Fitch Rates Air Force Villages (TX) Series 2016 Rev Bonds 'BB+'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has assigned a 'BB+' rating to approximately $120,185,000 of Tarrant County Cultural Education Facilities Finance Corporation, TX retirement facility revenue bonds series 2016 issued on behalf of Air Force Villages (dba Blue Skies of Texas (BST)). In addition, Fitch has downgraded the rating on BST's outstanding debt (listed at the end of the press release) to 'BB+' from 'BBB-'.

The Rating Outlook is revised to Stable from Negative.

The series 2016 bonds will be fixed rate, and bond proceeds will refund all of BST's outstanding debt, fund a debt service reserve fund, provide for the reimbursement of prior capital expenditures, and pay costs of issuance. BST will use other funds to terminate two outstanding interest rate swaps associated with the bank loans that are being refinanced. The series 2016 bonds are expected to price the week of Sept. 26 via negotiation.

SECURITY

The series 2016 bonds will be secured by a gross revenue pledge, mortgage pledge, and debt service reserve fund.

KEY RATING DRIVERS

LIQUIDITY DECLINE: The rating downgrade to 'BB+ from 'BBB-' reflects a continued decline of already weak liquidity metrics in fiscal 2016, which although were favorable to budget, are not consistent with an investment grade rating level. At June 30, 2016, BST had 299 days cash on hand and 27.4% cash to debt compared to 369 and 30.6%, respectively in fiscal 2012 and the BBB category medians of 400 and 60%, respectively.

IMPROVED OPERATING PERFORMANCE: Initiatives implemented by a management team that has been in place since 2011 have been favorable and has resulted in improved operating performance, however, overall meaningful improvement in the financial profile continues to be plagued by challenges at the BST East campus due to its location and competitive environment.

BENEFITS FROM REFINANCING: The series 2016 transaction will provide BST with additional cushion as it continues to evaluate longer term options for BST East. Debt service savings are almost $2 million a year. In addition, risks related to its current capital structure (bank loans and swap) will be eliminated.

LOW ILU OCCUPANCY: Fitch remains concerned about the low ILU occupancy at BST East, which has been challenged since the repositioning project completed in 2012. ILU occupancy was 67.9% in fiscal 2016 (June 30 year end) compared to 68.2% in fiscal 2015 and 68% in fiscal 2014. More rental contracts are being offered at this facility to preserve flexibility for longer term viability options. BST West's ILU occupancy is adequate at 85.4% in fiscal 2016 compared to 83.6% in fiscal 2015 and 80.2% in fiscal 2014.

ADEQUATE DEBT SERVICE COVERAGE: MADS coverage significantly benefits from the refinancing and coverage of pro forma MADS in fiscal 2016 is 1.6x compared to actual MADS coverage of 1.3x. The budgeted debt service coverage in fiscal 2017 is 2x. MADS reduces to approximately $8 million with the refinancing compared to the current $9.9 million.

RATING SENSITIVITIES

IMPROVED LIQUIDITY: A return to an investment grade rating on Air Force Village's (dba Blue Skies of Texas) outstanding bonds will be dependent on growing liquidity in line with 'BBB' category medians while maintaining debt service coverage around 2x.

CREDIT PROFILE

BST operates two continuing care retirement communities (CCRC), BST East and BST West located in San Antonio, TX. BST East opened in 1970 and BST West opened in 1983 and both communities have historically served retired officers of all uniformed services and their spouses, widows or widowers. As of November 2013, the board approved the expansion of eligibility to individuals with no prior military affiliation. The organization changed its name in May 2014 and the official launch of a rebranding campaign began in October 2014. BST predominately offers a Type B contract. As of July 2016, BST had a total of 739 ILUs, 57 assisted living units (ALUs), 72 memory care units, and 127 skilled nursing facility (SNF) beds. BST had $47.4 million in total revenue in fiscal 2016 (June 30 fiscal year end; unaudited).

IMPROVED OPERATING PERFORMANCE

The current management team has continued its focus on operating expenses due to pressures on revenue growth and operating ratio is now below 100% and was 98% in fiscal 2016 compared to 108% in fiscal 2012. Expense initiatives have mainly been in the areas of labor and net operating margin was 13.6% in fiscal 2016 compared to 3.8% in fiscal 2012.

Although operating performance has continued to improve, meaningful improvement in the overall financial profile has been hampered by the struggling BST East campus.

MIXED OCCUPANCY

ILU occupancy at BST West remains solid while occupancy at BST East remains the most challenged despite capital investment. Fitch toured the community in 2015 and found it to be well maintained and marketable with a diverse array of ILU options; however, the campus is expansive and there is a large inventory of smaller units.

The organization has only been marketing as the BST brand since October 2014, and the benefits from the transition to open eligibility could take at least three years to be realized. Management has various marketing initiatives in place that focus on the local primary market area (PMA) as well as nationally due to its military heritage. The majority of the nontraditional residents have been at BST East as well as rental contracts.

For fiscal 2016, ILU occupancy at BST East was 67.9% compared to BST West with 85.4%. ALU occupancy was 89.9% at BST East and 98% at BST West. There are only memory care units at BST West and occupancy was 84.5% while SNF occupancy was 84.4% at BST East and 84.9% at BST West.

The market is competitive and the location of BST East results in more competition with rental facilities. In addition, there has been increased free standing ALU and memory care competition.

LIGHT LIQUIDITY

Unrestricted cash and investments totaled $33.4 million at June 30, 2016 and the level of cash has dropped from $40.8 million at FYE 2012 due to capital expenditures outsizing available funds from cash flow, however, are necessary to enhance marketability. Unrestricted cash and investments are projected to remain stable in fiscal 2017 and end the year with $34.5 million. Days cash on hand and cash-to-debt were 299 and 27.4%, respectively, at June 30, 2016 compared to the 'BBB' category medians of 400 and 60%. BST has three parcels of land on the BST West campus for sale, which could aid liquidity growth.

BENEFITS FROM REFINANCING

The series 2016 bonds will refinance all of BST's outstanding debt and will be 100% fixed rate, which is viewed favorably. The current amount of debt outstanding is $122 million and the debt mix is 85% underlying fixed rate and 15% underlying variable rate. There are two variable rate bank loans ($17.5 million) with Frost Bank that extend through 2023 with an $8.5 million bullet payment due in December 2023. In addition, the outstanding floating to fixed rate swaps are being terminated.

Fitch used pro forma MADS of $8 million, which was provided by the underwriter and assumes an all in interest cost of 4.2%. The underwriter indicated that similar rated transactions are pricing more favorably. Debt service is level. The final maturity is in 2045 and the maturity on the refinanced series 2007 bonds is being extended to 2045 from 2037. Pro forma MADS accounts for 16.3% of total revenue in fiscal 2016 compared to the 'BBB' category of 12.4%.

COMPLIANCE WITH COVENANTS

BST has been compliant with its bond covenants. Debt service coverage is required to be 1.2x on annual debt service and there is a 180 days cash on hand covenant, which is consistent with the bank loan's covenant of maintaining $20 million of unrestricted cash and investments. There will be a new master trust indenture with the series 2016 bonds. Proposed covenants are essentially the same at 1.2x annual debt service coverage and 180 days cash on hand.

BST has more cushion related to its debt service coverage with the refinancing with a covenant calculation of 1.33x in fiscal 2016 and 1.35x in fiscal 2015 compared to pro forma MADS coverage in those years of 1.6x.

DISCLOSURE

BST covenants to provide annual audits within 150 days of fiscal year-end and quarterly disclosure within 45 days of quarter-end.

Outstanding debt:

--$45,740,000 Tarrant County Cultural Education Facilities Finance Corporation (TX) (Air Force Village Obligated Group Project) fixed rate revenue bonds series 2009;

--$58,660,000 Tarrant County Cultural Education Facilities Finance Corporation (TX) (Air Force Village Obligated Group Project) retirement facilities revenue bonds series 2007.

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/site/re/868824

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

https://www.fitchratings.com/site/re/750012

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1010938

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1010938

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

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Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1-415-732-5620
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Adam Kates
Director
+1-312-368-3180
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1-415-732-5620
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Adam Kates
Director
+1-312-368-3180
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com