NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed at 'B+' the rating on approximately $737 million series 2007A health system revenue bonds issued by Allegheny County Hospital Development Authority for the benefit of West Penn Allegheny Health System (WPAHS).
The Outlook is revised to Stable from Evolving.
Security is provided via a pledge of gross revenues and a mortgage on the system hospital facilities.
KEY RATING DRIVERS
NARROWING LOSSES: The rating affirmation and revision of the Outlook to Stable reflects the continued progress and expected finalization of the affiliation with Highmark as well as the narrowing of the operating losses starting with the third quarter ended March 31, 2012 (the interim period) as the system starts to benefit from the ramping up of operations at West Penn Hospital.
AFFILIATION AGREEMENT WITH HIGHMARK INC.: The Oct. 31, 2011 signing of an Affiliation Agreement with Highmark Inc. (Highmark), in which Highmark committed to provide a total of $475 million to WPAHS over a period of three years is viewed positively. To date, Highmark has already contributed a total of $200 million in the form of grants and loans. The failure to execute the affiliation by the May 2013 deadline would result in significant downward rating pressure as WPAHS is currently not able to meet its 1.1x rate covenant without the infusion of capital from Highmark.
INTERIM MANAGEMENT IN PLACE: WPAHS engaged the services of a management company with turnaround experience - Alvarez and Marsal (A&M), which has provided an interim CEO, CFO, and COO at WPAHS. Fitch credits the turnaround team with the reduction in losses which are evident in the third-quarter results.
PHYSICIAN RECRUITMENT AND RETENTION ARE KEY: Fitch sees the ability to retain and recruit physicians as central to the improvement in WPAHS's finances. Several physicians have recently been recruited for key leadership positions.
MANAGEABLE DEBT LOAD: WPAHS has a conservative debt structure with all fixed-rate debt and maximum annual debt service (MADS) represents a manageable 3.5% of revenues. Based on the year to date results WPAHS does not have sufficient coverage of MADS by EBITDA, but Fitch expects WPAHS to meet its 1.1x rate covenant requirement as $50 million of funds from Highmark, currently classified as deferred revenue, is expected to be reported as non-operating income before the end of the fiscal year and included in EBITDA.
VERY THIN LIQUIDITY: Cash and unrestricted investments were at $242.9 million, equal to 58.4 days cash on hand (DCOH), 30.7% cash to debt and 4.4x cushion ratio at 2011 fiscal year end, but declined to $203.4 million at March 31, 2012, equating to 47.9 DCOH, 24% cash to debt and 3.3x cushion ratio.
WHAT COULD TRIGGER A RATING ACTION
FAILURE TO STEM OPERATING LOSSES: The inability to continue to stem operating losses would result in downward rating pressure.
FINALIZATION OF AFFILIATION WITH HIGHMARK: Fitch believes WPAHS's viability hinges on the successful execution of the affiliation with Highmark. If the affiliation agreement is not finalized, a multi-notch negative rating action is likely to occur.
The Affiliation Agreement signed by Highmark and WPAHS in October 2011 has already cleared the Department of Justice anti-trust scrutiny and received IRS approval, but still requires approval from the Pennsylvania Department of Insurance (PID) and the state Attorney General. Highmark expects that the PID review will likely be concluded in the early fall. The structure of the affiliation will keep the current WPAHS obligated group intact and does not call for WPAHS assets or liabilities to be assumed by Highmark. The goal of the affiliation is to create an integrated health care system using WPAHS facilities and physicians as part of the network. Highmark is also independently pursuing investing in expanding the network of outpatient facilities and creating linkages with physicians in support of the integrated network.
The sudden dismissal of the Highmark CEO earlier this spring was a concern, but a new, highly credentialed CEO has been appointed effective July 2012 and Highmark's Chairman of the Board, in his capacity as the acting CEO, has confirmed Highmark's commitment to pursue the affiliation with WPAHS.
WPAHS reported an operating loss of $87.8 million for the interim period, including $7.9 million of restructuring expenses, which translates to a negative operating margin of 7.4% and negative operating EBITDA margin of 0.8%. The year to date loss compares to an operating loss of $75.1 million in fiscal 2011 (negative operating margin of 4.8%), which included $26.8 million of restructuring expenses. Fitch views the consummation of the affiliation as essential given the continued significant operating losses. The operating loss for the interim period was mainly driven by a decline in patient revenues reflecting the closure of the West Penn Hospital (West Penn) Emergency Department (ED), as well as many other acute care services for all but the last 45 days in the current fiscal year. However, with the reopening of West Penn ED and the gradual reinstatement of acute care services, the operating loss before restructuring expenses of $22.6 million for the third quarter shows a material improvement over the $32 million in the second quarter.
As contemplated in the affiliation, WPAHS has used a portion of the Highmark funding to reopen the West Penn ED and is gradually reopening acute care services at the site and upgrading portions of the facility. The ED, which closed effective December 2010, was reopened in February 2012 and the West Penn's average daily census was reported at 94 at March 31 and has continued to increase. Management has also invested $20 million in upgrading Forbes Regional Hospital (Forbes) in anticipation of the opening of the new UPMC East Hospital, located 1 mile from Forbes, which is likely to have a negative, but limited, impact on Forbes' volumes. Highmark has recently affiliated with the Premier Medical Group (Premier), which is a large admitter to Forbes, and has relieved WPAHS of its remaining $22 million funding commitment to Premier pursuant to an agreement WPAHS entered into with Premier in 2010.
Headquartered in Pittsburgh, WPAHS is a large, integrated health system now operating five hospitals and other related entities that primarily serve Allegheny County and its five surrounding counties. WPAHS's flagship is the 661-licensed bed Allegheny General Hospital. Total revenues in fiscal 2011 were approximately $1.6 billion. Disclosure to Fitch and to bondholders has been provided on a quarterly basis and consists of a management discussion and analysis, income statement, balance sheet, cash flow statement, and utilization statistics.
For more detail on WPAHS see Fitch's press releases 'Fitch Downgrades West Penn Allegheny Health system (PA) Bonds to 'B+' from 'BB-', Outlook Revolving', dated Dec. 23, 2011 and 'Fitch Places West Penn Allegheny Health system (PA) on Rating Watch Evolving,' dated June 29, 2011, available on the Fitch website at www.fitchratings.com.
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--Criteria', dated June 12, 2012.
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Aug. 12, 2011.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Nonprofit Hospitals and Health Systems Rating Criteria