Fitch Rates Brazos Presbyterian Homes (TX) Series 2016 Bonds 'BB+'; Outlook Revised to Positive
The Rating Outlook is revised to Positive from Stable.
The series 2016 bonds will be fixed rate and bond proceeds will be used to advance refund the series 2013B bonds. The par amount on the series 2016 bonds will be higher than the amount being refunded ($67.5 million) given the escrow sizing requirements. There will be a debt service reserve fund (DSRF). The bonds are expected to price the week of Oct. 10th.
The bonds are secured by a gross revenue pledge, mortgage pledge and DSRF.
KEY RATING DRIVERS
EXECUTION OF SIGNIFICANT EXPANSION PROJECT: The Outlook revision to Positive from Stable reflects Brazos' successful fill of its new independent living units (ILUs), which occurred over a short time period. The expansion project at Brazos Towers is essentially complete with the construction of a new tower (East Tower) that includes 84 additional ILUs, 25 assisted living units (ALUs), and eight memory support units. The new ILUs were available for occupancy gradually with the first move in in March 2016 and the new units are almost 100% occupied as of September 2016 (83 of 84). The new ALU and memory support as well as four additional ILUs (converted from existing ALU) should be available for occupancy in late third quarter 2016. The project cost is relatively in line with budget and has met the original timeline for reaching stabilized occupancy despite weather conditions that slowed construction.
GROWTH IN LIQUIDITY: Brazos' liquidity has significantly improved since Fitch's last rating review in September 2015 due to receipt of initial entrance fees. During 2016, Brazos used its own cash to fund project costs and to pay down temporary debt, which was subsequently replenished with the receipt of initial entrance fees. Total initial entrance fees received through July 31, 2016 was $25 million and the initial entrance fee pool is projected to total $29.7 million. At July 31, 2016, days cash on hand and pro forma cash to debt of 1,041 and 67.6%, respectively compare favorably to the 'BBB' category medians of 400 and 60%, respectively.
PAYDOWN OF TEMPORARY DEBT: Fitch views favorably the paydown of the temporary debt, which was a $25 million construction loan from BB&T. Brazos only used approximately $13 million of the loan, which was paid off by April 2016. In addition, Brazos is no longer exposed to the more stringent bank agreement terms.
HIGH DEBT BURDEN: Brazos' debt burden is high and pro forma maximum annual debt service (MADS) accounted for 26.6% of total revenue through the seven months ended July 31, 2016. Debt service coverage is depressed as the additional revenue from the expansion project is not yet fully realized. MADS coverage was 1.3x through the seven months ended July 31, 2016 compared to 1.5x in 2015 and 1.2x in 2014. Coverage for 2017 is expected to be 1.7x.
CONSISTENT OCCUPANCY: Demand is good as demonstrated by solid occupancy at both communities. Brazos Towers will need to backfill some existing ILUs as several residents for the East Tower had moved to the existing West Tower while waiting for construction completion. At July 31, 2016, overall ILU occupancy was 88% with 85% at Brazos Towers and 92% at Hallmark. There could be more existing ILUs at the West Tower that need to be backfilled once the additional ALUs and memory support units come on line (net additional 25 units).
IMPROVED DEBT SERVICE COVERAGE: Fitch will monitor management's progress with the remaining elements of the project - fill of assisted living units and memory support - and subsequent backfill of existing independent living units. The successful execution of the remainder of the project in combination with the benefits of the expected additional revenue is likely to result in positive rating movement.
Brazos is a Type B continuing care retirement community (CCRC) that owns two communities, Brazos Towers at Bayou Manor (Brazos Towers) and the Hallmark, located in Houston, TX. These communities have been operated by Brazos since 1963 and 1972, respectively. Brazos Towers currently has 173 ILUs (84 added since March 2016), eight ALUs, and 37 licensed skilled nursing (SNF) beds. By the end of late third quarter 2016, total available units at Brazos Towers will be 177 ILUs, 25 ALUs, eight memory support units, and 37 bed SNF.
The Hallmark has 125 ILUs, 12 ALUs, 10 memory support units, and 32 bed SNF. Although the communities are only approximately six miles apart, the resident draw for each community is from different zip codes within the Houston area. Brazos had $21 million in total revenue in 2015 (Dec. 31 year end).
The expansion project at Brazos Towers has been in the planning stages since 2008, and the project is essentially complete. In addition to the additional units (84 ILUs, 25 ALUs, eight memory support units), the project also added new common spaces and amenities (fitness center, pool and an informal dining option), additional parking and the renovation of its healthcare center (completed in 2015). Eight of the existing ALUs will be converted to four ILUs. Management indicates high resident satisfaction with the project and a seamless transition architecturally between the existing (West Tower) and new (East Tower).
The final project cost is still to be determined as change orders are being processed, but is expected to total $96 million compared to the budget of $94 million. Funding sources include 2013 bond proceeds, construction loan (paid down as of April 2016), initial entrance fees, and equity contribution.
The new ILUs were available beginning March 2016 and as of Sept. 1, 2016, management stated 83 of the 84 new units are occupied. About 22-24 residents for the East Tower units moved to the community early while waiting for construction to be complete. With the move of these residents from the existing units to the East Tower the backfill of the existing units (West Tower) will be a focus.
CONSISTENT ILU OCCUPANCY DESPITE INCREASED CAPACITY
Fitch believes Brazos' service area has favorable characteristics with good demographics and a stable housing market. Spectrum has also been on board since 2009 and has provided marketing services especially related to the new project. At July 31, 2016, ILU occupancy at Brazos Towers was 85%. Overall ILU occupancy was 88% for both communities combined.
Brazos Towers' SNF occupancy has recently improved as the SNF was undergoing renovations and became fully available in September 2015. SNF occupancy was 81.9% through the seven months ended July 31, 2016 compared to 67.4% in 2015. The percentage of Medicare residents also increased due to its relationship with local hospitals. The Brazos Towers SNF is rated five stars by CMS. The Hallmark's SNF is 100% private pay but management is considering applying for Medicare certification.
GOOD FINANCIAL PROFILE
Many of Brazos' financial metrics compare favorably to investment grade medians, especially with the growth in the balance sheet since Fitch's last rating review. However, given the high debt burden, debt service coverage will need to be more in line with 'BBB' category medians before upward rating movement.
Profitability has weakened due to increased depreciation and interest expense but net operating margin is still very favorable at 29% through the seven months ended July 31, 2016 compared to 33.4% in 2015 and the 'BBB' category median of 19.3%.
Debt service coverage based on existing MADS (excluding debt for expansion project) is very good and the covenant calculation was 3.9x through the seven months ended July 31, 2016 compared to 4.6x in 2015 and 3.7x in 2014. Debt service coverage based on pro forma MADS ($6.6 million) will be tested as of 2017 with the stabilization of the project. Debt service coverage on pro forma MADS was 1.3x through the seven months ended July 31, 2016 compared to 1.5x in 2015. Debt service coverage is projected to be 1.7x in 2017.
Brazos' liquidity position has always been strong for the rating level, but further improved since Fitch's last rating review. Unrestricted cash and investments totaled $70.4 million at July 31, 2016, which increased from $56.8 million at fiscal year-end 2015. Brazos has received approximately $25 million in initial entrance fee receipts through July 2016. Days cash on hand and pro forma cash to debt compare favorably to the 'BBB' category medians. Final spending on the project is expected to be about $3.5 million, which will be funded from the initial entrance fees. Ongoing capital expenditures are projected to total about $4 million a year.
HIGH DEBT BURDEN
Total debt outstanding is $92 million and is 100% fixed rate and includes the 2013A and B bonds as well as note payable. Pro forma debt outstanding will increase despite the refinancing of the outstanding 2013B bonds since the refunding par amount will need to be higher than the outstanding debt to fund the escrow for the advance refunding. Total pro forma debt after the series 2016 issuance is approximately $104 million.
Fitch views favorably the repayment of the construction loan, which was well in advance of the mandatory tender date of Dec. 1, 2018. In addition, the full amount was never utilized.
LEGAL PROVISIONS AND DISCLOSURE
Under the MTI, Brazos is required to maintain MADS coverage of 1.2x, 180 days cash on hand and various marketing and occupancy targets. There are no events of default related to the liquidity, marketing or occupancy covenants. Events of default include MADS coverage below 1.2x for two consecutive years and below 180 days cash on hand or MADS coverage below 1x.
Brazos covenants to provide annual audits within 150 days of fiscal year end and quarterly disclosure for all four quarters within 45 days of quarter end.