Fitch Rates Royal Oaks (AZ) Series 2016 Revenue Bonds 'A'; Outlook Stable
The series 2016 bonds will be fixed rate and refund all outstanding debt, which totals $39.5 million and are direct bank loans. The series 2016 bonds are expected to price the week of Sept. 5th.
The Rating Outlook is Stable.
The series 2016 bonds will be secured by a gross revenue pledge and mortgage pledge of the obligated group (OG).
KEY RATING DRIVERS
WEAKER FINANCIAL PERFORMANCE IN FY 2016: After consistently strong financial performance, Royal Oaks' financial profile weakened in fiscal 2016 (February 29 fiscal year end) due to the impact of the opening of its new memory care building (Friendship House) in May 2015. Although the project is viewed favorably and is a strategic investment for the long term marketability of the community, the near-term impact was negative. Profitability and debt service coverage declined in fiscal 2016 compared to prior years.
PRESSURED REVENUE: The opening of Friendship House resulted in a slight decline in resident service revenue in fiscal 2016. Although this was anticipated, a sustainment of this trend would be viewed negatively. Management is in the process of developing a master facility plan, which is expected to generate incremental revenue growth.
GOOD LIQUIDITY: Liquidity metrics remain solid and compare favorably to Fitch's A category medians. Days cash on hand and cash to debt were 1,054 and 172.1%, respectively at May 31, 2016 compared to the A category medians of 681 and 125.1%.
STRONG OCCUPANCY: Royal Oaks' Independent living unit (ILU) occupancy has been consistently strong the last three years after hitting a low in October 2011. The community benefits from its location in a retirement destination, Sun City, and the vast majority of prospective residents are from resident referrals. Management has been reinvesting in its plant and 70% of its ILUs have been upgraded and renovated upon unit turnover. ILU occupancy was 94.8% in fiscal 2016, 95.8% in fiscal 2015 and 94.2% in fiscal 2014.
REDUCED CAPITAL STRUCTURE RISKS: With the series 2016 financing, Royal Oaks will eliminate risks with its current capital structure that included bank renewal and interest rate risk.
MASTER FACILITY PLAN: Royal Oaks is in the process of developing a master facility plan. To date, the organization has been securing adjacent land when available. Fitch will evaluate the impact of the plan when details are available, which is expected in about a year.
People of Faith, Inc. d/b/a Royal Oaks (the Corporation) is a Type A continuing care retirement community (CCRC) with 360 ILUs (258 apartments and 102 garden homes), 59 assisted living units (ALUs), 56 memory care private suites, and 60 bed high acuity assisted living care center (Care Center) located in Sun City, AZ. Royal Oaks relicensed its skilled nursing facility (SNF) to directed assisted living in May 2016 and the level of services in the Care Center are the same as it was in the SNF.
The OG includes the Corporation only. The consolidated financials include two non-obligated group members, Cactus Sky Holdings and People of Faith Foundation (foundation). Cactus Sky Holdings' purpose is to purchase and hold land for future development. The Corporation is expected to transfer $5 million to Cactus Sky Holdings. The foundation's primary purpose is to support the Corporation and had cash and investments of $38 million at FYE 2016.
The Corporation includes the development fund (delineated in consolidating statements of the audit and internal financial statements). Although the development fund is included in the OG, most of the assets are donor restricted. Therefore, Fitch uses the Corporation only column in its analysis. Total revenue in fiscal 2016 (audited Feb. 29 fiscal year end) was $27.2 million.
New Memory Care Building and Other Capital Projects
Friendship House opened in May 2015 and was on time and within budget. The total project cost was $16.8 million. The building is two floors with a total of 56 private suites and is state of art design with a neighborhood model. Fitch toured this facility in 2016 and believes it significantly enhances the marketability of the organization.
The memory care residents historically made up about half of skilled nursing occupancy and with the new facility; management has converted the existing facility into 100% private rooms, which resulted in loss revenue of approximately $1.2 million as residents were generally paying a second person fee to convert a semi private to private. Management has been focused on increasing its outside admits, which has offset some of the decline in revenue.
Management is developing a master facility plan, which would most likely include a new building for the Care Center (demolish existing SNF) and new ILUs. Securing adjacent property will be key to the master facility plan and Royal Oaks recently purchased an additional 2.7 acres. Fitch will evaluate the master facility plan when details are available but expects that the overall project should result in improved cash flow.
Royal Oaks has been renovating and upgrading the ILUs as they turn over and incoming residents are allowed to customize units (up to 4% of entrance fee) and there is a design center on site. The total capital budget for fiscal 2017 is $3.7 million with $1.2 million earmarked for the apartment remodels.
Royal Oaks' overall financial profile has historically been very strong but weakened in fiscal 2016. Profitability deteriorated in fiscal 2016 with operating ratio increasing to 114.4% from 100.4% in fiscal 2015 and 100.8% in fiscal 2014. Net operating margin-adjusted declined to 17.5% from 22% and 23.7%, respectively. Royal Oaks implements consistent rate increases; however, resident service revenue dropped to $17.9 million in fiscal 2016 from $18.1 million the prior year.
First quarter fiscal 2017 results are ahead of budget and operating performance has improved from fiscal 2016 with an operating ratio of 109.1% and net operating margin-adjusted of 21.2%.
Net turnover entrance fees have been healthy at $8.7 million in fiscal 2016 compared to $7 million in fiscal 2015 and $7.2 million in fiscal 2014. Royal Oaks' actuarial study projects ongoing turnover of about 32 - 35 units a year, which would result in net entrance fees around $6 million. Royal Oaks does not offer a refundable residency contract.
At May 31, 2016, unrestricted cash and investments totaled $67.6 million compared to $64.6 million at fiscal year end 2016, $67.1 million at fiscal year end 2015 and $59.6 million at fiscal year-end 2014. Liquidity metrics are solid with 1,054 days cash on hand and 172.1% cash to debt at May 31, 2016.
The series 2016 financing will refund all of Royal Oaks' outstanding debt and provide 100% fixed rate, committed capital. MADS remains unchanged at $2.5 million. MADS accounted for 9% of total revenue in fiscal 2016 compared to the A category median of 9.2%. Debt service coverage declined to 2.9x in fiscal 2016 compared to 4.2x in fiscal 2015 and 3.9x in fiscal 2014 but rebounded to 3.4x for the three months ended May 31, 2016. Fitch will evaluate any additional debt plans and the current rating could be pressured depending on the magnitude of issuance.
There will be a new master trust indenture dated Sept. 1, 2016. Covenants include maintaining 1.2x debt service coverage and 120 days cash on hand. Existing financial covenants under the bank documents include 1.25x debt service coverage and 70% cash to debt.
Royal Oaks will covenant to provide annual disclosure within 150 days of fiscal year end and quarterly disclosure within 60 days of quarter end in conjunction with the series 2016 issuance.
Fitch has also withdrawn the 'A' implied general revenue bond rating on Royal Oaks. Since there is a rating on the series 2016 bonds, the implied general revenue bond rating is no longer considered by Fitch to be relevant to the agency's coverage.