Fitch Affirms Bethesda Health Group's (MO) at 'BBB+'; Outlook Revised to Negative

NEW YORK--()--Fitch Ratings has affirmed the 'BBB+' rating on following bonds issued by the Health and Educational Facilities Authority of the State of Missouri on behalf of Bethesda Health Group (Bethesda):

--$39.3 million of health facilities revenue bonds, series 2015.

The Rating Outlook is revised to Negative from Stable.

Bethesda has approximately $73.1 million in outstanding series 2013A and 2013B bonds, which Fitch does not rate, but incorporates in its analysis.

SECURITY

The bonds are secured by a pledge of unrestricted receivables, a first mortgage lien on principal facilities, and a six-month debt service reserve fund.

KEY RATING DRIVERS

WEAK FISCAL 2016 PERFORMANCE: The Outlook revision to Negative is prompted by weaker than expected profitability in fiscal 2016 (June 30 year-end). Bethesda's 1.4% net operating margin (NOM) was weak compared to 5.6% in fiscal 2014, and to Fitch's 'BBB' median of 8.9%. Profitability was impacted by unfavorable shifts in Bethesda's payor mix due to certain ongoing renovations, as well as wage expense pressures. Additionally, cash flow and debt service coverage were impacted by Bethesda's weaker investment returns, which have historically been a large component of income available for debt service.

SOFT DEBT SERVICE COVERAGE: Weaker operating performance resulted in thin 1.4x actual annual debt service (AADS) coverage, based on Fitch's calculations compared to Bethesda's bond compliance calculation at 1.56x. Bethesda's debt service requirement rises to $6.2 million in fiscal 2018 and to $7.1 million by fiscal 2019 from the current $4.3 million, which will require improved operating performance to produce sufficient coverage as maximum annual debt service (MADS) coverage is only 0.8x in fiscal 2016.

LARGE CAPITAL PROJECTS UNDERWAY: Bethesda is in the process of an expansion project on its Bethesda Dilworth campus. Additional assisted living units (ALUs) and independent living units (ILUS) are expected to open in fiscal 2017. The projects are being funded with proceeds from the 2015 bonds and should be accretive to Bethesda's financial profile over the medium term.

ADEQUATE LIQUIDITY POSITION: Bethesda's $74.3 million in unrestricted cash and investments at June 30, 2016, while declined from $79.5 million in the prior year, remained adequate for the rating category. Bethesda's 334 days cash on hand (DCOH), 65.5% cash to debt and a 10.4x cushion ratio were all in line with Fitch's 'BBB' category medians of 400 days, 60% and 7.3x, respectively. Bethesda's somewhat aggressive investment mix of 27% in cash and fixed income and the rest in equities, hedge funds and commodities is a credit concern, as evidenced by heavy unrealized losses in fiscal 2015 and 2016 ($8.1 million over the two fiscal years) which have negatively impacted liquidity.

RATING SENSITIVITIES

OPERATING IMPROVEMENT NEEDED: Fitch expects Bethesda Health Group to exercise tighter expense controls, as well as realize the incremental benefits from its capital projects, which should allow the organization to sufficiently cover its rising debt service over the medium term. Failure to improve operations and generate adequate debt service coverage could result in a downgrade.

CREDIT PROFILE

Bethesda owns and operates five independent living facilities, one assisted living facility and three SNFs in the St. Louis, MO area. Additionally, Bethesda has management agreements with BJC HealthCare to operate Village North Retirement Community (IL & SNF; 50% ownership) and Eunice Smith Home (SNF) (effective Jan. 1, 2015), and Barnes Jewish Extended Care (effective Jan. 1, 2016). Including current construction, Bethesda owns and/or operates 729 ILUs, 78 ALUs, and 1044 SNF beds. Total revenues in the fiscal year ended June 30, 2016 were $82.7 million.

WEAK FISCAL 2016 PERFORMANCE

Bethesda's operating performance was weak in fiscal 2016 with a 1.4% NOM, compared to 5.6% in fiscal 2014, and to Fitch's 'BBB' median of 8.9%. Profitability was impacted by unfavorable shifts to governmental payors in Bethesda's payor mix due to certain ongoing renovations, as well as wage expense pressures, particularly for the skilled nursing facility (SNF) staff. Management reports that most losses were incurred in the first half of the fiscal year, and that performance has improved in the second half and has carried over into the current fiscal year. Additionally, management is looking to narrow future losses with tighter expense controls and implementation of stronger IT management tools.

In addition to lower operating profitability, Bethesda recorded another year of lower entrance fee receipts. Net receipts were $1.3 million in fiscal 2016 compared to $871k in fiscal 2015, $4.2 million in 2014 and $5.1 million in 2013. However, the decline is not inconsistent with historical fluctuations, as the organization actively utilizes both entrance fee and rental contracts. Fitch notes that 2013 and 2014 were particularly strong years as Bethesda filled its vacant units as ILU occupancy was only 74% in fiscal 2012 compared to 95% in fiscal 2016.

Bethesda's heavy historical reliance on investments gains to support operations and debt service coverage is a credit concern. Investment gains have averaged $5.6 million annually from fiscal 2013 to fiscal 2015. Due to market volatility in 2015 and the first part of 2016, Bethesda's investment gains were a tempered $718,000 in fiscal 2016, which has negatively impacted cash flow and debt service coverage.

An additional credit concern is Bethesda's high 65% of net revenues from the SNF. Of the SNF revenue, Medicare and Medicaid make up 64% of the total payor mix. This is concerning due to the evolving landscape with Medicare reimbursement and the introduction of the bundled payment program. However, given Bethesda's relationship with a number of St. Louis acute care providers, the community should be better positioned for future Medicare reform.

FUTURE GROWTH EXPECTED

A downgrade is precluded in part by Bethesda's continued revenue growth over the last four years, and the expectation of further growth. The organization was able to increase its revenue base by 35% from fiscal 2013 to fiscal 2016, which is impressive, particularly for the continuing care sector. Growth was achieved mainly through improved occupancy across all levels of care, as well as the addition of three management agreements in fiscal 2015 and fiscal 2016.

Bethesda is expected to continue growing its revenues over the medium term as its ALUs and ILUs projects are completed. Net income from the new units is likely to be breakeven in 2017, and increase thereafter until stabilizing in 2019. The ability to meet targeted projections is critical as the capitalized interest period ends on the series 2015 bonds in fiscal 2018 and $6.2 million of debt service payments commence (ramps up to $7.1 million in fiscal 2019).

SOFT DEBT SERVICE COVERAGE

Bethesda's AADS coverage was a weak 1.4x in fiscal 2016, while its MADS coverage was an even weaker 0.8x, significantly below Fitch's 'BBB+' median. Bethesda's bond compliance calculations of 1.56x coverage are based on AADS and do not back out "amortization of entrance fees" and do not include net entrance fee receipts, as do Fitch's calculations. Additionally, Bethesda's current annual debt service of $4.3 million rises to $6.2 million in fiscal 2018 and further to $7.1 million in fiscal 2019. Bethesda's ALU and ILU expansion projects are expected to stabilize by the time debt service rises; however, coverage could be stressed without sufficient incremental revenues from the projects that drive improvement in operating performance. Actual debt service coverage is budgeted to be 2.1x in fiscal 2017 and projected to be around 2x in fiscal 2018-2020.

LARGE CAPITAL PLANS UNDERWAY

Bethesda is currently in the process of expanding its Dilworth campus with the addition of new ALUs and ILUs. Approximately $17.7 million of funds from the series 2015 bonds are being used to fund the construction of 58 new ALUs (60 beds total). The project is expected to be completed in December of 2016 and to be open for occupancy in February of 2017. Management reports that construction to date has been on time and on budget. Bethesda's service area has historically lacked AL supply, and Bethesda has lost some residents due to lack of AL capacity. Given that nearly all area ALs currently operate at full capacity, Fitch believes there is sufficient demand and rationale for the expansion project. The new AL capacity will be available in February 2017.

In addition, approximately $8.5 million of funds from the 2015 bonds are being used to construct 18 new ILU villas on the Dilworth campus. The villas will be constructed in sets of six with the first set expected to be completed in December of 2016 and the final set to be completed in April of 2017. Complex site work and regulatory issues have increased the initially projected costs for this project by approximately $1 million. Bethesda has just kicked off an early-depositors campaign for the villas. Given high historical occupancy rates at the Oaks Fitch believes fill risk is manageable and that the new units will be accretive to Bethesda in the medium to long term.

In addition to aforementioned construction projects, routine capital is budgeted at $3.5 million for 2017.

DEBT PROFILE

At fiscal 2016, Bethesda had $122.5 million in total long-term debt outstanding. The series 2015 bonds are fixed-rate. The series 2013A bonds were issued as variable rate direct purchase bonds (due June 2023), and the series 2013B bonds were issued as VRDBs supported by an LOC (expiring June 2018). The majority of floating rate debt is swapped to fixed. Additionally, Bethesda has an outstanding $2.5 million line of credit which the organization expects to repay before the end of the fiscal year. Debt service is level after 2019 at $7.1 million.

Bethesda has three outstanding fixed-payor swaps with a notional amount of $45 million. As of June 30, 2016, the mark-to-market valuation was negative $16.5 million. Bethesda does not have any collateral posting requirements at the current rating, and would only have to do so if the underlying credit rating dropped below 'BBB-'.

DISCLOSURE

Bethesda discloses annual financial statements within 120 days and quarter unaudited financial statements within 60 days through the MSRB 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/site/re/868824

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

https://www.fitchratings.com/site/re/750012

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012410

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
Associate Director
+1-212-908-0345
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Emily Wadhwani
Director
+1-312-368-3347
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations
Elizabeth Fogerty
+1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com