Fitch Affirms Wesley Homes (WA) Rev Bonds at 'BBB-'; Outlook to Negative

Fitch Ratings has affirmed the 'BBB-' rating on the approximately $43 million Washington State Housing Finance Commission nonprofit housing revenue bonds series 2007A issued on behalf of Wesley Homes (WH).

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are secured by a gross revenue pledge, mortgage pledge and debt service reserve fund of the obligated group (OG).

KEY RATING DRIVERS

INCREASED DEBT BURDEN: The revision in the Outlook to Negative from Stable reflects WH's increased debt burden since the last review in Dec. 2013 and the expectation for additional debt in the short term. WH incurred a $10 million variable rate bank loan in Sept. 2014 (series 2014 note) to fund the construction of a skilled nursing facility (SNF) at its Lea Hill campus. Pro forma debt service coverage is adequate for the rating level at 1.5x through the nine months ended Sept. 30, 2014 and for 2013. Revenue-only coverage is solid at 1x and 0.9x, respectively for the same time periods.

SOLID OCCUPANCY: After a slight dip in independent living unit (ILU) occupancy in 2012, ILU occupancy improved to 93.5% in 2013 and was 90.7% through the nine months ended Sept. 30, 2014. Occupancy in the assisted living units (ALU) and SNF have remained in the 90% range.

WEAK LIQUIDITY: Liquidity metrics continue to be weak for the rating category and have been one of Fitch's main credit concerns. Although weak, unrestricted cash and investments have continued to grow year over year. Total unrestricted cash and investments at Sept. 30, 2014 was $23 million and translated to 243.1 days cash on hand and 45.4% cash to debt compared to the 'BBB' category of 408 and 61.6%, respectively. The series 2014 note is structured in a draw-down mode and only $90 thousand has been drawn to date. Including the entire $10 million, cash-to-debt falls to 37.8% as of Sept. 30, 2014.

MAJOR CAPITAL PROJECTS ON THE HORIZON: WH has significant capital plans that include a major rebuilding of the Des Moines campus and two start-up continuing care retirement communities (CCRCs) on land owned in Puyallup and Renton. The current OG debt is callable January 2018 and management intends to restructure the current OG, and these major capital projects will either be financed outside the OG or part of an OG restructuring. Fitch will assess these plans as they are finalized. Management indicates that approximately $10 million-$12 million of additional debt will likely be issued in the near term to start the Des Moines campus project and to refinance a $2.2 million promissory note for the land purchase in Puyallup.

RATING SENSITIVITIES

ADDITIONAL DEBT: With the already increased debt burden from the recently issued series 2014 note, Fitch believes there is no debt capacity for additional debt at the current rating level. Financing plans remain in flux and Fitch will assess the impact on the rating as plans are finalized. Further additional debt will likely result in negative rating action.

CREDIT PROFILE

WH consists of two CCRCs, Wesley Homes Des Moines (WHDM) and Wesley Homes Lea Hill (WHLH). WHDM is a Type B CCRC located in Des Moines, WA (approximately 20 miles south of Seattle) with 76 independent cottages, 249 ILUs (apartment style), 39 ALUs, and 148-bed SNF. WHLH is a Type C CCRC located in Auburn, WA (approximately 10 miles southeast of WHDM) with 22 village homes, 104 ILUs (apartment style), 32 ALUs and 16 memory care units. In fiscal 2013 (Dec. 31 fiscal year-end), total revenue for the consolidated entity was $38 million. The OG is practically the consolidated entity and includes Wesley Homes, WHDM, WHLH, Wesley Homes Foundation, and Wesley Homes Community Health Services. The only entity outside of the OG is Wesley Homes at Home. Management expects to withdraw Wesley Homes Community Services from the OG by the end of 2014 given poor financial performance of its home health business.

Solid Occupancy

ILU occupancy has been relatively stable after being challenged by higher than normal turnover. New marketing initiatives include adding a rental option at the WHDM campus and offering different entrance fee options at WHLH. ILU occupancy was 92.4% in 2010, 91.1% in 2011, 89.4% in 2012, 93.5% in 2013 and 90.7% through the nine months ended Sept. 30, 2014. Occupancy in the ALUs and SNF has consistently been in the low-to mid-90% range and through the nine months ended Sept. 30, 2014, the ALUs had 94.4% occupancy and the SNF had 93%.

Adequate Financial Profile for Rating Level

WH's liquidity is weak; however, profitability remains solid and debt service coverage is adequate. Operating ratio continues to be sound at 93.5% for 2013 and 94.6% for the nine months ended Sept. 30, 2014 compared to the 'BBB' category median of 97.4%. Rate increases have been steady and was 3% in 2014 and budgeted to be 3.5% in 2015.

Turnover entrance fees totaled $2.7 million in 2013, $3.2 million in 2012 and $1.9 million through the nine months ended Sept. 30, 2014, supporting debt service coverage. Pro forma maximum annual debt service (MADS) coverage dropped to 1.5x in 2013 from 1.8x (without series 2014 note) and Fitch believes there is no further debt capacity at WH's current rating level.

Major Capital Projects

WHLH currently does not have any SNF beds and the series 2014 note will fund a 36-bed SNF at this campus. The project budget is $12 million with $10 million funded from the series 2014 note and the remainder from philanthropy, which has already been raised. The project was delayed due to permit issues and construction is just beginning. Management anticipates that the project will be completed by Dec. 2015.

Fitch was aware of a longer term capital plan to develop a third campus in Puyallup where WH currently owns land, however, Fitch did not know about another potential start up CCRC in Renton as well as a major campus re-building at WHDM. Both start-up CCRCs do not have a current timeline, but management indicated that they would likely move as fast as financing is available. The rebuilding of the WHDM campus will be completed in phases, as it would require demolishing the south side of the campus and rebuilding the ILU, ALU, and SNF. The cost of this project is estimated to be approximately $100 million and management expects the next bank financing for $10 million-$12 million would start with the demolition of nine cottages and building 15 replacement cottages.

Debt Profile

Total debt outstanding including the entire drawdown of the series 2014 note is $62 million with 68% fixed rate and 32% variable rate. The $10 million series 2014 note is with Washington Federal and has an initial 10-year period. There are some additional covenants including days cash on hand and debt service coverage specifically related to WHLH. WH was in compliance with all bond and bank covenants as of Sept. 30, 2014. Fitch used MADS of $5.1 million, which incorporates $4.1 million MADS on the prior outstanding debt plus approximately $1 million MADS on the $10 million series 2014 note.

Disclosure

WH covenants to provide through the Municipal Securities Rulemaking Board's EMMA system audited financial statements within 120 days of each year end and quarterly unaudited financial statements within 45 days of each quarter end.

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

Applicable Criteria and Related Research:

-- Not-for-Profit Continuing Care Retirement Communities Rating Criteria, July 24, 2014.

Applicable Criteria and Related Research:

Not-for-Profit Continuing Care Retirement Communities Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=752470

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=934735

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