NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB-' rating to the expected issuance of the following State of Connecticut Health and Educational Facilities Authority bonds issued on behalf of Duncaster, Inc. (Duncaster):
--$12,000,000 revenue bonds, Duncaster, Inc. Issue, series A.
The Rating Outlook is Stable.
The series 2014 bonds are expected to be issued as fixed rate. Bond proceeds will be used to fund most of the costs of an expansion project on Duncaster's campus and pay for funded interest, a debt service reserve fund and costs of issuance. The remaining costs for the expansion project are expected to be funded by a $4.4 million short-term bank construction loan, which is expected to be paid down by the entrance fees from newly built independent living (IL) units by February 2016. Maximum annual debt service (MADS), which was provided by the underwriter, is expected to be $2.6 million and does not include the $4.4 million construction loan. Debt service is steady through 2024 and then falls to approximately $1.2 million. The bonds are anticipated to be sold via negotiation during the week of Sept. 2.
The bonds will be secured by a pledge of Duncaster's gross revenues, a mortgage, a debt service reserve fund and a foundation guarantee not to let debt service fall below the 1.2 times (x) covenant.
KEY RATING DRIVERS
SOFT OPERATING PERFORMANCE: Duncaster's operating ratio of 99.3% and its net operating margin adjusted of 16.9% at year-end 2013 were both weaker than Fitch's 'BBB' category medians of 97.2% and 21.3%, respectively. Duncaster had solid net entrance fee receipts of $3.3 million, but underlying operations were thinner as IL occupancy continues to rebuild after a wave of turnover a few years back.
IMPROVING OCCUPANCY: After IL occupancy fell below 80% in 2012, Duncaster has improved IL occupancy to 93.4% at June 30, 2014. Occupancy improvement is attributed to the revamping of its marketing efforts and lower levels of turnover. The higher IL occupancy has improved Duncaster's operating ratio to 94.8% in the six month 2014 interim period.
MIXED DEBT SERVICE COVERAGE INDICATORS: At year end 2013, Duncaster had pro forma MADS coverage including turnover entrance fees of 1.8 times (x), which compares well to Fitch's median of 1.9x. Revenue only coverage was weaker at 0.5x relative to a median of 0.9x. Historically revenue only coverage has been low for Duncaster, but Fitch believes revenue only coverage will improve driven by the improving IL occupancy and the additional revenue that will be generated by the capital projects being funded with this debt issuance. Interim 2014 debt coverage reflects the improved performance with coverage of 2.4x with entrance fees and revenue only coverage of 0.7x.
SOLID LIQUIDITY METRICS: Duncaster's liquidity is solid for the rating level with 439 days cash on hand (DCOH), a pro forma cushion ratio of 8.4x and pro forma cash to debt of 70.4%, all of which are better than their respective 'BBB' medians.
UPCOMING EXPANSION PROJECT: Duncaster is moving forward on an expansion project to build 12 IL units and 12 AL Memory Care units on its existing campus. Approximately $16.4 million in debt will be issued to fund the projects, of which $4.4 million will be a short-term construction loan that will be paid down by initial IL entrance fee receipts. Pro forma analysis of the additional debt indicates a manageable debt burden at the current rating level.
PROJECT COMPLETION: The expansion project brings with it the usual construction and fill-up risks, which will remain in place until stable occupancy is reached. Fitch expects the project to be finished in July 2015 and stable occupancy for both the IL and memory care units to be reached by December 2015. Fitch notes positively that all of the IL units have been pre-sold.
OPERATIONAL IMPROVEMENT: Fitch expects Duncaster's operations to remain stable over the construction period. Once the expansion project is completed and occupancy of the new units stabilized, there could be positive pressure on the rating should Duncaster's IL occupancy remain above 90% and revenue only coverage improve with the help of the additional IL and AL revenues.
Duncaster operates a not-for-profit life-care community in Bloomfield, CT, which is located just to the northwest of Hartford, CT. Opened in 1984, the current mix of units includes 183 IL units, 30 assisted living (AL) units, and 60 private skilled nursing beds. In 2013, Duncaster had total operating revenue of $20.9 million. For purposes of analysis, Fitch includes the cash and investments of a separate non-obligated foundation, which exists solely to support Duncaster. The foundation had approximately $8.4 million in unrestricted cash and investments at June 30, 2014.
The 'BBB-' rating reflects Duncaster's strong liquidity, solid pro forma coverage (including entrance fees), and a good market position. These are offset by weaker revenue only coverage and the risks associated with the current expansion project.
Improving Financial Profile
Over the last four audited years, Duncaster's operating ratio and net operating margin - adjusted has averaged 102.4% and 14.6%, weaker than Fitch's 'BBB' medians of 97.2% and 21.3%. Over this time, net entrance fee receipts have remained solid and relative stable averaging $2.9 million a year. As a result, pro forma MADS coverage with entrance fees has been solid, hovering near the median three out of the last four years, while revenue only has trailed the median three out of the last four years.
Duncaster's underlying operational performance has been challenged by a wave of turnover in 2010. The community began 2010 with IL occupancy at 90% and by year end it had fallen to below 80%. In 2011, Duncaster also had a slower year for sales and as a result coverage was very weak, falling to 1.3x with entrance fees and a 0.5x with revenue only on a pro forma basis. In response, management implemented a number of initiatives to improve performance, including a restructuring of its marketing and sales and a focus on cost reduction. Operations and occupancy have been slowly improving since then, with the operating ratio climbing to high 103.7% in 2012, but steadily coming down since then. Interim 2014 results are the strongest through the four year historical, with costs remaining manageable and IL occupancy climbing back above 90%.
Duncaster has also improved the census mix of its skilled nursing unit. In 2010, nearly 70% of the skilled nursing payor mix was composed of lifecare residents. At Dec. 31, 2013 that figure had declined to 55% and had been filled in by a higher number of private pay and Medicare patients, which have a higher rate of reimbursement. Fitch believes the improvements in Duncaster's operations are sustainable and should be helped as the expansion units are built and come on line over the next two years.
Duncaster's liquidity at the current rating is a credit strength, with all of its pro forma liquidity metrics comparing well to the category medians. As operations have improved, Duncaster has shown modest growth in unrestricted cash and investments. At Dec. 31, 2013, the community had $22 million in unrestricted cash and investments, up from $18.9 million at Dec. 31, 2010.
Good Market Position
Fitch believes Duncaster's overall credit profile benefits from a good market position which is supported by a relatively affluent service area, entrance fee pricing competitive with area housing prices, and an attractive campus. Connecticut (GO bonds rated 'AA', Negative Outlook by Fitch) is the wealthiest state per capita in the United States, and the zip codes around Duncaster have solid wealth metrics, which Fitch views as a credit positive. Duncaster's entrance fees for a fully amortizing contract range from $101,000 to $347,000, which is reasonable relative to area housing prices.
Fitch visited the campus and found it very marketable with an attractive layout and landscape. While opened in 1984, the campus looks updated, has good amenities, including a large pool, and a recent dining room renovation has added to the campus' marketability. The memory care AL and skilled nursing are located in a separate building on the campus. Duncaster's skilled nursing center, Caleb Hitchcock, received a five star rating from the Centers for Medicare and Medicaid. Fitch believes the high quality of care and attractiveness of the campus offset concerns regarding fill up of the expansion project, as well positions Duncaster well to sustain recent occupancy improvements.
Debt Profile/Capital Plans
In spite of the additional debt, most of Duncaster's financial ratios remain comfortably within the 'BBB' category. At Dec. 31, 2013, pro forma MADS as a percent of revenue was 12.3%, relative a median of 12.4%, and pro forma debt to EBITDA, including the additional $11.9 million in long term debt, was 6.8x, relative to a median of 6.6x. These figures assume the pay down of the $4.4 million short-term construction loan.
The project involves the construction of 12 IL units and 12 AL Memory Care units. Both will be built as additions to current buildings. Duncaster is in the final stages of signing a GMP and Fitch does not expect the financing structure or amounts to change. Overall, while there is construction and fill up risk for the project, Fitch believes the expansion is modest and the timing and cost reasonable. Fitch also believes that there is ample financial flexibility at the current rating should the project run into unexpected challenges.
After issuance, Duncaster will have approximately $31.2 million in long-term debt, not including the short term construction loan. The debt mix will be 38% fixed and 62% variable, which Fitch views as aggressive at the current rating level. The variable rate is privately placed and has a call date in 2020, so that mitigates remarketing and put risks. The variable rate is hedged with a fixed payor swap that extends to 2020 and matches the par amount on the variable rate bonds. Duncaster pays a 3.96% rate. The mark to market at June 30, 2014 was a negative $1.1 million. There are no collateral posting requirements.
Duncaster covenants to post annual reports no later than 150 days after fiscal year-end and quarterly reports no later than 45 days after quarter-end on EMMA.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Not-for-Profit Continuing Care Retirement Communities Rating Criteria', July 24, 2014.
Applicable Criteria and Related Research:
Not-for-Profit Continuing Care Retirement Communities Rating Criteria