NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB+' rating to the expected issuance of the following Cumberland County Municipal Authority bonds issued on behalf of Diakon Lutheran Social Ministries (Diakon):
--$35,000,000 revenue bonds series of 2016 (Diakon Lutheran Social Ministries Project)
In addition, Fitch has affirmed the 'BBB+' ratings on the following Cumberland County Municipal Authority (PA) bonds also issued on behalf of Diakon:.
--$145,550,000 revenue bonds series of 2015 (Diakon Lutheran Social Ministries Project)
--$9,260,000 Cumberland County Municipal Authority Bonds series 2009
The Rating Outlook is Stable.
The series 2016 bonds will be issued as fixed-rate debt. Bond proceeds will be used to refund the 2014B bonds, fund capital expenditures and pay for a swap termination and the cost of issuance. Pro-forma maximum annual debt service (MADS), which was provided by the underwriter, is expected to decline very slightly to $16.4 million. The bonds are expected to price via negotiation the week of June 4.
SECURITY
--Gross receipts of the obligated group (OG), a mortgage of certain properties, and a debt service reserve fund on the outstanding series 2009 bonds. There will be no debt service reserve fund for the 2016 bonds.
KEY RATING DRIVERS
IMPROVING FINANCIAL PROFILE: Diakon's financial results have been on a positive trajectory driven by improved performance at its core entrance fee campuses and helped by the moving of social service programs outside of the OG. In 2015, Diakon's operating ratio of 95.5%, its net operating margin - adjusted of 13.7%, and pro forma maximum annual debt service coverage (MADS) of 2.3x, were all the strongest metrics through the four year historical period. First quarter 2016 results show a year-over-year improvement for most metrics.
SOLID OVERALL OCCUPANCY: At March 31, 2016, Diakon had independent living occupancy (IL) of 91%, assisted living (AL) of 95%, and skilled nursing occupancy of 95%. IL occupancy has materially improved over the last six years, rising from 83% in fiscal 2010. Improved occupancy has been driven by Diakon's capital investments across the system, including a major repositioning project at Luther Crest, and a revamped marketing effort.
OPERATIONS STRENGTHENING: Diakon's focus on a number of initiatives to strengthen the core OG performance has yielded positive results. In addition, the establishment of a new entity outside the OG in 2014 to house most of Diakon's social service programs and the moving of the statewide adoption network, SWAN, out of the OG in 2015, has had a positive impact as well.
ADEQUATE LIQUIDITY: At March 31, 2016, Diakon had $116.7 million in unrestricted cash and investments which equated to 314 days cash on hand (DCOH) and 50.6% cash to debt, both of which trail category medians. DCOH has improved as the OG's expense base has gone down with the transitions of the social service organizations and SWAN. Fitch views Diakon's unrestricted liquidity as adequate for the rating level, especially given its conservative debt structure. Fixed-rate bonds account for 83% of Diakon's long-term debt (pro forma), and Diakon is terminating its swaps with this debt issuance, further reducing the risk profile of its debt structure.
DIVERSITY AND SIZE PROVIDE STABILITY: Fitch believes Diakon's geographic diversity (eight obligated group campuses located in separate Pennsylvania markets) and its size, with over 2,100 total units in service and nearly $200 million in obligated group operating revenue, enable Diakon to maintain consistent levels of performance, even if individual campuses are underperforming or undergoing significant capital projects.
RATING SENSITIVITIES
STABLE FINANCIAL PERFORMANCE: Fitch believes Diakon Lutheran Social Ministries current level of performance will remain stable. Higher debt service coverage coupled with liquidity growth could lead to positive rating pressure. A sustained period of negative performance coupled with lower debt service and liquidity could lead to negative rating pressure.
CREDIT PROFILE
Diakon Lutheran Social Ministries is headquartered in Allentown, PA. The obligated group is composed of 889 skilled nursing beds, 421 personal care beds and 834 ILUs located in Pennsylvania. Total OG operating revenue in FY 2015 was $192.9 million.
Fitch's analysis is based on the OG, which consists of the senior living campuses located in PA (there is an entrance fee community located in Hagerstown, MD that is outside the OG) and currently represents the vast majority of the consolidated entities assets and income.
Financial Profile
In 2015, Diakon generated 95.5% operating ratio and a 13.7%, net operating margin - adjusted, which were improved over 2014's, 99.4% operating ratio and a 9.7% net operating margin - adjusted. MADS coverage on a pro forma basis was also stronger rising to 2.3x, from 1.8x coverage relative to Fitch's 'BBB' median of 2x. The solid operations have been supported by good growth in patient service revenue which had a CAGR of 5% from 2012 to 2015.
First quarter 2016 results show Diakon maintaining the steady improvement in operational performance, with the 95.3% operating ratio, a 17.0% net operating margin - adjusted, and debt service coverage of 1.9x, all improved year over year.
Update on Initiatives
Diakon continues to execute on a number of revenue enhancing initiatives. Results remain positive with occupancy across all levels of care remaining high. Diakon's focus on growing the short-term rehab service line has been successful as well, with Diakon maintaining its patient acuity levels and Medicare census, which remained above 10% in the three-month 2016 interim period.
While it has slowed down, Diakon's spending on capital remains strong. Capital spending as a percentage of depreciation over the last four audited years averaged 195.2%, above the category median of 106.2%. It was at 109.4% in 2015. The capital spending, which was funded by a combination of bond funds and equity contributions, have supported projects that have improved the marketability of various campuses, as well as funded a system wide electronic medical record.
The largest of these projects was a $75 million campus repositioning project at Luther Crest, which included a cottage expansion. Over the near term, Fitch does not expect projects as large as the Luther Crest repositioning project but expects capital spending to remain above the category median as Diakon continues to invest in its campuses to remain competitive. The largest of these projects is a repositioning project at Twining Village, which should help address IL occupancy challenges on that campus.
In 2016, Diakon has moved its SWAN program, a state contract for adoption services, out of the OG. Diakon distributes states funds through SWAN to statewide adoption programs while receiving a small amount of funds to administer the program. Since the program was not an operating income generator, the expenses associated with the program suppressed Diakon's DCOH and some of its operating ratios. The transferring of SWAN to outside the obligated has strengthened the financial results of the OG. In 2014, Diakon moved most of its social service programs outside the OG, which had a similar impact.
Debt Profile
After the debt issuance, Diakon's debt structure will be conservative. On a pro forma basis, the $237 million in long-term debt will be approximately 83% fixed and 17% variable. In 2014, Diakon refinanced much of its letter of credit (LOC) variable rate debt with a $41.5 million private placement with PNC. With this debt issuance, Diakon will be terminating its two outstanding swaps, which also will make for a more conservative debt profile.
Diakon's debt burden remains relatively manageable. Pro-forma MADS as percent of 2015 revenue is low at 8.3% relative to a 'BBB' median of 12.4%. Debt to EBIDA was slightly elevated in 2015 at 6.3x relative to a median of 5.9x.
Disclosure
Diakon covenants to disclose annual audited financial statements and quarterly disclosures. Diakon has voluntarily held annual investor calls and posts all of its disclosure via EMMA, which includes quarterly financial statements (balance sheet, income statement, and statement of cash flows), detailed utilization trends, and payor mix trends.
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
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Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1004847
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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