Fitch Affirms Duncaster, Inc. (CT) at 'BBB-'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'BBB-' rating on the following State of Connecticut Health and Educational Facilities Authority bonds issued on behalf of Duncaster, Inc. (Duncaster):

--$12,000,000 revenue bonds, Duncaster, Inc. issues, series 2014A.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a pledge of Duncaster's gross revenues, a mortgage, a debt service reserve fund and a foundation guarantee not to let debt service fall below the 1.2x covenant.

KEY RATING DRIVERS

STRONG 2014 PERFORMANCE: Duncaster's performance improved in 2014, driven by revenue growth outpacing expense growth as occupancy continued to improve, and a robust year of entrance fee receipts. Duncaster's 21% net operating margin (NOM)-adjusted and 2.3x maximum annual debt service (MADS) coverage were the strongest through the four-year historical period and both were above Fitch's respective 'BBB' medians of 20.4% and 2.0x.

WEAKER INTERIM 2015 RESULTS: Duncaster's financial performance dropped significantly through the six-month interim period (ended June 30, 2015), due to higher turnover in the first part of 2015 and slightly weaker operating results. Coverage of MADS was a weak 0.7x through the six months; however, Fitch expects full-year coverage to improve as Duncaster collects turnover entrance fees on the vacated units.

STRONG OCCUPANCY: Duncaster's independent living unit (ILU) occupancy improved to 95% in 2014 from 79% in 2012, and remained strong at 94% through the six-month interim period. The high ILU occupancy offsets the near-term concerns regarding the weaker interim performance.

SOLID LIQUIDITY METRICS: Duncaster's unrestricted liquidity position (including foundation endowment funds) remained solid at June 30, 2015 with 348 days cash on hand (DCOH), 68.9% cash to debt and a 6.9x cushion ratio, all of which were in line with Fitch's 'BBB' medians of 408 days, 60.2% and 6.9x, respectively.

EXPANSION PROJECT NEARING COMPLETION: Duncaster's independent and assisted living unit (ALU) expansion project is on budget through the interim period, although construction was slightly delayed due to severe winter weather. Management expects the ILUs and ALUs to be ready for occupancy by October and September, respectively, and forecasts the new ILUs to fill-up by Dec 2015. Fitch believes the incremental revenue from the expansion project will help improve core operating profitability going forward.

RATING SENSITIVITIES

CONTINUED STABILITY EXPECTED: Fitch expects Duncaster's full-year 2015 performance to be softer than prior year results, but much improved over the six-month interim results as turnover entrance fees are collected on recently vacated ILUs. Moreover, Fitch expects the additional revenues from the new ILUs and ALUs to help improve core operating profitability over the next two to three years.

CREDIT PROFILE

Duncaster operates a not-for-profit type-A life-care community in Bloomfield, CT, which is located just to the northwest of Hartford, CT. Opened in 1984, Duncaster's current unit mix of units currently includes 183 ILUs, 30 ALUs, and 60 private skilled nursing facility (SNF) beds. In 2014, Duncaster had total operating revenue of $22.6 million. For purposes of analysis, Fitch includes the endowment of a separate non-obligated foundation which exists solely to support Duncaster. The foundation had approximately $8.5 million in unrestricted cash and investments at June 30, 2015.

MIXED FINANCIAL PERFORMANCE

Duncaster's operating performance has shown steady improvement over the last three audited years, as evidenced by operating ratio improving from 103.7% in 2012 to 98.4% in 2014. Improved operating performance is attributed to a significant increase in occupancy which helped grow top-line revenues over the time period. Operating performance in 2014 is highlighted by continued revenue growth which has outpaced growth in expenses, as well as strong net entrance fee receipts of $4.6 million. Robust cash flows for the year resulted in a solid NOM-adjusted of 21% and MADS coverage of 2.3x, both of which were above Fitch's respective 'BBB' medians.

Financial performance has suffered through the interim period, due to a high level of turnover in the smaller, one-bedroom apartments, which Duncaster has had trouble refilling to date. Net entrance fee receipts of just $379,000 through the interim resulted in a weak 0.7x MADS coverage. Coverage is tested annually for the 2014 bonds and quarterly (on a rolling 12-month basis) for the 2010 debt. As of June 30, 2015 Duncaster's covenant calculations showed coverage of 1.6x. Management is employing additional marketing strategies and focusing on the sale of smaller apartments; there have been four closings in July and August and an additional five are expected before the end of September. Management expects to earn approximately $2.1 million in additional net entrance fee receipts in the second part of the year, which should bring full-year 2015 coverage to above 1.5x.

STRONG OCCUPANCY

Although Duncaster's occupancy declined from 97% in the first quarter of 2015 to 91% in the second quarter, average occupancy remained strong 94%, which mitigates some of the near-term concerns regarding the weaker interim performance. In addition, ALU and SNF occupancies have averaged 93% and 91%, respectively, over the last three years. The payor mix in the SNF has improved with the percentage of private pay and Medicare revenues increasing to 49% of gross revenues from 38% in 2011, contributing to steady revenue growth over the time period.

EXPANSION PROJECT NEARING COMPLETION

Duncaster's ILU and ALU expansion project, which includes the addition of 12 ILUs and 12 AL Memory Care units, has been tracking close to budget, but is slightly behind the originally projected schedule. The ILU and ALU apartments are expected to be ready for occupancy in October and September, respectively, and all the apartments have been pre-sold to date. Management is anticipating an accelerated fill-up period of one month for the ILUs. The initial entrance fees will be used to pay off the $4.4 million construction loan, and the additional monthly service fees should contribute to improved core operating profitability. Fitch expects that the incremental revenue from the expansion project will help grow Duncaster's revenues and operating income over the medium term.

DEBT PROFILE

Duncaster has approximately $29.8 million in long-term debt, not including a short-term construction loan. The debt mix is approximately 40% fixed and 60% variable, which Fitch views as aggressive at the current rating level. The variable rate debt is privately placed and has a call date of 2020, which mitigates some remarketing and put risks. The private placement is on parity with the 2014 bonds and the bond documents contain cross-default provisions and similar covenant language for both series. The variable rate debt is hedged with a fixed payor swap that also extends to 2020 and matches the par amount of the variable rate bonds. The mark-to-market on the swap was a negative $958,800 as of July 23, 2015. There are no collateral posting requirements.

DISCLOSURE

Duncaster covenants to disclose annual reports no later than 150 days after the fiscal year-end and quarterly reports no later than 45 days after quarter-end. Duncaster posts its disclosure to the Municipal Securities Rulemaking Board's EMMA website.

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

Applicable Criteria

Not-for-Profit Continuing Care Retirement Communities Rating Criteria (pub. 04 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=868824

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

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

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=989619

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=989619

Endorsement Policy

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

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Contacts

Fitch Ratings
Primary Analyst
Dmitry Feofilaktov
Analyst
+1-212-908-0345
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Gary Sokolow
Director
+1-212-908-9186
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Dmitry Feofilaktov
Analyst
+1-212-908-0345
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Gary Sokolow
Director
+1-212-908-9186
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com