News Column

Fitch Rates Royal Oaks Life Care Center, AZ's Implied Gen Rev Obligations 'A'; Outlook Stable

May 20, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned a rating of 'A' to Royal Oaks Life Care Center (Royal Oaks), AZ's implied general revenue obligations.

In addition, Fitch affirmed the 'A' underlying rating on the $14,660,000 variable rate demand bonds (VRDBs), series 2002, issued by Arizona Health Facilities Authority on behalf of Royal Oaks Life Care Community Project. The series 2002 bonds are supported by a letter of credit (LOC) from Bank of America. Royal Oaks also has outstanding approximately $12,450,000 in series 2008 VRDBs supported by a LOC from Bank of America, which is not rated by Fitch.

Royal Oaks plans to issue $26,295,000 in series 2014A bonds to refund the series 2002 and 2008 bonds in full, and issue $15,000,000 in series 2014B bonds to fund capital expenditures. The transaction is expected to close the week of May 19, 2014.

The rating takes into account approximately $41,295,000 of proposed debt but is assigned to implied general revenue obligations since none of the obligations are publicly held.

The Rating Outlook is Stable.

SECURITY

The series 2002 bonds are secured by a gross revenue pledge and mortgage pledge of the obligated group (OG). Fitch's analysis is based on the consolidated entity, which includes the People of Faith Foundation (the Foundation), a non-obligated entity. The OG accounted for 88% of total assets and 96% of total revenue of the consolidated entity in fiscal year ended (FYE) Feb. 28, 2014.

KEY RATING DRIVERS

EXCELLENT FINANCIAL PROFILE: Royal Oaks' overall financial profile is strong with robust liquidity, improved profitability, and very good debt service coverage. Strong financial performance has been supported by improved occupancy driven by continued investment in its plant and service offerings.

GOOD OCCUPANCY: With the hiring of a new marketing director, Royal Oaks' occupancy has steadily improved after hitting a low in October 2011. Marketing initiatives that have been implemented include a deferred entrance fee program, renting vacant units, allowing customization of units, as well as a revamped website and monitoring of sales-lead generation. Independent living unit (ILU) occupancy was 94.2% in the fiscal year ended Feb. 28, 2014.

NEW MEMORY CARE BUILDING: Royal Oaks in the process of constructing a dedicated memory care building and renovate all existing skilled nursing beds to private suites. Project costs are estimated at $17 million and will be funded by a combination of debt and equity. The new building is slated to open March 2015.

RESTRUCTURING DEBT PORTFOLIO: The series 2014 bonds are expected to fund $15 million in project costs and refund all outstanding VRDBs into a direct bank loan. Fitch views favorably the reduction in near to medium term put risk, and believes there is sufficient capacity to absorb the new debt.

RATING SENSITIVITIES

EXECUTION OF CONSTRUCTION PROJECT: Despite various risks inherent in executing a major capital project, Fitch expects the overall operational and financial profiles to remain stable over the next year and believes the current financial position provides cushion for temporary operating variability. Successful execution leading to continued financial strengthening may lead to positive rating pressure.

CREDIT PROFILE

People of Faith, Inc. d/b/a Royal Oaks is a Type A continuing care retirement community (CCRC) with 364 ILUs, 59 assisted living units (ALUs), and 125 bed skilled nursing facility (SNF; includes 54 memory care beds) located in Sun City, AZ. Total revenue in fiscal 2014 was $25.9 million.

Excellent Financial Profile Supported by Demand for Services

Royal Oaks' overall financial profile is characterized by excellent liquidity, cash flow, and debt metrics. Solid financial profile is supported by high demand for services, reflected by strong sales results and sound occupancy across the campus. In fiscal 2014, occupancy was 94.2% in ILUs, 96.6% in ALUs, and 79.2% in skilled nursing.

Profitability metrics are weak against the 'A' medians, reflecting Royal Oaks' Type A entrance fee structure, but remained relatively consistent over the last three fiscal years. Most recently in fiscal 2014, operating ratio was 102.7% compared to Fitch's 'A' median of 95.8% and Fitch's Type A median of 98.8%. Net entrance fees received was solid at $7.2 million, albeit down from a high of $9.9 million in the prior year.

New Memory Care Building and Other Capital Projects

Royal Oaks is currently in the process of constructing a new memory care building, which will house 56 private units over two floors. The building will accommodate dementia care patients, which has historically made up about half of skilled nursing occupancy. The existing skilled nursing units will be renovated to private units, and in the process, bed capacity may decrease to 113 from 125.

Of the $17 million of estimated total project costs, $15 million is expected to be funded with 2014 bond proceeds, and the rest with equity. Fitch believes there is sufficient financial cushion at the 'A' rating to absorb the new debt and equity spend. However, there remain concerns around the operational impact of the project from pricing the new units appropriately, loss of eight garden homes (demolished to make room for the new building), and planned reduction to total health center capacity.

Over the years, Royal Oaks has renovated and upgraded its campus with a new wellness and dining facility and refurbished all the ILUs as they turn over. Routine capital is budgeted at approximately $2.4 million annually.

Strong Debt Metrics Pro Forma 2014 Bonds

Late May 2014, Royal Oaks plans to issue $41.3 million in series 2014A&B direct bank loans with Bank of America with a 10-year initial term and a LIBOR-based rate. The proceeds will be used to fund $15 million in project costs and refund all outstanding debt (series 2002 and 2008 VRDBs). The new issue is expected to generate level debt service of approximately $2.5 million, which is double the prior maximum annual debt service (MADS).

Despite over $15 million increase in debt, pro forma debt metrics are solid, with 4.4x pro forma MADS coverage and 8.4% pro forma MADS as a % of total revenue compared to the respective medians of 3.0x and 8.4x. Revenue-only coverage of 1.5x in fiscal 2014 is also very strong against Fitch's median of 1.2x, and especially for a type A CCRC. The elimination of near- to medium-term put risk with the bank loans is also viewed favorably.

Robust Liquidity

At Feb. 28, 2014, unrestricted cash and investments totaled $79.1 million, up $10 million from one year prior, and nearly doubled from FYE 2010. Liquidity metrics of 1,419 days cash on hand and 291.9% cash to debt at FYE 2014 are very strong against the medians of 563.7 days and 125.2x. Cash to debt falls to 186.7% with the 2014 issue but remains far stronger than the rating category median. The pro forma cushion ratio of 31.5x also compares favorably against the median of 15.3x.

DISCLOSURE

Royal Oaks does not provide disclosure to bondholders, since all of the debt is VRDBs. Royal Oaks has been providing quarterly and annual disclosure to Fitch with access to management.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria' (June 3, 2013);

--'Not-for-profit Continuing Care Retirement Communities Rating Criteria' (July 10, 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

Not-for-Profit Continuing Care Retirement Communities Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712401

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=830958

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Fitch Ratings

Primary Analyst

Jennifer Kim, +1 212-908-0740

Associate Director

Fitch Ratings, Inc.

One State Street Plaza

New York, NY 10004

or

Secondary Analyst

Emily Wong, +1 415-732-5620

Senior Director

or

Committee Chairperson

Jim LeBuhn, +1 312-368-2059

Senior Director

or

Media Relations:

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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