and investments.
IMPROVED ILU OCCUPANCY: Atherton opened a 50 independent living unit (ILU) expansion (Courtyard) in June 2011 that experienced very slow fill, but is now essentially fully occupied with 49 of 50 units occupied. Atherton's focus over the last year has been to increase the occupancy in the older part of the campus (Classic - 170 ILUs). Classic ILU occupancy has improved to 82.9% in the fourth quarter of 2014 (4Q'14) from 77.6% in the 1Q'14; however, occupancy and revenue targets have been below budget. The fiscal 2015 budget assumes an average occupancy of 83.5% in the Classic ILUs, which Fitch views as reasonable and combined with price increases should generate a slight improvement in profitability for fiscal 2015.
ACHIEVING FINANCIAL STABILITY: Atherton has made key managerial and governance changes, which are intended to improve financial and operational performance. A key driver to generating financial stability in the near term will be improving occupancy in the Classic ILUs. Management's five year forecast projects meeting all bond covenant requirements, increasing occupancy in the 170 Classic ILUs to 91.2% by 2019 and building liquidity, which Fitch believes could be achievable if the board provides appropriate oversight and management accountability.
Atherton Baptist Homes is a Type C continuing care retirement community (CCRC) located in Alhambra, CA, with 170 Classic ILUs, 50 Courtyard ILUs, 38 assisted living units (ALU), and 99 skilled nursing facility (SNF) beds. Total revenue in fiscal 2014 (Dec. 31 year end; unaudited) was $16.8 million.
Management Consultant Report
A management consultant report was issued in March 2014 due to the violation of the occupancy requirement in the bond documents and the cumulative cash used for operations financial covenant (this covenant will no longer be tested as of fiscal 2015). An update to the report was provided in September 2014 and another update as of December 2014 will be available in a few weeks. There were several recommendations for improvements in the areas of governance and management practices as well as in marketing and sales strategies. Fitch expects that changes made to date and other changes that are in the process of being implemented should benefit the organization.
Bond Covenant Compliance
Atherton will be tested on the following bond covenants: 1.2x maximum annual debt service (MADS) coverage tested quarterly on a rolling 12 month basis beginning March 31, 2015, 180 DCOH tested every June 30 and Dec. 31 beginning June 30, 2015, and maintaining 46 occupied Courtyard ILUs (92%) and 140 Classic ILUs (82.4%) every quarter. The occupancy covenants are already being tested. Based on management's fiscal 2015 budget, all of these covenants will be met for the Dec. 31, 2015, period. However, the liquidity covenant test as of June 30, 2015, will likely not be met. The liquidity covenant does not trigger an event of default as long as there is a consultant call in. The only covenant that would trigger an event of default is having less than 1x MADS coverage for two consecutive years (based on audited fiscal year).
Continued Improvement in Occupancy is Key
The Courtyard project was part of Atherton's campus improvement plan. The project added 50 ILUs to the existing campus and included the renovation and upgrade of existing common facilities. The total construction cost was $33.4 million and the Courtyard opened on time and within budget in June 2011. Atherton issued $29.3 million fixed rate series 2010A bonds and $14.64 million of series 2010B bonds to fund the project. The Courtyard fill up was much slower than anticipated but has reached 98% occupancy (49 units) as of February 2015. The projections include the Courtyard units maintaining at least 96% occupancy.
Fitch believes that Atherton needs to improve the occupancy in the 170 existing Classic units to improve overall financial performance. The marketing and sales initiatives remain largely the same as last year with some incentives being offered. New initiatives are being considered including offering a certain amount of free days in the health center as well as a refundable entrance fee model for its Classic ILUs. As of February 2015, Classic ILU occupancy was 140. Classic ILU occupancy is budgeted at 142 (83.5%) for fiscal 2015 and improving to 155 (91%) by 2019. Net turnover entrance fees is projected to total $5 million in fiscal 2015 and $4.9 million in fiscal 2016, which will be key to meeting debt service coverage requirements as operating performance is projected to remain weak. Fitch views the $5 million of net turnover entrance fees budgeted for 2015 with some skepticism since the amount is much higher than the $3.4 million collected in 2014 and the $2.1 million collected in 2013. However, the net turnover entrance fees incorporate a price increase as well as a reasonable assumption for improved occupancy.
Historical profitability has been poor. Atherton missed its fiscal 2014 budget due to lower than projected revenue and continued pressure from workers' compensation expense. Atherton's bottom line in fiscal 2014 was negative $3.5 million compared to a budget of negative $3 million. Unbudgeted workers' compensation expense was related to settlement of claims from its old captive insurance and the timing of the settlement of the remaining claims will likely have a volatile impact on Atherton's performance going forward until all the claims are settled. Total revenue was below budget due to lower than budgeted Classic ILU occupancy and healthcare census.
Atherton's fiscal 2015 budget has a bottom line loss of $2.7 million and includes reasonable occupancy assumptions (Classic at 83.5%) and also includes price increases on monthly service fees. Although operating performance is projected to improve slightly, Fitch views the structural imbalance of cash operating expenses in excess of cash operating revenue as a major credit weakness and believes it is reflective of Atherton's historically poor management practices and weak board oversight. Atherton will be dependent on net turnover entrance fees to meet debt service coverage, similar to fiscal 2014 with a 1.3x debt service coverage ($3.33 million net available for debt service with $3.4 million net turnover entrance fees received).
Weak Liquidity Metrics
At Dec. 31, 2014, Atherton had $7.9 million of unrestricted cash and investments which equated to 158.3 DCOH, a 3.1x cushion ratio and 27.2% cash to debt compared to Fitch's 'BBB' category medians of 407.6, 6.9x and 60.2%. Fitch notes that Atherton's investment portfolio is fairly aggressive for its rating level with 63% of its investments exposed to equities. This has been reduced from 75% but still remains high.
Management is budgeting unrestricted cash and investments to improve to over $9 million by year-end 2015 due in part to higher net entrance fee receipts, which would allow Atherton to meet its liquidity covenant at the Dec. 31 test date. The budget also incorporates a higher amount of capital spending, which is now projected at approximately $2 million a year from 2015-2019 compared to $1.3 million per year from 2012-2014 to fund campus improvements to enhance the marketability of the Classic ILUs. Further, Atherton is expected to have a deferred maintenance study completed sometime this year, which may result in recommendations for even higher level of capital spending. Atherton maintains a defined benefit pension plan that is currently underfunded; however, the pension plan is not subject to ERISA requirements. It is unlikely that pension contributions will be made over the near term as there are other demands on liquidity such as meeting its liquidity covenant and future capital needs.
Total debt outstanding is approximately $29 million and is 100% fixed rate. MADS is $2.56 million and accounted for 14.5% of total revenue in fiscal 2014 compared to Fitch's 'BBB' category median of 12.3%. Atherton's debt service coverage was a thin 1.3x in fiscal 2014 from 1.39x coverage per bond covenant calculation in fiscal 2013.
Atherton posts monthly disclosure on EMMA and also hosts investor calls.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Not-for-Profit Continuing Care Retirement Communities Rating Criteria', July 24, 2014.
Applicable Criteria and Related Research:
Not-for-Profit Continuing Care Retirement Communities Rating Criteria