OREANDA-NEWS. Fitch Ratings has assigned a 'BBB+' rating to the expected issuance of \$145.5 million of Cumberland County Municipal Authority (PA) revenue bonds, series 2015 to be issued on behalf of Diakon Lutheran Social Ministries (Diakon).

In addition, Fitch affirms the 'BBB+' ratings on the following Cumberland County Municipal Authority (PA) bonds issued on behalf of Diakon:.

--\$121,260,000 revenue refunding bonds, series 2009;
--\$61,955,000 revenue bonds series, 2007A.

The Rating Outlook is Stable.

The series 2015 bonds are expected to be issued as fixed rate debt. Bond proceeds will be used to refund the 2007A bonds, a portion of the 2009 bonds and pay costs of issuance. Pro forma maximum annual debt service (MADS) of \$16.5 million was provided by the underwriter and is down from prior MADS of \$17.5 million. The bonds are expected to price via negotiation the week of May 4.

SECURITY: Gross receipts of the obligated group (OG), a mortgage of certain properties, and a debt service reserve fund on the remaining series 2009 bonds, following the issuance of the 2015 bonds.

KEY RATING DRIVERS

STEADY FINANCIAL RESULTS: Diakon's financial profile remains stable and is characterized by good debt service coverage, adequate operational performance and liquidity, and solid net entrance fee receipts. In addition, Diakon's debt profile is conservative with approximately 70% fixed-rate debt, adding a further measure of stability at the current rating level.

IMPROVING IL OCCUPANCY: Independent living occupancy (IL), which had fallen to 83% in fiscal 2010 has improved to 89% at Feb. 28, 2015. The improvement in occupancy reflects the effects of Diakon's strong capital investments, especially at Luther Crest, and revamped marketing efforts across the system over the last few years. Personal care and skilled nursing occupancy remained above 90%, consistent with the three-year historical period.

IMPROVING SENIOR LIVING FACILITIES PERFORMANCE: Diakon continues to focus on a number of initiatives to strengthen the core performance of the OG. Diakon recently established a new entity outside the OG that will house most of Diakon's social service programs. Fitch views this restructuring positively, believing it better positions Diakon's senior living services and its social services to maximize their operational effectiveness.

REGIONAL DIVERSITY AND SIZE. Fitch believes Diakon's level of geographic diversity (8 OG campuses located in separate Pennsylvania markets) and its size (more than \$200 million in consolidated operating revenue) enable Diakon to maintain consistent levels of performance even if individual campuses are underperforming or undergoing significant capital projects.

RATING SENSITIVITIES

SUSTAINING OPERATING PERFORMANCE: Fitch believes Diakon's current level of performance will remain stable. Stronger debt service coverage coupled with liquidity growth could lead to positive rating action. Conversely, a sustained period of weaker operating performance leading to weaker debt service coverage could lead to negative rating pressure.

CREDIT PROFILE
Diakon Lutheran Social Ministries, headquartered in Allentown, PA, is composed of 969 skilled nursing beds, 531 personal care beds and 903 ILUs located in Pennsylvania and Maryland. Total OG operating revenue in FY 2014 was \$208.3 million. Fitch's analysis is based on the OG, which consists of the senior living campuses located in PA and currently represents the vast majority of the consolidated entity's assets and income.

Financial Profile
In 2014, Diakon generated a 99.4% operating ratio, a 9.7% net operating margin - adjusted, and 1.8x coverage of pro forma MADS compared to Fitch's respective 'BBB' category medians of 97.4%, 20.4%, and 2x, respectively. Financial results in 2014 are above the prior year period and reflect strong top-line revenue growth. Resident service revenue in 2014 increased a robust 8.8% compared to 3.4% in the prior year. The revenue growth was driven by the further improvement in IL occupancy. In addition, Diakon's total available IL units stood at 903 at Feb. 28, 2015 up from 896 at Dec. 31, 2013, and Diakon filled these additional units while keeping IL occupancy at 89%.

The solid operating year in 2014 produced pro forma debt service coverage of 1.8x and revenue-only coverage of 1.1x. Two-month interim results show the operational performance remaining steady, with net entrance fees up slightly year over year. Debt service coverage was thin at 1.2x but was not a concern as Fitch expects entrance fee receipts to get stronger as the year progresses.

Unrestricted cash and investments remain adequate. At Feb. 28, 2015, Diakon had \$108.1 million in unrestricted cash and investments, which equated to 213 days cash on hand (DCOH), a 6.5x cushion ratio, and 47.1% cash to debt, all of which trail the respective 'BBB' category medians. DCOH continues to be suppressed by approximately \$48.7 million in expenses related to Diakon's administration of a state adoption contract.

Update on Initiatives
On July 1, 2014, Diakon moved most of its social service programs outside the OG. Fitch believes the change will have a positive impact on the OG performance and will help position the social service programs to be more financially sustainable, especially as related to grants and philanthropy. Historically, Fitch has used Diakon's consolidated financial statements for its analysis; however, with this review Fitch will base its rating largely on the OG performance, while also evaluating the activities and performance outside the OG that could impact OG performance.

Diakon continues to undertake a number of revenue enhancing initiatives. Results remain positive with the census remaining strong and Diakon maintaining its patient acuity levels and its Medicare census, which remained above 10% in the two-month interim period.

Debt Profile
Diakon's debt structure is relatively conservative. Its \$229.3 million in long-term debt is approximately 70% fixed and 30% variable. In 2014, Diakon refinanced much of its letter of credit (LOC) variable-rate debt with a \$41.5 million private placement with PNC Bank. The remaining \$29 million in variable-rate debt is supported by an LOC from M&T Bank, with an expiration date in 2019.

To hedge its variable-rate exposure, Diakon has two variable- to fixed-rate swaps, one each with Wells Fargo and PNC Bank, for a total notional amount of \$71.4 million. The mark-to-market valuation as of March 31, 2015 was a negative \$10.8 million. There are no collateral posting requirements for Diakon.

Diakon's debt burden remains relatively manageable. Pro forma MADS as percent of 2014 revenue is low at 7.9%. Removing the revenues from the state adoption progam increases MADS as a percent of revenue to 10.4%, which is still below the 'BBB' category median of 12.3%. Debt to EBITDA is slightly elevated at 7.7x, relative to a median of 6.3x.

Diakon's spending on capital has been very strong over the last five years, with capital spending as a percent of depreciation remaining materially above the category median of 79.7%. It was at 99.5% in 2014. Diakon's average age of plant of 11.1 years is also below the category median of 11.7 years. The capital spending, which was funded by a combination of bond funds and equity contributions, has supported projects that have improved the marketability of various campuses, as well as funded a system-wide electronic medical record. The largest of these projects was a \$75 million campus repositioning project at Luther Crest, which included a cottage expansion, which is completely filled, and other major campus upgrades. Over the near term, Fitch does not expect projects as large as the Luther Crest repositioning project but expects capital spending to remain above the category median as Diakon continues to invest in its campuses to remain competitive.

Disclosure
Diakon covenants to disclose annual audited financial statements and quarterly disclosures. Diakon has voluntarily held quarterly investor calls and posts all of its disclosure via EMMA, which includes quarterly financial statements (balance sheet, income statement, and statement of cash flows), detailed utilization trends, and payor mix trends.