NEW YORK--()--Fitch Ratings has affirmed the 'BBB-' long-term rating on HealthEast and Controlled Affiliates' (HealthEast) outstanding debt listed below:
--$201,966,000 St. Paul Housing & Redevelopment Authority (MN) (HealthEast Project) hospital revenue bonds series 2005;
The Rating Outlook is Stable.
The bonds are secured by a gross revenue pledge and are governed by a master trust indenture that contains various standard business and financial covenants. In addition, there is a mortgage pledge.
SENSITIVITY / KEY RATING DRIVERS
LEADING MARKET POSITION: HealthEast has a leading and stable market position in the favorable St. Paul service area, which is considered a key credit strength. Further, Minnesota's highly regulated Certificate of Need creates high barriers of entry and is viewed positively.
IMPROVING OPERATING PERFORMANCE: HealthEast's operating performance and profitability has shown steady year-over-year (YoY) improvement in each of the last three fiscal years. In fiscal 2012, HealthEast generated operating and operating EBITDA margins of 3.2% and 7.4%, respectively.
WEAK LIQUIDITY: Fitch's main credit concern remains HealthEast's weak liquidity position with ratios that are below the 'BBB' category medians.
ADEQUATE DEBT SERVICE COVERAGE: With consistent operating performance, historical coverage of maximum annual debt service (MADS) by EBITDA has been stable at 2.2x and 2.1x in fiscal 2011 and 2012, respectively, which is adequate but below the 'BBB' category median of 2.8x.
STRATEGIC INITIATIVES: HealthEast has identified three strategic initiatives in operating efficiency, information technology and clinical integration that should better position the organization for the post-reform environment.
The affirmation at 'BBB-' reflects HealthEast's leading market share position, steady improvement in operating performance and adequate debt service coverage which helps to mitigate the corporation's weak liquidity position.
HealthEast's main credit strength is its leading market share position in the St. Paul service area. In the east metro area of the Twin Cities market, HealthEast captured 32.7% of the discharges in the primary service area compared to 25.9% for HealthPartners and 23.1% for Allina Hospitals and Clinics (revenue bonds rated 'AA-' by Fitch). Service area characteristics are favorable because of the area's lower unemployment rates and above-average income and employment levels compared to national averages. Further, Minnesota's highly regulated Certificate of Need requirements create high barriers of entry, resulting in fairly stable market position.
HealthEast's operating performance and profitability has shown YoY improvement in each of the last three fiscal years. In FY 2012, HealthEast generated operating income of $29.7 million on total revenues of $894.6 million resulting in operating margin of 3.2%; marking the third consecutive year of operating margin improvement. Similarly, FY 2012 operating EBITDA margin of 7.4% is an improvement over operating EBITDA margins of 6.8% in FY 2011 and 5.8% in FY 2010. The operational improvement reflects growth in outpatient and clinic visits, receipt of $6.6 million in 'meaningful use' payments, a $5.2 million payment from Medicare for 'rural Floor' settlement, and improved efficiency as illustrated by a lower length of stay and increased Medicare Case Mix index.
HealthEast's capital and leverage metrics continue to moderate. Due to heavy historical capital spending, many of HealthEast's leverage indicators have been elevated relative to the 'BBB' category medians. However, with lower capital spending in FY 2011 and FY 2012 and improving operating performance, leverage metrics are coming into line with 'BBB' category medians. In FY 2012, MADS equated to 2.8% of total revenues as compared to 3.2% in 2009. Similarly, debt to capitalization at FYE 2012 was at 60.1%, which is high compared to the 'BBB' median of 49.1% but is a material improvement from 70.2% at FYE 2009. Coverage of MADS by EBITDA has been very stable at 2.1x, 2.2x and 2.1x in fiscal 2010, 2011 and 2012, respectively. However, leverage will increase due to the expected issuance of a $60 million direct placement to fund the portion of the costs associated with HealthEast's new electronic medical record system. The bonds are expected to be structured with interest-only through 2015 with principal amortizing from 2016-2021. Pro forma MADS is estimated to increase to $31.9 million from $25.9 million currently. Fitch did not factor the new debt into the various financial ratios referenced in this rating commentary.
As of Nov. 30, 2012, HealthEast's total outstanding debt was $264.5 million and is 100% fixed rate. HealthEast does not have any outstanding swaps. During calendar 2012, HealthEast refunded its series 1997 and series 1998 bonds through two separate direct placement financings issued through the Housing and Redevelopment Authority of the City of St Paul (which Fitch was not asked to rate). The series 2012 bonds are secured on parity with the series 2005 bonds.
Fitch's main credit concern is HealthEast's weak liquidity position, which provides HealthEast limited financial flexibility. At Nov. 30, 2012, HealthEast had $137.6 million of unrestricted cash and investments which equated to 57 days cash on hand, 5.3x cushion ratio, and 52% of long term debt; all of which trail the respective 'BBB' category medians of 138.9, 9.4x and 82.7%. While liquidity ratios improved over the last three years, liquidity is not expected to improve as HealthEast will make a $135 million investment in a new enterprise-wide electronic health record. The new IT platform will be funded with $60 million of debt with the balance funded through operating cash flow.
HealthEast has identified three strategic initiatives in operating efficiency, information technology and clinical integration that should better position the organization for the post-reform environment. A key area of focus is to improve operating and clinical efficiency through adoption of LEAN management principles and the investment in a new enterprise-wide electronic health record. Further, HealthEast has received approval from the Centers for Medicare and Medicaid Services (CMS) for the creation of an Accountable Care Organization (ACO) in the St. Paul metro market. While Fitch believes these initiatives are necessary to better position the organization for the post-health care reform environment, the investment in its clinical IT platform is expected to curb further YoY improvement in operating performance, leverage moderation and liquidity growth. The need to realize efficiency gains will be critical in light of HealthEast's modest operating margins and light liquidity cushion at the current rating level.
The Stable Outlook reflects Fitch's expectation that HealthEast's efficiency efforts will preserve profitability. Given HealthEast's weak liquidity, stable operating profitability is imperative to maintaining the current rating. A deterioration in profitability or liquidity metrics could result in downward rating pressure.
HealthEast operates 509 staffed beds at three acute care hospitals in downtown St. Paul (St. Joseph), Maplewood (St. Johns) and Woodbury (Woodwinds), as well as a 140-bed long-term acute care hospital, and various outpatient imaging and surgery operations. The system also employs over 360 physicians practicing within its hospitals and throughout the community. In fiscal 2012, HealthEast generated total operating revenue of $928 million. HealthEast provides annual and quarterly disclosure via the MSRB's EMMA system and Digital Assurance Certification (DAC). Interim disclosure includes detailed financial statements, volume statistics, payor mix, and management discussion and analysis.
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:
--'Revenue-Supported Rating Criteria', dated June 20, 2011;
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Aug. 12, 2011.
For information on Build America Bonds, visit www.fitchratings.com/BABs.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Nonprofit Hospitals and Health Systems Rating Criteria