CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB-' rating on the following bonds issued by the Bexar County Health Facilities Development Corporation on behalf of Army Residence Community (ARC):
--$52,655,000 million revenue bonds series 2010;
--$23,390,000 million refunding revenue bonds series 2007.
The Rating Outlook is Stable.
SECURITY
Bond payments are secured by a gross revenue pledge. A fully funded debt service reserve fund and a mortgage deed of trust provide additional security.
KEY RATING DRIVERS
IMPROVED OPERATING PROFITABILITY: Operating profitability continues to improve with operating ratio decreasing to 111% in fiscal 2014 and the six-month interim period ending Dec. 31, 2014 (the interim period) from 118% in fiscal 2013, reflecting some of the benefits of recent expansion projects. Net operating margin-adjusted increased to 29.1% in fiscal 2014 and 25.9% in the interim period, exceeding Fitch's 'BBB' median of 21.3%.
HIGH DEBT BURDEN: While moderating over the past five years due to revenue growth, ARC's debt burden remains high with maximum annual debt service (MADS) equal to 20.8% of revenue in fiscal 2014. Reflecting the moderating debt burden, improved profitability and continued entrance fee generation, MADS coverage improved to 1.9x in fiscal 2014 from 1.3x in fiscal 2013. However, revenue-only MADS coverage remained light at 0.5x.
STRONG DEMAND: Demand remains strong as evidenced by ARC's successful fill up of its phase I and phase II expansions, robust wait list and improved occupancy rates. Independent living unit (ILU) occupancy increased from 89.4% in fiscal 2012 to 96.4% at Dec. 31, 2014, including the addition of 28 new ILU cottages.
COMPRESSED LIQUIDITY: As expected, unrestricted liquidity decreased 11% to $35.8 million at Dec. 31, 2014. The decrease was primarily due to cash spent on the final phase of the expansion project and renovations of legacy units. Liquidity is expected to rebound upon receipt of initial entrance fees and due to decreased capital spending going forward.
RATING SENSITIVITIES
SUSTAINED OPERATING IMPROVEMENT: Fitch expects that ARC's operating profitability and cash flow will further improve as the community realizes the benefits of its significant expansion projects bringing financial ratios more in-line with its 'BBB-' peers. ARC's high debt burden and mixed liquidity metrics allow little room for deterioration in profitability and debt service coverage at the current rating.
CREDIT PROFILE
ARC is a Type-A continuing care retirement community (CCRC) for retired career military officers located in San Antonio, TX with 445 ILUs, 78 assisted living units (ALUs), and 91 nursing care beds (including 18 dementia care). Total operating revenue equaled $29.1 million in fiscal 2014. ARC's primary credit strengths continue to be its unique market niche and strong demand for services. ARC exclusively serves retired military officers who have stable pension income and solid healthcare benefits, which Fitch views as a credit positive.
ARC's CEO retired in 2014 and was replaced by Mary Garr, who became ARC's third-ever CEO in October 2014. Prior to joining ARC, Colonel Garr (ret) served in the U.S. Army's Medical Service Corps for over 30 years, most recently as garrison commander of Fort Sam Houston, managing all of the base's operations including all facilities, dining and services. Fitch views her prior management experience favorably.
IMPROVED OPERATING PROFITABILITY
Operating profitability continued to improve in fiscal 2014 with operating ratio decreasing to 111.4% from 118.3% in fiscal 2013 and net operating margin increasing to positive 3.1% from negative 4.1%. The improvement was primarily due to phase II ILU maintenance fees, a full year of ALU operations at capacity, and continued cost management initiatives. The improvement continued through the interim period with 111.1% operating ratio and 2.6% net operating margin. While improved, both metrics lag behind Fitch's respective 'BBB' category medians of 97.4% and 9.2%. However, solid entrance fee generation produced strong net operating margin-adjusted of 29.1% in fiscal 2014 and 25.9% in the interim period, exceeding Fitch's 'BBB' category median of 20.4%. Interim profitability was normalized to exclude a non-recurring severance payment to ARC's former CEO who retired.
Operating profitability is expected to continue to improve as the 24 phase III ILUs come online during the summer of 2015 and as the new CEO executes operating improvement initiatives. Now that the expansion projects are completed, management's focus will be increasingly on improving profitability. Operating improvement initiatives include an increased focus on cost management and reasonable rate increases. Operating ratio is budgeted to decline to 107.7% in fiscal 2015 while net operating margin is budgeted to improve to 5.1%.
HIGH DEBT BURDEN
ARC's debt burden remains very high with MADS equal to 20.8% of revenue relative to Fitch's 'BBB' category median of 12.3% and is a primary credit concern. However, the debt burden has moderated over the last five years, decreasing from 30.7% of operating revenue in fiscal 2010. The decreasing debt burden reflects substantial revenue growth as ARC completed phases I and II of its campus expansion. Operating revenue increased 41% from $20.6 million in fiscal 2010 to $29.1 million in fiscal 2014.
MADS coverage continued to improve in fiscal 2014, increasing to 1.9x from 1.3x and is now consistent with Fitch's 'BBB' category median of 2x. MADS coverage moderated somewhat in the interim period to 1.7x, but remains improved over fiscal 2013 levels. The continued improvement reflects an increase in net entrance fee proceeds in fiscal 2014 and the improved profitability. Revenue-only MADS coverage of 0.5x in fiscal 2014 and the interim period, while improved, remains weak relative to Fitch's 'BBB' category median of 0.9x. Given the high debt burden, ARC will need to sustain the improvements in operating profitability.
STRONG DEMAND
Demand for services remains strong as evidenced by the deep priority wait list of 339 prospective residents, the quick fill up of expansion units and strong occupancy. Following a low of 89.4% in fiscal 2012, ILU occupancy improved to 96.4% at Dec. 31, 2014, including the 28 new Phase II ILUs. ALU occupancy has continued to strengthen since opening 45 additional units in 2012, increasing from an average of 54.2% in fiscal 2012 to 96.1% at Dec. 31, 2014. Fitch views the strong demand for ARC's services to be a primary credit strength.
COMPRESSED LIQUIDITY
As expected, unrestricted liquidity decreased from $40.3 million at Dec. 31, 2013 to $35.8 million at Dec. 31, 2014. The decrease reflects ARC's continued reinvestment in its campus, including the phase III expansion and renovations of legacy units, in addition to some unrealized investment losses. The decrease is expected to be temporary until phase III entrance fee receipts are received. Days cash on hand remains strong at 454.4 days, exceeding Fitch's 'BBB' median of 408 days. However, cash-to-debt of 39% and cushion ratio of 5.7x remain light relative to Fitch's 'BBB' category medians of 60.2% and 6.9x. Fitch expects that liquidity metrics will improve now that the campus expansion projects are completed and no new major projects are planned.
DISCLOSURE
ARC covenants to provide annual disclosure within 120 days of each fiscal year-end and quarterly disclosure within 45 days of the first three fiscal quarters. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA system.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', June 2014;
--'Not-for-profit Continuing Care Retirement Communities Rating Criteria' (July 24, 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
Not-for-Profit Continuing Care Retirement Communities Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=752470
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982525
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