Fitch Affirms Sunset Retirement Communities (OH) Revs at 'A-'; Outlook Stable
The Rating Outlook is Stable.
Debt payments are secured by a pledge of the gross revenues of the obligated group and a mortgage on the property. Further, a fully funded debt service reserve fund provides additional security for bondholders.
KEY RATING DRIVERS
GOOD OPERATING HISTORY: SRC has consistently produced sound and stable operating results through the economic cycle with moderate occupancy fluctuations and solid cash flows despite its rental only model.
SOUND FINANCIAL PROFILE: SRC's financial profile continues to be characterized by robust profitability, excellent liquidity, and adequate debt service coverage. As expected, financial metrics were weaker but good in fiscal 2014 (Dec. 31 year-end) and through the six month interim period ended June 30, 2015, as the organization took some units out of service during construction and renovation, and spent internal liquidity to fund capital projects.
LARGE CAPITAL PLANS: Significant capital plans are underway at both campuses, with \\$16.6 million budgeted for 2016 - 2018 primarily to fund the expansion of independent living units (ILUs) and a new therapy center at Sunset Village.
EXCELLENT LIQUIDITY: Current liquidity metrics are excellent, well in excess of the 'A' medians. Management expects to fund capital plans with internal cash and investments. While pressure on liquidity metrics will be significant, Fitch believes there is sufficient room at the current rating to absorb the impact and expects SRC to continue producing metrics in line with the 'A-' rating.
CONSISTENT DEBT SERVICE COVERAGE: Revenue only coverage of maximum annual debt service (MADS) ranged from 2.2x - 2.7x over the last four years compared to the median of 1.2x. MADS coverage is expected to weaken in the next 3 years during the construction period, and recover thereafter.
TEMPORARY FINANCIAL WEAKENING: Management is projecting profitability to be weaker than historical levels in fiscal 2015 and 2016 as SRC executes a large portion of its capital plan. Fitch believes there is some room for compression given healthy liquidity cushion. However, inability to meet targeted performance would be viewed unfavorably.
PROJECT EXECUTION: Fitch believes SRC has sufficient room to absorb projected cash demands at the 'A-' rating. However, material deviations from the budget may lead to negative rating pressure.
SRC is a rental CCRC with a campus in Toledo and Sylvania, Ohio. Its Toledo campus includes the Woodlands, consisting of 65 ILUs, and Sunset House, consisting of 70 assisted-living units (ALUs) and 29 skilled nursing beds. Sunset Village, its Sylvania campus, consists of 60 ALUs and 52 nursing beds (30 dedicated to dementia care). Operating revenue in 2014 was \\$17.2 million.
Large Capital Plans
Following a comprehensive market study in 2013, SRC is undergoing significant renovation and expansion projects on both campuses. In 2014 and 2015, ALUs were modernized at Sunset Village and gut renovated at Sunset House to better meet resident demands. The new and improved units should help improve marketing and occupancy, particularly at Sunset House, which has historically had low occupancy.
At Sunset Village, a 32-unit ILU expansion is planned, with site work progressing. The first phase includes the construction of six buildings (12 units). The second phase consists of 10 buildings (20 units) and a 10,000 square foot clubhouse. The entire project is estimated to cost \\$15.3 million (including contingency and site work), and is expected to be expended in 2015 - 2018. Sunset Village is also contemplating a new state of the art rehab center with a therapy pool at an estimated cost of \\$2.4 million. The project is currently undergoing certificate of need approval process.
Total capital investments, including construction projects and technology, is estimated at \\$8.3 million in 2016 and \\$6.3 million in 2017. While some ILU construction is planned for 2018, capital expenditures are projected to decline near depreciation levels from 2018 and onward.
Sound Operating and Financial Performance
Core operations weakened slightly in 2014 and 2015, as a number of ALUs at Sunset House were taken out of service for renovation. However, overall profitability metrics were solid for the rating with operating ratio of 80.5 % in 2014 and 78.7% in 2013 versus the 'A' median of 97.1%. Similarly, net operating margin was very good at 21.3% in 2014 and 23.5% in 2013 compared to the median of 6.2%.
Performance through the six month period ended June 30, 2015 was weaker, as the completion of ALU renovations at Sunset House was four months behind schedule, just opening in August 2015. Management noted that an average of 26 ALUs (out of 70) were out of service during the construction period, which equates to about \\$900,000 of revenues on an annualized basis. Fitch was aware of this potential pressure at the time of last review, and notes that occupancy was in line with expectations.
Some additional profitability compression is projected during the construction period as occupancy in the new units will take some time to ramp up, but management projects that it will improve steadily through stabilization in 2019. Fitch expects profitability to return to historical levels by 2017, and believes there is sufficient cushion at the current rating for some temporary negative variances.
Strong Liquidity Supports Capital Projects
Liquidity growth slowed in 2014 and 2015 as SRC began utilizing internal cash and investments to fund capital projects. However, unrestricted cash and investments totaled a solid \\$47.4 million at June 30, 2015. Liquidity metrics are excellent with 1,329 days cash on hand, 170% cash to debt, and, 18.5x cushion ratio compared to the respective 'A' medians of 692 days, 127%, and 15.8x.
Despite large spending plans, Liquidity metrics are expected to remain near or above Fitch's 'A' medians during the entire five year projection period. Management's projections anticipate liquidity to drop to a low of \\$38.4 million at FYE 2017 and recover steadily thereafter. The 'A-' rating takes into account the planned liquidity declines, with the expectation that it will recover as initial entrance fees are received and incremental revenues are realized.
Aggressive Investment Portfolio
SRC's investment portfolio includes over 70% allocation in equities, which is an aggressive allocation. This is somewhat mitigated by the sophistication of SRC's board, ongoing monitoring of the investments, and the conservative structure of SRC's debt portfolio.
At June 30, 2015, long-term debt totaled \\$27.9 million, consisting of series 2009 bank qualified loans and series 2011 fixed rate bonds. All debt is fixed, and produces level debt service of \\$2.6 million through 2030. Debt burden measure by MADS as a percentage of revenues was high at 13.3% in 2014 compared to the median of 8.9%. However, revenue-only coverage was solid at 2.7x compared to the median of 1.2x. Coverage was lower at 1.5x in the six month interim period due to weaker profitability, but the weakening was near expected levels given the ALU renovation that took place.
SRC covenants to provide annual audited financial statements to bondholders within 150 days of its fiscal year end and quarterly, unaudited financial statements within 60 days of the end of each fiscal quarter.