OREANDA-NEWS. August 17, 2015. Fitch Ratings has affirmed the 'BBB+' rating on the following bonds issued by North Carolina Medical Care Commission on behalf of Arbor Acres United Methodist Retirement Community (Arbor Acres):

--\\$16.43 million, series 2007 first mortgage revenue bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by gross revenues, security interest in the residency agreements, a first mortgage, and a debt service reserve fund.

KEY RATING DRIVERS

STABILIZED CASH POSITION: Unrestricted liquidity balances are stable after an elevated period of capital spending and the receipt of initial entrance fees from independent living unit (ILU) expansions. As of June 30, 2015, \\$19.8 million of unrestricted cash and investments amounts to 315 days operating expenses or 45.9% of long-term debt.

VERY GOOD OCCUPANCY: Demand at Arbor Acres remains healthy with average occupancy of 94% in the ILUs, 95% at the assisted living units (ALUs), and 94% in the skilled nursing facility (SNF) during fiscal 2014. Additionally, from 2011 through 2013, Arbor Acres successfully filled 55 new ILUs. For the first six months of fiscal 2015, occupancy has been relatively stable.

MODEST OPERATING PERFORMANCE: Arbor Acres' consistent occupancy levels, facility improvements, and ILU expansions supports modest operating performance. After weaker performance in fiscal 2011 and 2012, the net operating margin was 0.9% and break-even, respectively, in fiscals 2013 and 2014.

MANAGEABLE DEBT BURDEN: After the planned drawdown of a bank loan, pro forma maximum annual debt service (MADS) represents 13.3% of total revenue in fiscal 2014, which is slightly above Fitch's 'BBB' category median of 12.3%. Additionally, the adjusted debt to capital ratio of 46.5% is below the 59% 'BBB' category median.

UNCOMMITTED CAPITAL STRUCTURE: After drawing down \\$7.5 million from a bank loan, Arbor Acres will have about \\$50 million of debt outstanding, of which \\$34 million will be direct-placement bank obligations. Fitch views this level of bank debt with refinancing risk aggressive given Arbor Acres' light unrestricted liquidity relative to debt.

RATING SENSITIVITIES

CAPITAL SPENDING PLANS: After an elevated period of capital spending, Arbor Acres is embarking on an \\$11.25 million project to renovate and expand its SNFs. Any additional debt above the new taxable bank loan or a reduction in unrestricted cash balances, could negatively pressure the rating.

MAINTENENACE OF OPERATING PROFILE: The 'BBB+' rating assumes that Arbor Acres maintains it solid occupancy levels and continues to improve operating profitability, particularly after the SNF expansion project is complete. If operating performance is not sustained and profitability levels do not continue to improve, negative rating pressure may occur.

CREDIT PROFILE

Arbor Acres is a Type-C (fee-for-service) continuing care retirement community located on 82 acres in Winston-Salem, North Carolina. Arbor Acres has a total of 420 units, up from 393 in 2011. The unit mix includes 266 ILUs, 93 ALUs (66 ALU and 27 memory care units) and 61 SNF beds. Favorably, ILU resident agreements include non-refundable entrance fees with a declining balance over time. Additionally, the SNF is 100% private pay, which Fitch views positively.

Last September, Fitch downgraded Arbor Acres' bond rating to 'BBB+' from 'A-' primarily as a result of the continued heavy capital spending that increased its debt profile and suppressed the unrestricted cash position from historical levels. The downgrade also anticipated Arbor's Acres proceeding with the SNF renovation project and proposed additional debt issue.

STABILIZED LIQUIDITY

After a heightened period of capital spending, unrestricted liquidity balances are stable. As of June 30, 2015, \\$19.8 million of unrestricted cash and investments amounts to 315 days operating expenses or 45.9% of long-term debt. Both metrics are below Fitch's 'BBB' category medians of 408 days and 60.2%, respectively, but are adequate given Arbor Acres mostly non-refundable fee-for-service residency agreements. Additionally, Arbor Acres enjoys a favorable history of fundraising and holds over \\$10 million of restricted funds to support operations and capital spending projects.

SOLID FINANCIAL PERFORMANCE AND POSITION

Arbor Acres' very good occupancy levels, investments in facilities and ILU expansions has resulted in modest operating performance and improved cash flow. After weaker performance in fiscal 2011 and 2012, the net operating margin was 0.9% and break-even, respectively, in fiscals 2013 and 2014. Additionally, the operating ratio remained below 100% in each of the last four fiscal years. During the six-month interim period for fiscal 2015, the net operating margin improved to 1.9% mostly due to staffing reductions and better charity care cost controls. Healthy receipt of net entrance fees from turnover ILUs has resulted in better cash flow, with annual improvements in the adjusted net operating margin, debt to net available, and pro forma MADS coverage over the past four years. In fiscal 2014, 1.9x pro forma MADS coverage is nearly equal to Fitch's 'BBB' category median of 2.0x. Through the first six months of fiscal 2015, coverage of pro forma MADS (\\$3.75 million) increased to 2.6x.

MANAGEABLE DEBT BURDEN

In fiscal 2014, pro forma MADS represented 13.3% of total revenue compared to Fitch's 'BBB' category median of 12.3%. Arbor Acres recently executed a \\$9 million draw-down bank loan to partially fund the modernization and expansion of its SNF which Fitch was aware of in our prior rating action. This level of new debt is a neutral rating factor, since it only modestly affects capital-related metrics at the 'BBB' category. Additionally, Arbor Acres anticipates using only about \\$7.5 million of the draw-down loan with the remaining project costs funded by a capital campaign that has already raised \\$3.8 million. Furthermore, Fitch views the project favorably, since the renovated SNF should enhance the community's marketability and support demand.

UNCOMIITTED CAPITAL STRUCTURE

After drawing down \\$7.5 million of the taxable bank loan, Arbor Acres will have about \\$50 million of debt outstanding, of which \\$34 million will be direct placement bank obligations with two providers. The \\$27 million series 2010 bank loan with BB&T is at an indexed floating rate with a mandatory put on Dec. 20, 2023. To hedge a portion of the interest rate risk, Arbor Acres entered into an \\$18.5 million swap. The new \\$9 million bank loan with First Tennessee is at an indexed variable interest rate with a maturity of July 1, 2025. The bank bonds and series 2007 bonds are parity obligations and include the same financial covenants. Fitch views this level of bank debt with interest rate, counterparty, and refinancing risk as aggressive given Arbor Acres' 'BBB' category credit quality and light unrestricted liquidity relative to debt.

DISCLOSURE

Arbor Acres covenants to provide annual audited financial statements within 120 days of its fiscal year end and unaudited financial statements within 30 days of each fiscal quarter.