OREANDA-NEWS. September 01, 2015. Fitch Ratings has downgraded the rating on the approximately \\$42 million Washington State Housing Finance Commission nonprofit housing revenue bonds series 2007A issued on behalf of Wesley Homes (WH) to BB+ from 'BBB-'.

The Rating Outlook is revised to Stable from Negative.

SECURITY

The bonds are secured by a gross revenue pledge, mortgage pledge and debt service reserve fund of the obligated group (OG).

KEY RATING DRIVERS

INCREASED DEBT BURDEN: The rating downgrade reflects a further increase in WH's debt burden that was expected during Fitch's last review in November 2014 in addition to the risks associated with a planned repositioning project that can pressure operations. WH secured another \\$14 million bank loan that is expected to be used for the beginning phases of a major repositioning project at WH's Des Moines facility. Of WH's total debt - \\$24 million is in a draw down mode and although only \\$5.5 million has been drawn to date, the full amount of bank loan has been incorporated in Fitch's analysis given the ability to draw the full amount.

WEAK LIQUIDITY: Liquidity metrics continue to be weak for the rating category and have been one of Fitch's main credit concerns. Unrestricted cash and investments totalled \\$24.3 million at June 30, 2015 with 253 days cash on hand and cash to proforma debt of only 35% compared to 'BBB' category medians of 408 and 60.2%.

SOLID OCCUPANCY: Occupancy at WH's Lea Hill campus remains very strong with almost 100% occupancy in its ILUs. Occupancy at the WH Des Moines campus is weaker and as of July 2015, occupancy was 90.6% in the ILUs, 88.7% in the ALUs, and 86.8% in the SNF. The Des Moines campus is in need of a repositioning and some units have remained vacant or converted to rentals to prepare for the project.

MAJOR CAPITAL PROJECTS ON THE HORIZON: WH has significant capital plans that include a major rebuilding of the Des Moines campus and two start-up continuing care retirement communities (CCRCs) on land owned in Puyallup and Renton. The current OG debt is callable January 2018 and management intends to restructure the current OG, and these major capital projects will either be financed outside the OG or part of an OG restructuring. Fitch will assess these plans as they are finalized.

RATING SENSITIVITIES

FINANCING OF UPCOMING PROJECTS: Financing plans for the various projects remain in flux and Fitch will assess the impact on the rating as plans are finalized.

CREDIT PROFILE

WH consists of two CCRCs, Wesley Homes Des Moines (WHDM) and Wesley Homes Lea Hill (WHLH). WHDM is a Type B CCRC located in Des Moines, WA (approximately 20 miles south of Seattle) with 68 independent cottages, 245 ILUs (apartment style), 39 ALUs, and 148-bed SNF. WHLH is a Type C CCRC located in Auburn, WA (approximately 10 miles southeast of WHDM) with 22 village homes, 104 ILUs (apartment style), 32 ALUs and 16 memory care units and offers a fully refundable entrance fee model. In fiscal 2014 (Dec. 31 fiscal year-end), total revenue for the consolidated entity was \\$38 million. The OG includes the two CCRCs and the corporate parent. The OG accounted for 87.7% of consolidated assets and 91% of consolidated revenue in 2014. The financial metrics cited in this report are for the consolidated entity.

Solid Occupancy

Occupancy is much stronger at WHLH with ILU occupancy averaging 99.6% in the ILUs for the seven months ended July 31, 2015 compared to the ALUs with 92.3%. Occupancy at WHDM is still solid but lower at 90.7% for ILUs, 92.1% for ALUs, and 90.2% of SNF for the seven months ended July 31, 2015.

Adequate Financial Profile for Rating Level

The rating downgrade is driven primarily by the additional leverage and WH's continued weak liquidity in addition to the risks associated with a planned repositioning project, however, WH's profitability and debt service coverage are solid for its rating level.

Through the six months ended June 30, 2015, operating ratio was very strong at 93.4% compared to 100.8% in 2014 and 96.7% in 2013. Fiscal 2014 performance was impacted by \\$2 million of bad debt expense related to an increase in reserves for billing and collection issues at its home health division and WHDM SNF. Rate increases have been steady and was 3% in 2014 and budgeted to be 3.5% in 2015.

Turnover entrance fees are primarily from WHDM and totaled \\$1.9 million in 2014, \\$2.7 million in 2013, and \\$3.2 million in 2012 and were \\$758,000 through the six months ended June 30, 2015. Fitch used MADS of \\$4.8 million, which assumes the full draw down on the bank loans over a 30-year amortization period (per bank documents). Debt service coverage (calculated by Fitch) was 1.8x through the six months ended June 30, 2015, 1.3x in 2014 and 1.5x in 2013. Per MTI covenant calculations, debt service coverage by the OG was 2.92x for the 12-month rolling period ended June 30, 2015 and 1.95x in 2014.

Major Capital Projects

WH is constructing a 36 bed SNF at WHLH. The project and start up budget is \\$12 million with up to \\$10 million funded from the series 2014 note and the remainder from philanthropy, which has already been raised. The project is expected to be complete by January 2016 and management does not expect the full \\$10 million bank loan will be utilized.

Other major capital projects include a repositioning of the WHDM campus and two potential start up CCRCs in Puyallup and Renton. The Des Moines project is slow in getting started and would be completed in phases, as it would require demolishing the south side of the campus and rebuilding the ILU, ALU, and SNF. Management expects to use the 2015 bank loan to fund the start of the project with the demolition of nine cottages and building 15 replacement cottages, which is scheduled to start in 2016.

Management indicated that the Puyallup start up CCRC will move as quickly as financing is available and several options are being explored including standalone financing. Fitch will monitor these developments; however, a feasibility study has not been completed yet.

There has been no progress on the Renton start up CCRC.

Debt Profile

Total debt outstanding including the entire drawdown of both bank loans is approximately \\$70 million. The \\$10 million series 2014 note is with Washington Federal and has an initial 10-year period and the \\$14 million series 2015 note is with Washington Federal and has an initial 5 year period. There are some additional covenants in bank loans. WH was in compliance with all bond and bank covenants as of June 30, 2015.

Disclosure

WH covenants to provide through the Municipal Securities Rulemaking Board's EMMA system audited financial statements within 120 days of each year end and quarterly unaudited financial statements within 45 days of each quarter end.