Fitch Affirms Morningstar Senior Living (PA) Revs at 'BBB-'; Outlook Revised to Negative

NEW YORK--()--Fitch Ratings has affirmed the 'BBB-' ratings on the following Northampton County Industrial Development Authority (PA) bonds, issued on behalf of Morningstar Senior Living (MSL):

--$28.7 million series 2012.

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are secured by a pledge of gross revenues, a first mortgage lien, and a debt service reserve fund.

KEY RATING DRIVERS

WEAKER RESULTS IN 2015: The Outlook revision to Negative is driven by MSL's weaker than expected results in fiscal year (FY) 2015 (ended June 30, 2015). The community's net operating margin (NOM)-adjusted declined to 11.5% in FY 2015, well below the 18.9% in FY 2014 and below Fitch's 'BBB' category median of 19.3%. The decline in profitability is attributed to somewhat lower entrance fee receipts, below budgeted occupancy, and higher than anticipated lifecare resident utilization in MSL's skilled nursing facility (SNF).

DECLINED LIQUIDITY POSITION: MSL's 264 days cash on hand (DCOH), 48.4% cash to debt and 6.7x cushion ratio at fiscal year-end (FYE) 2015 were all below the 340 days, 58.5% and 8.3x, respectively, at prior year-end. Weaker liquidity is the result of an approximately $1 million unrealized loss on investments, as well as increased capital spending that was funded out of cash in FY 2015.

SOFT DEBT SERVICE COVERAGE: Driven by pressured operations, MSL's debt service coverage declined to 1.4x in FY 2015, below the investment grade mean of 2.0x. Per MSL's reported bond covenant calculation coverage was a stronger 2.0x. Fitch notes revenue-only coverage was a weak 0.3x in FY 2015.

SLOWDOWN IN EXPANSION PROJECT: Presales for MSL's 'Heritage Village' independent living unit (ILU) expansion have been slower than expected, and in response, management has engaged a consulting firm to provide marketing, sales, and other support for the project. The current project scope anticipates a $37 million debt financing to fund a portion of the construction costs, which Fitch believes could not be absorbed at the current rating level.

RATING SENSITIVITIES

IMPROVEMENT IN FINANCIAL PROFILE: Further rating pressure is currently precluded by better interim profitability, and the expectation that Morningstar Senior Living returns to prior levels of operating profitability and coverage in FY 2016, which are more consistent with the 'BBB' rating category. Any unexpected deterioration in the community's financial profile will likely lead to negative rating pressure.

LIMITED DEBT CAPACITY: Fitch believes that Morningstar Senior Living has limited debt capacity at the investment grade rating level. Fitch will continue to monitor the pace of presales, and the size, structure, and timing of the financing as it unfolds over the medium term.

CREDIT PROFILE

MSL is located in Nazareth, PA, within the Lehigh Valley area, approximately 70 miles north of Philadelphia. It sits on 16 acres, and includes 132 independent living apartments, 61 personal care units, 35 dementia care beds (licensed as personal care), and 61 licensed nursing care beds. In FY 2015, MSL reported total revenues of approximately $21.2 million.

Fitch uses consolidated financial statements in its analysis. The obligated group (OG) includes Morningstar Senior Living, which represented substantially all assets and 97% of total revenues of the consolidated entity in FY 2015. Not included is Morningstar Senior Solutions, which is a non-medical home care and care management business serving Lehigh Valley, and a wholly-owned subsidiary of MSL.

WEAKER RESULTS IN 2015

MSL's operating ratio has increased from 96.1% in FY 2012 to a high 104.3% in FY 2015, unfavorable to Fitch's 'BBB' median of 96.1%. Additionally, lower net entrance fee receipts of $2.3 million in FY 2015 contributed to a declined NOM-adjusted of 11.5%, below the 19.3% median. Management attributes the decline in operating performance to lower than budgeted occupancy and higher lifecare resident utilization in its SNF.

Entrance fee receipts in FY 2015 were impacted by a number of move-ins towards the end of the fiscal year, the entrance fees for which were not received until FY 2016. Management is budgeting to receive a total of $3.8 million in entrance fee receipts in FY 2016. Given the cyclicality of both entrance fee receipts, and lifecare resident utilization of higher levels of care, Fitch would expect MSL to return to historical levels of performance in FY 2016.

Challenged operations in FY 2015 resulted in a low maximum annual debt service (MADS) coverage of 1.4x according to Fitch's calculations, below 2.3x in FY 2014. However, according to MSL's covenant calculation, which includes certain entrance fee receipts from new units which were released from escrow, coverage was a stronger 2.0x. Coverage improved to 1.8x through the first quarter of FY 2016. Management is budgeting for coverage of 2.4x in FY 2016, which Fitch views as reasonable, given improved performance year-to-date and the expected increase in entrance fee receipts for the year.

DECLINED LIQUIDITY POSITION

MSL's $14.3 million in unrestricted cash and investments at FYE 2015 equated to 264 DCOH, 48.4% cash to debt and a 6.7x cushion ratio, all of which were below the 'BBB' medians of 400 days, 60% and 7.3x, respectively. MSL's unrestricted liquidity declined by approximately $3.5 million from FYE 2014, due mainly to an approximately $1 million unrealized loss on investments and $2 million in over-budgeted capital expenditures that were funded out of cash in FY 2015. Management is budgeting to spend a manageable $3.3 million on capital in FY 2016, which, coupled with the expected entrance fee receipts, should help it preserve, or grow it cash position during the year.

SLOWDOWN IN EXPANSION PROJECT

As of Nov. 1, 2015, MSL had 21 depositors for its 'Heritage Village' ILU expansion project. The first phase of the project contemplates the construction of 104 ILUs, with 72 presales required to begin construction. Given the slower than expected presale progress, management has engaged a consulting firming to provide marketing, sales, and other support for the project. The current project scope anticipates a $37 million debt financing to fund a portion of the construction costs. Fitch believes that MSL has limited debt capacity, and that a debt financing of such magnitude could not be absorbed at the current rating level.

DEBT PROFILE

All of MSL's outstanding long-term debt is fixed rate. MADS equals nearly $2.2 million, and debt service is level through maturity in 2035. MSL has no outstanding swaps or capital leases.

DISCLOSURE

MSL provides quarterly (within 45 days) and annual (within 120 days) disclosure via 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. 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=995202

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=995202

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
Emily E. Wadhwani
Director
+1-312-368-3347
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@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
Emily E. Wadhwani
Director
+1-312-368-3347
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@fitchratings.com