Fitch Rates John Knox Village's (MO) Series 2016A Bonds 'BB+'; Outlook Revised to Stable

CHICAGO--()--Fitch Ratings has assigned a 'BB+' rating to approximately $40.1 million of series 2016A senior living facilities revenue bonds expected to be issued by the Industrial Development Authority of the City of Lee's Summit (the Authority) on behalf of John Knox Village (JKV). Additionally, Fitch has downgraded the rating on $66.9 million of bonds issued by the Authority on behalf of JKV to 'BB+' from 'BBB-'.

The series 2016A bonds are expected to be issued as fixed-rate bonds. Bond proceeds will be used to finance various capital projects including the Meadows independent living unit (ILU) project, reimburse for prior capital expenditures, fund a debt service reserve fund, fund capitalized interest and pay costs of issuance. Pro forma maximum annual debt service (MADS) is expected to increase to approximately $8.6 million from $6.3 million. The bonds are expected to price the week of Oct. 26, 2016 through negotiation.

The Rating Outlook has been revised to Stable from Negative.

SECURITY

Debt payments are secured by a pledge of the unrestricted gross revenues of the obligated group, a first mortgage lien on all the real property constituting JKV's core campus, and a debt service reserve fund for the series 2016A bonds.

KEY RATING DRIVERS

INCREASED DEBT BURDEN: The downgrade reflects JKV's increased pro forma debt burden with MADS increasing 36.4% and MADS as a percent of fiscal 2016 revenue increasing to 12.6% from 9.2%. Pro forma MADS coverage equaled a light 1.1x in fiscal 2016 and 1.4x in the three-month interim period ending June 30, 2016 (the interim period).

REBOUNDING PROFITABILITY: Net operating margin adjusted (NOMA) decreased to 10.6% in fiscal 2016 from 13.2% in fiscal 2015 before rebounding to 17.3% in the interim period. The decline in fiscal 2016 was due to increased labor pressure and elevated benefits costs due to a few high healthcare claims. The increased expenses were partially mitigated by increased net entrance fee generation.

MAJOR CAPITAL PROJECTS: Capital plans are significant reflecting JKV's continued campus transformation project and include the construction of a new ILU building, the Meadows Project. JKV recently completed another new ILU building, the Courtyard Project, which is approximately 58% sold.

LIGHT LIQUIDITY: Liquidity metrics remain light with 213 days cash on hand, 31.2% cash to pro forma debt and 4.5x cushion ratio at June 30, 2016.

RATING SENSITIVITIES

CONTINUED PROFITABILITY IMPROVEMENT: Fitch expects John Knox Village's operating profitability to continue the positive trend evidenced in the interim period, providing additional cash flow to absorb the increased debt burden.

EXECUTION OF CAPITAL PROJECTS: Fitch expects John Knox Village to successfully execute its capital projects, achieve project stabilization as projected, and to achieve the expected associated financial benefits, including bolstered liquidity through net entrance fee generation and increased revenue generation, thereby offsetting the impact of the increased debt burden.

CREDIT PROFILE

John Knox Village is a continuing care retirement community (CCRC) located in Lee's Summit, MO, with 869 available ILUs, 180 assisted living units (ALUs) and a 430-licensed bed (330 available) skilled nursing facility (SNF). Additional operations include a home health agency, hospice services, a 24-hour ambulance and paramedic service and a foundation. JKV is one of the largest single-site CCRCs in the country by both acreage and number of units and is the second largest single-site not-for-profit CCRC in the 2015 LeadingAge Ziegler 150.

Fitch's analysis and all figures and ratios cited in this press release are based on JKV's consolidated financial statements from its sole member, PremierLife. The retirement community and the foundation are currently members of the obligated group (OG). JKV is planning to remove the foundation from the OG. The foundation accounted for 2.1% of the OG's total assets and 0.3% of total revenue. Without the foundation, the OG would have accounted for 97.4% of consolidated total assets and 99.4% of consolidated operating revenues in fiscal 2016. Total consolidated operating revenue for PremierLife and Affiliates equaled $68 million in fiscal 2016.

INCREASED DEBT BURDEN

The community's pro forma debt burden increased materially, with pro forma MADS increasing from a light 9.2% of fiscal 2016 revenue to 12.6%. Pro forma MADS coverage decreased to 1.1x in fiscal 2016, reflecting the compressed profitability and increased pro forma debt burden, but rebounded to 1.4x in the interim period, consistent with Fitch's below investment-grade category median of 1.5x. Revenue-only MADS coverage decreased to 0.1x in fiscal 2016 and 0.2x in the interim period, comparing unfavorably with Fitch's below investment-grade category median of 0.8x. The increased debt burden is partially mitigated in the near term by a 15-month capitalized interest fund. Per JKV's master trust indenture (MTI), expenses and revenues associated with the Courtyard and Meadows projects will be excluded from covenant calculations until each project achieves stabilization. Per the MTI calculation, MADS coverage equaled approximately 1.1x. However, the difference will become greater as project-related expenses and revenues increase.

REBOUNDING PROFITABILITY

Operating profitability compressed in fiscal 2016 with net operating margin (NOM) and NOMA decreasing from 3.4% and 13.2% in fiscal 2015 to negative 1.3% and positive 10.6% in fiscal 2016, respectively. Management had budgeted for NOMA to increase to 15.9% in fiscal 2016. The decrease was primarily due to increased salaries expense related to improving labor markets, increased benefits expense due to greater than expected healthcare insurance claims and pressured revenue in JKV's home health division. The increased benefit cost was due to a few large claims and is not likely to be recurring. Management is budgeting profitability to rebound in fiscal 2017 with NOM and NOMA increasing to 4.6% and 16.5%, respectively. NOM and NOMA increased to 3.3% and 17.3% in the interim period.

Management has been working on several initiatives, including the campus consolidation project described below, to strengthen profitability. JKV has continued to consolidate smaller units into larger units and introduced new modified type B entrance fee contracts in fiscal 2015 to increase the community's marketability and value proposition. Additionally, JKV's health services are experiencing faster growth in ALU and home health programs than skilled nursing, which should increase the care center's profitability.

MAJOR CAPITAL PROJECTS

Capital spending increased to $20.2 million in fiscal 2016 and is expected to remain at elevated levels through fiscal 2018 as JKV continues its campus redevelopment plan. A primary goal of the redevelopment plan is to increase the number of entrance fee contracts. Over the past 10 years, management has removed smaller ILUs from inventory and converted them to either larger square-foot units or to high-demand ALUs and dementia units. While the number of occupied units has decreased, occupied square footage has increased, thereby driving increased revenue per unit. Additionally, the community's entrance fee contracts as a percent of total sales increased to 61.5% in fiscal 2016 from 37.4% in fiscal 2015 and approximately 20% in fiscal 2012. The increasing number of entrance fee contracts is expected to be accretive to both profitability and liquidity metrics.

Two main components of the redevelopment plan include the Courtyard and Meadows projects. Both projects included the demolition of existing ILU buildings and cottages. The Courtyard project included the construction of a new 52-unit ILU building, additional parking, new common space and renovations to existing common spaces. The project was completed on time and on budget ($19 million) with residents beginning to move into the new ILU building in January 2016. The new building was 44% occupied and 58% sold at Sept. 19, 2016. The project is expected to reach stabilization in March 2017.

The Meadows project consists of the construction of a new 112-unit ILU building, including underground parking, a new restaurant and new wellness facilities, including a pool. The project is expected to cost $55 million and will be funded by a construction line of credit, series 2016A bond proceeds, and an equity contribution which has been substantially completed. Only the $34 million series 2016A bond issuance is expected to be permanent debt. Approximately 45% of the ILUs were sold at Sept. 19, 2016. The project is expected to be completed in fiscal 2018 with stabilization in 2022.

Fitch views the campus repositioning strategy favorably as larger ILUs are typically in higher demand and more profitable than smaller units. While the two expansion projects increased JKV's leverage, Fitch expects that the expansion projects will be successfully executed and that the revenue and entrance fees generated by the additional ILUs will allow JKV to grow into the increased debt burden. Additionally, the new larger ILUs are expected to be accretive to profitability, thereby strengthening MADS coverage from historical levels.

LIGHT LIQUIDITY

Unrestricted cash and investments decreased $6.9 million (9.7%) since fiscal 2015 to $38.8 million at June 30, 2016. The decrease is due to increased capital expenditures and unrealized investment losses. Pro forma liquidity metrics are light with 213 days cash on hand, 31.3% cash-to-pro forma debt and 4.5x cushion ratio relative to Fitch's respective below investment grade category medians of 227 days, 37.3% and 5.0x.

JKV has spent approximately $6.2 million of cash to date on pre-development work for the Meadows project, of which $2.9 million will be reimbursed from series 2016A bond proceeds. Additionally, JKV has $2.2 million in restricted funds that will be used to pay down debt in fiscal 2017 and approximately $4 million of series 2016A bond proceeds will be used for future routine capital expenditures, both of which should help improve liquidity metrics. Liquidity is also expected be strengthened by increased entrance fee generation related to the successful execution of the campus repositioning projects.

DEBT PROFILE

Subsequent to the series 2016A bond issuance, JKV will have approximately $124 million of total debt outstanding, composed of 100% fixed-rate bonds, a bank term loan and a bank line of credit. The community is not counterparty to any swap agreements. JKV closed on a $26.7 million construction line of credit in May 2015 to be drawn down as needed for construction of the Meadows and Courtyard projects. Approximately $10 million is expected to be drawn by closing of the series 2016A bond issuance. Of the entire loan, only $5 million is expected to be permanent debt with the remainder to be repaid by entrance fees.

DISCLOSURE

JKV covenants to provide audited financial statements within 180 days of each fiscal year-end and quarterly interim statements within 60 days of each quarter-end. Disclosure is provided through 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/site/re/868824

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

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

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Contacts

Fitch Ratings
Primary Analyst
Adam Kates
Director
+1-312-368-3180
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Paul Rizzo
Director
+1-212-612-7875
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com