Fitch Affirms Diakon Lutheran, Pennsylvania Revs at 'BBB+'; Outlook Stable
NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB+' rating on the following Cumberland County Municipal Authority (PA) bonds issued on behalf of Diakon Lutheran Social Ministries (Diakon):
--$123,210,000 revenue refunding bonds, series 2009;
--$61,955,000 revenue bonds series, 2007A.
The Rating Outlook is Stable.
SECURITY: Gross receipts of the obligated group, a mortgage of certain properties, and a debt service reserve fund.
KEY RATING DRIVERS
STABLE FINANCIAL PROFILE: Diakon's overall financial profile has remained stable over the last few years, characterized by good debt service coverage, thin but consistent operational performance, and mixed liquidity. Diakon's debt profile is conservative with 70% fixed-rate debt, which adds a measure of stability at the current rating level. While first-quarter 2014 (1Q'14) financial results are lower year over year, the results are being driven by a softer quarter for entrance fees ($1.2 million lower) and not by a deterioration in core operations.
STRONG ENTRANCE FEE YEAR: In 2013 Diakon had $14.3 million in net entrance fee receipts, its highest figure through the four-year historical period. Move-ins for independent living units (ILUs) were 140 in 2013, up from 121 in 2012, and materially over the 87 in 2011.
OVERALL OCCUPANCY SOLID: At March 2014, total occupancy across all three levels of care was approximately 92%, consistent with prior year occupancy levels.
REGIONAL DIVERSITY AND SIZE: Fitch believes Diakon's level of geographic diversity (eight obligated group campuses located in several Pennsylvania markets) and its size (more than $200 million in consolidated operating revenue) contribute to operational and financial stability. This enables Diakon to maintain consistent levels of performance even if individual campuses are underperforming or undergoing significant capital projects.
REVENUE-ENHANCING INITIATIVES: In July 2013, Diakon implemented revenue initiatives focused on better coding, enhancements to physical therapy services, the strengthening of post-acute-care referrals, and the increasing of the overall census across the continuum of care. Early indications show positive returns on the initiatives. In 1Q'14, Diakon's patient service revenue grew a solid 10% year over year, and its net operating margin - a good measure of operating revenue relative to operating expenses - improved to 3.7% from 2.3% for the same time in 2013. However, it still significantly trails Fitch's 'BBB' category median of 9.9%.
ADEQUATE LIQUIDITY: At March 31, 2014, Diakon had $99 million in unrestricted cash and investments (net of a $14.9 million draw on a line of credit), which equated to 169.8 days cash on hand (DCOH), a 5.6x cushion ratio, and 44.4% cash-to-debt, all of which trail their respective 'BBB' medians. Diakon's unrestricted cash and investments have remained relatively stable throughout the historical period and Diakon's DCOH is suppressed by approximately 60 days due to expenses related to a state adoption contract.
SUSTAINING OPERATING PERFORMANCE: Fitch believes Diakon's revenue enhancing initiatives will enable the organization to sustain current levels of performance, including maximum annual debt service (MADS) coverage at approximately 1.7x. There is potential for negative rating pressure over the next three to five years should coverage fall to 1.5x or below for two consecutive years.
Diakon Lutheran Social Ministries, headquartered in Allentown, PA, is composed of 963 skilled nursing beds, 535 personal care beds and 896 ILUs located in Pennsylvania and Maryland. Total operating revenue in FY 2013 was $211.8 million. Fitch's analysis is based on the consolidated system.
Financial results in 2013 were consistent with Diakon's 2012 performance, but most of the financial ratios remain below category medians. In 2013, Diakon had a 102.7% operating ratio, a 7.5% net operating margin - adjusted, and 1.7x debt coverage, relative to Fitch's respective 'BBB' category medians of 97.2, 21.3, and 1.9. Fitch notes positively that Diakon's revenue-only coverage has remained strong at 0.9x, consistent with the 'BBB' category median.
Results for 1Q'14 showed a 101.0% operating ratio, a 4.2% net operating margin - adjusted, and 0.8x debt coverage, all weaker than the prior year 1Q performance (when excluding one-time items in FY 2012). While the drop in performance is a credit concern, Fitch notes that it is driven more by the timing of entrance fees. Diakon's management reported that net entrance fee receipts have improved through May to $3 million and that another $4 million is under contract. Overall underlying operating performance has remained stable, reflected by revenue-only coverage of 0.8x in the first quarter of 2014.
UPDATE ON INITIATIVES
Diakon undertook a number of revenue-enhancing initiatives in 2013. Early results show positive returns when comparing March 2014 and March 2013 figures. Overall census showed improvement, climbing to 92% from approximately 90%. For skilled nursing, Diakon implemented a program to better facilitate the process of accepting hospital referrals. Skilled nursing occupancy was a very strong 97.1% at March 31, 2014, up from 93.3% at March 31, 2013. In addition, Medicare increased to 12% from 10% of skilled nursing revenues in the year-over-year interim period further reflecting the improvement and the focus on hospital referrals. This increase in Medicare reflects a revamping of therapy services as well another component of the initiative. Diakon has also implemented a program for better coding. Diakon's acuity levels have increased as a result, and Diakon estimates an approximately $2 million a year positive impact on revenues moving forward.
In addition, on July 1, Diakon is planning to move most of its social service programs outside the obligated group. While the short-term impact on Diakon's financial performance should be neutral, over the longer term it should improve the obligated group performance and help position the social service programs to be more financially sustainable, especially as related to grants and philanthropy. Fitch currently uses the consolidated results of Diakon for its analysis, as historically the obligated group has represented the vast majority of the consolidated revenues and assets. However, moving forward Fitch will likely look at both obligated group and consolidated group performance to measure the impact of this change.
Diakon's debt structure is relatively conservative. Its $232.6 million in long-term debt is approximately 70% fixed and 30% variable. In 2014, Diakon refinanced much of its letter of credit (LOC) variable-rate debt with a $41.5 million private placement with PNC Bank that included approximately $25 million in new funds. The transaction reduces the put risk of the prior debt, but did increase MADS to $17.5 million from $16.3 million. All coverage figures in this release reflect the new MADS number. In addition, Diakon has approximately $29 million in other variable-rate debt, supported by an LOC from M&T Bank. The LOC expires in 2019.
To hedge its variable-rate debt, Diakon has two variable- to fixed-rate swaps, one each with Wells Fargo and PNC Bank, for a total notional amount of $71.4 million. The mark-to-market valuation as of March 31, 2014 was approximately a negative $10 million. There are no collateral posting requirements for Diakon.
Diakon covenants to disclose annual audited financial statements and quarterly disclosures. Diakon holds quarterly investor calls and posts all of its disclosure via 'zieglerresearch.com', which includes quarterly financial statements (balance sheet, income statement, and statement of cash flows), detailed utilization trends, and payor mix trends. Additionally, Diakon issues a detailed investor presentation in advance of its quarterly update call.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Rating Guidelines For Nonprofit Continuing Care Retirement Communities' (July 10, 2012).
--'Nonprofit Nursing Home Rating Criteria', (July 24, 2013).