Fitch Rates Holland Home Obligated Group (MI) 2016 Revs 'BBB-'; Affirms Outstanding; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned a 'BBB-' to the expected issuance of the following bonds issued on behalf of Holland Home Obligated Group (HH):

--$28,765,000 Kentwood Economic Development Corporation (MI) limited obligation refunding revenue bonds, series 2016 (Holland Home Obligated Group);

--$8,495,000 Holland Home Obligated Group - Michigan Strategic Fund - Direct Note Obligation - series 2016B.

Both series of bonds will be issued as fixed rate. Proceeds from the bonds will be used to refinance the outstanding series 2006A bonds, fund capital projects, and pay for a debt service reserve fund and costs of issuance. Bonds are expected to sell via negotiation the week of Oct. 11.

In addition, Fitch affirms the following Kentwood Economic Development Corporation (MI) revenue bonds also issued on behalf of HH at 'BBB-':

--$50.20 million, series 2012;

--$32.37 million series 2006A.

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a revenue pledge of the obligated group (OG), a first mortgage lien on certain property, and a debt service reserve fund.

KEY RATING DRIVERS

STABILIZED OPERATING PROFILE: The 'BBB-' rating reflects HH's consistent performance over the last three and a half years, supported by high occupancy, solid net entrance fee receipts, and good debt service coverage.

CHANGE TO OBLIGATED GROUP: HH is removing its home health and hospice services from the OG. Fitch views the change largely as a credit neutral. A pro forma analysis shows a near term dilution of the OG, but management fees and the programmatic flexibility these programs will have outside the OG should offset this over the next few years. None of the OG debt is associated with these programs, and no OG funds are anticipated to be used in support of them.

ESCALATING DEBT SERVICE: Maximum annual debt service (MADS) of $8.6 million occurs in 2033. While pro forma coverage of MADS is good at 1.6x, coverage of the $7.2 million actual debt service figure is stronger at 1.9x., at June 30, 2016. Coverage by the new OG will be slightly weaker but Fitch expects actual debt service coverage to remain consistent with the rating level.

ADEQUATE LIQUIDITY METRICS: At June 30, 2016, Holland Home had approximately $37.6 million in unrestricted cash and investments (net of a $3.4 million line of credit), which equated to 187 days cash on hand and 35.8% cash to debt, both of which trail Fitch's 'BBB' category medians. Holland Home's liquidity remained flat from 2014 to 2015, after a period of liquidity growth, driven in part by the strong cash flow from the fill up on a back log of available units. Fitch expects liquidity to remain stable over the next two to four years.

IL EXPANSION UNDERWAY: Holland Home is moving forward on a 119 independent living (IL) expansion at Breton Homes that will be built in two phases--47 units built in the first phase and 72 units in the second phase. The project is expected to last five to seven years. Units will be built as they are pre-sold. Seed funding of up to $4 million to start the project is expected to come from a Holland Home entity outside the OG, and entrance fees from the built and filled units will fund the building of the subsequent units and phases. Construction on a model triplex began on May 1, 2016.

RATING SENSITIVITIES

STABILITY IN PERFORMANCE: Fitch expects Holland Home Obligated Group (HH) performance to remain stable, with coverage near or at the category median and liquidity remaining stable. A trend of weaker performance, a drop in liquidity, or a debt issuance could pressure the rating.

PROJECT COMPLETION: Fitch would expect HH's operational performance to improve from additional cash flow, should HH be able to build and fill the 119 IL units.

CREDIT PROFILE

Holland Home is a type-B continuing care retirement community (CCRC) that operates three campuses of multi-level senior housing in Grand Rapids, MI, providing a total of 723 ILUs and cottages, 435 assisted living (AL) and dementia units, and 241 nursing beds. Total operating revenues in fiscal 2015 were $77.4 million (Dec. 30 fiscal year-end).

As of July 1, 2016, HH's home health services and hospice service were no longer in the OG. In 2015, these service lines accounted for 25% of operating revenues and 11% of total assets. The operating loss for these entities was $350,000.

STEADY OPERATING PERFORMANCE

In May of 2016, Fitch upgraded HH due to its steady performance over the historical period. In 2015, HH's operating ratio improved to 101.6% from 103.5% in 2014. The continued strength of IL occupancy and improvements at HH's hospice helped lift the core operating results. The 101.6% operating ratio was more in line with HH's historical performance, but trailed Fitch's 'BBB' category median of 96.1%.

HH's net operating margin - adjusted weakened slightly to 13.9% from 15.7%, driven by fewer IL unit sales. HH had 65 sales or move ins in 2015, compared with 78 sales or move ins in 2014 and 79 in 2013. The drop in the number of sales is being driven by HH's IL units being near full capacity, relative to 2013 and 2014, when there was a back log of apartments to fill. Six month results show the maintenance of the steady performance with a 101.3% operating ratio and 13.1% net operating margin - adjusted.

Overall, occupancy remains good. At June 30, 2016, IL occupancy was 95%, AL occupancy was 87% and skilled nursing was 88%. HH has seen some volatility in its skilled nursing census, due largely to industry trends including fewer rehab patients available for referrals and shorter lengths of stay. However, Fitch believes the issues are manageable for HH. Medicare revenue has held steady at approximately 15% of gross skilled nursing revenues.

Capital Update: IL Expansion Project

HH is nearing completion of an AL expansion and skilled nursing refurbishment, which was funded by philanthropic support.

HH is now moving forward on a large two-phase 119 IL expansion on Breton Woods, called Breton Homes North. A number of details on the project have been clarified since Fitch's last rating review, including the project funding.

The funding to start the project is being provided by an organization within the Holland Home corporate entity but that is not part of the OG. Units will be built as they are sold, and the entrance fees from the sold and filled units will fund the building of additional units as those are pre-sold. Fitch expects no additional long-term debt to be issued for the construction of the 119 IL units. HH broke ground on a model triplex unit, and Fitch expects eight to 12 units to be pre-sold and built as phase 1 begins.

Fitch notes that the funding and building of the Breton Homes North expansion is very different from an expansion HH undertook in 2007, when HH issued debt to fund a 123 IL unit expansion. HH incurred debt to build all the units at once, and slow fill up on the units led to Fitch downgrading HH to 'BB+' from 'BBB-'. For the building of Breton Homes North, HH has largely mitigated the fill up and debt risks by building smaller groups of units as they are pre-sold, by the use of entrance fees to fund most of the expansion, and by issuing no additional long term debt for construction.

Further mitigating concerns on the expansion is the robust pool of new entrance fees that is expected to be generated by the entrance fees, which should provide further financial cushion for the project.

HH also has a number of other projects as part of its Vision 2030, which is a strategic plan to position the organization for the longer term health care delivery environment. Projects from the strategic plan include those within and outside the OG. Fitch's expectation is that HH will be able to maintain the current rating while pursuing these projects, should cash flow and philanthropy stay stable. However, the final scope, funding, and timing of the projects could impact the rating.

Debt Profile

HH's debt structure before issuance consists of 78% natural fixed-rate and 22% direct bank-placed variable-rate bonds. The $22 million of bank-placed mandatory tender bonds subjects HH to an elevated level of remarketing and interest rate risk. However, HH's improved liquidity position over the last few years and a 2024 tender date mitigate some of these concerns.

After issuance HH's fixed rate debt will increase slightly as will total debt, but the small amount of additional debt inconsequential. HH has seven separate swaps composed of three floating-to-fixed rate swaps and four basis swaps. Fitch views the swap portfolio as aggressive for the rating level. HH does have counterparty diversity as the swaps are with three different banks. There are no collateral posting requirements but some of the swaps allow for the counterparty to terminate the swap should HH's rating fall to below 'BB'. At March 31, 2016, the mark-to-market on all the swaps was negative $8.7 million with the largest individual swap valuation being negative $2.6 million.

HH has a frozen defined benefit pension plan. At Dec. 31, 2015, the pension had an $11 million liability and was 65% funded. HH management is considering a debt issuance to reduce the liability. The current rating does not factor in this debt issuance, and Fitch will evaluate it as details emerge on the potential borrowing, which will be closer to the time of issuance.

CONTINUING DISCLOSURE

Under the Continuing Disclosure Agreement, HH covenants to provide audited financial statements and utilization statistics within 180 days of each fiscal year-end and quarterly interim financial statements and utilizations within 60 days of each fiscal quarter-end. HH's disclosure to Fitch has been excellent in terms of content and timeliness.

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/site/re/868824

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

https://www.fitchratings.com/site/re/750012

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1012343

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012343

Endorsement Policy

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

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Source: Fitch Ratings

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