Fitch Affirms The Forest at Duke's (NC) Revs at 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the 'BBB+' rating on the following bonds issued by the North Carolina Medical Care Commission on behalf of The Forest at Duke (FD):

--$24.3 million first mortgage revenue refunding health care facilities, series 2007;

--$8.9 million revenue bonds, series 2003A;

--$135,000 revenue bonds, series 1994.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by pledged assets including gross receipts, a first mortgage lien, and a debt service reserve fund.

KEY RATING DRIVERS

SOLID FINANCIAL PERFORMANCE: FD's financial performance is solid and characterized by a healthy balance sheet position, consistent operations, and adequate debt service coverage levels that are in line with the 'BBB' category medians.

GOOD MARKET POSITION AND UTILIZATION: Despite the competitive nature of the Durham, NC's service area, FD has sustained a solid market position as a result of continued investment in its plant, communication with residents and its relationship with Duke University (including lifelong learning programs), which has provided for occupancy consistently above 90% across the continuum of care.

ELEVATED DEBT BURDEN: FD's debt burden is elevated as measured by maximum annual debt service (MADS) as a percent of revenue. MADS of $4.5 million equates to a 20.3% of fiscal 2014 revenues. As a result, debt service coverage is just adequate at 1.8x in fiscal 2014 despite strong profitability. However, FD's debt service schedule is front loaded with MADS dropping to $1.6 million beginning in fiscal 2020.

RATING SENSITIVITIES

IMPROVEMENT IN DEBT SERVICE COVERAGE: The Forest at Duke is nearing completion of its 15 cottage expansion project with all units reserved as of the end of May. The additional monthly service fees should contribute to sustained solid core operating performance (operating ratio and net operating margin) going forward. Improved operations resulting in higher debt service coverage could move the rating up.

COMPLETION OF CAMPUS RENOVATION PLAN: Forest at Duke started its $10 million campus renovation project in October 2014, which is being funded through cash and cash flow. The project will add parking, upgrade dining and fitness areas and reconfigure the main entrance. The project is expected to be completed by February 2016. While Fitch expects the project to be completed on time and within budget, major cost over runs that would erode the balance sheet more than projected could pressure the rating.

CREDIT PROFILE

FD operates a type-B continuing care retirement community (CCRC) located in Durham, NC. The CCRC consists of 240 independent living units, 34 assisted living units, and 58 skilled nursing beds. FD is CCAC-CARF accredited, North Carolina OSHA Star certified, and Medicare certified. In the fiscal year ended (FYE) Sept. 30, 2014, FD had total operating revenues of $20.4 million.

STRONG BALANCE SHEET

FD's balance sheet metrics have consistently compared well against Fitch's 'BBB' category medians. At March 31, 2015 (six-month interim) FD's unrestricted cash and investments totaled $30.2 million equating to 670 days cash on hand, 6.7x cushion ratio and 80.9% cash-to-debt. These figures compare favorably to the respective 'BBB' category medians of 408 days, 6.9x and 60.2%. Additionally, outstanding debt includes a $3.8 million construction loan that will be paid off from initial entrance fees on the 15 unit cottage expansion and as of May 2015, the balance on the construction loan was $772,000. Because of spending on the campus renovation project, management expects days cash on hand to fall to around 450 days by fiscal 2016, which Fitch believes is still adequate given FD's solid operations. A significant deviation from liquidity expectations would be viewed negatively.

CONSISTENT OPERATING PERFORMANCE

In fiscal 2014, operating profitability compressed slightly with an operating ratio of 95.1% and a net operating margin (NOM) of 11.7% compared to an operating ratio and NOM of 93.8% and 13.5%, respectively, in fiscal 2013 reflecting higher unit turnover in fiscal 2014. Through the six month interim period ended March 31, operating ratio, NOM and NOM-adjusted have improved to 94.2%, 12.4% and 34.3%, respectively . FD's profitability metrics compare favorably to Fitch's 2014 'BBB' category medians (operating ratio 93.8%, NOM 9.2% and NOM-adjusted 20.4%). Through six month ended, FD expects to meet its budget of $2.2 million of income from operating income (excluding interest expense) for fiscal 2015.

CAPITAL PLANS UNDERWAY

FD is nearing completion of its 15 unit cottage expansion project. As of the end of May, 14 of the 15 cottages are pre-sold with a deposit and approximately seven units are occupied. The total entrance fee pool is approximately $7.9 million which will be used to repay a $6 million construction loan for BB&T, of which only $772,000 remains outstanding. Fitch views the expansion positively as it should improve FD's core operating profitability through the receipt of additional monthly service fees. FD started its $10 million campus renovation project in November 2014, which includes additional parking, renovation and reconfiguration of the main entrance, expansion of the fitness center and renovations to the dining room. To date, FD has spent approximately $2.3 million towards the project which will be funded from operations and internal funds. The project is expected to be completed by February 2016.

ADEQUATE DEBT SERVICE COVERAGE

As of March 31, 2015, FD had approximately $33.2 million of long-term, fixed rate debt and a $3.8 million balance on the BB&T construction loan. The construction loan is expected to be repaid from initial entrance fees. MADS of $4.5 million equated to a high 20.3% of fiscal 2014 revenues as compared to the 'BBB' category median of 12.3%. However, FD's debt service is front loaded with MADS dropping to just $1.6 million beginning in fiscal 2020. As a result, debt service coverage is just adequate at 1.8x in fiscal 2014 despite FD's strong operating profitability. Revenue only coverage of 1.0x in fiscal 2014 is improved from the prior year and is consistent with the 'BBB' median of 0.9x. Through the six month interim period, FD generated MADS coverage of 1.8x.

GOOD OCCUPANCY

Despite a very competitive service area that includes five other communities within 18 miles of its campus, FD has been able to maintain good occupancy across the spectrum of care. Occupancy across the continuum has been above 91% over the last four years. At March 31, 2015, occupancy was 94% for independent living units, 82%for assisted living units and 90% for skilled nursing facility units. In addition, FD maintains an active waiting list with 176 interested parties. FD's long history of strong occupancy can be attributed to its focus on lifelong learning supported by its relationship with Duke University, and open communication with residents. FD also has no Medicaid exposure in its skilled nursing operation, which Fitch views positively.

DISCLOSURE

FD covenants to disclose audited financial statements within 120 days of FYE, and quarterly financial statements within 30 days of quarter end, to the Municipal Securities Rulemaking Board's EMMA system.

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

Applicable Criteria

Not-for-Profit Continuing Care Retirement Communities Rating Criteria (pub. 24 Jul 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=752470

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

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

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985697

Endorsement Policy

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

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Contacts

Fitch Ratings
Primary Analyst
Jim LeBuhn
Senior Director
+1-312-368-2059
Fitch Ratings, Inc.
70 W. Madison Street
Chicago IL 60602
or
Secondary Analyst
Gary Sokolow
Director
+1-212-908-9186
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jim LeBuhn
Senior Director
+1-312-368-2059
Fitch Ratings, Inc.
70 W. Madison Street
Chicago IL 60602
or
Secondary Analyst
Gary Sokolow
Director
+1-212-908-9186
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com