OREANDA-NEWS. Fitch Ratings has affirmed the 'A' rating on implied general revenue bonds of Royal Oaks Life Care Community's (Royal Oaks). Royal Oaks only has direct bank loans outstanding ($39.5 million series 2014A&B).

The Rating Outlook is Stable.

SECURITY

The series 2014A&B bonds are direct bank loans and secured by various assets of People of Faith, Inc. dba Royal Oaks Life Care Community including a mortgage pledge. The assets include cash and deposit accounts.

KEY RATING DRIVERS

WEAKER FINANCIAL PERFORMANCE IN FISCAL YEAR (FY) 2016: After consistently strong financial performance, Royal Oaks' financial profile weakened in fiscal 2016 (Feb. 29 fiscal year end) due to the impact of the opening of its new memory care building (Friendship House) in May 2015. Although the project is viewed favorably and is a strategic investment for the long term marketability of the community, the near term impact was negative. Profitability and debt service coverage declined in fiscal 2016 compared to prior years.

PRESSURED REVENUE: The opening of Friendship House resulted in a slight decline in resident service revenue in fiscal 2016. Although this was anticipated, a sustainment of this trend would be viewed negatively. Management is in the process of developing a master facility plan, which is expected to generate incremental revenue growth.

GOOD LIQUIDITY: Despite poor investment performance, liquidity metrics remained solid and compared favorably to Fitch's 'A' category medians. Days cash on hand and cash to debt were 1,013 and 163.3%, respectively at Feb. 29, 2016 compared to the A category medians of 681 and 125.1% but down from the prior year with 1,192 and 173.8%.

STRONG OCCUPANCY: Royal Oaks' Independent living unit (ILU) occupancy has been consistently strong the last three years after hitting a low in October 2011. The community benefits from its location in a retirement destination, Sun City, and the vast majority of prospective residents are from resident referrals. Management has been reinvesting in its plant and 70% of its ILUs have been upgraded and renovated upon unit turnover. ILU occupancy was 94.8% in fiscal 2016, 95.8% in fiscal 2015 and 94.2% in fiscal 2014.

CAPITAL STRUCTURE RISKS: All of Royal Oaks' outstanding debt is placed with a bank and is at an indexed floating rate. The bonds have a mandatory tender date in May 2024. Fitch believes Royal Oaks' liquidity position somewhat mitigates these risks.

RATING SENSITIVITIES
MASTER FACILITY PLAN: Royal Oaks is in the process of developing a master facility plan. Fitch will evaluate the impact of the plan when details are available, which is expected by the end of the year. There is no additional debt capacity based on current performance and continued performance similar to fiscal 2016 levels could result in negative rating pressure.

CREDIT PROFILE
People of Faith, Inc. d/b/a Royal Oaks (the Corporation) is a Type A continuing care retirement community (CCRC) with 360 ILUs, 59 assisted living units (ALUs), 56 memory care units, and 66 bed skilled nursing facility (SNF) located in Sun City, AZ. The consolidated audit includes People of Faith Foundation, which is excluded from the security of the bonds. The financials cited are for the Corporation only (from consolidating schedule in audit). Total revenue in fiscal 2016 (unaudited) was $27.2 million.

New Memory Care Building and Other Capital Projects
Friendship House opened in May 2015 and was on time and within budget. The total project cost was $16.8 million. The building is two floors with a total of 56 private units and is state of art design with a neighborhood model. The residents historically made up about half of skilled nursing occupancy and with the new facility; management has converted the SNF into 100% private rooms, which resulted in loss revenue of approximately $1.2 million as residents were generally paying a second person fee to convert a semi private to private.

Management is in the process of converting its SNF license to assisted living with various levels of care that can be provided under the assisted living license. Management stated that the level of care will be the same, just under a different license (directed care ALU). In addition, management is developing a master facility plan, which would most likely include a new building for the directed care ALU (demolish existing SNF) and new ILUs. Fitch will evaluate the master facility plan when details are available but expects that the overall project will result in improved cash flow that can offset the loss revenue related to the Friendship House project.

Royal Oaks has been renovating and upgrading the ILUs as they turn over and incoming residents are allowed to customize units (up to 4% of entrance fee) and there is a design center on site. The total capital budget for fiscal 2017 is $3.7 million with $1.2 million earmarked for the apartment remodels.

Weakened Financial Performance
Royal Oaks' overall financial profile has historically been very strong but weakened in fiscal 2016. Profitability deteriorated in fiscal 2016 with operating ratio increasing to 114.4% from 100.4% in fiscal 2015 and 100.8% in fiscal 2014. Net operating margin adjusted declined to 17.5% from 22% and 23.7%, respectively. Royal Oaks implements consistent rate increases, however, resident service revenue dropped to $17.9 million in fiscal 2016 from $18.1 million the prior year.

Net turnover entrance fees have been healthy at $8.7 million in fiscal 2016 compared to $7 million in fiscal 2015 and $7.2 million in fiscal 2014. Royal Oaks' actuarial study projects ongoing turnover of about 32-35 units a year, which would result in net entrance fees around $6 million. Royal Oaks does not offer a refundable residency contract.

Good Liquidity
At Feb. 29, 2016, unrestricted cash and investments totaled $64.6 million compared to $67.1 million the prior year and $45.3 million in fiscal 2012. Liquidity metrics are solid and are very strong when including the Foundation. Unrestricted cash and investments including the Foundation totaled $77.9 million at Feb. 29, 2016 that equated to 1,223 days cash on hand and 197.1% cash to debt.

Debt Profile
In May 2014, Royal Oaks refinanced all of its outstanding debt and added $15 million new money through a direct bank loan. Financial covenants under the bank documents include 1.25x debt service coverage and 70% cash to debt.

Maximum annual debt service (MADS) is $2.5 million and debt service is structured with a final maturity in fiscal 2034 (series 2014A; refunding) and fiscal 2040 (series 2014B; new money). MADS accounted for 9% of total revenue in fiscal 2016 compared to the A category median of 9.2%. Debt service coverage declined to 2.9x in fiscal 2016 compared to 4.2x in fiscal 2015 and 3.9x in fiscal 2014. Fitch will evaluate any additional debt plans, however, there is no additional debt capacity based on current performance.

DISCLOSURE
Royal Oaks does not provide public disclosure since all of the debt is privately held. Royal Oaks has been providing quarterly and annual disclosure to Fitch with access to management.