1、 Public Finance Healthcare Special Report 2010 Senior Living Outlook Analysts Summary Fitch Ratings maintains its negative outlook for the senior living sector as the fragility in the global economic recovery, combined with such sector-specific negative credit factors as renewal risk on letters of c
2、redit (LOCs), weaker liquidity, higher capital costs, and uncertainty in the real estate market, outweighs the surprising resiliency that Fitch-rated, senior living credits have shown in the past year. The negative outlook reflects Fitchs expectation that rating downgrades will exceed upgrades in th
3、e coming year, with affirmations remaining the most frequent rating action in the sector. Sector Credit Risks The senior living sector has been under unprecedented pressure over the past 18 months due to turmoil in the real estate, capital, and financial markets. As a result, senior living providers
4、 have experienced lower occupancy levels, higher costs of capital, reduced cash flow, and weaker balance sheets. While the U.S. economy seems to have stabilized somewhat, the operating environment in the sector remains challenged. Sector-specific credit concerns over the next year include the follow
5、ing: Renewal Risk on LOCs: a number of LOCs supporting variable-rate debt are set to expire over the next 1224 months. As LOC banks exit the senior living market, Fitch is concerned about the lack of available LOCs, which may result in senior living providers converting variable-rate debt to fixed r
6、ate, incurring higher interest rates, or, worse, having the debt revert to bank bonds with term-out provisions that accelerate bond amortization. While lower rated credits are at a higher risk for limits on market access, even the higher rated providers who are able to secure LOCs will face higher f
7、ees and be subject to more restrictive provisions. Gary Sokolow +1 212 908-9186 James LeBuhn +1 312 368-2059 Jeff Schaub +1 212 908-0680 Related Research Revenue-Supported Rating Criteria, Dec. 29, 2009 2009 Median Ratios for Nonprofit Continuing Care Retirement Communities, Sept. 28, 2009 Rating
8、 Guidelines for Nonprofit Continuing Care Retirement Communities, Dec. 15, 2008 Weaker Liquidity: Fitchs 2009 medians (based on 2008 audits) showed weaker balance sheets across the rating spectrum. While the recovery in the financial markets has improved balance sheets, they have yet to return to pr
9、e-recession levels. As such, Fitch views the thinner financial cushions of providers entering 2010 as a risk, with the potential for another downturn in the markets or other potential draws on liquidity a concern. Higher Capital Costs: while access to the capital markets for senior living providers
10、improved recently, the cost of capital has risen materially as senior living providers remain largely unable to access the variable-rate debt market and investors are demanding a higher risk premium from senior living borrowers. Many senior living providers delayed debt issuance and capital projects
11、 over the past year, but capital needs in the industry remain strong. Senior living providers may face rating pressure as they enter the bond market seeking to meet capital needs and/or fund expansion projects. Real Estate Market Stress: while the residential real estate market appears to be showing
12、 signs of a nascent recovery, the ability and willingness of potential residents to sell their homes remain highly constrained. However, regional and local real estate markets are highly variable, making it difficult to draw general conclusions on stability and/or recovery of home prices. With many
13、providers beginning the year with lower March 16, 2010 Public Finance levels of occupancy and some providers opening new units on expansion projects, occupancy continues to be a primary credit concern. Sector Credit Strengths Across the sector, management has maintained adequate levels of occupancy
14、 by stepping up marketing efforts, renovating and upgrading existing units to enhance marketability, prudently using a variety of incentive programs, and focusing on the satisfaction of current residents. Strong expense management through select reduction of services, improvement in vendor pricing,
15、control of labor costs, and reduced capital spending have helped offset lower occupancy and weaker cash flow. Historical concerns in the areas of high employee turnover, increasing labor expenses, and insurance costs have moderated, helping to blunt lower occupancies. Demand in the senior sector rem
16、ains solid. Even during the depth of the market crisis in late 2008 and early 2009, when refill on vacant units slowed to a near halt and potential residents delayed decisions, many Fitch-rated credits reported stable waitlists and solid responses to marketing efforts. Key Credit Rating Drivers The
17、current economic recovery continues; a retreat from the recovery could intensify rating pressure on the sector as many senior living providers began the year with thinner financial cushions and less financial flexibility. Senior living providers with LOC exposure are able to successfully refinance o
18、r renew their expiring LOCs, without a materially detrimental impact to their cost of capital and ability to service such debt. Senior living providers access to the capital markets continues to normalize. Strong management practices continue to mitigate stress on occupancy levels. 2009 Review and O
19、utlook During 2009, within the senior living/long-term sector, Fitch affirmed 48 ratings, downgraded five ratings, and upgraded one rating. Five Rating Outlooks were revised to Negative from Stable. In 2009, affirmations were overwhelmingly the most common rating action, and Fitch expects this to co
20、ntinue in 2010. Fitch also expects to see some stabilization from the downward trends experienced over the past 1218 months, reflecting an expectation that the worst of job losses and home-price devaluation is behind us. The greatest credit risks Fitch sees in the sector in the coming year are LOC r
21、enewals and debt restructuring, combined with weaker balance sheet cushions and lower occupancies. Fitch also believes that proactive management practices in the areas of labor, food and supply costs, marketing and nursing census, and payor mix will be key credit factors in 2010 and beyond. Looking
22、at the senior living sector and the enormous stress its been under during the past 1218 months, a divide becomes clear between established communities, characterized by strong reputations in their service areas, solid historical occupancies, and strong resident allegiances, and start-up and newer fa
23、cilities that have no prior tie to the local service area. While the industry has been negatively affected by several start-up facilities that have struggled with pre-sales and occupancy, Fitchs investment-grade credits, which are generally mature, well established facilities, showed remarkable resi
24、liency, ending the year weaker but with adequate occupancy, liquidity, and operating metrics. 2 2010 Senior Living Outlook March 16, 2010 Public Finance The case of Erickson Retirement Communities provides a good example of the sectors bifurcation between start-up and mature communities. During 2009
25、, Erickson, one of the pioneers in the development and management of nonprofit continuing care retirement communities (CCRCs), filed for bankruptcy protection due to slower than anticipated sales and occupancies at several start-up communities under development and a very tight credit environment. W
26、ithin the same period, Fitch affirmed ratings on three mature communities that Erickson had fully developed and continues to manage under management contracts; most recently, in early 2010, Fitch placed one on Positive Rating Outlook. For 2009, each of these facilities maintained high levels of occu
27、pancy while reporting solid operating performance. With the very tentative return of start-up new issuance in late 2009, 2010 could prove to be a critical year for the re-emergence of start-up CCRCs. 2010: Fundamental Sector Drivers Credit Markets/Liquidity Dislocations in the credit markets and tur
28、moil in the financial markets have significantly stressed the senior living sector over the past 18 months. At the most acute period of distress, almost all senior living providers were locked out of the credit markets, with issuance virtually non-existent. Providers with LOC-backed variable-rate bo
29、nds dealt with increased interest expense resulting from downgrades of LOC providers and rising fees. Additionally, negative returns on investment portfolios shook many balance sheets. Some providers violated debt service coverage covenants as a result of realized losses on investments, inclusion of
30、 impaired investments in debt service calculations, or, in rare instances, inclusion of unrealized losses in debt service coverage calculations. In its analysis, Fitch tended to see through these credit events to the underlying operational strength of a provider, namely, its occupancy, operating mar
31、gins, and liquidity relative to expense needs. However, the rate violations often provided an opportunity for LOC providers, especially those interested in exiting the senior living market, to rework the terms of the LOC, raising fees and tightening covenants. Fitchs 2009 medians (based on 2008 audi
32、ts) reflect the weakened balance sheets as days cash on hand (DCOH), the cushion ratio, and cash to debt for Fitchs investment-grade providers dropped from the 2008 medians (based on 2007 audits). The 2009 median for DCOH dropped to 390 days from 462 days in 2008, while the cushion ratio of 9.1x and
33、 cash to debt of 65% were down from 10.2x and 75.5%, respectively, in the prior year. However, the 2009 median liquidity ratios are in line with 10-year historical averages, which stood at 380 DCOH, 8.7x cushion ratio, and 71.5% cash to debt for Fitchs investment-grade facilities. The fact that prov
34、iders received such a significant shave off liquidity measures yet remained within the boundaries of historical liquidity figures reflects the solid balance sheets that Fitchs investment-grade facilities have built in recent years. For 2010: Despite the normalizing of credit and financial markets, s
35、hort-term volatility and an overall retreat from the current recovery remain concerns, especially given the thinner financial cushions of many senior living providers. Fitch expects to continue to see more conservative investment portfolios, especially relative to debt structure and “put” risk, with
36、 those facilities with outsized risks in their investment portfolios and/or debt structure facing possible negative rating pressure. 2010 Senior Living Outlook March 16, 2010 3 Public Finance Many of Fitchs Negative Rating Outlooks in 2009 were related to LOCs expiring in the upcoming year, often co
37、mbined with cash-to-debt figures below 1.0x for the LOC-backed debt. For providers with exposure, the resolution of this situation (through renegotiated LOCs with tenable terms, new LOCs, or the fixing out of debt) will be a key rating determinant. As many providers look to enter the market to remed
38、iate variable-rate debt and fund new capital projects, the continued normalization of the capital markets will be a factor in maintaining sector stability. Occupancy/Cash Flow Historically, Fitch has viewed the consistent cash flow generated through monthly maintenance fees on independent living uni
39、ts (ILUs) and actuarially steady unit turnover as credit strengths of the senior living sector. Steady monthly income, combined with manageable expenses, should provide for stability with net CCRC entrance fees (the difference between funds brought in by unit turnover and refunds provided on those u
40、nits) further supporting cash flow. This view has been severely tested over the past 12-18 months as housing-price deflation, combined with the negative returns that many potential residents experienced in their investment portfolios, slowed the rate of unit turnover and entrance fee collections. Wh
41、ile 2009 was as difficult an operating year as the sector has experienced, Fitchs investment-grade providers showed remarkable resiliency. The median operating ratio weakened to 99.6% in 2009 from 92.1% in 2007 but still remained below 100%, the point at which operating expenses would exceed residen
42、t revenue. Additionally, the median adjusted operating margin, which factors in net entrance fees, improved to 16.8% from 15.4%, year over year. Moreover, occupancy, while stressed, held up. Many credits have rolling occupancy covenants, and most did not have violations in 2009. Management and marke
43、ting teams implemented a variety of creative incentive programs to get potential residents to move in, helping to support occupancy. Many programs were limited in scope and duration. Among the various incentive programs, Fitch saw the following used: Promissory note programs that provided interest-f
44、ree notes for 6090 days, giving residents a window within which to sell their houses while occupying a unit. Promissory notes represented, at most, less than one-quarter of resold units, and these programs were combined with appraisal services that assessed the marketability of the houses and other
45、real estate and moving-support services. Offers of two to three months of free residency upon move in, a reduction in entrance fees, or unit customization (such as cabinetry and appliances) for a reduced price or for free. Providers that offered such incentives generally proposed only one type and f
46、or a limited period, for example, by offering a 10% discount on entrance fees for the last two months of the year, a particularly slow time, as an incentive before new-year price increases. Fitch believes the factors that contributed to resilient occupancy within its investment-grade credits were th
47、e maturity of CCRC communities, as reflected in a strong reputation in the local area, and average entrance fees that compared well with local real estate prices, even in areas that experienced real estate market declines. Over the years, many of these mature facilities had modest yearly entrance fe
48、e increases, keeping the fees comfortably within the range of local real estate prices. Even as real estate prices appreciated significantly in certain markets, most providers raised entrance fees only modestly, which provided a measure of cushion when those local 4 2010 Senior Living Outlook March
49、16, 2010 Public Finance area housing prices dropped. Moreover, the demographic profile of potential CCRC residents consists of senior citizens who own debt-free houses, with home values that have remained above the prices paid, despite any recent market fluctuations. For 2010, Fitch expects the following: Cash flow should remain stable. Occupancy will remain stable as the financial markets continue to stabilize and pot
