NEW YORK--()--Fitch Ratings assigns an 'A' rating to the following revenue bonds to be issued on behalf of MedStar Health (MedStar) by the Maryland Health and Higher Educational Facilities Authority:
--Approximately $129.6 million series 2013A;
--Approximately $184.3 million series 2013B.
In addition, Fitch affirms at 'A' the rating on approximately $836.5 million of outstanding revenue bonds issued by Maryland Health and Higher Educational Facilities Authority or the District of Columbia on behalf of Medstar.
The Rating Outlook is Stable.
The series 2013A and 2013B bonds will be issued as fixed rate, and proceeds will be used to refund portions of series 1998A (MD) and 1998B (MD) bonds, provide permanent financing for acquisition of Southern Maryland Hospital Center and fund various system capital needs and pay costs of issuance. The bonds are expected to price the week of March 11, 2013 via negotiation.
The bonds will be issued on parity with outstanding debt issued under the Master Trust Indenture (MTI) dated Dec. 1, 1998, as amended and supplemented. The bonds are secured by pledges of gross revenues of the system hospitals and are further secured by mortgages on the system hospitals and parking facilities.
Key Rating Drivers
SIGNIFICANT MARKET PRESENCE: The system has a strong market presence in the Baltimore - Washington D.C. corridor, which includes a large ambulatory network, a significant and increasing level of physician alignment and a reputation for clinical excellence, garnering MedStar a leading 21.6% market share. The most recent acquisition of the Southern Maryland Hospital Center (Southern Maryland) increased its geographic coverage of the southern Maryland market.
CONSISTENT PROFITABILITY: While operating metrics are lower than the 'A' category medians, MedStar has maintained a consistent level of profitability, with operating margins of around 2% and operating EBITDA margins of 7%, generating a robust cash-flow from operations, averaging $269 million annually over the last four fiscal years.
MODEST LIQUIDITY METRICS: At Dec 31, 2012, Medstar's $1.26 billion of unrestricted cash and investments equates to 120.5 days cash on hand (DCOH) and 96% of cash to pro forma debt. However, liquidity growth has been limited by the substantial investment in the system growth, which had largely been funded from operating cash-flow.
CONSERVATIVE DEBT STRUCTURE: While Medstar's liquidity metrics are light compared to 'A' category medians, the system benefits from a conservative debt structure with over 80% of its long term debt in fixed rate mode, solid coverage of pro forma maximum annual debt service (MADS) by EBITDA of 3.7x (times) and MADS representing a still moderate 2% of revenues.
WELL POSITIONED FOR HEALTH CARE REFORM: MedStar's geographic coverage of its market, its robust and growing ambulatory network and close alignment with 1,300 employed and 1,000 contracted physicians provide a solid base for participating in population based health management programs.
NEED TO PRESERVE PROFITABILITY: The Stable Outlook and maintenance of the 'A' rating is dependent on MedStar's ability to maintain profitability at the current levels in order to generate sufficient cash flow from operations to support the planned ongoing investments in the system facilities and programs.
The 'A' rating assignment and affirmation is based on MedStar's large and diversified revenue base, sustained profitability and its significant footprint with a leading market share position and strong clinical reputation in its service area, which includes two major urban markets - Baltimore (MD) and Washington D.C. Fitch also notes the strength of its leadership, which has systematically transformed MedStar into a truly integrated healthcare system with 10 hospitals, a large cadre of aligned physicians and an extensive and growing ambulatory network. The weak liquidity compared to Fitch's 'A' medians remains a concern given the need to continue to invest in the enterprise but is mitigated by the system's consistent profitability, conservative debt structure, good debt service coverage and modest debt burden.
Significant Market Presence
MedStar commands a leading 21.6% market share of its primary service area, which encompasses the cities of Baltimore and Washington D.C. and the 11 surrounding Maryland counties, compared to 15.2% for University of Maryland Health System (rated 'A'; Outlook Stable) and 14.4% for Johns Hopkins (rated 'AA-'; Stable Outlook by Fitch), based on 2012 data. The system also reports leading market share in several high-end clinical service lines, including oncology (20.8%), cardiology (27.6%), neurology (22.1%) and orthopedics (22.8%). Management has successfully executed its strategy through increasing its footprint and strengthening its market presence by building a close relationship with physicians and a well-designed expansion of its ambulatory network. MedStar now has a total of 1,300 full-time salaried physicians, with several hundred practicing in large multispecialty groups, and an additional 1,000 physicians under contract. Fitch believes the current effort to consolidate the salaried physicians into a single group should result in further improvement in coordination of care and the ability to implement clinical best practices. MedStar's ability to strive toward true 'systemness' was demonstrated by the regionalization of certain service lines under single clinical leaders, such as heart care, cancer, orthopedics and neurosurgery, eliminating duplication and generating savings.
The expansion of the ambulatory network has been a continuing focus and a $30 taxable million borrowing later this year will provide a portion of the planned $200 million capital investment in the distributed care delivery network. MedStar's latest addition of the Southern Maryland facility fits well into the system's geographic coverage strategy. The plan is to enhance tertiary services already available at Southern Maryland and to increase area referrals to MedStar's D.C. tertiary providers (Georgetown University Hospital and Washington Hospital Center). Southern Maryland's service area has a solid demographic profile and the facility is in a favorable location on Rt. 5, which is the main access to D.C. from the three southern Maryland counties. The majority of MedStar's commitment to provide future capital needs of the facility are expected be funded from the facility's operating cash-flow. Proceeds of the series 2013B are expected to provide permanent financing for the December 2012 acquisition, which was financed with a bridge loan.
MedStar has generated a modest, but improving level of profitability over the last four years, with operating margin averaging 2% and operating EBITDA margin averaging 7%. For the fiscal year ended June 30, 2012, MedStar reported operating income of $98.5 million, equal to a 2.5% operating margin and 7.5% operating EBITDA margin, exceeding budget by 40%. Through the six months ended Dec. 31, 2012, MedStar's income from operation was reported at $38 million for operating margin of 1.9% and operating EBITDA margin of 6.9%. MedStar's operating metrics are slightly lower than Fitch's medians of 2.8% for the operating margin and 9.8% for the operating EBITDA margin, partially due to the system focus on physician recruitment and expansion of the ambulatory network, and the reimbursement constraints imposed by the Maryland all payor system. Management is budgeting a 2% operating margin for the current fiscal year and forecasts the operating margin to remain at 1.9% through the 2014-2016 period.
Conservative Capital Structure
MedStar's debt burden remains manageable on a pro forma basis with coverage of pro forma MADS by EBITDA of 3.7x and pro forma MADS representing a moderate 2.1% of revenues through the interim period. After the 2013 issuance, Medstar will have a conservative 80% of its long-term indebtedness at a fixed rate of interest. Management has planned additional debt issuance of $200 million in fiscal 2015 and in 2016 to fund portions of their capital investment plan, the major components of which are $350 million for the D.C. investments, $100 million for Baltimore and $200 million for various other system capital needs. Management anticipates that approximately $180 million of the capital needs will be funded from operating-cash flow on an annual basis. Fitch considers the rating stable even when assuming the potential additional debt issuance, provided profitability is maintained at the current level.
MedStar has a $250 line of credit, with $108 million drawn as of Dec. 31, 2012 (deducted from available unrestricted cash for purposes of Fitch liquidity metrics calculation). The three letters of credit backing the District of Columbia series 1998A, B and C bonds have staggered expiration dates in May 2014, 2015 and 2017 with repayment terms over five years. The mark to market of its one swap with notional par of $109 million was a negative $21.9 million at Dec. 31, 2012.
Fitch views MedStar's modest liquidity relative to the 'A' category medians to be the main credit weakness. The low liquidity levels, however, need to be seen in the context of the investment in system growth that was accomplished from internally generated cash-flow with essentially no increase in long term indebtedness over the last four years. Unrestricted cash and investments of $1.3 billion at Dec 31, 2012 translate to 120.5 DCOH, 15.2x cushion ratio and 96% of cash to pro forma debt, lower than the respective 'A' category medians of 191 days, 16.3x and 116.4%. MedStar's lower liquidity metrics are partially mitigated by a modest debt load, the system's considerable geographic diversification and advanced level of system integration. Fitch does not anticipate liquidity to increase significantly over the next several years based on the capital needs of the system, 50% of which will be funded from operating cash flow.
MedStar is a large, integrated health care system composed of 10 hospitals (nine acute care and one rehabilitation hospital) with a total of 3,398 licensed beds and several other health care-related organizations. MedStar had total operating revenues of $4 billion in fiscal 2012. MedStar covenants to provide annual and quarterly disclosure to bondholders. Quarterly disclosure is very good and includes a balance sheet, income statement, cash flow statement, utilization, 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.
In addition to the sources of information identified in Fitch's Revenue Supported Rating Criteria, this action was informed by information from Citi as underwriters.
Applicable Criteria and Related Research:
--'Revenue Supported Rating Criteria', June 12, 2012;
--'Non-Profit Hospital and Health System Rating Criteria', July 23, 2012.
Applicable Criteria and Related Research
Revenue-Supported Rating Criteria
Nonprofit Hospitals and Health Systems Rating Criteria