OREANDA-NEWS. November 18, 2015. Fitch Ratings has affirmed the 'BBB-' rating on Air Force Villages' dba Blue Skies of Texas (BST) outstanding debt which is listed at the end of this press release.

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are secured by a gross revenue pledge, mortgage pledge, and debt service reserve fund.

KEY RATING DRIVERS

WEAK FINANCIAL PROFILE: The Negative Outlook reflects the lack of meaningful improvement in BST's financial profile over the last several years despite various initiatives to improve marketability and overall occupancy. Despite improved operating performance in fiscal 2015, BST's overall financial profile remains very weak relative to Fitch's 'BBB' category medians and lags its 'BBB-' peer group.

HIGH DEBT BURDEN: Even with improved profitability, coverage remains light for the rating category due to BST's high debt burden and an inability to fill up vacant independent living units (ILUs), particularly at BST East. Maximum annual debt service (MADS) equates to a high 20.9% of fiscal 2015 revenues. MADS coverage equaled a light 1.3x in fiscal 2015 compared to 1.4x in fiscal 2014 and is weak relative to Fitch's 'BBB' category median of 2x.

LIGHT LIQUIDITY: BST's liquidity metrics are light with 298 days cash on hand, 27.3% cash-to-debt and 3.4x cushion ratio at Sept. 30, 2015, comparing unfavorably to Fitch's 'BBB' category medians of 400 days, 60%, and 7.3x, respectively. Furthermore, BST's absolute level of unrestricted cash and investments has declined over the last three years, falling from \\$40.6 million at FYE 2013 to \\$34.1 million at Sept. 30, 2015 reflecting continued capital spending in excess of available cash flow.

LOW ILU OCCUPANCY: While there has been an improvement in net ILU move-ins in fiscal 2015 (+19), BST has seen little improvement in overall ILU occupancy over the last four years. Occupancy in the ILUs was 77% in fiscal 2015 compared to 75% in fiscal 2014, and 77% in both fiscal 2013 and fiscal 2012. ILU occupancy remains low at BST East with 68.2% for FY 2015 compared to BST West with 83.6%. BST East's ILU occupancy has been challenged since the repositioning project completed in 2012. Assisted living and dementia occupancy remained solid at 89.5% and 86.7% in fiscal 2015, respectively, while skilled nursing occupancy increased to 93% from 87.6% in the prior year.

RATING SENSITIVITIES

MATERIAL IMPROVEMENT IN OCCUPANCY NEEDED: While management improved core operating performance in 2015, a material improvement in occupancy resulting in improved liquidity and stronger debt service coverage will be necessary to maintain the 'BBB-' rating. Fitch will monitor management's plans for the BST East campus, and the lack of a plan with a demonstrated positive impact on BST's overall financial profile by Fitch's next review would likely lead to negative rating action.

CREDIT PROFILE
BST is a Type B continuing care retirement community (CCRC) that operates two communities, BST East and BST West located in San Antonio, TX. BST East opened in 1970 and BST West opened in 1983 and both communities have historically served retired officers of all uniformed services and their spouses, widows or widowers. As of November 2013, the board approved the expansion of eligibility to individuals with no prior military affiliation. The organization changed its name in May 2014 and the official launch of a rebranding campaign began in October 2014. BST has a total of 730 ILUs, 57 assisted living units (ALUs), 72 dementia units, and 127 skilled nursing facility (SNF) beds. BST had \\$46 million in total revenue in fiscal 2015 (June 30 fiscal year end; audited).

IMPROVED OPERATIONS BUT OVERALL PROFILE STILL WEAK

Operating performance continued to improve in fiscal 2015 with a net operating margin of 11.1% compared to 2.2% in fiscal 2011 and the 'BBB' category of 8.9%. Performance was driven by a 5.6% increase in resident fees from the prior year compared to expense growth of 3.3%. There has been an initiative to grow Medicare revenue, and other healthcare revenue growth strategies are underway including increasing the acuity of cases in the SNF, affiliating with more local hospitals, and focused marketing of its skilled nursing services.

However, despite the improved core operating performance, BST's overall financial profile is still an outlier for its rating level and its peer group, and meaningful improvement
in financial performance will be necessary to maintain the current rating level, which will likely only occur once BST East's occupancy improves.

Unrestricted cash and investments totaled \\$34 million at Sept. 30, 2015 compared to \\$37 million at FYE 2014 and \\$40.6 million at FYE 2013. Management budgets that unrestricted cash and investments will decline further to \\$31.9 million in fiscal 2016 due to capital expenditures outsizing available funds from cash flow, which Fitch views as a concern despite the necessity of the capital investments to enhance marketability. Days cash on hand and cash-to-debt were 298 and 27.3%, respectively, at Sept. 30, 2015 compared to the 'BBB' category medians of 400 and 60%.

LOW ILU OCCUPANCY

Despite an improved trend in net ILU move-ins and increased interest from 'nontraditional' prospective residents, overall ILU occupancy remains weak at 78% for the first quarter ended Sept. 30, 2015 compared to 77.3% in fiscal 2015, 75.2% in fiscal 2014 and 77.2% in fiscal 2013.

ILU occupancy at BST West remains solid while occupancy at BST East remains the most challenged despite the capital investment. Fitch toured the community and found it to be well maintained and marketable with a diverse array of ILU options; however, the campus is expansive and there is a large inventory of smaller units. With the expanded eligibility, management has various marketing initiatives in place that focus on the local primary market area (PMA) as well as nationally due to its military heritage, and management's ability to hone the marketing and sales to the dual populations will be important. Management is also reviewing the pricing structure of BST East relative to the PMA, which should also help improve occupancy.

HIGH DEBT BURDEN

BST's total debt outstanding as of June 30, 2015 was \\$125.2 million and the debt profile is 85% underlying fixed rate and 15% underlying variable rate. The approximately \\$19 million of variable rate debt is structured in two bank loans that refinanced two lines of credit in 2013 and 2014. The bank loans are with Frost Bank and extend through 2023 with an \\$8.5 million bullet payment due in December 2023. Management expects to refinance or pay off the bullet payment at that time. BST also entered into two floating- to fixed-rate swaps to hedge the variable rate on the bank loans. There are no collateral posting requirements or termination events tied to BST's rating level.

Fitch used MADS of \\$9.9 million and MADS coverage is weak at 1.3x in fiscal 2015 compared to 1.4x in fiscal 2014 and 1.5x in fiscal 2013. Higher contributions and realized investment gains supported coverage in 2013 and 2014. MADS coverage is only 1.2x through the three months ended Sept. 30, 2015, and is budgeted at 1.3x for fiscal 2016.

COMPLIANCE WITH COVENANTS

BST has been compliant with its bond covenants. Debt service coverage is required to be 1.2x on annual debt service and there is a 180 days cash on hand covenant, which is consistent with the bank loan's covenant of maintaining \\$20 million of unrestricted cash and investments.

DISCLOSURE
BST covenants to provide annual audits within 120 days of fiscal year-end and quarterly disclosure for all four quarters within 45 days of quarter-end.

Fitch affirms the following outstanding debt at 'BBB-':

--\\$45,736,764 Tarrant County Cultural Education Facilities Finance Corporation (TX) (Air Force Village Obligated Group Project) fixed rate revenue bonds series 2009;

--\\$61,029,170 Tarrant County Cultural Education Facilities Finance Corporation (TX) (Air Force Village Obligated Group Project) retirement facilities revenue bonds series 2007.