The fiscal 2019 U.S. not-for-profit senior living sector medians highlight pre-pandemic stability in the sector with mixed changes overall in the ratios compared to fiscal 2018 (see table 1). On average, key operating ratios remained stable or weakened while balance sheet metrics improved. S&P Global Ratings' senior living sector portfolio is generally split between medium to high investment grade (A/AA) and low investment grade (BBB) credits. As expected, the financial profiles of the higher-rated cohort are typically stronger, and in fiscal 2019 many key operating and balance sheet median results highlight the underlying, and in some cases growing, gap in credit quality between the two rating levels (see table 2).

The stability of continuing care retirement communities (CCRCs) in fiscal 2019 was driven in part by a robust residential real estate market in many areas, generally favorable investment market performance despite some periods of volatility, a healthy economy, and sector-specific trends related to favorable enterprise profile characteristics, including strong occupancy and continued high demand for new and existing units (see chart 1). Balance sheet ratios, particularly liquidity, have trended favorably for several years, providing many senior living communities the crucial liquidity and financial flexibility needed to meet near-term challenges associated with managing operations with the onset of the novel coronavirus (COVID-19) pandemic earlier this year. Furthermore, we believe the stability of S&P Global Ratings' CCRC portfolio once again reinforces the importance of strong management teams who can provide the necessary leadership to effectively mitigate many pandemic-related and other near-term operational risks. Management capabilities combined with healthy demand and liquidity and financial flexibility metrics support our view of our rated credits' stability despite expected headwinds from the recessionary environment and ongoing uncertainty about the trajectory of the pandemic over the next year or two. If those headwinds accelerate to materially weaken occupancy levels and negatively affect financial performance, it may lead us to revise our view.

Table 1

Table 2

Chart 1

S&P Global Ratings rates the debt of 22 not-for-profit senior-living obligors, including two confidential ratings. Through the 11-month period between Sept. 30, 2019 and Aug. 31, 2020, which covers the span of rating actions between our last report and this one, we upgraded three credits and downgraded one credit (see table 3). This is consistent with the rating actions included in our 2019 published report. Most of the ratings were affirmed, resulting in minimal movement in the rating distribution, with all CCRC ratings being investment grade (see chart 2). As has been the trend for several years, the majority (all but three) of our rated organizations have a stable outlook, supporting our expectation that credit profiles and ratings on senior-living providers will remain consistent within the two-year outlook horizon (see chart 3).

Table 3

Chart 2

Chart 3

Management Teams' Swift Response To Adverse Conditions, Including COVID-19, Are Critical To Credit Stability

Management teams have always been a critical factor influencing our view of credit stability. The senior-living providers rated by S&P Global Ratings generally have experienced and well tenured management teams that operate in markets with strong demand and historically limited direct competition. We also recognize that key macro-level factors, such as natural disasters or pandemics, the health of the U.S. economy, and the investment markets, are not directly within management's control but still weigh heavily in maintaining credit stability. As evidenced by the stability of recent rating actions, management's ability to recognize adverse business conditions early and take corrective action helps maintain credit quality during periods of operating stress. Management's focus on what it can control, such as pricing flexibility, revenue growth, and cost containment with a strong emphasis on increasing efficiencies, should remain a priority in our view and includes efforts such as improving staff retention levels, outsourcing non-essential functions, and pursuing more strategic purchasing and contracting.

While the broader retirement sector in the U.S. struggled with the onset of the COVID-19 pandemic, the U.S. not-for-profit CCRC organizations rated by S&P Global Ratings have exhibited overall resiliency. In large part, this has been due to management teams reacting quickly to limit the number of positive COVID-19 cases among both staff and residents (cases have been limited year-to-date among CCRCs that we rate). Since the onset, we believe that the health care and retirement industry has learned a significant amount about how to manage operations within this new environment. And, with more testing capabilities than earlier in the pandemic, we believe management teams are now better equipped to address challenges. Nonetheless, we believe ongoing vigilance is required to continue to mitigate pandemic-related risks and maintain stable financial performance and occupancy rates.

Managements' actions to stem the effect of the pandemic at CCRCs were comprehensive. Precautions included enacting strict protocols for visitors and direct admissions. In most cases, direct admissions into skilled nursing facilities (SNF) were temporarily suspended, not only to prevent COVID-19 from spreading in its community, but also because hospitals temporarily suspended all elective surgeries, resulting in virtually no patients being transferred to a SNF for post-acute care. Management efforts to contain the outbreak typically extended to closing common areas, securing a supply of personal protective equipment, and shutting down various non-essential amenities while at the same time developing contingency planning. Many CCRCs leverage their investments in information technology to keep residents connected or have developed their own formal testing processes and contact tracing procedures campus wide for both residents and staff. We view these efforts as necessary and prudent, despite the disruption it caused to operations and cash flow. To help offset revenue losses and increased expenses associated with the pandemic, many organizations received relief funding through the Coronavirus Aid, Relief, and Economic Security (CARES) Act and leveraged the Paycheck Protection Program where possible.

Overall, Credit Quality Remains Stable Among Rated CCRCs

Occupancy and demand support operations but expenses increase

The benefits of high occupancy continue to support stability for S&P Global Ratings' rated CCRC organizations, which have thus far demonstrated resilience despite the pandemic and ongoing weakness in several macroeconomic trends that affect the sector. Occupancy, which is the predominant factor in operating revenue growth for CCRCs, remained relatively stable in 2019 and comparable to 2018 occupancy levels, although, as of this writing about 70% of our credits have reported occupancy levels for 2019. These high occupancy levels, in combination with adequate rate increase, support revenue growth to cover operating expenses and provide adequate cash flow for capital needs. As fluctuations in assisted living and skilled nursing occupancy depend on the timing of transitions by residents from one level of care to another, we typically view a certain amount of short-term variances as routine and focus more on longer-term trends. We also recognize developing trends in how CCRCs manage occupancy, due in part to the growing trend of aging in place and the influence of technology on the delivery of care. Rather than compete with aging in place services, we have seen providers collaborate to support new residents as they move into their independent living unit or allow residents to remain in that unit for a longer period before moving to assisted living. In some cases, occupancy for an independent living unit and an assisted living unit are combined and categorized as "residential care" as many residents who may need assisted living services can remain in an independent living unit and still get the same quality of care. From a credit risk perspective, we look to the underlying trend of all services provided, and how the delivery of those services influences financial performance.

In the near term, we expect post-pandemic occupancy rates to correlate somewhat with pre-pandemic trends, whereby credits with consistently strong demand and high occupancy will likely perform better than those credits with below average occupancy or generally weak demand. Occupancy levels across the continuum have generally softened from 2019 levels due to move-in delays resulting from the pandemic; however, management teams report that move-in rates have begun to rebound and waitlists have remained stable. Thus, over the long-term we anticipate that the macro trends of the growing senior citizen population will support our assessment that demand for services will continue. Marketing and sales incentives can also be effective tools in managing a prolonged downturn in demand and help jumpstart the recovery for many providers, as exhibited during the last recessionary period and housing downturn that occurred in the 2007-2009 time frame.

The pandemic and recessionary pressures are exacerbating other operating challenges that already existed in the industry, such as staffing and cost pressures relating to increasing wage levels, employee benefit costs and the reluctance to work in an industry with perceived increased health risks. In particular, the pandemic has highlighted nursing shortages and the resulting expense for contract labor. Many providers are elevating their focus on retention strategies to limit turnover and offset difficulties finding appropriate staff to fill open positions, especially due to the negative media attention on the industry stemming from the pandemic. While investments in both staffing and facilities can yield an improved census, we continue to view the latter as more positive from a credit perspective as additional units generate incremental revenue growth.

Dependence on investment markets remain a credit risk to both nonoperating income and reserves

Investment market performance can affect both non-operating income as well as unrestricted reserves, the latter being one of the cornerstones for CCRCs credit stability. Further, CCRCs are typically reliant on non-operating investment income to support maximum annual debt service (MADS) coverage. We generally view this reliance as a credit risk, given that it can be inconsistent and subject to various external factors, and thus, operational results excluding investment income will always be an important rating factor. The sector had enjoyed solid investment returns in recent years but excess margins, while still positive, weakened in fiscal 2019 whether comparing medians overall or by rating category. When combined with weaker operations for lower investment grade credits, it contributed to a decline in adjusted MADS coverage and days' cash on hand. Higher investment grade credits fared better.

Favorable investment returns can help credits maintain consistent cash flow and strengthen their balance sheets thereby mitigating to some extent weaker operating performance. Management teams have thus increased their oversight and focus on investment portfolios, including asset allocation and liquidity, while also augmenting non-operating income with contributions and donations, as they try to limit some of the downside risk and preserve capital. Strong liquidity and financial flexibility is important to mitigating exposure to several risk factors, including the health care liability of a life-care facility, limited capital access, or earnings volatility related to cost spikes or occupancy pressures.

We observe that most balance sheet metrics for the sector extended a general trend of improvement in 2019. However, upon closer analysis, this improvement is heavily driven by the 'AA/A' rating level medians suggesting there may be a growing divide in the credit quality gap as organizations with stronger underlying credit quality having greater resources and are better positioned to respond to adverse business conditions and unexpected industry challenges, such as the COVID-19 pandemic. In particular, the stronger days' cash on hand (DCOH) and unrestricted reserves to debt metrics for higher investment grade credits suggest meaningful improvement in unrestricted reserves and good expense management. Conversely, relatively stable unrestricted reserves to debt compared to softer DCOH for the 'BBB' rating category suggests that reserves are stable but not growing at the same rate as the expense base for those credits.

With the emergence of the COVID-19 pandemic this spring, there occurred significant volatility in the investment markets reflecting the considerable uncertainty driven by the pandemic and recessionary pressures. The Chicago Board Options Exchange Volatility Index, a closely watched barometer that measures the stock market's expectation of future volatility, increased significantly in 2020 (see chart 4). While volatility persists, many management teams have reported that investment portfolios have since rebounded, providing much-needed cash flow relief during a period of stress.

Chart 4

The market volatility compounded by the recessionary pressures highlights the risks to unrestricted reserves (depending on the asset allocation) as well as those organizations that remain overly reliant on non-operating revenue, particularly investment income, to mask persistent operating deficits.

Continued capital investment in facilities is key to growing and maintaining demand

As the demand for senior-living facilities is partly due to curbside appeal, amenities offered, and preferred models of care, capital spending in 2019 resulted in only the higher-rated credits achieving modest improvement in the median average age of plant, while the weaker operations and weaker balance sheets for the lower investment-grade credits may have reduced the ability or flexibility to spend on capital improvements, resulting in an uptick in average age of plant. Given that most management teams significantly pulled back on capital spending during the pandemic, we expect near-term weakening of the median average age of plant. However, we expect average age of plant to steadily improve and then stabilize over the medium to longer term, driven in part by the need for ongoing capital investments to remain competitive, or to accommodate demand with new units. Given the very low interest rate environment and modest improvement in debt-related metrics, we expect that some organizations may take this opportunity to access the capital markets to reposition or expand existing communities as pandemic risks subside.

Rating Distribution Edges Toward Higher Investment-Grade Credits

Currently S&P Global Ratings rates the debt of 22 not-for-profit senior-living obligors, including two confidential ratings. The rating distribution over the past several years had been roughly balanced between 'AA/A' and 'BBB' rating level credits with a slight shift in 2019 to more higher investment-grade credits. Of the 20 providers (excluding two confidential ratings) with long-term ratings or underlying ratings, we now rate 59% in the 'A' category and 32% in the 'BBB' category, with 9% (or one credit) in the 'AA' category.

We've observed that during economic downturns and weak business cycles, lower-rated obligors tend to deteriorate at a faster pace than their higher-rated counterparts. This is because the former often lack the liquidity to cushion themselves against increased operating stress. They also may not benefit from the strong business positions, revenue or geographic diversity, or favorable locations that higher-rated obligors have. We expect this to hold true with respect to post-pandemic stress and continued recessionary pressures and financial performance between the rating levels will likely remain notably different.

2019: Year of Infrequent Rating Actions And Outlook Revisions

Rating actions remain infrequent but favorable, with three upgrades and one downgrade to public ratings since our last report. We note that the upgrades occurred prior to the pandemic at the end of 2019. For additional details on the rating actions, please see the issuer review of rated obligors containing a summary of key credit factors from our latest published reports for each rated senior-living credit (see table 4). Movement in our outlook distribution within the most recent review cycle was also minimal, though more negative, with two outlook revisions to negative from stable, including one on a confidential rating. COVID-19 has not yet had a meaningful influence on rating and outlook actions to date among our rated portfolio.

Industry's Near-Term Challenges Include The Pandemic, Shifting Business Models

Pandemic, economic challenges could pressure ratings if demand, occupancy levels destabilize

We recognize that the COVID-19 pandemic continues to evolve and has the potential to further disrupt the long-term care industry, and possibly the not-for-profit CCRC sector. We also believe the pandemic and its associated economic challenges will generally pressure the sector's earnings via ongoing market volatility, potentially affecting non-operating income and unrestricted reserves. Should overall occupancy levels remain near fiscal 2019 medians, we believe U.S. not-for-profit CCRCs generally have some capacity to absorb near-term strain on their financial metrics. However, a more prolonged or severe stress to either operations or key balance sheet metrics could pressure ratings. That said, macroeconomic factors such as the favorable borrowing environment, aging population, and housing markets that remain generally healthy could help management teams navigate these headwinds.

Through the initial phases of the pandemic, demand appears to be steady as many seniors and their families perceive the relative safety and community of a quarantined campus facility as preferable to living independently in isolation. And, we consider the growing ranks of senior citizens a long-term positive credit factor for the sector (the U.S. Census Bureau projects about 73 million adults will be 65 years of age or older by 2030, compared to about 56 million today with nearly one in four Americans projected to be 65 years of age or older by 2060). However, in the near term, the stability of demand and occupancy levels could waver should ongoing vigilance be insufficient to prevent the spread of COVID-19, undermining the sense of safety and security among residents and their families. We anticipate that the need to ensure the health and safety of residents and staff, in tandem with continued strong demand, will likely result in higher capital spending over the longer term and an increasing debt burden for many providers as the sector expands to service the growing population. In particular, we expect the pandemic will spur management teams to develop new strategic and capital plans, revise campus and residence layouts, continue to invest heavily in technology, and establish business or operating models that may be more flexible and resilient in the face of future pandemics or other crises.

Strategic affiliations, consolidations may be key as sector evolves

We also expect the aging population to spur increased competition as new entrants, from CCRCs to single-specialty type providers, look to capitalize on the growing demand. The competitive landscape comes in all shapes and sizes as the U.S. retirement industry includes a broad array of providers and facilities, some of which are free standing and not part of a full continuum such as CCRCs. These include independent or active adult living facilities, assisted living facilities, memory care facilities, nursing homes, and combined memory care and assisted living facilities. Further, there are for-profit and not-for-profit operators. In addition, there are various niche and specialty type providers that may restrict admissions to targeted constituencies. Senior living facilities also exhibit a myriad of housing, service, and affordability characteristics. Organizations with aging facilities, whose product offerings do not meet current market expectations, or that are based in particularly competitive markets, are more likely to experience financial stress. These organizations may increasingly look for affiliations, partnerships, or mergers to remain viable in the long term.

While consolidation is not as prevalent in this sector as it is in the acute-care hospital space, acquisition and affiliation activity does occur. We expect the stronger CCRCs to continue to be opportunistic in their approach to mergers and acquisitions (M&A), and we believe strategic affiliations will likely continue at a modest pace so that providers remain competitive in the long term. We also believe that size and scale may take on greater importance over time, allowing CCRCs to expand their footprint and diversify their revenue base, while also gaining cost efficiencies. Those that pursue strategic growth through acquisitions may also experience some credit pressure, although historical trends suggest that if M&A or affiliations are well conceived and well implemented, credit pressure tends to be short-lived. As hospitals and health systems continue their transformation to population health, a post-acute care strategy is becoming ever more crucial. In a post-pandemic environment, the evolving nature of the business model and role of post-acute care services includes new challenges, potentially making mergers more difficult to consummate with additional risk factors.

Issuer Review

Table 4

Related Research

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