CHICAGO - A weak economy, slow housing market, and too much variable-rate debt took their toll on continuing-care retirement communities over the last year and are expected to continue to trouble the sector throughout next year, Fitch Ratings said in a report released yesterday.

Fitch maintains a negative outlook on the senior-living sector and notes that all its median profitability ratios - from days' cash on hand and liquidity to maximum annual debt service - declined significantly in 2008.

The downturn ends several years of relatively strong operating performance.

"We went through a pretty long period - three or four years - where we saw overall positive rating actions," Fitch analyst Jim Mitchell said in a teleconference on the median report yesterday.

"Over the last 18 months there's been about 14 negative ratings and zero positive rating actions. That gives you an idea of what the trends in the industry are, and the effect they're having on ratings."

The sector is expected to see strong demand in the future, however, as baby boomers begin to retire and look to sell their homes and move into retirement communities.

"Everyone in the industry expects robust demand for years to come," Mitchell said.

Like all borrowers, senior-living credits have been plagued by problems tied to their variable-rate debt amid recent market turmoil and investment bank downgrades.

Many issuers found their variable-rate debt failing to draw investors during remarketing cycles after rating agencies downgraded the banks that had provided letters of credit supporting the debt.

Borrowers continue to face credit problems as many banks have stopped providing credit or have notified issuers they would not renew current LOCs upon their expiration.

More than half of Fitch's negative rating actions in the last year were due more to a troubled debt structure than to a weak operating performance, according to Mitchell.

"Going forward we're very focused on debt structure and investment allocation," he said. "Some credits were affected through no fault of their own. Resident move-ins were good, they were controlling expenses, but their bank got downgraded and the market locked up and created a lot of problems."

Fitch expects that the availability of LOCs will continue to be scarce in 2010 and that could mean increased capital costs for some borrowers.

"Negative rating actions could be precipitated by short termination periods and short term-out periods," Fitch said in its report. "In addition, Fitch's analysis reflects an increased sensitivity to the composition of the borrower's investment portfolio to determine the possible effect on liquidity should the financial markets experience a severe downturn like that of the fourth quarter of 2008."

Big declines in investment income helped drive down overall liquidity measures, including median days' cash on hand, which fell to 390 in 2008 from 462 in 2007.

But Mitchell said the sector may have hit the bottom - at least when it comes to liquidity - in late 2008, with modest improvements on the horizon next year.

"We're starting to see improvements in financial markets, but the soft economy is still putting pressure on the industry, along with [the soft housing market] keeping people from making that decision to move and creating longer turnaround times," Mitchell said.

Fitch rates 67 continuing-care retirement facilities. Of those, 25 are in the A category, 37 are in the triple-B category, and five are below investment grade.

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