OREANDA-NEWS. April 04, 2016. Fitch Ratings has affirmed the 'BBB-' rating on approximately \\$74.1 million of bonds issued by the Bexar County Health Facilities Development Corporation on behalf of Army Residence Community (ARC).

The Rating Outlook is Stable.

SECURITY

Bond payments are secured by a gross revenue pledge. A fully funded debt service reserve fund and a mortgage deed of trust provide additional security.

KEY RATING DRIVERS

EXPANSION PROJECTS COMPLETED: ARC completed a series of expansion projects with the completion of 24 new independent living unit (ILU) cottages in summer 2015. In total, the expansion projects added 84 new ILU cottages and 48 new assisted living units (ALUs) since 2009, significantly contributing to 67.8% revenue growth through fiscal 2015.

CONTINUED IMPROVEMENTS IN PROFITABILITY: Operating profitability continues to improve with operating ratio decreasing to 109.6% in fiscal 2015 and 104.3% in the six-month interim period ending Dec. 31, 2015 (the interim period), reflecting the benefits of the expansion projects and operating improvement initiatives. Net operating margin-adjusted remains strong at 25.2% in fiscal 2015 and 25% in the interim period, exceeding Fitch's 'BBB' median of 19.3%.

HIGH DEBT BURDEN: While moderating over the past five years due to revenue growth, ARC's debt burden remains high with maximum annual debt service (MADS) equal to 19.2% of revenue in fiscal 2015. Reflecting the high debt burden, MADS coverage remained adequate at 1.6x in fiscal 2015 and 1.4x in the interim period despite the improved operating profitability. However, revenue-only MADS coverage remained light at 0.5x.

STRONG DEMAND: Demand remains strong as evidenced by ARC's successful fill up of its expansion projects, robust wait list and strong occupancy rates.

MIXED LIQUIDITY METRICS: Liquidity metrics remain mixed with a solid 396 days cash on hand and with light cash to debt and cushion ratio, equal to 34.2% and 4.9x respectively, reflecting ARC's heavy debt burden.

RATING SENSITIVITIES

SUSTAINED OPERATING IMPROVEMENT: Now that Army Residence Community has completed its expansion projects, Fitch expects the continued focus on operations to further improve profitability while improving liquidity and coverage metrics to levels more commensurate with the rating level. ARC's high debt burden and mixed liquidity metrics allow little room for deterioration in profitability and debt service coverage at the current rating.

CREDIT PROFILE

ARC, located in San Antonio, TX, is a Type-A continuing care retirement community for retired military officers with 468 ILUs, 78 ALUs, and 91 nursing care beds (including 18 dementia care beds). Total operating revenue equaled \\$32 million in fiscal 2015.

ARC's CEO retired in 2014 and was replaced by Mary Garr, who became ARC's third-ever CEO in October 2014. Prior to joining ARC, Colonel Garr (ret) served in the U.S. Army's Medical Service Corps for over 30 years, most recently as garrison commander of Fort Sam Houston, managing all of the base's operations including all facilities, dining and services. Fitch views her prior management experience favorably.

ARC's primary credit strengths continue to include its unique market niche and strong demand for services. ARC exclusively serves retired military officers who have stable pension income and solid healthcare benefits, which Fitch views as a credit positive.

EXPANSION PROJECTS COMPLETED

Beginning in 2009, ARC undertook a series of significant expansion projects, the final phase of which added 24 new ILU cottages and was completed in summer 2015. During the expansion projects, ARC materially increased its debt burden while increasing its revenue base 67.8%, from \\$19 million in fiscal 2009 to \\$32 million in fiscal 2015. The expansion, which occurred in three distinct phases, added a total of 84 new ILU cottages (32 in 2010, 28 in 2012 and 24 in 2015) and 48 new ALUs which opened in 2012 and were filled in 2013. The new units are larger than the existing legacy units and should be more accretive to profitability. ARC has no plans for further expansion in the foreseeable future.

CONTINUED IMPROVEMENTS IN PROFITABILITY

With the expansion projects winding down, management turned its focus upon improving operating profitability in fiscal 2014. Operating ratio decreased from a high 119.6% in fiscal 2013 to 111.4% in fiscal 2014, 109.6% in fiscal 2015 and further improved to 104.3% in the interim period. The continued improvement reflects the increased revenue generated from the new phase II and phase III ILUs, sustained ALU operations at capacity and cost management initiatives.

During this period, net operating margin improved from negative 4.2% in fiscal 2013 to positive 4.4% in fiscal 2015 and positive 10% in the interim period and now compare favorably to Fitch's 'BBB' category median of 8.9%. Solid entrance fee generation has produced strong net operating margin adjusted of 25.2% in fiscal 2015 and 25% in the interim period. Fiscal 2015 operations included only a portion of the benefit of the 24 phase III expansion units. Profitability should benefit from the full impact going forward.

HIGH DEBT BURDEN

ARC's debt burden remains high but has moderated over the past five years, with MADS decreasing from 26.1% of fiscal 2011 revenue to 19.2% of fiscal 2015 revenue, reflecting the revenue growth associated with the expansion but remaining significantly above Fitch's 'BBB' category median of 12.4%. The high debt burden is a primary credit concern and will require operating profitability to remain at the improved levels to support adequate debt service coverage.

MADS coverage moderated somewhat from 1.9x in fiscal 2014 to 1.6x in fiscal 2015 and 1.4x in the interim period, comparing unfavorably to Fitch's 'BBB' category median of 2.0x. The decreased coverage reflects decreased net entrance fees generated from turnover of existing units and is partially due to the successful sale of the new phase III ILUs. Fitch expects that MADS coverage will improve as ARC begins to benefit from turnover entrance fee generation from its larger ILU base. Revenue-only MADS coverage of 0.5x in fiscal 2015 and the interim period remains weak relative to Fitch's 'BBB' category median of 0.9x. However, management's sustained focus on operating improvements and increased revenue from the new Phase III ILUs should improve this metric.

STRONG DEMAND

The demand for ARC's services remains strong and is a primary credit strength. The strong demand is evidenced by ARC's deep priority wait list of 397 prospective residents, the quick fill up of expansion units through all three phases of ARC's expansion projects and strong occupancy. ILU occupancy decreased from 96.4% at Dec. 31, 2014 to 91.7% at Dec. 31, 2015 due to the addition of the 24 new ILU cottages but remains solid. Fitch expects that ILU occupancy will improve as legacy units are filled given ARC's strong wait list. Additionally, ALU occupancy remains strong at 95%.

MIXED LIQUIDITY METRICS

Unrestricted liquidity continued to decrease from \\$35.8 million at Dec. 31, 2014 to \\$30.9 million at Dec. 31, 2015. The decrease was due to ARC's continued reinvestment in its campus, including the phase III expansion and renovations of legacy units, in addition to some unrealized investment losses. Days cash on hand remains solid at 396 days and is consistent with Fitch's 'BBB' median of 400 days. However, cash-to-debt of 34.2% and cushion ratio of 4.9x remain light relative to Fitch's 'BBB' category medians of 60% and 7.3x. Fitch expects that liquidity metrics will improve as no new major projects are planned.

DEBT PROFILE

ARC had approximately \\$90.5 million of total debt outstanding at Dec. 31, 2015. The debt portfolio is comprised of 83% underlying fixed rate bonds and 17% underlying variable rate bonds. The community is not counterparty to any swaps.

DISCLOSURE

ARC covenants to provide annual disclosure within 120 days of each fiscal year-end and quarterly disclosure within 45 days of the first three fiscal quarters. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA system.