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Fitch Affirms Friendship Village A- Rating

Fitch Affirms Friendship Village of Sunset Hills, MO Revs at 'A-'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A-' rating on the following Industrial Development Authority of the County of St. Louis, MO, issued on behalf of Friendship Village of South County (dba Friendship Village of Sunset Hills, FVSH):

--Approximately $41 million series 2013A bonds;

--Approximately $17 million series 2013B bonds;

--Approximately $26.9 million series 2012 bonds.

The Rating Outlook is Stable.

SECURITY

The bonds will be secured by a pledge of gross revenues of the obligated group, a mortgage on substantially all obligated group property and equipment. The series 2013A bonds are additionally secured by a debt service reserve fund.

KEY RATING DRIVERS

SIGNIFICANT EXPANSION COMPLETED EARLY, WITHIN BUDGET: FVSH is nearing fill up of a major expansion project, which added 78 independent living (IL) units in a two wing apartment building and 10 IL villas. The expansion benefitted from strong presale velocity, with all units presold 120 days prior to construction. Further, construction was completed early and within budget. Wing A began occupancy in July 2015 (10 weeks early) and wing B began occupancy in October 2015. Total initial entrance fees (EF) received to date total $15.5 million, 58% of the projected total EFs. EFs on nine units that have moved in are yet to be collected, and only 10% of the value of the EFs has been received on those units to date.

STRONG OCCUPANCY: FVSH's occupancy has been consistently strong. As of Oct. 31, 2015, occupancy in the expansion was 95% and overall campus IL occupancy was 91%. Assisted living (AL) and skilled nursing (SN) occupancy were strong at 97% and 92%, respectively. Management projects full occupancy of the expansion by end of calendar year.

HIGH LEVERAGE: Maximum annual debt service was 21.4% of 2015 revenues (excludes temporary debt), well above the 'A' category median of 9.2%. Coverage was soft in 2014 and 2015 at 1.1x and 1.9x, respectively; however, actual annual debt service was robust at 12x and 5.2x, respectively. FVSH will be tested on MADS beginning in fiscal 2017, which is projected to be 1.9x.

MIXED LIQUIDITY PROFILE: The rating reflects FVSH's adequate cash position, which provides some flexibility against its high debt level. FVSH had $60.4 million in unrestricted liquidity in fiscal 2015, equating to a solid 1,013 days cash, but its 71% cash to debt and 12.6x cushion ratio were both below category medians. Fitch expects FVSH to pay down $17 million of series 2013B temporary debt using entrance fee proceeds by 2018, which should improve the cash to debt metric.

RATING SENSITIVITIES

CONSISTENT RECEIPT OF TURNOVER ENTRANCE FEES, DELEVERAGING: Given its sizeable debt burden and reliance on turnover entrance fees, Fitch believes FVSH has minimal capacity for volatility in occupancy. Improving debt service coverage and cash to debt metrics are expected to maintain the rating. There are limited capital needs and no additional debt plans.

CREDIT PROFILE

Friendship Village of South County (dba Friendship Village Sunset Hills, FVSH), was incorporated as a Missouri not-for-profit corporation in May, 1976 and currently operates a life care continuing care retirement community on 52 acres in Sunset Hills, MO. Today the community has 381 ILUs, 61 ALUs, and 118 SNF beds. FVSH is located approximately 16 miles southwest of St. Louis, Missouri in the Sunset Hills area.

The obligated group consists of the entire consolidated FVSH entity. Total revenues equaled $22.8 million in fiscal 2015 (year ended June 30). FVSH provides annual disclosure within 150 days of fiscal year end, and quarterly disclosure within 45 days of quarter end.

SIGNIFICANT EXPANSION NEARING FILL-UP

FVSH is nearing fill up of a sizeable campus project, which included construction of new common amenities, the combination of certain apartments, a 78-unit ILU apartment expansion, and 5 additional villas (10 duplex units). Wing A of the IL apartment expansion was completed 10 weeks early and allowed early move-in beginning in July 2015, which management reports allowed net operating margin to come in $100,000 over budget for the first quarter of 2016 (Sept 30). Wing B was predominantly occupied in Oct. 2015, with 4 units unoccupied to date.

The total cost of the project was $43.5 million, below budgeted $46 million and was funded from bond proceeds. The total entrance fee (EF) pool is projected to equal approximately $26.4 million, of which $17 million will be used to pay off the series 2013B debt (due Sept. 1, 2018). Management expects to use the $9.4 million in excess EFs for capital projects or to augment its balance sheet.

The initial EFs are currently held in escrow under state regulations; half of the initial EFs will be released upon occupancy of the new units (from Sept. 2015 - Aug. 2016), and the remainder are amortized at 1% per month from Sept. 1, 2015, thru June 30, 2021. FVSH's original projections were for stabilization at 94% in 2017, which it has already exceeded. No funds have yet been released from escrow and are still in trustee held funds until the temporary debt payment on Sept. 1, 2018.

Fitch believes the project helped position FVSH more competitively within the active St. Louis CCRC market, which has generally favorable demographic and wealth levels. Occupancy projections are well ahead of schedule at 95% in the expansion and 91% across the campus. Original projections had FVSH expansion reaching 84% by end of 2016 and stabilization in 2017 at 94%.

HIGH DEBT

FVSH's debt profile is high and a key factor in the 'A-' rating. Positively, all debt is fixed rate and $17 million will be paid off in 2018. Pay off of temporary debt will help moderate key ratios; Fitch estimates that cash to debt will be stronger at 84% and debt to capitalization will be 65%.

Sunset Hills projects 1.9x coverage of debt service at its lowest point in 2017, when its first full debt service payment occurs. Debt service is level and MADS of $4.8 million excludes the temporary debt. Coverage of MADS in fiscal 2015 was 1.9x due to an unusually high year in turnover EFs compared to 1.1x in fiscal 2014. Actual annual debt service coverage is much stronger at 5.2x in fiscal 2015 and 12x in fiscal 2014.

Fitch believes FVSH will need to incrementally improve coverage in 2018 and beyond to maintain the 'A-' rating.

ADEQUATE THOUGH VARIABLE PROFITABILITY

Operating ratio has been somewhat volatile over the past four years, varying from approximately 90% to 99%; however, operating margin remained positive across all four years. In fiscal 2015, adjusted net operating margin was 28.6%, well above the 'A' category median of 22.2% and driven by an anomalously high year of turnover fees ($11.5 million); net operating margin was soft at negative 1.5%, deteriorating from year prior (3.6%). Growth in operating expenses in fiscal 2015 outpaced revenue growth, though Fitch expects incremental revenue from its expansion project to be accretive to FVSH's financial profile in fiscal 2016 and after. Management reports that fiscal 2016 is seeing an increase in utilization of healthcare services under the lifecare contract, which management hopes to offset with its efforts to increase short-term stays through partnerships and bundled payments.

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

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=994252

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=994252

Endorsement Policy

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

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