Fitch Affirms Army Residence Community's (TX) Revs at 'BBB-'; Outlook Revised to Stable

Fitch Ratings has affirmed the rating on the following bonds issued by the Bexar County Health Facilities Development Corporation on behalf of Army Residence Community (ARC) at 'BBB-':

--$52,655,000 million series 2010 revenue bonds;

--$23,945,000 million series 2007 refunding revenue bonds.

The Rating Outlook is revised to Stable from Negative.

SECURITY

Bond payments are secured by a gross revenue pledge. A fully funded debt service reserve fund and a mortgage deed of trust provide additional security.

KEY RATING DRIVERS

IMPROVED OPERATING PROFITABILITY: The Rating Outlook revision to stable reflects improvements in operating profitability in fiscal 2013 and the six month interim period ending Dec. 31, 2013 (the interim period) as some of the benefits of recent expansion projects have started to be realized. Net operating margin adjusted increased to 19.9% in fiscal 2013 and 28% in the interim period from 12.8% in fiscal 2012, relative to Fitch's 'BBB' median of 21.3%.

HIGH DEBT BURDEN: With maximum annual debt service (MADS) equal to 22.4% of revenue in fiscal 2013, ARC's debt burden remains very high. Despite the improved profitability, MADS coverage remains light at 1.3x in fiscal 2013 relative to Fitch's 'BBB' category median of 1.9x. Coverage further improved to 1.6x in the interim period.

STRONG DEMAND: Demand remains strong as evidenced by ARC's successful fill up of its phase I and phase II expansions, robust wait list and improved occupancy rates. ILU occupancy increased from 89.4% in fiscal 2012 to 93.3% at Dec. 31, 2013, including the addition of 28 new ILU cottages.

IMPROVING LIQUIDITY METRICS: Unrestricted liquidity increased 53% since June 30, 2012 to $40.3 million at Dec. 31, 2013 primarily due to a combination of entrance fee generation and investment gains. Despite the large increase, liquidity metrics remain mixed with a strong 537.7 days cash on hand and a light 43.5% cash to debt.

RATING SENSITIVITIES

SUSTAINED OPERATING IMPROVEMENT: Fitch expects that ARC's operating profitability and cash flow will continue to improve as the community realizes the benefits of its significant expansion projects, thereby continuing to strengthen MADS coverage. ARC's high debt burden requires continued profitability improvement to provide coverage consistent with the 'BBB' category.

CREDIT PROFILE

ARC is a Type-A continuing care retirement community (CCRC) for retired career military officers located in San Antonio, TX with 445 ILUs, 78 ALUs, and 91 nursing care beds (including 18 dementia care). Total operating revenue equaled $26.7 million in fiscal 2013. ARC's primary credit strengths continue to be its unique market niche and strong demand for services. ARC exclusively serves retired military officers who have stable pension income and solid healthcare benefits which Fitch views as a credit positive.

IMPROVED OPERATING PROFITABILITY

After an unexpected deterioration in fiscal 2012, operating profitability improved in fiscal 2013 and continued to strengthen in the six-month interim period ending Dec. 31, 2013 (the interim period). While operating ratio remained relatively stable at a high 118%, net operating margin and net operating margin adjusted improved to negative 4.1% and positive 19.9% in fiscal 2013 relative to negative 11.3% in and 12.8% in fiscal 2012. The improvement was due to the fill up of both the new ALUs that opened in 2012 and the phase II ILUs that opened in summer 2013. Profitability continued to strengthen in the interim period with net operating margin increasing to positive 3.5% and net operating margin adjusted increasing to a strong 28% relative to Fitch's 'BBB' median of 21.3%, while operating ratio decreased to 110.4%.

The improved operations indicate that ARC is beginning to realize the benefits of its expansion strategy which began in fiscal 2010 and to date occurred in two phases. Phase I included construction of 32 new ILU cottages in 2010 and 48 new ALUs that opened in 2012. Due to strong demand, ARC built 28 new ILU cottages in 2012. ARC is now embarking on the final phase of its expansion project which includes 24 new ILU cottages which are expected to be completed in spring 2015 for a total cost of $10 million and filled by June 2015. ARC has already received 13 deposits on the 24 phase III ILU cottages. After phase III is completed, ARC does not plan to continue expansion activities.

Operating profitability is expected to continue to improve throughout fiscal 2014. Reflecting a full year of benefit from the phase II expansion cottages and continued expense management, operating ratio is budgeted to decline to 105.7% while net operating margin and net operating margin adjusted are budgeted to increase to 7% and 27.1%, respectively.

HIGH DEBT BURDEN

ARC's debt burden remains very high with MADS equal to 22.4% of revenue relative to Fitch's 'BBB' category median of 12.4% and is a primary credit concern. MADS coverage improved to 1.3x in fiscal 2013 from 0.8x in fiscal 2012 and continued to strengthen to 1.6x in the interim period, reflecting the improved profitability. However, revenue only MADS coverage of 0.3x in fiscal 2013 and 0.4x in the interim period, while improved, remain weak relative to Fitch's 'BBB' category median of 0.9x.

ARC's rate covenant calculation equaled 6.0x in fiscal 2013 and is currently based upon only the series 2007 debt service of $1.8 million. However, starting in fiscal 2014, the rate covenant calculation will be based on total bonded MADS ($6.3 million). The covenant calculation allows for inclusion of initial entrance fees received on new units.

Given the high debt burden, ARC will need to sustain the improvements in operating profitability. Fitch notes that ARC's high debt burden is beginning to decrease as the community's new units have come on-line and its revenue base has increased. MADS as a percent of revenue is budgeted to decrease to 20.5% in fiscal 2014, reflecting the continued growth in ARC's revenue base.

STRONG DEMAND

Demand for services remains strong as evidenced by the deep priority wait list of 420 prospective residents, the quick fill up of expansion units and improving occupancy. Following a low of 89.4% in fiscal 2012, ILU occupancy improved to 93.3% at Dec. 31, 2013, including the 28 new Phase II ILUs. ALU occupancy has continued to strengthen since opening 45 additional units in 2012, increasing from an average of 54.2% in fiscal 2012 to 93.5% at Dec. 31, 2013. Fitch views the strong demand for ARC's services to be a primary credit strength.

IMPROVING LIQUIDITY METRICS

Liquidity metrics remain mixed for the rating category but have improved across the board. Unrestricted cash and investments increased 53% since June 30, 2012 to $40.3 million at Dec. 31, 2013. The increase was due to a combination of entrance fee generation, investment gains and $4 million of reimbursement related to the series 2012A bond issuance. Days cash on hand increased to 537.7 and is strong relative to Fitch's 'BBB' category median. While cash to debt and cushion ratio improved to 44.5% and 6.6x, they remain below Fitch's 'BBB' category medians of 58.9% and 6.9x, respectively. ARC expects to fund its phase III expansion cost of $10 million through unrestricted cash, which should temporarily compress liquidity until associated entrance fee receipts are received.

DISCLOSURE

ARC covenants to provide annual disclosure within 120 days of each fiscal year end and quarterly disclosure within 45 days of the first three fiscal quarters. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA system.

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

Applicable Criteria and Related Research:

--'Not-for-profit Continuing Care Retirement Communities Rating Criteria' (July 10, 2013).

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=712401

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=827457

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