Fitch Affirms Covenant Retirement Communities, IL at ‘BBB+’; Outlook Revised to Positive

NEW YORK–(BUSINESS WIRE)–Fitch Ratings has affirmed the ‘BBB+’ rating on approximately $312
million of bonds issued by the Colorado Health Facilities Authority and
California Statewide Communities Development Authority on behalf of
Covenant Retirement Communities (CRC).

The Rating Outlook is revised to Positive from Stable.

SECURITY

The bonds are secured by a pledge of CRC obligated group’s gross
revenues, a mortgage interest in certain property, and debt service
reserve funds.

KEY RATING DRIVERS

STRONG CASH FLOWS AND DEBT SERVICE COVERAGE: The Positive Rating Outlook
reflects improved and consistent cash flow growth driven by increasing
net entrance fee receipts and improving operations. For the past three
years, net entrance fees from reoccupied units exceeded $50 million
leading to maximum annual debt service (MADS) coverage of about 3x.

IMPROVING DEMAND INDICATORS: The Positive Rating Outlook is also based
on very good improvement in independent living unit (ILU) occupancy.
Through Dec. 31, 2015, (11 month fiscal year 2016 interim), average
occupancy in CRC’s 3,127 ILUs improved to 91% from 83% in fiscal 2013.
Average aggregate occupancy in the assisted living units (ALU) and
skilled nursing facility (SNF) through the 11 months ended Dec. 31, 2015
remained solid at 90% and 87%, respectively.

BENEFITS OF SIZE AND GEOGRAPHIC DIVERSITY: Fitch believes that CRC’s
operating risk profile is moderated due to the size and diversity of its
enterprise and the geographic dispersion of its continuing care
retirement communities (CCRC). The CRC obligated group operates 12 CCRCs
and two other senior care providers in eight states with no single
community accounting for more than 11% of revenues.

SATISFACTORY CASH POSITION: Despite unrestricted cash levels that
slightly lag Fitch’s ‘BBB’ category medians, CRC’s liquidity metrics are
considered adequate given the benefits of its large business base and
geographic diversity. At Oct. 31, 2015, CRC’s unrestricted cash and
investments totaled $221 million which equates to 347 days cash on hand,
a 7.7x cushion ratio, and cash to long-term debt of 54.3%.

MANAGEABLE DEBT BURDEN: MADS of $28.5 million amounts to a very
manageable 10.1% of unaudited fiscal 2016 revenues while adjusted debt
to capitalization at Oct. 31, 2015 of 53.9% is below the ‘BBB’ category
median of 58.8%. Additionally, debt to net available improved in each of
the past three years and amounts to a favorable 4.6x for the nine month
period ending Oct. 31, 2015.

RATING SENSITIVITIES

SUSTAINED OPERATING AND CASH FLOW IMPROVEMENTS: Upward rating movement
is possible if Covenant Retirement Communities maintains its healthy
operating performance and debt service coverage trends so long as
liquidity and other debt-related metrics remain at or around current
levels.

STABLE LIQUIDITY: Positive rating pressure also assumes that Covenant
Retirement Communities’ cash position remains in-line with current
metrics even at the higher rating level given the benefits of its large
size and geographic diversity.

CREDIT PROFILE

CRC is a type B CCRC system that owns and operates 14 senior living and
care providers in eight different states with a total of 3,127 ILUs, 694
ALUs and 950 SNFs. CRC operates as an affiliate of Covenant Ministries
of Benevolence (CMB) which is administered by the Board of Benevolence
of the Evangelical Covenant Church. CMB also serves as the parent
company of Swedish Covenant Hospital (rated ‘BBB+’/Outlook Stable by
Fitch) and a variety of other senior care and social service
organizations. CMB also oversees the investment portfolio management of
CRC and its related entities, which Fitch views favorably. In fiscal
2015, the CRC obligated group generated total operating revenues of $249
million. Fitch’s analysis and financial ratios are based on the
obligated group’s operations and results. The obligated group
represented 91.3% of total system revenues and 98.3% of total system
assets in fiscal 2015.

Consolidated results include the operations of non-obligated Covenant
Retirement Services (CRS), which comprises a home health company, a
management service organization, and several rental retirement
communities. In fiscal 2015, CRS reported a $2.4 million operating loss,
which is improved from the $4.2 million operating loss two years
earlier. CRC is in the process of restructuring several of its
non-obligated affiliates which will result in non-cash write-offs of
prior advances of about $7 million in fiscal 2016. As a result, CRC’s
advances ($28.7 million as of Oct. 31, 2015) to non-obligated entities
will be reduced. Fitch views these management actions favorably as it
should reduce financial support to non-obligated entities and provide
more focus and resources to core operations.

GEOGRAPHIC AND BUSINESS LINE DIVERSITY

CRC’s enjoys a lower overall risk profile than single-site CCRCs due its
large scale, multiple locations, and revenue and cash flow diversity of
its operations. CRC is composed of 14 campuses in eight states with no
single community accounting for more than 11% of total obligated group
revenues. In addition, net operating income and net entrance fee
receipts are fairly dispersed throughout the system. With communities in
Florida, Connecticut, Minnesota, Colorado, Illinois, California,
Michigan and Washington, Fitch believes the geographic diversity helps
reduce overall operating volatility from adverse economic, demographic
or competitive changes in a particular service area or community.
Despite some concentration in Illinois, Fitch views CRC’s scope and
geographic diversity as a primary credit strength.

IMPROVING OPERATING AND CASH FLOW PERFORMANCE

Driven by consistently rising occupancy levels over the last five years,
particularly in its ILUs, CRC has generated robust net entrance fee
receipts. Enhanced marketing programs, staffing changes and rebounding
real-estate markets has resulted in strong ILU sales performance. Given
these positive factors and much lower use of sales incentives (entrance
fee discounts), CRC generated net entrance fee receipts in excess of $50
million for the past three fiscal years. As result, the net operating
margin-adjusted of 26.5% in fiscal 2015 and 25% for the nine month
period ending Oct. 31, 2015 are greatly improved from prior year levels
and in excess of Fitch’s ‘BBB’ category median of 19.3%.

Higher system-wide occupancy, expanded Medicare short stay census in the
SNFs, and performance improvement initiatives has resulted in improved
core operating profitability. Through the nine month interim period of
fiscal 2016, the net operating margin increased to 6.6% from 3.3% in
fiscal 2013. In addition, the operating ratio improved in each of the
past five years and amounted to an adequate 99.5% for the nine month
period ending Oct. 31, 2015.

MANAGEABLE DEBT POSITION

The series 2015 refunding provided good cash flow savings and reduced
the par amount of debt outstanding. MADS of $28.5 million is down from
prior MADS of $30.5 million and equates to 10.1% of fiscal 2016 total
revenues, which is lower than the ‘BBB’ category median of 12.4%. Debt
to net available improved in each of the past three years and amounts to
a very solid 4.6x for the nine month period ending Oct. 31, 2015. This
level is also more favorable than the ‘BBB’ category median of 5.9x.

Adjusted debt to capitalization of 53.9% at Oct. 31, 2015 is also below
the ‘BBB’ category median of 58.8%. Historical coverage of MADS
including net entrance fee receipts in fiscal 2015 and through the nine
month interim period for fiscal 2016 has been strong at 3.0x and 3.1x,
respectively and exceeds the ‘BBB’ category median of 2.0x. Further,
revenue-only coverage of MADS at 1.1x through Oct. 31, 2015 is a sharp
improvement from 0.5x in fiscal 2013, reflecting the healthier core
profitability.

DEBT PROFILE

CRC’s capital structure is somewhat conservative with 81% fixed rate
bonds and 19% variable rate direct bank placements. In addition, CRC is
counter-party to three floating-to-fixed rate interest rate swaps with a
total notional amount of $89 million. At Jan. 26, 2016, the aggregate
mark-to-market value on the swaps was negative $14.17 million.
Collateral posting requirements are very limited and the counterparty
has termination rights if CRC’s rating falls below ‘BBB-‘. CRC also
provides guarantees on the debt of its non-obligated rental retirement
communities in the amount of roughly $32 million. This level of
guaranteed debt is not a negative factor at the current rating level but
could become burdensome if these obligations or other financial support
for non-obligated entities grows.

DISCLOSURE

CRC’s disclosure requirements under its bond documents include the
submission of annual audited statements within 120 days of fiscal year
end and quarterly unaudited statements on a GAAP basis within 45 days of
quarter end to the Municipal Securities Rulemaking Board’s EMMA system.

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

Applicable Criteria

Not-for-Profit Continuing Care Retirement Communities Rating Criteria
(pub. 04 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=868824

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=999577

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=999577

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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