LTC Properties, Inc.
Q2 2013 Earnings Call Transcript

Published: 9 Aug 2013

[Operator:]

Good morning and welcome to the LTC Properties Inc Second Quarter 2013 Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions). I’d like to remind everyone that today’s comments including the question-and-answer session will include forward-looking statements. These statements are subject to risks and uncertainties that may cause actual results and events to differ materially. These risks and uncertainties are detailed in the LTC Properties filings with the Securities and Exchange Commission, including the company’s 10-K dated December 31, 2012. Please also note this event is being recorded. I would now like to turn the conference over to Ms. Wendy Simpson. Please go ahead.

[Wendy L. Simpson:]

Thank you, Jessica. Good morning everyone and thank you for joining us today. At the time of our last earnings call, we were a day or so late from issuing 4,025,000 shares of our common stock at $44.50 a share. This issuance was primarily to fund $141 million transaction we announced yesterday. In May, looking forward we determined that based on our confidence in the deal pipeline and our development pipeline, we would need to issue equity by the end of the year or start growing in 2014, or take our leverage above our 30% comfortable levels and four of that earned good equity markets in 2014. In May, we thought the Michigan deal will close earlier this year, but it’s a fairly complicated transaction and it has taken longer than we anticipated. Clint will provide more details about this transaction in a movement. At the time we issued the new equity, we could have experienced no dilution this year had Michigan closed sooner than now scheduled. However, we are very pleased to have the deal and while I regret the dilution, I believe we were right in securing the permanent equity at the time and at the price. Now, I’ll turn the call over to Pam Kessler, our Executive Vice President and Chief Financial Officer, who will comment on our financial results and operator coverage specifics. Then Clint, our Executive Vice President and Chief Investment Officer will talk about the deal, our pipeline and our development activities. I will then have closing comments before opening the call to questions. Pam?

[Pamela J. Shelley-Kessler:]

Thank you, Wendy. I will be discussing quarter-over-quarter results. I will refer you to our Q that was filed yesterday for a discussion of year-over-year results. For the income statement, revenues were flat quarter-over-quarter; interest expense decreased $335,000 primarily due to the pay-off of our line of credit in May with the proceeds from the equity offering. General and administrative expense decreased $540,000. In the first quarter, G&A included a one time charge of $707,000 related to the retirement of our former Senior Vice President of Marketing. On a normalized basis, G&A was $167,000 higher in the second quarter due primarily to the timing of certain seasonal expenses surrounding the annual meeting, proxy, legal and some state franchise sales in East Texas. We recognized a $1 million loss on the sale of a 47 bed skilled nursing property in Colorado that was built in 1954. Although we were not actively marketing this property for sale, we determine that we do not want to own and further invest possibly needed capital in the small world property. Annual rent for this property was approximately $138,000. The property was approximately 60% occupied and had EBITDAR coverage of 0.8 times and EBITDAR coverage of 100 times for the trailing 12 months ended March 31, 2013. When the current operator offered to buy it, we view this as opportunistic time to remove this property from our portfolio. Net income available to common shareholders was flat quarter-over-quarter. Normalized fully diluted FFO per share was $0.57 this quarter compared to $0.61 last quarter. The decrease is due to the increase in the weighted average shares outstanding during the quarter resulting from the equity offering in May. Normalized fully diluted FAD per share was $0.57 this quarter compared to $0.60 last quarter. Turning to the balance sheet, during the quarter we invested approximately $7.5 million in development, redevelopment and capital improvement at a weighted average yield of approximately 8.8%. Capitalized interest for the quarter was approximately $300,000. We sold a 47 bed skilled nursing property as previously discussed. During the quarter, we received approximately $470,000 in scheduled principal payments on mortgage loans receivable. Also during the quarter, we received a $2.3 million pay-off of a note receivable and we funded approximately $450,000 under various notes receivable. During the quarter, we sold 4,025,000 shares of common stock at a gross sales price of $44.50 per share. Net proceeds from the offering of $171.4 million were used to pay down the line of credit and to fund our development commitment. At June 30, 2013 and currently our line of credit is undrawn, therefore we have $240 million available under our line of credit. Additionally, we have $109 million available under our Shelf agreement with Prudential and approximately $65 million of cash on hand. In July, we filed a new Shelf registration statement to replace our old Shelf. We currently have $800 million available under this new Shelf and we are considering a new genetic file with our old Shelf. During the quarter, we granted 8,400 shares of restricted stock at a grant price of $46.54 per share and 6,000 shares of restricted stock at a grant price of $41.83 per share. During the second quarter, we paid $16.4 million in preferred and common dividends. Turning to operator statistics, and discussing operator statistics, I'll give the general caveat that these numbers come from our operators are unaudited and have not been independently verified by us. Additionally, their occupancy and lease coverage information is for the 12 months first quarter 2013 compared to the trailing 12 months fourth quarter 2012. Occupancy in our same property out portfolio was flat at 78%, excluding properties leased with Assisted Living Concepts and Extendicare, occupancy for out-portfolio was 87%. EBIDTAR lease coverage after a 5% management fee was 1.4 times. Before management fee or EBIDTARM coverage was 1.6 times. Occupancy in our same property SNF portfolio increased to 79%. EBIDTAR lease coverage after 5% fee was 1.9 times and before fee or EBIDTARM coverage was 2.5 times. Occupancy in our same property range of care portfolio, which consists of properties that provide any combination of skilled nursing, assisted living, independent living and/or memory care services was 86%. EBITDAR lease coverage after 5% fee was 1.4 times. Before management fee or EBITDARM coverage was 1.8 times. The underlying payor mix for the 12 months ended December 31, 2013 for our same property portfolio, which includes skilled nursing, assisted living, memory care, independent living and properties with a combination thereof was 59% private pay, 15% Medicare, and 26% Medicaid. Within our same property SNF portfolio, the underlying payor mix was 25% private pay, 28% Medicare and 47% Medicaid.

[Wendy L. Simpson:]

Thank you Pam, Clint?

[Clint B. Malin:]

Thank you Wendy and good morning everyone. We are very excited to announce our transaction with affiliates of Prestige Healthcare. We are providing long-term mortgage financing for their acquisition of assets in Michigan from the (inaudible). Prestige Healthcare is a privately held operating company based in Louisville, Kentucky that currently operates skilled nursing facilities with approximately 2,500 beds in seven states including one facility in Michigan. They are operated currently within our portfolio, operating in range of care property in South Carolina, which we acquired in February of 2011. Each of the three principals of Prestige is over 20 plus years of experience in the skilled nursing industry. Since our first deal in 2011, we have sought opportunities to expand our relationship with Prestige and this opportunity at Michigan was a unique off market transaction they have brought to us. Michigan portfolio consist of 15 properties with 2,092 licensed skilled nursing beds and 24 IL units, which will increase Prestige’s total beds under operation to approximately 4,500. We’ve announced the details of this $141 million investment in our press release issued on Wednesday. So I’ll first speak to the benefits to help you see this transaction and then walk through the details of the investment. To begin, this was a non-marketed transaction, which we always prefer as it increased the likelihood of our execution, and helps us better prioritize deployment of our resources. The transaction adds a new state to our portfolio and expand the relationship with an existing customer. And evaluating a new state, we’ve taken the consideration of critical mass and obviously this transaction meets that requirement. Additionally, 85% of the properties in this transaction are located in the Detroit Metro area. Continuing to improve our metric of investments located in the top 31 MSAs. Additionally, this investment continues to reduce our gross investment concentration in Texas from 25% to 22%, and reduces operator concentration within our portfolio to under 10% for operator with the exception of Prestige, which will be a 13% upon closing of the loan. This transaction increases our SNF concentration within our portfolio, based on gross investment to 57%, and revenue derived from SNF to 59%. To mitigate this higher concentration, we are continuing our development financing program target towards private pay, seniors housing properties. As these transactions are completed, we will continue to grow our private pay assets allowing us to maintain more of a balance between government reimbursed and private pay assets. Turing to the details of this investment, as a requirement of Prestige and due to certain regulations in Michigan this investment is structured as a mortgage loan. But, it embodies most elements of a long-term master lease. Loan is for a term of 30 years and will bear interest at an initial rate of 9.41% for five years escalating annually thereafter by 2.25%. Payments will be interest only for a period of three years after which the borrower will make interest payment along with animal principal payments of $1 million. The $141 million loan includes a $12 million forward commitment to capital improvements available for 30 months from the date of closing and a contingent $3 million commitment for short-term working capital. The $3 million working capital commitment is available for 15 months after the date of closing and must be fully repaid at the end of 18 months. Also this loan agreement provides the borrower with access to an additional loan proceeds of up to $40 million plus any principal payments made subject to a 1.45 times forward interest coverage ratio based on audited financial statements for a trailing 12 month period. Such additional loan proceeds are limited to a maximum of $10 million per year. The additional loan proceeds maybe requested between the third and the 12th year of the loan, but only available with the partial prepayment option, which I will discuss next. One, has expired without exercise. Two, has been exercised with sales to close or has been rescinded. The borrower has a one-time option between the third and 12th year to repay 50% of the loan balance outstanding without penalty. Exclusively for the purposes of this option, the properties collateralizing loan have been separated by LTC into two pools of assets. If and when the option is exercised LTC will identify which of the two pools it will release for prepayment and removals from the portfolio of properties securing the loan. Had this transaction been structured as a lease agreement, instead of a mortgage loan, this arrangement would be equivalent to granting a partial purchase option to a lessee. If the partial prepayment option is exercised and timely concluded the borrower forfeits its opportunity to access the $40 million of additional loan proceeds. Additionally, under certain circumstances including a change in regulatory environment, LTC has an option to purchase the properties for an amount not to exceed $178 million of consideration paid at closing equal to the outstanding loan balance, plus any principal payments made and an amount based upon certain operating metrics and subject to audited financial statements. The loan then converts to a pre-negotiated master lease for the remaining term. The purchase price paid at closing is less than $178 million when exercising the option. The difference based upon a rent coverage ratio for the master lease will be available to the 12th anniversary of the loan closing as an earn-out. Within this portfolio, there was one property undergoing a major addition and renovation and another undergoing a major renovation totalling approximately $6.5 million in aggregate and is been funded by the seller in completion as a condition to our loan closing. Including this amount, the total capital invested by the seller in this portfolio over the past five years is approximately $33 million. After funding the $12 million commitment for capital improvements from the loan proceeds, this portfolio of assets will have approximately $45 million deployed into the properties within a six to seven year timeframe. Additionally, about a third of the properties have excess land available to consider additional major additions to the properties and to replacement projects, creating additional opportunities within this portfolio. Over the past three years, the occupancy for the portfolio has been maintained in the 82% to 84% range and is 84% for the most recent trailing 12 months period. We have underwritten this investment at 1.5 times interest coverage ratio, but this coverage is conservative for a number of reasons. First, the interest rate for the first five years of loan is fixed. So without an increase in interest cost over the next five years perspective coverage should increase. Second, the 1.5 times interest coverage includes a fully loaded management fee of 5%. However, given the size and geographic concentration of this portfolio, the 5% management fee as an [allocated] expense is in excess of actual cost. Next, one of the facilities underwent a complete renovation and modernization in 2011 and has been in the 60% occupancy range, because it initially only accepted Medicare residents. However, because of the lower overall occupancy, the facility began accepting residents of Medicaid in the first part of 2013. Today, the Medicaid center represents only about 10% of the facility’s resident population. Our borrower believes they will be able to run this facility at mere 90% occupancy by significantly eroding the Medicaid population, which will still give the facility an approximate 40% quality mixed based on census. One of the facilities I previously mentioned that is undergoing a major renovation currently has had approximately one-third of its beds out of service. The 1.5 times coverage does not include any increased NOI resulting from the repopulation of residents to this facility. Additionally, our underwritten coverage does not include any increased NOI attributable to the $12 million commitment for capital improvements. Finally, the current EBITDAR margin for the portfolio is only at 10%, which is on the lower end of the average. In addition to items just mentioned, our borrower believes they can achieve increases to the margin via efficiencies from the operational model and better expense management. Closing on the loan is expected to occur on or about November 1 subject to standard conditions to closing, including the issuance of new operating licenses to affiliates of Prestige. Of the aggregate loan amount, we anticipate funding $126 million under this loan agreement at closing. The initial funding amount represents an 83% loan-to-value metric based on a portfolio valuation contained in independent third party appraisal report obtained as part of our underwriting process. Lastly, as it relates to this transaction I want to mention the city of Detroit, since it has been in the news as of late and we are assuming that might prompt questions on this call, regarding the city’s bankruptcy filing and what impact it might have on this transaction. Although a majority of the properties are located in Detroit MSA, none of the properties are located in the city of Detroit proper. So, we viewed Detroit’s bankruptcy filing as headline risk only. Detroit’s finances have no direct impact on the state’s Medicaid program. The recovery of the auto industry as well as the overall economy in Michigan since the recession has led to significant growth in the state, including Michigan’s Rainy Day Fund from its low point during the recession of $2 million to $580 million in 2013. State 2014-2015 fiscal budget beginning in October 13 in 2013 was signed in the law by Governor Rick Snyder in June and did not include any significant changes to the state’s Medicaid reimbursement system. In the state’s prior fiscal budget, which began in October in 2012, the facilities in this portfolio received an average increase in their Medicaid rate of approximately 4%. Despite Michigan’s economic trouble during the recession, the state’s Medicaid payment system has remained relatively healthy in recent years. According to a recent study by state Medicaid underfunding commissioned by the American Healthcare Association, Michigan was the only state of 37 states studied to have an average Medicaid rate and excess of average cost in 2010. Also, Michigan has adopted [total reform]. Turning to other items, we are very pleased to have two of our development projects opened within the last 45 days, the 120-bed skilled nursing replacement projects in Amarillo operated by fundamental opened on June 20, and is currently at 68% occupancy and a 41% quality mixed based on census. Our 60 unit free-standing private-pay memory care property in Littleton, Colorado operated by Anthem Memory Care opened on July 15 with 43 resident deposits. As of yesterday, the community has admitted 38 residents and a 63% occupied within less than 30 day of opening. Our underwriting projections assumed Anthem would not reach 63% average occupancy until the 12th month after opening. This speaks to Anthem’s capabilities and site selection and lease up execution. It also demonstrates our disciplined approach and prudent underwriting process in evaluating development projects, both projects were completed on budget. Following the announcement of our Michigan transaction, our pipeline stands at approximately $170 million including expansion and renovation projects within our portfolio. The majority of the pipeline relates to development opportunities. We do have a fully executed letter of intent for a sale lease back transaction on a skilled nursing facility with an existing tenant. This transaction will not close until late fourth quarter due to contractual obligations of the operator. Transaction documents are being negotiated and we look forward to announcing this transaction in the near-future once all documents have been executed. Additionally, we are close on finalizing documentation on the four development projects for free-standing private-pay memory care properties with Anthem. We should be in a position to purchase land on one side in the near future and concurrently begin funding construction. We look forward to announcing the details of these projects once the transactions documents are executed. And to conclude on June 4, we announced the hiring of Brent Chappell, as the company’s Vice President, Investment and Portfolio Management. We are very excited that Brent decided to join our team. Brent’s prior experience with AHP is a great fit for LTC providing increased capabilities for continued execution of our growth strategy through acquisition and development. He brings a wealth of knowledge about the industry to our company as well as exposure to relationships cultivated with operating companies during his tenure within AHP. Now I’ll turn the call back to Wendy.

[Wendy L. Simpson:]

Thanks, Clint. We are quite pleased with how Amarillo and (inaudible) have turned out. We are looking forward to attending the opening of our Wichita project on October 5. And we might have another opening in Wisconsin at the end of the year. Our construction and development initiatives are progressing at a pleasing rate and are adding new and modern properties to our portfolio. At the June quarter, we had $90 million of active development and leased up projects underway with $34 million having been dispersed through the end of June. We have $56 million committed to complete these projects. We anticipate spending 27 million for the remainder of 2013 on these projects and $29 million in 2014. The largest project rolling over into 2014 is the new skilled property we are building with Carespring in Kentucky. Of the $29 million we are currently committed to spend in 2014, I anticipate that about $80 million of that spending will be done by the end of the second quarter in 2014, and we will be producing additional rental income. Carespring is the project that will be completed at the end of 2014 and probably opening in 2015 or very close to the end of 2014. As a reminder we talk about our pipeline at those possibilities in which we have a reasonable chance of converting to an actual deal. Right now the dollar investment opportunities for sale leaseback transaction is relatively low in our pipeline, but recently Mark Hemingway, our Vice President of Marketing has introduced two new operators who are possibly interested in pursuing sale leaseback transactions. With the heaviest listing of the Michigan deals now done, Clint will be turning his attention to address these opportunities. Now, we get to what has become my favorite part of these calls. How do we feel about assisted living concept? I am sure you all know that the TPG acquisition of ALC have closed, and that Jack Callison previously of Holiday Retirement has been named CEO. Several weeks ago, I got an e-mail from an ALC representative, letting me know that Mr. Callison would like to meet, but as of today, we have not set a date for that to happen. So all the current information I have about ALC is from the fine reporting of Steve Monroe in The SeniorCare Investor. For those of you who have addressed Steve’s comments, Mr. Callison is described to have energy and optimism. My interpretation of Steve’s full article is that he is slightly skeptical in general about the resurrection of this company, however he did point out positive strategy discussed with Mr. Callison such as increasing quality of care, investing in technology to ensure they are in compliance with our state rules and regulations, investing in staff, and staff training. I agree with SeniorCare that if Mr. Callison can do all of these things that will be a win-win-win for him, TPG, the industry, residence, their families, the staffs of the properties, but it will take lots of time and lots of energy and optimism. Right now, I am not sure what that means for 37 properties that are owned by LTC and currently operated by ALC, I do expect Mr. Callison to not default on any of the obligations ALC has under its leases. I have now towards 21 of the properties and we will just one more in a couple of weeks. They continue to be very well maintained, and in markets that I believe can be revived with the appropriate marketing and operating energy. Some of the properties have experienced occupancy increase and some have experienced slight decreases so all in all a pretty stable environment during a period of great turmoil. I continue to be positive about the opportunities I see in these 37 properties and look forward to meeting Mr. Callison. As I said in my preliminary comments, when we gave guidance at the end of the first quarter, while we were anticipating an equity transaction, I was not anticipating solution based on projected deal completion. However, timeline slipped and so has our normalized FFO guidance. Anticipating that Michigan deal closing no sooner than November 1, and using our line to fund, I am giving guidance of normalized fully diluted FFO in the range of $235 million to $237 million. Again as in the past, the guidance is on an as is basis, and does not contemplating terming out our draws under our unsecured line of credit or doing additional accretive deals before year-end. I am not giving 2014 guidance for the Michigan deal will be very accretive in 2014 and beyond. We still have great opportunities to add to our FFO by converting some of the details in our pipeline and continue to build our relationships with our operators and new operators that we meet. Thank you for taking the time today to listen to our presentation, and Jessica I will now open it up to questions.

[Operator:]

(Operator Instructions) The first question comes from Karin Ford with KeyBanc.

[Karin A. Ford:]

Hi, Good morning.

[Wendy L. Simpson:]

Good morning, Karin.

[Karin A. Ford:]

Just a question on your comments that sale leaseback volumes are relatively low in the pipeline today, why do think that it is because there was a lot of management attention on the Prestige deal or do you think something has changed in the environment that created a shortfall in the volume mix.

[Clint B. Malin:]

This is Clint Karin. Part of this has been just the attention on the Michigan deal. It was a little bit of a complicated transaction to structure and that’s probably the primarily driver on that. I see that there will be more opportunities for us to pursue sale leasebacks as Wendy mentioned.

[Karin A. Ford:]

Okay, so the increase in rates and some of the uncertainty there in the capital market at present hasn’t changed the seller interest or the competitive landscape in anyway?

[Clint B. Malin:]

No. Right now, no.

[Karin A. Ford:]

Okay, thanks. And what was the primary reason that the Prestige deal got delayed this year?

[Clint B. Malin:]

Just structuring.

[Karin A. Ford:]

Yeah. Perhaps it’s just because it was complicated.

[Wendy L. Simpson:]

Right.

[Clint B. Malin:]

Right.

[Karin A. Ford:]

Okay. And then finally, there has been some discussion about new supply come in specifically into the memory care space. Have you guys thought about that as you’re looking at new additional memory care developments and owning those properties going forward?

[Clint B. Malin:]

Absolutely, I mean we look at that primary concern of ours and we get market studies. We got off the markets, but looking at the Littleton project that we just completed, is a good example of the due diligence we undergo to look at the opportunity, but we’re very cognizant that there are more development projects coming on line and you really have to know the specific market and partner with the right operators who knows that marketplace?

[Karin A. Ford:]

Thank you.

[Wendy L. Simpson:]

Thank you, Karin.

[Operator:]

The next question comes from Tom Roberts with Hilliard Lyons.

[John Roberts:]

It’s John. Hi, Wendy. First, I want to ask if there is anything specific with you doing all the investment in Kentucky. We hope you’re coming out and seeing us when you are here looking around is all I can say.

[Wendy L. Simpson:]

We can move the corporate offices.

[John Roberts:]

Yeah, it sounds like it. First of all, let’s ask a little bit here about the acquisition environment, heard lot of people, sellers might be taking a little time to adjust to the new reality. Is there a function and the pipeline being mostly development at this point?

[Wendy L. Simpson:]

I am sorry, Pam was just saying something. Who said that?

[Pamela J. Shelley-Kessler:]

No, John talking about all of our peers…

[Wendy L. Simpson:]

That the sellers are taking a pause…

[Pamela J. Shelley-Kessler:]

Yeah, a pause.

[Clint B. Malin:]

Well, John this is Clint. I think on the private pay side there has been a fair amount of competition between our peers for that asset type. And so there is still a lot of you looking at deals I think on the private pay side. On the skilled nursing side, lot of people look to diversifying away from skills, talk some of our competitor skills ago. So I think that there are similar opportunities on the skilled side and hence looking at the transaction that we were able to execute on in Michigan.

[John Roberts:]

Okay. Yeah, and almost talking about more from the seller side, you think sellers really hold back at this point, not adjusting to the new…

[Clint B. Malin:]

No they haven’t…

[John Roberts:]

In reality.

[Clint B. Malin:]

I haven’t seen the whole back a lot no.

[John Roberts:]

Are they willing to come, to understand the cap rates have moved with the move across the capital?

[Clint B. Malin:]

I think that there is so much competition on the private pay side that you got private reseller active looking in investing in that space. You’ve got. All of these are trying to diversify. I think that sellers are still can command a certain price of that product type and that’s one of the reasons we are focusing on development of the private pay assets, because we think it’s a better value proposition and a better risk adjusted return for us.

[John Roberts:]

Good. Any guidance on G&A for the remainder of the year?

[Wendy L. Simpson:]

I think last quarter I had putout a guidance of about $2.7 million a quarter and it think on average that’s still good. There are slight seasonal fluctuations in G&A, but on the whole, I think $2.7 million is still a good run rate.

[John Roberts:]

Okay. You are operating another expenses, now that’s just including just G&A, are putting acquisition costs in there et cetera?

[Wendy L. Simpson:]

There are some acquisition costs in there. Right now, it’s pretty immaterial, but with next quarter, with Michigan, it maybe a bit higher, maybe $100,000 higher.

[John Roberts:]

Okay.

[Wendy L. Simpson:]

Based on that, yeah.

[John Roberts:]

All right, very good.

[Wendy L. Simpson:]

And we will obviously point that out, we always – any fluctuations that’s not normal or recurring, we typically disclose.

[John Roberts:]

Super. Well, and as I said, how far are you going to do due diligence, give us a call (inaudible).

[Wendy L. Simpson:]

Okay. Thanks, John.

[John Roberts:]

Thank you.

[Operator:]

Next question comes from Daniel Bernstein with Stifel, Nicolaus.

[Daniel Marc Bernstein:]

All right, good morning.

[Wendy L. Simpson:]

Good morning Dan.

[Daniel Marc Bernstein:]

Many congrats on the mortgage procedure…

[Wendy L. Simpson:]

Thank you.

[Daniel Marc Bernstein:]

…I think it’s a big event for you. Any tremendous detail that you gave as well earlier in the call, I have one question on that. Once they go ahead and I guess we developed the asset, the properties and fully stabilize some of the assets they have in their portfolio, where do you think the centers Medicare or Medicaid centers would be or quality mix or still mix, whatever you prefer to mention could be. How are you underwriting, where that portfolio will be and when it’s stable?

[Clint B. Malin:]

Right now, they are at about, I would say other than a couple of a assets, I mean pretty much is stabilized. Right now, they are looking at Medicare centers probably in about upper teens to 20% for Medicare. And I think they have got the ability to grow that a little bit, and in Medicaid centers right now, it’s right around the 65% range.

[Daniel Marc Bernstein:]

Are they moving anywhere in terms of liquidity up or down in terms of Medicare they are looking to give more (inaudible). I’m just trying to understand where that portfolio is going in terms of volume.

[Clint B. Malin:]

We are not looking at that at the time being, but as they get more into the marketplace and see what the relationships are with the local hospital systems, mainly script writers I mean that could change over time, but right now it’s really still more the focus on short-term readmissions.

[Daniel Marc Bernstein:]

Okay.

[Wendy L. Simpson:]

See, I would put out, you are one of the few analysts that actually talks about quality mix in terms of sensitive most of the other analysts talk about in terms of revenue. So, but the other analysts out there that are, we typically about quality of mix based on revenue. It’s obviously much higher than census quality mix.

[Daniel Marc Bernstein:]

No, no. absolutely, that’s why asked skilled mix.

[Wendy L. Simpson:]

Yeah.

[Daniel Marc Bernstein:]

Whatever your favorite metric was…

[Wendy L. Simpson:]

Yeah.

[Daniel Marc Bernstein:]

And then the – I also wanted to ask about the dynamic of looking at top 31 assets versus 31 to 100 metro areas, you have been outside of the top 100. What are you liking about top 31 markets versus going outside that, I think some other REITs and maybe some other operators like going outside of that top 31, they see this maybe a buried entry for construction because folks can’t get the rents they want. How do you look at the dynamic between top 31 and outside, and maybe difference between seniors housing and skilled nursing obviously.

[Clint B. Malin:]

I think it’s different between the two asset types. It’s really a function of positioning these assets in a going forward and the new environment with ACLs potentially coming about being able to integrate into hospital systems lining with them. Managed care systems being able to provide higher acuity levels of care. But, we look at smaller markets as well we’ve made some investments in that. So it really depends on the underwriting and the opportunity in front of us. But, we do think that, what is top 31 of the top 100, I think our portfolio we have a large percentage in that…

[Wendy L. Simpson:]

It’s over 60%.

[Clint B. Malin:]

60% on top 100 and I think that provides a lot of opportunity ultimately probably some changing environments, that would be implementation of ACLs, whenever that does happens.

[Daniel Marc Bernstein:]

Okay, it’s not that the top 31 is so much better than 32 to 100 or…

[Clint B. Malin:]

Oh no, no…

[Daniel Marc Bernstein:]

Is it the market-by-market analysis?

[Clint B. Malin:]

I think generally the industry rates are down sort of in those classifications we provide that for comparative purpose.

[Daniel Marc Bernstein:]

Okay. And then also I want to understand the competition for development funding or the loan funding as well, obviously folks have asked lot of questions on the acquisition side of the competition there. But, do you think you kind of help a well competitive environment for development finding for the kind of loans that you did or proceed, is that why your operators are coming to you for development and the loan financial?

[Clint B. Malin:]

Well I would look at Prestige as far as development funding. I think the development primarily in a private pay side and that is getting more competitive. I think you are seeing banks that are willing to lend a little bit more. You are seeing some of our re-competitors, getting more active in developments of the private pay assets. It is getting there is more competition on that side.

[Daniel Marc Bernstein:]

Okay, but it’s still not so competitive that you can’t win development deals in. I think that’s all I have. Thank you very much.

[Wendy L. Simpson:]

Thank you, Dan.

[Operator:]

The next question comes from Todd Stender with Wells Fargo.

[Todd J. Stender:]

Hi. Good morning everybody.

[Wendy L. Simpson:]

Good morning.

[Pamela J. Shelley-Kessler:]

Good morning.

[Todd J. Stender:]

Clint, any indication on Prestige’s credit rating? I know they are private. They probably don’t have one, but kind of what your shadow rating is or how you assess the credit quality of Prestige?

[Clint B. Malin:]

So, disclosing that information, well, we got confidentiality agreements on that, but we’ve gone through letting of their organization and their management group and we’ve evaluated them overall as the credit risk. We also look not only to the operator, but we look to the assets as well. So it’s a combination of underwriting both. Our risk is always, do we have to replace a tenant and the question of replacing a tenant is what is the asset quality, location, concentration. So we look at both aspects.

[Wendy L. Simpson:]

And you said we evaluated them from a credit risk standpoint, not evaluated that as the credit risk.

[Clint B. Malin:]

Correct.

[Wendy L. Simpson:]

And then I’m not sure we mentioned that we’re getting deposits. So, I mean, generally as we have loans, we don’t get loan service deposits, but because this is functioning as there is a loan, but really functioning as a master lease, we have three months of interest coverage, deposit…

[Clint B. Malin:]

Debt service, tax escrow, things of that nature.

[Todd J. Stender:]

That was my next question. Thanks for bringing that up. So that cash will be held in escrow for a certain amount of time.

[Clint B. Malin:]

Well, it’s expected to – at security deposit in the form of letter of credit, well, us as a beneficiary of that as well as the replacement reserves that have a minimum balance after you maintain the escrow capital dollars with us along with we will say taxes on a monthly basis.

[Todd J. Stender:]

Okay. Thank you, Clint. And I don’t think I got this. Of the 15 properties how many of them are currently stabilized or by the time that you extend the first payment?

[Clint B. Malin:]

They would be pretty much all of them except the three that – the one that I mentioned that has, was caving premiss to an all Medicare population and the two that are under as addition to renovations going on right now.

[Todd J. Stender:]

Okay. And the timing of the first payment of $126 million is in Q4. Is there any chance that this gets delayed within the quarter?

[Clint B. Malin:]

It really now subject to licensor as the main item outstanding. Michigan has an 80-day process for licensor and applications have been filed by Prestige with the state. So, at this point I don’t see any delay in that. Typically our experiences with licensor of state has gone fairly smoothly. So I’m not anticipating it’s always subject to their review process, but the good thing is Prestige already operates in the State of Michigan, familiar with the state’s process. So I’m not expecting any delay at this point in time.

[Todd J. Stender:]

Okay. Thank you. And Pam, kind of your blended cost of capital, has that changed at all? Do you see equity to pay down your line and now you’re probably looking at terming out the line of credit that you’ll be using to fund the first payment. Any kind of think about what your investment spread is going to look like at the end of the day.

[Pamela J. Shelley-Kessler:]

Yeah, that’s a good question. Yeah, certainly our cost of capital has increased. Our weighted cost of capital, including equity has certainly increased. Rates have increased, but spreads have come down. So I would say, right now if we were looking at a long-term borrowing eight years to 10 years or probably 4.5% to 5% and then for an overall weighted cost of capital probably low to mid 6s%.

[Todd J. Stender:]

Okay. Thank you.

[Pamela J. Shelley-Kessler:]

Thank you.

[Operator:]

Next question comes from Rich Anderson with BMO Capital Markets.

[Rich C. Anderson:]

Hey, good morning everybody.

[Wendy L. Simpson:]

Good morning.

[Clint B. Malin:]

Good morning.

[Rich C. Anderson:]

I am sorry. The deal, there is three parties involved here. What risk – what extent could somebody kind of I mean, this is out of your hand in terms of it not going forward, in terms of a deal actually happening.

[Clint B. Malin:]

Three parties including the seller.

[Rich C. Anderson:]

Yeah, including the seller.

[Clint B. Malin:]

I mean those documents have been executed and earnest money has gone hard. So, really it’s very minimal, Rich.

[Wendy L. Simpson:]

Risk is licensing.

[Clint B. Malin:]

The risk is with licenses, that’s it.

[Rich C. Anderson:]

That’s it. I mean, at this point they could walk away and risk losing those initial funds. Is that right?

[Clint B. Malin:]

I guess they could technically default and put a risk the earnest money, but I see that as given the time and effort and the opportunity within this portfolio I will see that as a very unlikely event.

[Rich C. Anderson:]

Where would you place the timing and how much of a surprise do you think the, because I don’t know how far back that goes, the Detroit bankruptcy and how that – when did that happen and how much do you think that comes through a range in the system in the whole negotiating process?

[Clint B. Malin:]

It didn’t feel any risk. They filed about a month ago, I believe…

[Wendy L. Simpson:]

That’s right.

[Clint B. Malin:]

That’s right. And that had basically no impact at all on the negotiation or on the deal. Again, as I said in my comments, we view that as just headline risk only and I addressed in my comments, I thought it might come up with a question on the call.

[Wendy L. Simpson:]

The operator had been – owned these properties for a long time. He has a Chief Operating Officer that’s been with him for 27 years and they just paged out and wanted to sell the assets. So I don’t think it’s got anything to do with the economics of the state of Michigan or the – and he didn’t have a management team that wanted to go forward and buy them out and he found a willing buyer and so that’s what happened.

[Rich C. Anderson:]

To what degree is this just a stepping stone in a sense that you mentioned your purchase option that you financed Prestige’s purchase and then within a short very window, you end up being the owner of the assets?

[Clint B. Malin:]

I mean, there is a contingency upon how we would, how our purchase option would be available. So I don’t know when that maybe a number of years down the road before that may even become into…

[Rich C. Anderson:]

Okay. So, there was a trigger that it can happen anytime soon in your side.

[Wendy L. Simpson:]

Right.

[Clint B. Malin:]

Correct.

[Wendy L. Simpson:]

Right.

[Rich C. Anderson:]

Okay. And well, I was going to ask you if you met Jack Callison, but you said you didn’t…

[Wendy L. Simpson:]

Do you know him?

[Rich C. Anderson:]

I know Jack very well, yeah.

[Wendy L. Simpson:]

Well, say, hi when you see him.

[Rich C. Anderson:]

Well, I don’t see him that much. Anyway, good luck thanks very much, good call.

[Wendy L. Simpson:]

Thanks Rich.

[Operator:]

The next question comes from Michael Carroll with RBC Capital Markets.

[Michael Albert Carroll:]

Can you give us an example of how and when your purchase options will be triggered? I think you said, well, a change in the regulatory environment would make those unavailable to you.

[Clint B. Malin:]

Sure. Right, now it’s the time, the reimbursement system under Medicaid in Michigan reimburses for property specific debt. And since we don’t have property specific debt on our investments other than a nominal amount, they don’t reimburse for rental expense. So if the state’s reimbursement system were to change at some point in time in the future, that would trigger a mechanism where we would be able to exercise the purchase option.

[Michael Albert Carroll:]

Okay. And then how is your current pipeline right now and do you have any other large portfolio that you’re looking at?

[Clint B. Malin:]

No, we are not looking at any other large portfolio. As I indicated, we’re about a $170 million right now, which primarily has a majority of its development or expansion renovation opportunities within our portfolio.

[Michael Albert Carroll:]

Okay, and then related to on the Assisted Living Concepts, I thought that the coverage ratios were largely flat and now they are about 0.9 times I mean is that where you expect to be kind of stabilize that?

[Pamela J. Shelley-Kessler:]

I would expect the sales to be going up. When Dr. Roadman started running the company, he was adding cost appropriately of course, he was staffing up and getting the right combination. And I think overall, we’ve seen some improvements in the census. So the census is catching up with the cost, and I think just the energy that a new company brings to or a new attitude brings to, I would expect that these properties will see increase in census. And it’s a trailing twelve, so we may have one more quarter for the additional cost of rolling, so we could have one more turn down. I think if you go to the before, Dr. Roadman took over it clicked down one turn each quarter, and I think we have one more quarter to go. So if we go…

[Wendy L. Simpson:]

But in those two quarter that ticked down.

[Pamela J. Shelley-Kessler:]

Yeah.

[Wendy L. Simpson:]

The next quarter might have had increase in census.

[Pamela J. Shelley-Kessler:]

Right

[Wendy L. Simpson:]

I’m not too concerned about those properties through the end of our lease term with them.

[Michael Albert Carroll:]

Okay, then the coverage ratios, is that $0.94 or $0.86 and our which one is it closer to?

[Wendy L. Simpson:]

It is 0.89.

[Michael Albert Carroll:]

Okay. And then, do you still expect or could we expect that a resolution could occur by year-end or how soon could we expect something to be completed?

[Wendy L. Simpson:]

I would expect that we will need a resolution by the end of this year, which is when the option is first addressed. And now that they are even more distance from Extendicare, I expect that Extendicare is not at all interested in renewing the lease. So, by the end of the year we will have some opportunity to start looking at additional for replacement operators if that’s the way we go.

[Pamela J. Shelley-Kessler:]

And I would point out Mike that that coverage is the EBITDAR after 5% fee. EBITDARM, it’s 1.1.

[Michael Albert Carroll:]

Okay, great. So they are still cash flow positive.

[Pamela J. Shelley-Kessler:]

Yeah.

[Wendy L. Simpson:]

Yes, they are cash flow positive.

[Michael Albert Carroll:]

Great. Okay.

[Wendy L. Simpson:]

Thank you.

[Operator:]

(Operator Instructions) With no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Wendy Simpson for any closing remarks.

[Wendy L. Simpson:]

Thank you, Jessica, and thank you all for listening to our conference call and hopefully we answered all of your questions about the Michigan deal, but if somebody has another question, give us a call. We’ll be in today and answering you and we look forward to talking to you at the end of the third quarter. Thank you very much.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.