OREANDA-NEWS. Fitch Ratings has upgraded to 'BB-' from 'B+' approximately $29 million of series 2010A bonds issued by the city of Alhambra, CA on behalf of Atherton Baptist Homes (Atherton).

The Rating Outlook is Stable.

SECURITY
The bonds are secured by gross revenue pledge, mortgage, and debt service reserve fund.

KEY RATING DRIVERS

PROGRESS BEING MADE: The rating upgrade to 'BB-' from 'B+' reflects Atherton's solid fiscal 2015 performance and progress since material organizational changes were made throughout 2014 to address Atherton's historically weak governance and management practices. These changes included a new CEO, a new Chairman of the board, and restated bylaws to broaden the breadth and diversity of board members. In addition, there is new oversight with a combined sales and marketing director effective November 2015, who is implementing a targeted marketing approach.

FISCAL 2015 PERFORMANCE LED BY IMPROVED OCCUPANCY: Atherton exceeded its fiscal 2015 budget and is currently compliant with all bond covenants. The improved performance was driven by increased occupancy in its Classic independent living units (ILU), which had a budgeted occupancy of 83.5% for fiscal 2015 and actual average occupancy was 84.4%. Atherton has shown incremental progress quarter over quarter from a low of 77.6% in the first quarter of 2014. Atherton's performance suffered after the slow fill of its 50 ILU expansion (Courtyard) that opened in June 2011. These units reached 90% occupancy by third quarter 2013 and have since maintained high occupancy (97% for fiscal 2015). The slow fill diverted attention from sales and marketing of the older part of the campus (Classic units - 170 ILUs) and with increased capital investment in these units and focused sales and marketing, the occupancy in the Classic ILUs is 89.4% as February 2016.

DEPENDENCE ON ENTRANCE FEES: Although profitability has improved with a positive net operating margin in fiscal 2015, there is a high dependence on entrance fees for debt service coverage, which is atypical for a Type C community. Debt service coverage by revenue only is only 0.3x in fiscal 2015 compared to the Type C median ratio of 1.4x. However, including entrance fees, debt service coverage is a solid at 2x.

LIGHT LIQUIDITY: Liquidity is light but in line with below investment grade credits with 199 days cash on hand (DCOH) and 34.1% cash to debt at Dec. 31, 2015. Atherton has historically missed its 180 DCOH covenant, but was met as of the Dec. 31, 2015 test date. Atherton's unrestricted cash and investments have been volatile since initial entrance fee receipts (used to pay down temporary debt from series 2010B) were part of unrestricted cash and investments. Atherton paid off the series 2010B bonds in full in 2014.

RATING SENSITIVITIES

MAINTAINING IMRPOVEMENT: Atherton's fiscal 2016 budget and five-year projections indicate continued steady improvement in ILU occupancy and financial performance, which Fitch believes is achievable and would result in further upward rating movement. However, there are longer-term capital plans (after 2020), which Fitch will assess as details and plans are available.

CREDIT PROFILE
Atherton Baptist Homes is a Type C continuing care retirement community (CCRC) located in Alhambra, CA with 170 Classic ILUs, 50 Courtyard ILUs, 38 assisted living units (ALU), and 99 skilled nursing facility (SNF) beds. Total revenue in fiscal 2015 (Dec. 31 year end; unaudited) was $18.6 million.

Organizational Changes
A management consultant report was issued in March 2014 due to the violation of the occupancy requirement in the bond documents and the cumulative cash used for operations financial covenant (this covenant no longer tested as of fiscal 2015). There were several recommendations for improvements in the areas of governance and management practices as well as in marketing and sales strategies. These changes were made throughout 2014 and have had a positive impact on fiscal 2015 performance and sustaining the continued improvement and progress will be key to reaching financial stability.

Management has implemented tools to track various measures including unit vacancies, time to move in, ongoing renovations, weekly sales report, and daily SNF payor mix. The management consultant is still engaged at Atherton although bond covenant compliance is being met and the consultant provides ongoing feedback to the board and management.

Improved Occupancy and Capital Spending
The Courtyard project was part of Atherton's campus improvement plan. The project added 50 ILUs to the existing campus at a total cost of $33.4 million and the Courtyard opened on time and within budget in June 2011. Atherton issued $29.3 million fixed rate series 2010A bonds and $14.64 million of series 2010B bonds to fund the project. The Courtyard fill up was much slower than anticipated but is now at 95% as of February 2016. The projections include the Courtyard units maintaining 96% occupancy.

There has been significant progress in the occupancy of its Classic units (170 units), which has been driven by much needed capital investment to improve the marketability as well as focused sales and marketing efforts. Atherton's capital budget includes updating each unit upon turnover and also addressing deferred maintenance needs. The organization is preparing a 30 year master facility plan, which could include several large projects (after 2020), and Fitch will assess the impact on the rating when details are available.

Classic ILU occupancy has improved quarter over quarter from a low of 77.6% in the first quarter of 2014 to 89.4% in the fourth quarter 2015 and was 89.4% as of February 2016. Marketing initiatives have been refined to a targeted approach versus broad based, which will better utilize the marketing budget. Current priorities are to update its website and have a better digital marketing presence. The fiscal 2016 budget assumes 87.1% occupancy in the Classic ILUs, and projections include steady improvement to 92.4% in 2020.

Positive Net Operating Margin
Although Fitch views Atherton's positive net operating margin in fiscal 2015 favorably, there has been a structural imbalance of cash operating expenses in excess of cash operating revenue due to its history of poor management practices and weak board oversight, which will likely take years to address. Operating ratio in 2015 was 109% down from 122% the prior year, however, the five year projections still show an operating ratio over 100%. One of the areas that was causing a significant issue was uncontrolled workers compensation costs, which has been addressed and is now being managed with seven open claims from a high of 26 in 2010.

Atherton's fiscal 2015 budget had a bottom line loss of $2.7 million and actual performance was negative $1.9 million. The fiscal 2016 budget has a bottom line loss of $1.452 million.

Dependent on Entrance Fees
Atherton's poor profitability necessitates the dependence on net entrance fees for debt service coverage. Net entrance fees in 2015 were $4.3 million compared to $3.3 million in 2014, $2.2 million in 2013, and $1.2 million in 2012. Atherton restructured its pricing for the Courtyard units in 2016 and the predominant contract type for the Courtyard is 90% refundable while the Classic units are predominantly nonrefundable. The projections include net entrance fees of $3.4 million in 2016, $3.6 million in 2017, $3.5 million in 2018, $3.7 million in 2019 and $3.7 million in 2020.

Debt service coverage was solid at 2x in 2015 compared to 1.3x in 2014 and 1.4x in 2013. With the projected net entrance fees, debt service coverage is expected to be 1.9x in 2016, 1.9x in 2017, 2x in 2018, 2.2x in 2019 and 2.3x in 2020 compared to the BBB category median of 2x.

Building Liquidity
At Dec. 31, 2015, Atherton had $9.8 million of unrestricted cash and investments which equated to 199 DCOH, a 3.8x cushion ratio and 34.1% cash to debt compared to Fitch's 'BBB' category medians of 400, 7.3x and 60%. With the projected improvement in occupancy and cash flow with moderate capital spending ($1.4 million a year), liquidity is projected to slowly build over the next five years with 310 DCOH and 63.6% cash to debt in 2020. Atherton's investment portfolio is fairly aggressive for its rating level with 57% of its investments exposed to equities, which has been reduced but still remains high.

Atherton maintains a defined benefit pension plan that is currently underfunded, but the pension plan is not subject to ERISA requirements. It is unlikely that pension contributions will be made over the near term as there are other demands on liquidity such as meeting its liquidity covenant and future capital needs.

Debt Profile
Total debt outstanding is approximately $29 million and is 100% fixed rate. MADS is $2.56 million and accounted for 13.6% of total revenue in 2015 compared to Fitch's 'BBB' category median of 12.4%.

Atherton is tested on the following bond covenants: 1.2x MADS coverage tested quarterly on a rolling 12 month basis, 180 DCOH tested every June 30 and Dec. 31, and maintaining 46 occupied Courtyard ILUs (92%) and 140 Classic ILUs (82.4%) every quarter. The liquidity covenant does not trigger an event of default as long as there is a consultant call in. The only covenant that would trigger an event of default is having less than 1x MADS coverage for two consecutive years (based on audited fiscal year). As of Dec. 31, 2015, Atherton is in compliance with all bond covenants.