Fitch Downgrades Arbor Acres United Methodist Retirement Community (NC) to 'BBB+'; Outlook to Stable
CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded to 'BBB+' from 'A-' the rating on the approximately $17 million series 2007 bonds issued by North Carolina Medical Care Commission on behalf of Arbor Acres United Methodist Retirement Community (Arbor Acres).
The Rating Outlook is revised to Stable from Negative.
The bonds are secured by gross revenues, a first mortgage, a security interest in the residency agreements, and a debt service reserve fund.
KEY RATING DRIVERS
CONTINUED CAPITAL SPENDING: The downgrade to 'BBB+' from 'A-' is based on Arbor Acres' continued robust capital spending, which has resulted in liquidity metrics that have not improved in line with Fitch's expectations during the last review. Further, management indicated that there are additional capital projects in the near term, which will likely suppress capital and liquidity metrics over the next few years. At June 30, 2014, unrestricted cash and investments totaled $18.6 million, which equals 299.9 days cash on hand (DCOH), 6.3x cushion ratio and 42.1% cash to debt.
SOLID ENTRANCE FEE RECEIPTS: Entrance fee receipts were solid in fiscal 2013 and remain steady through the six months ended June 30, 2014, as Arbor Acres grows into its additional independent living units (ILUs) that came online in 2013.
SOLID OCCUPANCY: Arbor Acres occupancy continues to be a credit strength, remaining solid with average occupancy across the continuum above 93% at June 30, 2014, despite additional units brought on line over the past three years.
HEAVY INVESTMENT IN PLANT: Capital spending as a percent of depreciation expense has continued to be very high, averaging 405.3% over the last three years (2011-2013), which is significantly above the 'A' category median of 104.4% as well as the 'BBB' category median of 85.3%. Arbor Acres has additional capital spending planned for the near term, including the renovation of its skilled nursing facility (SNF) and the common areas, which will likely start in January 2015. Although Fitch views the investment in plant favorably as it helps to maintain the marketability of the community resulting in sustained strong occupancy levels, this spending has suppressed liquidity growth and Fitch expects liquidity to remain in line with 'BBB' category medians despite future capital plans.
DEBT BURDEN UNFAVORABLE TO 'A' CATEGORY: Maximum annual debt service (MADS) as a percent of fiscal 2013 revenue was 10.6%, which is high against the 'A' category median of 8.4% but more in line with the 'BBB' category median of 12.4%. MADS coverage at 2.2x in fiscal 2013 and 3.5x at June 30, 2014 (six month interim) is light against the 'A' category median of 3x but good compared to the 'BBB' category median 1.9x. Fitch believes Arbor Acres now has some capacity at the lower rating level for additional debt.
FUTURE CAPITAL SPENDING: Arbor Acres is moving forward with several additional capital projects including the renovation and expansion of its SNF. Fitch expects that when the SNF project is complete the project will be accretive to its overall financial profile. Significant deterioration in liquidity, profitability or debt metrics could cause negative rating pressure.
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 434 units, up from 393 in 2011. The unit mix includes 267 ILUs (139 cottages, 103 apartments and 25 studios), 102 assisted living units [ALUs] (72 ALU and 30 dementia/memory care) and 65 SNF beds. The SNF beds are 100% private pay, which Fitch views positively.
Continued Capital Spending
A negative effect of the focus on renovation and expansion has been the drain on Arbor Acres' cash position. The 'BBB+' allows for some variance in Arbor Acres' liquidity as they continue to reposition the community. At June 30, 2014, unrestricted cash and investments totaled $17.7 million, down from a peak of $20.2 million in 2010. Liquidity metrics have dropped as well, with DCOH at 299.9 days down from 442 in fiscal 2010 and still below the 'BBB' category median of 371.3 but not as out of line as with the 'A' category median of 563.7 days. Cushion ratio of 6.3x and cash to debt of 42.1% at June 30, 2014, remain light but are closer to the respective 'BBB' category medians of 6.9x and 58.9%.
The majority of the ILU expansions and renovations were funded from entrance fees and unrestricted reserves. The skilled and assisted living expansions and renovations were funded from the $28 million direct bank loan issued in 2010. Arbor Acres' next large capital investment is the renovation and expansion of its 30-year old Fitzgerald Health Center. Arbor Acres has received a CON for five additional beds and is planning on bringing 13 beds back online. Total cost of the project is expected to be about $10.5 million, of which about $7.5 million will be from proceeds of a bank loan and the remaining money will be from contributions. The project is slated to commence January 2015 with an 18-month construction period. Some beds may come online as early as the fall of 2015. Management will consider additional expansion and renovation projects to maintain strong demand after the SNF renovation is completed. As a result of this investment in the community, net property plant and equipment has doubled since 2009, to $85.1 million in 2013 from $41.9 million, while the average age of plant has been brought down to 10.4 years, close to the 'BBB' rating category median of 10 years, from the former high of 13.4 in 2009. Capital spending as a percent of depreciation expense is declining but continued to be very strong at 161.7% in fiscal 2013 and significantly above the 'BBB' category median of 85.3%.
Arbor Acres has consistently maintained very solid occupancy across the continuum of care, even as additional residential units were brought on line over the past two and a half years. Through the first six months of fiscal 2014, ending June 30, average occupancy of ILUs, ALUs (including memory care) and SNF beds was 93.6%, 98.5% and 95.4%, respectively.
Historically, Arbor Acres had produced operating metrics in line with the rating category and after a light 2012 where metrics were impacted by construction and several one-time expenses including moving residents and investment in technology. Operating profitability in fiscal 2013 and through the six month interim period started to bounce back. Operating ratio in fiscal 2013 was 98.2%, which is in line with the 'BBB' category median of 97.2% Net operating margin in fiscal 2013 was 0.8%, up from negative 2.1% in fiscal 2012. Through the six month interim period, net operating margin continued to improve and was 4.9%. Adjusted net operating margin (including entrance fees) was good at 22.1% at June 30, 2014 and is in line with the 'BBB' category median of 21.3%. Fitch expects profitability to remain in line with the 'BBB' category medians as the community continues to reposition.
Uncommitted Capital Structure
Arbor Acres has $45 million of debt outstanding, of which $28 million is a direct bank loan (series 2010) with BB&T that is at an indexed floating rate and not rated by Fitch but considered in the analysis. The series 2010 bonds have a mandatory put date of Dec. 20, 2023 and the bank has to give Arbor Acres six months notice of a put. Arbor Acres entered into an $18.5 million swap in 2013 to hedge a portion of its variable rate debt. The series 2007 bonds are fixed rate. Arbor Acres is planning to finance $7.5 million of the SNF renovation with a direct placement; Fitch believes the community can absorb this additional debt at this rating level.
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 and Related Research:
--'Rating Criteria for Not-for-Profit Continuing Care Retirement Communities', July 24, 2014.
Applicable Criteria and Related Research:
Not-for-Profit Continuing Care Retirement Communities Rating Criteria