Fitch Affirms Arbor Acres (NC) Revenue Bonds at 'BBB+'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'BBB+' rating on the following bonds issued by North Carolina Medical Care Commission on behalf of Arbor Acres United Methodist Retirement Community (Arbor Acres):

--$15.18 million, series 2007 first mortgage revenue bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by gross revenues, security interest in the residency agreements, a first mortgage, and a debt service reserve fund.

KEY RATING DRIVERS

SATISFACTORY CASH POSITION: Unrestricted liquidity balances slightly increased after an elevated period of capital spending and the receipt of initial entrance fees from independent living unit (ILU) expansions. As of March 31, 2016, $22.3 million of unrestricted cash and investments amounts to 334 days operating expenses or 47.9% of long-term debt.

VERY GOOD OCCUPANCY: Demand at Arbor Acres remains healthy, with average occupancy of 92.2% in the ILUs, 97.7% at the assisted living units (ALUs), 95.3% for the memory care units, and 93.9% in the skilled nursing facility (SNF) during fiscal 2015. For the first three months of fiscal 2016, average occupancy improved to 94% in the ILUs, 99% in the ALUs, and 97% at the SNF.

MODEST BUT IMPROVING OPERATING PERFORMANCE: Arbor Acres' consistent occupancy levels, facility improvements, and ILU expansions supports modest, but improving operating performance. After relatively softer performance from fiscal 2011 through 2014, the net operating margin was 1.4% and 2.5%, respectively, in fiscal 2015 and the first quarter of fiscal 2016 mostly due to more rapid ILU turnover and better occupancy trends.

MANAGEABLE DEBT BURDEN: After the planned full drawdown of a bank loan, pro forma maximum annual debt service (MADS) represents 11.9% of total revenue in fiscal 2015, which is slightly below Fitch's 'BBB' category median of 12.4%. Additionally, adjusted debt to capital (43.3%) and debt to net available (5.3x) are below the 58.8% and 5.9% respective 'BBB' category medians.

UNCOMMITTED CAPITAL STRUCTURE: After the expected draw down of about $8.5 million from a bank loan, Arbor Acres will have approximately $50 million of debt outstanding, of which about $34 million will be direct-placement bank obligations. Fitch views this level of bank debt with refinancing risk as aggressive given Arbor Acres' light unrestricted liquidity relative to debt.

RATING SENSITIVITIES

CAPITAL SPENDING PLANS: After an elevated period of capital spending, Arbor Acres is nearing the conclusion of a $12.75 million project to renovate and expand its SNF and memory care units. Any additional debt above the taxable bank loan or a reduction in unrestricted cash balances, could negatively pressure the rating.

MAINTENENACE OF OPERATING PROFILE: The 'BBB+' rating assumes that Arbor Acres maintains it solid occupancy levels and continues to improve operating profitability, particularly after the SNF expansion project is complete. If operating performance is not sustained and profitability levels do not continue to improve, negative rating pressure may occur.

CREDIT PROFILE

Arbor Acres is a Type-C (fee-for-service) continuing care retirement community located on 82 acres in Winston-Salem, North Carolina. Arbor Acres has a total of 429 units, up from 393 in 2011. The unit mix includes 263 ILUs, 99 ALUs (69 ALU and 30 memory care units) and 67 SNF beds. Favorably, ILU resident agreements include non-refundable entrance fees with a declining balance over time. Additionally, the SNF is 100% private pay, which Fitch views positively.

STABILIZED LIQUIDITY

After a heightened period of capital spending, unrestricted liquidity balances improved slightly over the past few years. As of March 31, 2016, $22.3 million of unrestricted cash and investments amounts to 334 days operating expenses or 47.9% of long-term debt. Both metrics are below Fitch's 'BBB' category medians of 400 days operating expenses and 60%, respectively, but are adequate given Arbor Acres mostly non-refundable fee-for-service residency agreements. Additionally, Arbor Acres enjoys a favorable history of fundraising and holds $8.5 million of restricted funds to support operations and capital spending projects.

SOLID FINANCIAL PERFORMANCE AND POSITION

Arbor Acres' very good occupancy levels, investments in facilities and ILU expansions has resulted in modest operating performance and improved cash flow. After relatively softer performance from fiscal 2011 through 2014, the net operating margin was 1.4% in fiscal 2015. Additionally, the operating ratio remained favorably below 100% in each of the last five fiscal years. During the three-month interim period for fiscal 2016, the net operating margin improved to 2.5% due to better ILU occupancy, more flexible staffing levels in response to SNF census, and reduced operational overtime expenses. Healthy receipt of net entrance fees from turnover ILUs has resulted in better cash flow, with annual improvements in the adjusted net operating margin, debt to net available, and pro forma MADS coverage over the past several years. In fiscal 2015, 2.6x pro forma MADS coverage is higher that Fitch's 'BBB' category median of 2.0x. Through the three first three months of fiscal 2016, coverage of pro forma MADS ($3.47 million) increased to 3.2x.

MANAGEABLE DEBT BURDEN

In fiscal 2015, pro forma MADS represented 11.9% of total revenue compared to Fitch's 'BBB' category median of 12.4%. Arbor Acres has a $10 million draw-down bank loan to partially fund the modernization and expansion of its SNF and memory care units. This level of new debt is a neutral rating factor, since it only modestly affects capital-related metrics. Additionally, Arbor Acres anticipates using only about $8.5 million of the draw-down loan with the remaining project costs funded by a capital campaign that has already raised $3.8 million. Furthermore, Fitch views the project favorably, since the renovated SNF and memory care units should enhance the community's marketability and support demand.

UNCOMMITTED CAPITAL STRUCTURE

After drawing down about $8.5 million of the taxable bank loan, Arbor Acres will have about $50 million of debt outstanding, of which $34 million will be direct placement bank obligations with two providers. The $26.9 million series 2010 bank loan with BB&T is at an indexed floating rate with a mandatory put on Dec. 20, 2023. To hedge a portion of the interest rate risk, Arbor Acres entered into an $18.5 million swap. As of March 31, 2016, the interest rate swap had a negative market value of $1.46 million. The $10 million bank loan with First Tennessee is at an indexed variable interest rate with a maturity of July 1, 2025. The bank bonds and series 2007 bonds are parity obligations and include the same financial covenants. Fitch views this level of bank debt with interest rate, counterparty, and refinancing risk as aggressive given Arbor Acres' 'BBB' category credit quality and light unrestricted liquidity relative to uncommitted debt.

DISCLOSURE

Arbor Acres covenants to provide annual audited financial statements within 120 days of its fiscal year end and unaudited financial statements within 30 days of each fiscal quarter.

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=1009291

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009291

Endorsement Policy

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

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Contacts

Fitch Ratings
Primary Analyst
Paul Rizzo
Director
+1-212-612-7875
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dmitry Feofilaktov
Associate Director
+1-212-908-0345
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Paul Rizzo
Director
+1-212-612-7875
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dmitry Feofilaktov
Associate Director
+1-212-908-0345
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com