Fitch Affirms Morningside Ministries (TX) at 'BBB-'; Outlook Revised to Negative

Fitch Ratings has affirmed the 'BBB-' rating on the following bonds issued by the New Hope Cultural Education Facilities Finance Corporation on behalf of Morningside Ministries (MM):

--$48.2 million first mortgage revenue bonds, series 2013.

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are secured by a pledge of all revenues, first mortgage on all assets, and a debt service reserve fund.

KEY RATING DRIVERS

WEAKENED OPERATING PERFORMANCE: The Negative Outlook reflects pressured operating performance as a result of softer occupancy and new expenses from the delayed opening of a large expansion project at its Menger Springs campus in Boerne, TX. After a history of steady financial results, operations declined significantly and were below budgeted levels in fiscal 2015 and the first quarter of fiscal 2016.

REDUCED OCCUPANCY: The Negative Outlook is also based on lower occupancy levels in all levels of care, particularly independent living unit (ILU) census at its Meadows campus. System-wide average ILU occupancy dropped to 89% in 2015 and 85% during the first quarter of 2016, from 95% in 2014.

ADEQUATE LIQUIDITY INDICATORS: Despite the financial challenges, MM maintains a satisfactory liquidity position. As of March 31, 2016, $36 million of unrestricted cash and investments amounts to 276 days cash on hand (DCOH) and 40% of long-term debt. MM also holds $7 million of restricted funds and an additional $9 million of initial entrance fees in an escrow account that are expected to redeem long-term debt.

MANAGEABLE DEBT POSITION: As expected, debt increased over the past few years as MM drew down the entire amount of a $42 million bank loan to fund its Menger Springs expansion. MM expects to redeem about $12 million of the bank loan by the end of 2016 from initial entrance fees. As a result, maximum annual debt service (MADS) of about $4.97 million is manageable at 10.1% of 2015 revenue. Moreover, the additional monthly service fees from the expansion project are expected to further moderate the debt burden and improve coverage levels.

RATING SENSITIVITIES

OPERATING PERFORMANCE AND OCCUPANCY: Continued weak operating performance and occupancy challenges that lead to deteriorating debt service coverage or reduced liquidity indicators could cause a downgrade.

EXPANSION PROJECT STABILIZATION: Morningside Ministries' inability to fill-up and stabilize its Menger Springs expansion project could cause downward rating pressure if overall financial performance and debt service coverage are further negatively affected.

CREDIT PROFILE

MM was established in 1959 and began serving seniors in 1961. MM operates three senior living communities in the greater San Antonio, TX metropolitan area. MM at Menger Springs is a retirement community consisting of 92 rental ILUs, 40 entrance fee ILU cottages, 42 assisted living units (ALU, including 26 memory care units), and 40 skilled nursing facility (SNF) beds located in Boerne, TX. Menger Springs recently completed an expansion project that added 68 entrance fee ILUs (The Overlook) and 48 ALUs (including 16 memory care units). In addition, MM at the Meadows includes 142 rental ILUs, 68 ALUs, and 170 SNF beds. Finally, MM at The Chandler Estate is comprised of 38 rental ILUs, 24 ALUs, and 113 SNF beds.

ILU residents with entrance fee contracts are typically 90% refundable agreements with a limited amount of health care services. MM also operates a pharmacy and a training institute. In fiscal 2015 (Dec. 31 year-end), MM had total operating revenues of $46.57 million.

WEAKENED OPERATING PERFORMANCE

MM has experienced pressured operating performance as a result of lower Medicaid reimbursement at its SNF business, softer occupancy, and new expenses from the delayed opening of the Menger Springs expansion project. After a history of steady financial results, operations declined significantly and were below budgeted levels in fiscal 2015 and the first quarter of fiscal 2016. The net operating margin was above 11% in both 2013 and 2014, but dropped to 3.7% in 2015 and negative 0.5% during the first quarter of 2016. Lower than anticipated revenues from reduced occupancies and increased salary expenses for merit increases and new staff at Menger Springs contributed to the weaker performance. While some of the start-up losses were anticipated, actual results trailed budgeted expectations by $1.15 million in 2015 and $930 thousand for the unaudited three month period ending March 31, 2016. Pressure on revenues for the interim period is also a result of move-in discounts for the new Menger Springs ILU residents. The move-in discounts are expected to dissipate in the second half of the year providing a boost to revenues along with the continued fill-up of the new ILUs and ALUs.

The operating ratio increased in each of the past two years and the interim period, and amounted to 100.7% in 2015 and a weak 107% for the first quarter of 2016. Both these levels are below Fitch's 'BBB' category median of 96.1%. As a result, actual annual debt service coverage declined to 1.5x in 2015, from 2.6x the year earlier. Actual annual debt service coverage declined further during the first quarter of 2016, but is expected to rebound during the remainder of the year as the monthly service revenue from the newly constructed Menger Springs ILUs and ALUs ramp up.

REDUCED OCCUPANCY

After relatively stable census over the last several years, MM experienced lower occupancy levels in all levels of care, particularly ILU census at its Meadows campus. System-wide ILU occupancy dropped to 89% in 2015 and 85% during the first quarter of 2016, from 95% in 2014. At the Meadows campus, ILU occupancy declined to 77% in 2015 and 72.8% during the first quarter of 2016. MM management notes that attrition in the Meadows ILUs has been well-above average and more residents are aging in place and not moving into higher levels of care. Additional ILU occupancy challenges at the Meadows are also the result of new rental competition, but most of these communities do not offer healthcare services.

ILU occupancy at Menger Springs' 92 ILU apartments averaged a healthy 95.3% in 2015 and 93.2% for the first quarter of 2016. ILU occupancy at Menger Springs' 40 cottage ILUs averaged a robust 99% in 2015 and 97.8% for the first quarter of 2016. The 38 rental apartments at Chandler Estates averaged 88% in 2015 and fell to 77.7% for the first quarter of 2016 due to above average attrition rates.

ALU and SNF occupancy remains healthy but are down a bit from prior year levels. After averaging 94% and 92%, respectively in 2014, ALU and SNF occupancy decreased modestly to 92% and 90%, respectively in 2015. For the first quarter of 2016, existing ALU and SNF occupancies are down a bit due to more ILU residents aging in place, heightened competition from stand-alone facilities, and managed care organizations and health systems more aggressively controlling Medicare patient utilization for short-stay rehabilitation services. Fitch notes that MM's high exposure to skilled nursing services provides occupancy challenges given the shorter lengths of stay, particularly for its Medicare business that is being transformed by manage care organizations and governmental reimbursement initiatives like bundled payment programs that are prevalent in the San Antonio area.

Competition from other CCRCs is moderate and includes Blue Skies of Texas ('BBB-'/Outlook Negative) and Army Residence Community ('BBB-'/Outlook Stable). While both of these communities primarily serve residents with military affiliations, Blue Skies of Texas opened its admissions to non-military residents and changed its name from Air Force Villages. MM management reports that the Blue Skies of Texas modification has not had a noticeable effect on ILU marketing. Fitch notes that MM's main competition is derived from a variety of stand-alone assisted living and skilled nursing facilities that operate in the San Antonio region.

MENGER SPRINGS EXPANSION

The Menger Springs project includes 68 entrance fee ILUs and 48 ALUs (including 16 memory care units) and was completed on budget. The ILU expansion was scheduled to open in the fall of 2015, but was delayed about five months mostly due to weather-related construction delays. The project includes new dining facilities, expanded amenities and common space, and covered parking. ILU residents began moving in at the end of January 2016 and as of June 17, 49 of 68 or 72% of the units are occupied. Initial entrance fees collected as of June 17, total $13.2 million, with a total expected entrance fee pool of about $16.5 million. MM management expects fill-up and stabilized occupancy by the end of 2016. In addition, $12 million of the bank loan will be redeemed from the initial entrance fees by the end of the year.

The ALU expansion includes a three-story addition, with 48 new traditional ALUs (up from 16 units historically), various amenities and additional interior renovations. The ALU building was expected to be completed in September 2015, but was delayed to January 2016 mostly due to weather-related construction issues. The existing ALU building was renovated to accommodate all the memory care units, including the conversion of 16 prior traditional ALUs to memory care for a total of 42 memory care units. The 16 newly renovated memory care units were not available for occupancy until mid-May 2016. ALU residents began moving into the newly constructed 48 units in mid-January and as of June 17, 37 of 48 or 77% of the traditional ALUs were occupied. For the memory care units as of June 17, 24 of 42 or 57% of the units were occupied. Management expects two to three move-ins per month with stabilized occupancy at all the newly constructed units and additional memory care units by the end of 2016.

SKILLED NURSING OPERATIONS

MM has a heavy concentration to skilled nursing business, which represents about 53% of operating revenues. As a result, MM relies on Medicare and Medicaid for a relatively high 28% of total operating revenues. Additionally, managed care organizations comprise a growing portion of the governmental business. Moreover, Medicaid represents a significant 41% of its SNF revenues, leaving them susceptible to modifications or payment reductions in the program. For instance, the state of Texas moved its Medicaid platform to managed care organizations a few years ago and reimbursement rates have been under pressure. Traditional Medicare is also quickly transitioning to plans run by managed care organizations (Medicare Advantage) that are coordinating care more aggressively and scrutinizing reimbursement levels. Regardless, MM's SNF operations enjoy long operating histories, good relationships with hospitals and health systems, and sufficient quality indicators. For example, MM's Chandler Estate SNF and Menger Springs (Kendall House) SNF enjoy five star overall CMS ratings and its Meadows SNF (Morningside Manor) has a three star overall CMS rating, but a 5 star CMS quality rating.

ADEQUATE BALANCE SHEET

MM maintains a satisfactory liquidity position with $36 million of unrestricted cash and investments as of March 31, 2016, which is on par with the level at the end of 2013. Liquidity is down by about $3.6 million from the end of 2014 partially as a result of a $2.1 million land purchase contiguous to the Menger Springs campus. This level of liquidity is mostly below Fitch's 'BBB' category medians and amounts to 276 DCOH, 7.3x cushion ratio, and 40% of long-term debt. This amount of unrestricted cash is adequate for a retirement community with mostly rental and fee-for-service resident agreements. As of March 31, 2016, MM also holds $7 million of restricted funds and an additional $9 million of initial entrance fees in a segregated account that are expected to be used to redeem long-term debt. As of May 31, 2016, management reports that $13.2 million of initial entrance fees from the Menger Spring ILU expansion have been collected.

After bond principal amortization and the payment of $12 million of the bank loan with initial entrance fees by the end of 2016, MM is expected to have about $76 million of long-term debt outstanding. As a result, MADS of $4.97 million is manageable at 10.1% of 2015 revenue. Additionally, the new monthly service fees from the Menger Springs ILU and ALU expansion projects are expected to provide additional revenues to support debt service and improve capital-related metrics.

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

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1008265

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