Fitch Affirms The Forest at Duke, NC at 'BBB+'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'BBB+' rating on the following bonds issued by the North Carolina Medical Care Commission on behalf of The Forest at Duke (FD):

--$23.5 million first mortgage revenue refunding bonds, series 2007;

--$6.85 million revenue bonds, series 2003A;

--$115,000 revenue bonds, series 1994.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by pledged assets including gross receipts, a first mortgage lien, and a debt service reserve fund.

KEY RATING DRIVERS

SOLID FINANCIAL PERFORMANCE: FD's financial performance is solid and characterized by a healthy balance sheet, consistently strong operations, and adequate debt service coverage levels that are all good in comparison with Fitch's 'BBB' category medians.

GOOD MARKET POSITION AND OCCUPANCY: Despite the competitive nature of the Durham, NC's service area, FD has sustained an excellent market position as a result of continued facility investments, communication with residents and its relationship with Duke University (including lifelong learning programs). These factors have provided for consistently strong occupancy levels that have averaged nearly 94% in the independent living units (ILU) from fiscal 2012-2015.

ELEVATED DEBT BURDEN: FD's debt burden is elevated as measured by maximum annual debt service (MADS) as a percent of revenue. MADS of $4.5 million equates to a high 20.7% of fiscal 2015 revenues. As a result, debt service coverage has historically been adequate but dropped to 1.4x in fiscal 2015 despite strong profitability. However, FD's debt service schedule is front loaded with MADS dropping significantly to $1.6 million in fiscal 2020.

RATING SENSITIVITIES

DEBT SERVICE COVERAGE IMPROVEMENT: The Forest at Duke constructed and filled 15 new cottage-style ILUs at the end of fiscal year 2015 (Sept. 30 year-end). The additional monthly service fees are contributing to improved core operating performance (operating ratio and net operating margin) for the first six months of fiscal 2016. A sustained improvement in operations that results in higher debt service coverage could result in upward rating movement.

DEBT MODERATION: Rapid bond principal amortization and cash accumulation that results in improved capital-related and liquidity metrics could lead to a higher rating.

CREDIT PROFILE

FD operates a type-B continuing care retirement community (CCRC) located in Durham, NC. The CCRC consists of 249 ILUs, 34 assisted living units (ALU), and 58 skilled nursing beds. FD is CCAC-CARF accredited, North Carolina OSHA Star certified, and Medicare certified. For fiscal year 2015, FD had total operating revenues of $21.68 million.

STRONG BALANCE SHEET

FD's balance sheet metrics have consistently compared well against Fitch's 'BBB' category medians. At March 31, 2016 (six-month interim period), FD's unrestricted cash and investments totaled $25.3 million equating to 550 days cash on hand, 5.6x cushion ratio and 82.7% cash-to-debt. These figures compare favorably to the respective 'BBB' category medians of 400 days, 7.3x, and 60%.

The 15 new cottage-style ILUs cost $7 million, of which $4.8 million was funded from a construction loan. FD repaid this loan from proceeds of the initial entrance fees from the ILU expansion during fiscal 2015. While total cash balances are below prior year levels due to capital spending on the campus renovation project, liquidity remains good for the rating category.

CONSISTENT OPERATING PERFORMANCE

In fiscal 2015, operating profitability improved with an operating ratio of 93.9% and a net operating margin (NOM) of 12.3% compared to an operating ratio and NOM of 95.1% and 11.7%, respectively, in fiscal 2014 reflecting better expense management in fiscal 2015. Through the six month interim period ended March 31, 2016, the operating ratio, NOM and NOM-adjusted have improved to 89.2%, 16.5% and 41.2%, respectively. The key drivers of the operating improvement are the new monthly service fees from the new ILUs and higher ALU occupancy. FD's profitability metrics are well above Fitch's 2015 'BBB' category medians (operating ratio 96.1%, NOM 8.9% and NOM-adjusted 19.3%).

CAMPUS RENOVATION PROJECT MOSTLY COMPLETE

FD is nearing completion of its campus renovation project that began in October 2014. Its 15 cottage-style ILUs were completed and filled by Sept. 30, 2015 and generated $7.9 million of initial entrance fees. Fitch views the expansion positively as it is already improving FD's core operating profitability through the receipt of additional monthly service fees. FD's other projects for its campus renovation include additional parking, renovated and reconfigured main entrance, expanded fitness center, and renovated and enhanced dining facilities. As of March 31, 2016, FD spent about $9 million towards the $10 million project which is being funded from operations and internal cash. The projects are expected to be fully completed by the end of May 2016.

ADEQUATE DEBT SERVICE COVERAGE

As of March 31, 2016, FD had about $30.6 million of long-term, fixed rate debt. MADS of $4.5 million equated to a high 20.7% of fiscal 2015 revenues as compared to Fitch's 'BBB' category median of 12.4%. However, FD's debt service is heavily front loaded with MADS dropping to just $1.6 million in fiscal 2020.

MADS coverage has been variable at just 1.4x in fiscal 2015 compared to 1.8x in fiscal 2014 and 1.9x in fiscal 2013. Weaker performance in fiscal 2015 related to lower realized investment gains and net entrance fee receipts. Revenue only coverage of 0.6x in fiscal 2015 is lower from the prior year and is below the 'BBB' median of 1x.

Through the six month interim period, FD generated much improved debt service coverage of 2.7x and revenue only coverage was 1.0x, mostly due to the additional monthly service fees from the ILU expansion. In addition, net turnover entrance fees for the six months ended March 31, 2016 are higher than the amount received in all of fiscal 2015. Net turnover fees received totaled $3.8 million through the six months ended March 31, 2016 compared to $3.3 million in fiscal 2015.

GOOD OCCUPANCY

Despite a very competitive service area that includes five other CCRCs within 18 miles of its campus, FD has been able to maintain good occupancy across the spectrum of care. ILU occupancy has been above 92% from fiscal 2012-2015. At March 31, 2016, occupancy was 92% for ILUs, 88% for ALUs, and 90% for skilled nursing facility. In addition, FD maintains an active waiting list with 200 interested parties. FD's long history of strong occupancy can be attributed to its focus on lifelong learning supported by its relationship with Duke University, open communication with residents and attractive facilities and programs. FD also has very limited Medicare and no Medicaid exposure in its skilled nursing operation, which Fitch views positively.

DISCLOSURE

FD covenants to disclose audited financial statements within 120 days of fiscal year end, and quarterly financial statements within 30 days of quarter end, to 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/creditdesk/reports/report_frame.cfm?rpt_id=868824

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

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1004455

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1004455

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Paul Rizzo
Director
+1-212-612-7875
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dmitry Feofilaktov
Associate Director
+1-212-908-1345
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations:
Hannah James, +1 646-582-4947
hannah.james@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Paul Rizzo
Director
+1-212-612-7875
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dmitry Feofilaktov
Associate Director
+1-212-908-1345
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations:
Hannah James, +1 646-582-4947
hannah.james@fitchratings.com