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Rating Action:

Moody's assigns A3 to National Finance Authority's Federal Lease Revenue Bonds; outlook stable

22 Oct 2020

New York, October 22, 2020 -- Moody's Investors Service has assigned an A3 rating to the $140 million Federal Lease Revenue Bonds (VA Butler Health Care Center Project), Federally Taxable Series 2020 issued by the National Finance Authority on behalf of the facility owner, Cambridge Healthcare Solutions PA LP. Bond proceeds will refinance debt for the US Department of Veterans Affairs (VA) Health Care Center in Butler, Pennsylvania. The outlook is stable.

RATINGS RATIONALE

The A3 rating on the Series 2020 bonds reflects the credit strength of the United States of America (Aaa stable) acting through the Department of Veterans Affairs as lessee under the lease agreement supporting the bonds. The strength of the modified gross lease is offset by significant lease renewal risk (in May 2037) and refinancing risk (in October 2037) when approximately 66% of par will remain outstanding. The rating is supported by a strong legal structure, which includes the assignment and direct payment of all lease payments to the trustee, reducing bondholders' exposure to operating risk of the borrower and property manager, as well as a debt service reserve fund. The financed project, an outpatient healthcare clinic in Butler, Pennsylvania, is viewed as essential, supporting a high likelihood of lease renewal that is somewhat balanced by declining veteran demographics in the region. Absent renewal, however, recovery for bondholders will be limited because the high level of debt relative to market value of the property, the narrow local real estate market, and the likely difficulty in finding a new tenant who would pay the above-market rent currently paid by the VA.

We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. The coronavirus crisis is not a key driver for this rating action. We do not see any material immediate credit risks for the VA lease on the Butler Health Care Center. However, the situation surrounding coronavirus is rapidly evolving and the longer term impact will depend on both the severity and duration of the crisis. If our view of the credit quality of the VA lease on the Butler Health Care Center changes, we will update the rating and/or outlook at that time.

RATING OUTLOOK

The stable outlook reflects the rating outlook of the United States of America (Government of) and our expectation that lease payments will continue to flow uninterrupted to the trustee on a monthly basis.

FACTORS THAT COULD LEAD TO AN UPGRADE OF THE RATING

- Reduction in debt levels or final bullet payment that reduces overall leverage and refinancing risk

- Renewal of the lease with the VA that enables all bond payments to be serviced with revenue from leases currently in force

- Removal of all set-off and termination risks

FACTORS THAT COULD LEAD TO A DOWNGRADE OF THE RATING

- Downgrade of the United States (Aaa stable) issuer rating

- Interruption or delay in monthly lease payments

- Nonperformance of its obligations under the lease by the borrower

- Increased risk of non-renewal of the lease, due to deterioration in asset condition, weakened lessor/lessee relationship, faster-than-expected weakening of veteran demographics, reduced regional demand for VA medical services, and/or change in federal policies regarding the provision of veteran health care

LEGAL SECURITY

The bonds are ultimately secured by payments from the VA, including monthly lease payments, made to the borrower/lessor, Cambridge Healthcare Solutions PA LP (CHS). The bonds are also secured by a mortgage lien on the leased facility, the Butler Health Care Center, and a debt service reserve fund funded at 25% of maximum annual debt service.

The bonds are issued by National Finance Authority (NFA), a New Hampshire conduit issuer, and proceeds have been lent to CHS, the borrower and owner. NFA will service the debt using proceeds received under the terms of a loan agreement with CHS. CHS, in turn, will repay the loan solely using revenue received under its lease agreement with the VA.

The leased asset, the Butler Health Care Clinic (Butler HCC), is an essential asset of high importance to the VA's mission of providing health care to veterans. The VA has a 20-year modified gross lease agreement with CHS on the Butler HCC in Butler, Pennsylvania. Butler HCC is a 168,000 square foot, two-story medical building, located to serve veterans living in the western Pennsylvania counties of Beaver, Armstrong, Butler, Clarion, Forest, Venango, Lawrence and Mercer. The facility is a "build-to-suit" property constructed for the VA, and opened to patients in 2017. The lease expires on May 25, 2037.

The VA operates the facility as the Abie Abraham VA Health Care Center - the "hub" of the "hub-and-spoke" approach offered by the Butler VA Health System. The system serves 25,000 local veterans and includes the Community Living Center (CLC, provides long-term care), the Domiciliary Residential Rehabilitation Treatment Center, and five Butler-area Community Based Outpatient Clinics. In 2019, the Butler HCC had over 84,000 patient visits, equivalent to 72% of the Butler VA Health System's 117,100 total patient visits. After the transaction, the property will be managed by NLC Property Management, LLC, an affiliate of CHS and a subsidiary of Net Lease Capital, an experienced owner and manager of federal leased facilities.

The legal structure is strong, providing bondholders with minimal risk of rent payments being interrupted or reduced, and essentially no risk from construction, bankruptcy, abatement or termination. Assignment and direct payment of all rent payments from the federal government to the trustee protects bondholders from operating risks of the owner, property manager and lease facility. There is no termination for convenience, however the lease can terminate in the case of total destruction of the property. As is common with most federal leases, the VA can set-off, reduce, or abate operating rent if it vacates the building or if the borrower fails to perform any service or obligation under the terms of the lease and the VA, after a 30 day cure period, has to perform such tasks itself. However, these reductions on apply to the operating portion of the rent, and do not affect the shell rent used to pay debt service (more below). Appropriation risk is minimal given the 20-year firm term lease has previously been authorized by Congress. Risks related to federal budget delays are partially balanced by the timing of debt service payments (October 1 debt service payments are set-aside with the trustee in advance).

Annual debt service is approximately $5.8 million and will be paid quarterly until bond maturity on October 1, 2037. Annual shell rent, which is sized to recover the capital costs of the facility, including debt service, is $7.4 million. Total rent of $8.5 million includes a Base Rent portion that is designed to recover operating costs and will increase annually with CPI. Total rent is pledged to the bonds and will be paid directly to the trustee monthly. After monthly set-asides for principal and interest payments, as well as administrative and operating expenses, lease payments from the VA will fund a number of reserve funds, including: a debt service reserve fund of approximately $1.5 million (50% of the maximum quarterly debt service payment), a lease reserve fund of $451,000 (25% of annual operating costs) and a maintenance reserve fund (amount to be determined).

This project is highly leveraged, and has significant lease renewal risk and refinancing risk. After this transaction, total debt of $140 million will be more than 2x the net capital asset value of $68.7 million (as reported in owner's December 31, 2019 financial statements), and 16x the annual total rent payments. In addition, the lease terminates in May 2037, prior to final bond maturity and a large bullet maturity scheduled in October 2037. The $93 million balloon maturity is approximately 68% of par and will require refinancing, which will be contingent on re-signing the lease with the VA. The borrower has chosen this structure to enable amortization over a 40 year period to match with the useful life of the project. The maximum term of a VA lease is 20 years. Refinancing risk is balanced by the requirement that the shell rent portion of a new VA lease cover all capital costs of the facility, including interest costs.

While the likelihood of resigning the lease is high, it is moderated by the lack of history around VA lease renewals, and the potential for meaningful changes over the next 17 years to facility condition, veteran demographics, technology advancements in health services, and VA policies that could occur prior to the expiration of the current lease. At this time, incentives that increase the likelihood of renewal include: the high essentiality of the project, the high quality of the asset, the time and capital investments already made in the facility, the rapidly growing service demand of the veteran population, and the VA's current mission to expand service capacity, especially in underserved, rural areas.

Should the VA decide not to renew the lease on the Butler HCC, bondholder recovery would be very low - a key rating consideration. Our forecast of bondholder recovery incorporates an estimate of the facility's low "dark value" (i.e. the market value without a new lease in place) relative to the very high total debt outstanding at the time of lease expiration. The dark value of the facility is substantially lower than the reported net capital asset value due to conservative assumptions regarding the cap rate (net operating income to property asset value) and the expectation that it would require a significant length of time and investment to repurpose and relet or sell the facility. The VA would be a particularly difficult tenant to replace given the specialized nature of the property, the relatively small regional real estate market, and the above-market rent that is currently paid.

The loan agreement between the NFA and CHS requires that adequate levels of insurance be obtained and regularly renewed from highly rated companies, and names the trustee as a loss payee. The required insurance is extensive and includes all risk, comprehensive liability, business income, flood (if in zone), and workers compensation, among others. The property and casualty insurance on the facility must equal to the greater of (i) replacement cost or (ii) par amount of bonds.

The ownership structure has minimal bankruptcy risk. After this transaction, CHS will be owned by Legacy: Investment & Management, LLC (Legacy) which is owned by Marathon Investments LLC (85% owner) and Fedmo LLC (15% owner). The principals of these two special purpose vehicles are David J. Lyon and Andrew Molasky, respectively. A non-consolidation opinion has opined that in the event of a bankruptcy of Marathon, Fedmo or their principals, a judge would not order the consolidation of the assets and liabilities of CHS and Legacy in the case.

USE OF PROCEEDS

Bond proceeds will refund outstanding debt on the facility, fund indenture-required reserves, and pay acquisition costs for the facility. The refunded debt was originally issued to finance the Butler HCC construction costs.

PROFILE

The United States has the world's largest economy and is the center of global trade and finance, with a gross domestic product of $21.4 trillion in 2019. Its population of 328 million is third-largest. The Department of Veterans Affairs provides healthcare services and other benefits to military veterans.

The National Finance Authority is a New Hampshire conduit issuer and economic development entity that is tasked with developing businesses outside the state.

The borrower, Cambridge Healthcare Solutions PA LP, is a limited partnership of Marathon Investment, LLC (85%) and Fedmo (15%). The principal owners and parent companies of Marathon and Fedmo specialize in single tenant net lease properties, particularly with federal government agencies.

METHODOLOGY

The principal methodology used in this rating was Lease, Appropriation, Moral Obligation and Comparable Debt of US State and Local Governments published in July 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBM_1102364. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Baye Larsen
Lead Analyst
State Ratings
Moody's Investors Service, Inc.
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New York 10007
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Client Service: 1 212 553 1653

Emily Raimes
Additional Contact
State Ratings
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
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