U.S. Health Care REITs And Their Skilled Nursing Tenants: Credit Implications Of Rent Reductions
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
U.S. Health Care REITs And Their
Skilled Nursing Tenants: Credit
Implications Of Rent Reductions
Primary Credit Analysts:
George A Skoufis, New York (1) 212-438-2608; george.skoufis@standardandpoors.com
David A Kaplan, CFA, New York (1) 212-438-5649; david.a.kaplan@standardandpoors.com
Robert E Schulz, CFA, New York (1) 212-438-7808; robert.schulz@standardandpoors.com
Secondary Contact:
Michael H Souers, New York (1) 212-438-2508; michael.souers@standardandpoors.com
Table Of Contents
Challenging Prospects For SNFs Absent Lower Rents
Rent Reduction Scenarios And REIT Credit Quality
Possible SNF Default Scenario Logistics
Next Steps For Credit Quality
Related Criteria And Research
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 23, 2015 1
1380483 | 301932398U.S. Health Care REITs And Their Skilled Nursing
Tenants: Credit Implications Of Rent Reductions
Following persistent headwinds, Standard & Poor's Ratings Services reviewed the sector and took negative rating
actions on three U.S.-based skilled nursing facility (SNF) operators. We believe reimbursement trends stem at least in
part from fiscal pressures on federal and state budgets.
We think certain SNF's will struggle with contractual escalations in rents, because we expect the nursing home
industry to continue facing headwinds including from the ongoing shift of patients to managed-Medicare from
Medicare. Managed care payers typically negotiate reimbursement rates that are about 20% lower than Medicare's
average day rate of about $500. Managed care payors are also more focused on reducing the length of patient stays.
We rate 10 health care REITs, several of which have exposure SNF operators that we believe will continue to face this
difficult environment and three have exposure to one of the three SNF operators affected by the recent negative rating
actions.
Challenging Prospects For SNFs Absent Lower Rents
On Jan. 20, 2015, we lowered our ratings on two of the largest U.S.-based nursing home operators, Genesis
HealthCare LLC and HCR HealthCare LLC. Private-equity sponsors own those companies and both are burdened with
very high lease expenses that having annual escalators of around 3%. These leases stem from sale-leaseback
transactions the owners entered relating to the overwhelming majority of nursing home facilities that they operate. As
margins have softened in recent years, lease adjusted leverage for these two operators has reached very high levels
(9.5x for Genesis and about 11x for HCR HealthCare).
While nursing home EBITDAR margins (12% to 13% for Genesis, 14% to 15% for HCR HealthCare) should allow
nursing homes operators to thrive, for these companies most of their EBITDAR (75% for Genesis and 85% for HCR
HealthCare) is absorbed by the significant, and escalating, lease payments.
Rent Reduction Scenarios And REIT Credit Quality
Because we believe the post-acute/skilled nursing segment will remain under pressure for now, we have evaluated the
potential impact that rent reductions (for the single largest SNF tenant) would have on the rated health care REITs'
credit metrics, particularly the three REITs exposed to HCR and Genesis. We acknowledge that many health care
REITs (certainly the largest REITS) have facility type diversity and facility level rent coverage for many triple net
leases is sound. These leases are typically underwritten with adequate rent coverage, which provides a cushion to
protect REIT rents should facility or portfolio cash flows deteriorate, but, for purposes of this analysis, we assumed
scenarios whereby rents are affected in various degrees. We looked at three distressed scenarios under which the
largest REIT SNF tenant negotiated 10%, 15%, and 20% reductions in lease payments to the rated health care REIT.
Even in the case of a 20% reduction in rents by the largest tenant, credit metrics for most REITs only modestly
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 23, 2015 2
1380483 | 301932398U.S. Health Care REITs And Their Skilled Nursing Tenants: Credit Implications Of Rent Reductions
deteriorated (see tables 1 and 2). For CareTrust REIT Inc., which is the smallest health care REIT with 100% exposure
to one tenant, FCC would deteriorate to the low-1x and leverage would rise about 4x to more than 13.0x from 9.3x.
The impact in this case is meaningful and would stress covenants and place pressure on the credit profile. But as noted
above, CareTrust's facility-level rent coverage was strong at 1.85x, which mitigates the risk of its tenant requiring a
lease amendment. Similar to other peers that started out with small scale, such as Sabra Health Care REIT, we would
expect CareTrust to grow its platform and diversify its tenant base over time.
Accordingly, we do not currently expect the continued pressures on SNFs to lead to downgrades for rated health care
REITs. We think there is potential for lease reduction requests given the combined pressure of reimbursement
mix/rates and contractual rental increases on SNF cash flow absent other strategies, such as cost control and
disposing of underperforming assets. However, we also believe any reductions granted as part of a restructuring of an
SNF will not be of a magnitude to trigger a downgrade based upon our estimates of possible rate reductions and the
assumption that both tenants and lessors will want to maintain uninterrupted operations and preserve occupancy.
Table 1
REIT Fixed-Charge Coverage Impact Under Rent Reduction Scenarios
FCC w -10% FCC w -15% FCC w -20%
reduction in reduction in reduction in
Largest SNF lease receipts lease receipts lease receipts
Health Care Tenant (name % as LTM from largest from largest from largest
REITs Rating and rating) disclosed FCC tenant tenant tenant
REITs with HCR/Genesis Tenant Exposure
HCP Inc. BBB+/Stable/-- HCR (B) 29.00 3.5 3.4 3.3 3.3
Health Care BBB/Stable/-- Genesis 11.90 2.8 2.8 2.8 2.8
REIT Inc. HealthCare (B-)
Sabra Health BB-/Stable/-- Genesis (B-) 35.90* 3.1-3.2* 3.0-3.1 2.9-3.0 2.9-3.0
Care REIT
Inc.*
REITs with Top SNF Exposure Other Than HCR/Genesis
Ventas Inc. BBB+/Stable/-- Kindred 5.00 3.9 3.9 3.8 3.8
Healthcare, Inc.
(B+)
Omega BB+/Stable/-- New Ark 13.00 3.6 3.5 3.5 3.5
Healthcare Investment, Inc.
Investors Inc. (NR)
CareTrust B/Stable/-- Ensign (NR) 100.00 2 1.7 1.5 1.4
REIT Inc.
*Pro forma for recent transactions and financing activity. LTM FCC and Debt/EBITDA reflect 2015 base-case forescast.
Table 2
REIT Leverage Ratio Impact Under Rent Reduction Scenarios
TD/EBITDA w TD/EBITDA w TD/EBITDA w
Largest SNF -10% reduction -15% reduction -20% reduction
Tenant in lease receipts in lease receipts in lease receipts
Health (name and % as LTM from largest from largest from largest
Care REITs Rating rating) discloed Debt/EBITDA tenant tenant tenant
REITs with HCR/Genesis Tenant Exposure
HCP Inc. BBB+/Stable/-- HCR (B) 29.00 5.6 5.8 5.9 6.0
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 23, 2015 3
1380483 | 301932398U.S. Health Care REITs And Their Skilled Nursing Tenants: Credit Implications Of Rent Reductions
Table 2
REIT Leverage Ratio Impact Under Rent Reduction Scenarios (cont.)
Health Care BBB/Stable/-- Genesis 11.90 6.8 6.9 6.9 6.9
REIT Inc. HealthCare
(B-)
Sabra Health BB-/Stable/-- Genesis (B-) 35.90* 6.6-6.7* 6.8-6.9 7.0-7.1 7.1-7.2
Care REIT
Inc.
REITs with SNF Exposure Other Than HCR/Genesis
Ventas Inc. BBB+/Stable/-- Kindred 5.00 6.6 6.6 6.6 6.7
Healthcare,
Inc. (B+)
Omega BB+/Stable/-- New Ark 13.00 5.0 5.3 5.4 5.4
Healthcare Investment,
Investors Inc. (NR)
Inc.
CareTrust B/Stable/-- Ensign (NR) 100.00 9.3 11.1 12.2 13.6
REIT Inc.
*Pro forma for recent transactions and financing activity. LTM FCC and Debt/EBITDA reflect 2015 base-case forescast.
HCR - HCP Case Study
The recent downgrade of HCR caused us to look closely at HCP Inc., as HCR is HCP's largest tenant accounting for
29% of annualized (third-quarter ended Sept. 30, 2014) revenues. Even if a meaningful lease amendment is needed, we
do not see a material impact on HCP's credit profile. For example, under a hypothetical scenario whereby HCR rents
are adjusted downward by 10% to 20%, HCP's revenues would decrease by about $50 million to $100 million or a
modest 2% to 4% of annualized revenues. Under the more conservative 20% reduction assumption, which we estimate
would bring HCR's facility level rent coverage to about 1x, HCP's estimated trailing 12 months fixed-charge coverage
(FCC) would decline 20 basis points (bps) and debt/EBITDA would increase 40 bps to still-conservative 3.3x and 6.0x
levels, respectively. Additionally, while HCP's tenant base is concentrated, rent coverage across the remaining
portfolio is healthy (1.12x for senior housing and 1.56x for skilled nursing).
HCP's leases with HCR represent about 95% of HCR's real estate and are structured as master leases, which essentially
require HCR to meet its HCP lease obligations or risk losing all the facilities within a particular master lease. That
being said, we believe both HCP and HCR are closely tethered given the importance of each party to the other's
business. Additionally, HCR is considered one of the best operators in the industry and the heavy lease burden (with
3.5% annual escalators) and industry-wide pressures are the primary drivers for the pressure on HCR's cash flow and
FCC. We believe HCP is less likely to pursue an alternate operator and the most likely scenario is a haircut to the
current lease payments if a lease restructuring is required. Notably, HCP recently wrote down its equity stake in HCR
by nearly 50% because of expectations for continued operating pressure in 2015. Additional strategies HCP could
pursue include smaller rental increase, disposing of underperforming assets, and/or financing a portion of HCR's
capital expenditures, which would help preserve HCR's liquidity at least in the near term.
Possible SNF Default Scenario Logistics
Our credit ratings on the SNF companies reflect the risk of a payment default or a principal reduction or distressed
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 23, 2015 4
1380483 | 301932398U.S. Health Care REITs And Their Skilled Nursing Tenants: Credit Implications Of Rent Reductions
exchange type amendment with debtholders. They do not consider a renegotiation of lease terms as an event of
default, in of itself. Even if one of these companies eventually defaults, we would expect it would occur in the context
of an out-of-court negotiation with a high degree of cooperation from lessors, who have the biggest financial stake in
these entities.
Our default scenario for the SNF companies therefore contemplates lessors demanding term loan lenders take a loss
along with themselves, as part of a restructuring of lease payments. We believe that in this context the haircut term
loan lenders take would be a function of their negotiating position, which would be driven in large part by the value of
their collateral.
Next Steps For Credit Quality
We believe potential lease reductions (or at least lower escalations of lease payments) to weak SNF operators and
especially HCR are highly likely, but we do not currently expect any REIT downgrades as a result.
We think such rent reductions, if substantive, would benefit the SNFs' credit quality, but given other pressures, the
reductions are not likely to be sufficient to spur upgrades of more than one notch in the near term.
We would reevaluate these views in the unlikely event that rent reductions are far larger than we currently assume or if
we came to believe SNF companies would pursue bankruptcy rather than simply seek rent (and perhaps lender) relief.
We think the biggest challenge facing these SNFs is their lease costs, stemming from reduced industry profitability,
rather than operational problems, which would prove more difficult to solve than a rent renegotiation.
Related Criteria And Research
• S&P Discusses Several Rating Actions On U.S. Skilled Nursing Companies Following Sector Review, Jan. 20, 2015
• Research Update: HCR HealthCare LLC Rating Lowered To 'B-' From 'B' On Weak Industry Prospects; Outlook
Negative, Jan. 20, 2015
• Research Update: Genesis HealthCare LLC Rating Lowered To 'B-' On Weak Industry Prospects; Outlook Stable,
Jan. 20, 2015
• Research Update: Skilled Healthcare Group Inc. Ratings Placed On CreditWatch Negative Following Genesis
Healthcare LLC Downgrade, Jan. 20, 2015
• Bulletin: HCP Inc. Ratings Unaffected By Recent Downgrade Of HCR HealthCare LLC, Jan. 20, 2015
Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit
Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its
subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or
affirmation of, a Credit Rating or Rating Outlook.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 23, 2015 5
1380483 | 301932398Copyright © 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved.
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part
thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval
system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be
used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or
agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not
responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for
the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL
EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR
A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING
WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no
event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential
damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by
negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and
not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase,
hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to
update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment
and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does
not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be
reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain
regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P
Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any
damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective
activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established
policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P
reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites,
www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription) and www.spcapitaliq.com
(subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information
about our ratings fees is available at www.standardandpoors.com/usratingsfees.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 23, 2015 6
1380483 | 301932398You can also read
