Fitch Affirms John Knox Village's (MO) Revs at 'BBB-'; Outlook Negative

NEW YORK--()--Fitch Ratings has affirmed the 'BBB-' rating on $66.9 million of bonds issued by the Lee's Summit (MO) Industrial Development Authority on behalf of John Knox Village (JKV).

The Rating Outlook has been revised to Negative from Stable.

SECURITY

Debt payments are secured by a pledge of the unrestricted gross revenues of the obligated group and a first mortgage lien on certain properties including the care center.

KEY RATING DRIVERS

DECREASED PROFITABILITY: The Negative Outlook reflects the combination of compressed profitability in fiscal 2016 and an expected bond issuance in fall 2016. Profitability declined 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. Net operating margin adjusted decreased to 12% in fiscal 2016 from 13% in fiscal 2015.

MAJOR CAPITAL PROJECTS: JKV's continued capital plans are significant and include the construction of another new ILU building. Funding sources are expected to include the issuance of additional debt in fall 2016.

COMPRESSED COVERAGE: MADS coverage decreased to 1.4x in fiscal 2016 from 1.8x in fiscal 2015 and is now light for the rating category. Fitch will assess the credit impact of the planned debt issuance balanced against expected project benefits as financing details become more certain.

LIGHT LIQUIDITY: Liquidity metrics decreased due to increased capital spending and unrealized losses and are light for the rating category with 182 days cash on hand, 41.9% cash to debt and 5.4x cushion ratio at March 31, 2016.

RATING SENSITIVITIES

IMPROVED PROFITABILITY: Fitch expects John Knox Village's operating profitability to improve in fiscal 2017 providing additional cash flow for the community to absorb the expected new debt issuance. Failure to demonstrate improved profitability could result in negative rating pressure.

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.

CREDIT PROFILE

John Knox Village is a continuing care retirement community located in Lee's Summit, MO, with 873 available ILUs, 182 assisted living units (ALUs) and a 430 licensed bed (330 available beds) skilled nursing facility (SNF). Total operating revenue equaled $68.7 million in fiscal 2016. Fitch's analysis of fiscal 2016 results are based upon unaudited financial statements.

DECREASED PROFITABILITY

Operating profitability compressed in fiscal 2016 with net operating margin and net operating margin adjusted decreasing from 3.3% and 13.0% in fiscal 2015 to 0.4% and 12.0% in fiscal 2016. Management had budgeted for net operating margin adjusted 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 benefits 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 net operating margin and net operating margin adjusted increasing to 4.6% and 16.5%, respectively.

MAJOR CAPITAL PROJECTS

Capital spending increased to $19.6 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 effort 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.

Two main components of the redevelopment plan include the Courtyard Project and the Meadows Project. The Courtyard Project included the demolition of an existing ILU building and the construction of a new 52 unit ILU building, additional parking and 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 in the new ILU building in January 2016. The new building was 36% occupied and 46% sold at May 30, 2016. The project is expected to reach stabilization in March 2017.

The Meadows project will consist of 112 new larger ILUs, underground parking, a new restaurant and new wellness facilities, including a pool. The project is expected to cost $55 million and funded by a construction line of credit and a $34 million bond issuance. Only the $34 million bond issuance is expected to be permanent debt. The bond financing is now expected to occur in fall 2016 subject to a 50% pre-sale requirement. 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 are expected to increase JKV's leverage, Fitch expects that the expansion projects will be successfully executed and that the revenue 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. However, Fitch will assess the impact on JKV's credit profile of the additional debt as financing plans are finalized.

LIGHT DEBT BURDEN

The community's debt burden remains light with MADS equal to 9.2% of revenue in fiscal 2016, comparing favorably with Fitch's 'BBB' category median of 12.4%. The compressed operating profitability in fiscal 2016 caused MADS coverage and 'revenue only' MADS coverage to decrease to 1.4x and 0.1x, respectively. Coverage metrics are now weak relative to Fitch's 'BBB' category medians of 2.0x and 1.0x, respectively. If JKV achieves its budget targets, MADS coverage and 'revenue only' MADS coverage would increase to 2.1x and 0.6x.

LIGHT LIQUIDITY

Unrestricted cash and investments decreased $9.2 million (21.5%) since fiscal 2015 to $33.8 million at March 31, 2015. The decrease is due to increased capital expenditures and unrealized investment losses. Liquidity metrics are now light for the rating category with 182 days cash on hand, 41.9% cash to debt and 5.4x cushion ratio and compare unfavorably with Fitch's 'BBB' category medians of 400 days, 60% and 7.3x. JKV has $2.2 million of restricted funds that will be used to pay down debt in fiscal 2017. Liquidity is expected to be bolstered in the near term by $3 to $5 million of reimbursement for prior capital expenditures upon closing of the series 2016 bond financing. Additionally, liquidity is expected be strengthened by entrance fee generation related to the successful execution and fill up of the two ILU projects.

DEBT PROFILE

JKV had approximately $80.5 million of total debt outstanding at March 31, 2016, 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 $8 million was drawn at March 31, 2016. 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 45 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/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=1008299

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1008299

Endorsement Policy

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

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Contacts

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

Contacts

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