Changes issued earlier this year by the Financial Accounting Standards Board (FASB) regarding refundable entrance fees for continuing care retirement communities (CCRCs) aren’t expected to impact community ratings, according to a new Fitch Ratings report, but consumer reassurance may be required as a result.
The change has to do with whether income from refundable entrance fee contracts can be accounted for as amortized revenue. The new standard requires the residency agreement contract to have a very explicit condition in order to amortize revenue from refundable entrance fees: they have to specify that an entrance fee refund will be limited to the proceeds of the sale of a particular unit.
“What we’ve seen throughout the CCRC spectrum is that very few communities actually had the language in their residency agreements, and therefore, they would not meet the standard,” says Cline Comer, a partner at CliftonLarsonAllen, LLP.
Anecdotally speaking, it’s not surprising that Fitch doesn’t expect the new accounting change to effect CCRC ratings, he says. “It’s a non-cash accounting change. The financials will look somewhat different than before, but it doesn’t change the economics of the residency agreement.”
All communities with refundable entrance fee contracts that don’t specifically include the requisite language requiring refunds to be contingent on what the provider receives from the sale of a unit will be affected by the FASB change.
A start-up community only offering 90% refund plans that is amortizing the entrance fees it receives over the life of the building has a big portion of income that’s non-cash and currently presented as amortization revenue on an income statement, says Mario McKenzie, partner at CliftonLarsonAllen, and that would have to change. “For some communities, a substantial amount of revenue may go away from a cosmetic perspective,” he says. “All of a sudden, you don’t have that revenue.”
Many of the industry’s approximately 1,800 CCRCs offering refundable entrance fees have been amortizing revenue from those fees, says Comer, and stabilized communities may be doubly affected. “If a facility has been around for 20-30 years, with predominantly refundable contracts they’ve been amortizing, they’ll lose that amortization going forward, but they’ll also have an adjustment in net assets and equity to restore the amortization that has already occurred,” he says.
The accounting adjustment isn’t likely to directly result in widespread financial distress among the industry.
“Regardless of your income statement, as long as you’re priced correctly and can demonstrate that inflows will outpace outflows, then the economics don’t change,” says McKenzie.
Neither were surprised at Fitch’s announcement.
“Overall, Fitch views the FASB guidelines positively for the improved clarity and better consistency on the sector’s treatment of refundable entrance fees,” said Jim LeBuhn, Senior Director, in reference to the report. “Certain ratios such as operating and excess margins and debt to capitalization will be negatively impacted by the accounting change. However, the changes are non-cash, and many of the key financial metrics used in Fitch’s analysis will remain unaffected. Thus, the change in accounting treatment is not expected to have an impact on Fitch’s CCRC credit ratings.”
From a consumer perspective, though, communities may have to do a lot more explaining to do from a cash flow perspective.
“For someone who doesn’t understand the CCRC business model, they could look at a financial statement and conclude a community is underwater or about to go insolvent, but that’s not the case,” says Comer. “Most facilities who are operating with a pretty full occupancy and have their fees aligned won’t really see a change, but it will look a lot different [on the income statement] for non-educated consumers or residents.”
Investors will be looking for cash flow with a long-term perspective, McKenzie says, and may check to see that a community has an adequate disclosure and communication plan to educate consumers about the CCRC business model.
Only a few of CliftonLarsonAllen’s clients have indicated plans to restructure their contracts as a result of the accounting change, says Comer, but the majority are not inclined to do so.
Written by Alyssa Gerace