Fitch Rates Life Enriching Communities, OH's Revenue Bonds 'BBB-'; Outlook Stable
--$139.2 million healthcare improvement and refunding revenue bonds, series 2016.
Bond proceeds will refund LEC's series 2006 and series 2011A bonds ($85.4 million), significantly renovate and construct 45 new units at LEC's Twin Lakes campus ($40.8 million), reimburse and pay LEC for routine capital expenses ($10.5 million), provide funds for capitalized interest and debt service reserve accounts, and pay issuance costs. The bonds are scheduled to sell via negotiated sale the week of Sept. 5, 2016.
In addition, Fitch assigns a 'BBB-' rating to the following existing bond issue:
--$25.9 million healthcare refunding revenue bonds, series 2012.
The Rating Outlook is Stable.
The bonds are secured by mortgages on LEC's two continuing care retirement communities (CCRC), security interest in the obligated group's (OG) gross revenues, negative pledge agreement on the OG's securities and investments, and a debt service reserve fund.
KEY RATING DRIVERS
STEADILY IMPROVING DEMAND TRENDS: LEC's long operating history, quality service reputation, diversified facility offerings, and enhanced marketing programs resulted in improved independent living unit (ILU) occupancy over the last five years. Average ILU occupancy at LEC's two CCRCs increased to 90% for the six-month period ending June 30, 2016, from 81% during 2011 (Dec. 31 fiscal year-end).
RISING AND HEALTHY CASH FLOWS: As a result of the increased receipt of net entrance fees from the healthier ILU occupancy, net operating margin (NOM)-adjusted and pro forma maximum annual debt service (MADS) coverage improved over the last five years. NOM-adjusted increased to 26.8% in 2015, from 18.1% four years earlier. Pro forma MADS coverage jumped to 2.0x in 2015, from 1.1x in 2011.
INCREASING DEBT POSITION AND CAPITAL PLANS: With the series 2016 bond issue, LEC increases its total debt by about $54 million, resulting in a moderately high 19.6% pro forma MADS as a percent of revenues. Moreover, in addition to the projects being financed with the series 2016 bonds, LEC has phase II capital plans that would increase construction and fill-up risk and are likely to result in the issuance of additional debt.
SATISFACTORY LIQUIDITY: Despite robust capital spending that has resulted in a below-average age of plant (9.5 years in 2015), unrestricted cash and investments of $49 million amount to an adequate 409 days operating expenses. Additionally, LEC holds about $9.7 million of restricted funds to support operations and capital projects and also has $6.3 million of cash and investments outside the OG as of Dec. 31, 2015.
LARGE CAPITAL PLANS: The 'BBB-' rating incorporates Life Enriching Communities' (LEC) projects being funded with the series 2016 bonds as well as the likelihood of the phase II capital projects proceeding in 10 months. However, if the phase II project timing, scope or financing details change materially, those modifications could affect the rating at the time of debt issuance.
OPERATING PROFILE MAINTENANCE: The 'BBB-' rating also assumes that LEC's current operating profile, characterized by improved occupancy, healthy cash flows, and adequate liquidity balances, remains stable. Should any of these weaken during the planned construction and fill-up periods, there could be negative rating pressure.
LEC is an Ohio non-profit corporation founded in 2001 to serve as the parent corporation of two CCRCs, Twin Towers and Twin Lakes, and Life Enriching Communities Foundation (the Foundation), and all are OG members. The Foundation serves as the parent corporation of LEC Community Services, Inc. (LECCS). LECCS became an OG member in 2012 when it funded an affiliated investment in a homecare business. Twin Lakes Properties LLC (TLP), an Ohio for-profit limited liability company of which Twin Lakes is the sole member, was formed in March 2016 and is expected to become a member of OG at the closing of the sale of the series 2016 bonds. TLP was formed to hold title to real estate consisting of about 2.6 acres and to develop the land for commercial purposes. Non-OG affiliates include several entities formed for the purpose of investing in or operating related healthcare and senior living enterprises. Non obligated affiliates have modest operations, but hold about $6.3 million of unrestricted cash and investments. Non-obligated activities are expected to increase and absorb working capital with the establishment of Confident Living LLC, a continuing care at home program that was started earlier this year. The OG represented 97.4% of total system assets and 99.6% of total system revenues in 2015.
Established in 1899, Twin Towers is a CCRC located on a 112-acre wooded campus on one of Cincinnati's seven hills (in the College Hill section) about six miles from downtown. Twin Towers includes 124 ILU apartments, 131 ILU patio homes, 79 assisted living units (ALUs), 30 memory support ALUs, 101 skilled nursing facility (SNF) units and it leases 15 beds in space formerly occupied by Twin Towers to Hospice of Cincinnati for palliative care services. Twin Towers offers resident agreements with declining balance (nonrefundable) entrance fees or 75% refundable option. Many residents have type-C fee-for-service resident agreements and all declining balance and 75% refundable contracts provide a modest discount for healthcare benefits. The weighted average entrance fees for the declining balance option are $43,377/$59,665/$79,181 for the various ILU apartments and $74,391/$130,239 for the various ILU patio homes. The weighted average entrance fees for the 75% refundable agreement are $75,616/$102,538/$130,386 for the various ILU apartments, and $120,924/$213,278 for the various ILU patio homes.
Twin Lakes was a start-up CCRC that opened in phases from 2003-2005 on a multi-parcel 70-acre campus in the city of Montgomery and village of Indian Hill that is located about 15 miles northeast of downtown Cincinnati. Twin Lakes includes 92 ILU apartments, 114 ILU villas, 4 ILU manor homes, 28 ALUs, and 43 SNF beds. Twin Lakes offers resident agreements with 30% refundable entrance fees or a 90% refundable option that are type-C or fee-for-service arrangements. The weighted average entrance fees for the 30% refundable option are $227,103 for the ILU apartments and $258,837 for the ILU villas. The weighted average entrance fees for the 90% refundable agreement are $354,291 for the ILU apartments and $387,369 for the ILU villas.
OCCUPANCY AND DEMAND TRENDS
LEC's long operating history, quality service reputation, diversified facility offerings, and enhanced marketing programs resulted in improved ILU occupancy over the last five years, particularly at Twin Towers. Despite the economic recovery and modestly rebounding real estate values, Twin Towers ILU patio home occupancy remained soft until a few years ago. While ILU apartment occupancy averaged an adequate 88.6% from 2012 through June 30, 2016, ILU patio home occupancy averaged a low 69.4% during the same 4 ?-year period mostly due to affordability issues. However, campus upgrades, improving demographics, and a more robust marketing platform increased ILU patio home occupancy to 79% for the first six month of 2016, from 63% in 2013. Twin Lakes ILU occupancy remains very healthy and averaged 97.4% in the apartments and 90% in the villas from 2012 through June 30, 2016. At June 30, 2016, Twin Lakes ILU villa occupancy was at a high of 98%, indicative of the favorable economic indicators and healthy real estate values in the primary market area surrounding the city of Montgomery and the village of Indian Hill.
ALU and SNF occupancies have been relatively stable at both CCRCs. In 2013, Twin Towers completed a SNF expansion with the construction of a new, 120-room, state-of-the-art facility in the household model of care. The new facility offers 90 long-term care units and 30 memory support accommodations. The space that remained after the partial demolition was renovated to provide 26 units for short-term rehabilitative services. In July 2015, Twin Towers leased one of the households (with 15 beds) in the new facility to Hospice of Cincinnati, adding a valuable service and a stable revenue stream. Twin Towers ALU and SNF occupancy averaged 88.6% and 90.2%, respectively, from 2012 through June 30, 2016. Twin Lakes ALU and SNF occupancy are very healthy and averaged 97.4% and 96% during the last 4 1/2 years.
FINANCIAL PERFORMANCE AND POSITION
Mostly as a result of the increased ILU occupancy and receipt of net entrance fees, cash flows have steadily improved over the last five years. Net entrance fees from turnover ILUs surged to $9 million in 2015, from just $2 million four years earlier. As a result, NOM-adjusted jumped to 26.8% in 2015, from 18.1% in 2011. This compares very well to Fitch's 'BBB' category median of 19.3%. Other financial metrics softened over the past few years due to investments in programs and services designed to bolster occupancy, but remain adequate and in line with 'BBB' category medians. For instance, the operating ratio increased to 94.9% in 2015, from 90.8% in 2012, but still remains below Fitch's 'BBB' category median of 96.1%. In addition, the NOM fell in both 2013 and 2014, but rebounded to 11.4% in 2015 and is above the 'BBB' median of 8.9%. With the higher net entrance fee receipts, pro forma MADS coverage jumped to 2.0x in 2015, which is on par with Fitch's 'BBB' category median.
Despite robust capital spending that has resulted in a below-average age of plant (9.5 years in 2015), unrestricted cash and investments of $49 million amount to an adequate 409 days operating expenses. This level of liquidity is on par with Fitch's 'BBB' category median of 400 days cash on hand and is more beneficial given LEC's mostly Type-C fee-for service resident contracts. Additionally, LEC holds about $9.7 million of restricted funds to support operations and capital projects and also has $6.3 million of cash and investments outside the OG. However, these liquidity balances were built up from equity transfers from the OG. Additionally, non-OG activities are expected to increase and absorb working capital with the establishment of LEC's continuing care at home program earlier this year. Moreover, liquidity versus total pro forma debt (27% cash/debt) and pro forma MADS (4.8x cushion ratio) are well below Fitch's medians of 60% and 7.3x, respectively, and indicative of LEC's heavy debt position. However, unrestricted cash is projected to grow steadily as LEC finances a majority of its capital spending from bond proceeds and expects to receive $12 million of initial entrance fees from the 45 ILU-apartment expansion project at Twin Lakes.
In addition to refunding $85 million of existing debt, LEC is funding about $56 million of new money capital projects with bond proceeds. The most significant project is for $40.8 million at Twin Lakes and includes 45 new apartment ILUs, additional dining and common space including an auditorium seating 300 people, underground parking garage, renovations to the SNF to create separate long-term care and short-term rehabilitation units, and renovations to existing therapy space. The project is being driven by the desire to enhance the continuum of care at Twin Lakes and to take advantage of a market area with favorable demographics. While deposits for the new ILUs are just beginning, Twin Lakes has 77 current prospects on a waiting list as of July 27, 2016 that requires an at risk $5,000 deposit. Additionally, over 20 current ILU villa residents are on a waiting list to move to apartments if they become available. While the lack of deposits securing ILU reservation for large expansion projects is not typical, Fitch notes Twin Lakes' robust historical occupancy, long waiting list, and favorable service area demographics as offsetting factors. Construction and other risk mitigants such as a guaranteed maximum price contract, liquidated damages, and contractors insurance are in place for the project, which Fitch views favorably.
About $10.5 million of bond proceeds will fund future capital expenses over the next several years including land purchases ($2.5 million), Twin Towers dining venues ($3 million), wireless equipment and telephone system at both campuses ($1 million), and Twin Towers main building renovations ($1 million). LEC is also developing commercial property adjacent to the front entrance of Twin Lakes for the purpose of leasing it out for complementary uses. This project will be funded out of equity and cost about $2.5 million
Phase II capital plans include a 40-45-unit assisted living and memory support building on the Twin Lakes campus. Currently, memory support residents are housed on a floor of the SNF in a facility designed for highly acute medical purposes. The new memory support building will be designed to accommodate two distinct levels of care. The first would be for lower acuity, higher functioning residents. The second would be designated for higher acuity, lower functioning residents. The building will be designed and built to include flexibility to convert the units to skilled nursing licensure standards. Phase II also includes 18 new ILU villas on an adjacent six-acre site near the manor homes. The preliminary phase II timing includes initial site work in March 2017 and a bond financing for the entire amount in June 2017. The early cost range is approximately $27 million-$30 million.
Fitch's 'BBB-' rating assumes the aforementioned projects and level of anticipated debt are undertaken in 10 months. Changes to the timing, scope or financing details of the development could impact the rating. Despite the fact that the projects will increase LEC's leverage position and medium-term operating risks, Fitch has a positive view of the expansion plans. Twin Lakes' high ILU occupancy, favorable service area demographics, pent-up demand for assisted and memory care services, healthy financial performance, and management's prior experience with large development projects position LEC well to execute the plans.
INCREASING DEBT POSITION
With the series 2016 bond issue, LEC increases its total debt by about $54 million, resulting in a moderately high 19.6% pro forma MADS as a percent of revenues. While total debt/net available has dramatically improved over the past five years to levels more consistent with Fitch's 'BBB' category medians, they will weaken after the series 2016 bond issue. Furthermore, in addition to the projects being financed with the series 2016 bonds, LEC's phase II capital plans would increase construction and fill-up risk and are likely to result in the issuance of additional debt. However, the new revenues from the Twin Lakes ILU expansion are anticipated to support operations and debt service coverage once they are completed and occupied. The 45 new ILUs are expected to be ready for occupancy in early 2018 and have six fill up in February, five in March, four in both April and May and three per month until 95% occupancy in February 2019. Fitch views these assumptions as very reasonable based on Twin Lakes' strong historical demand and management's prior experience with other expansion projects.