NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA-' rating to the following series of bonds expected to be issued on behalf of UPMC:
--$125,000,000 Pennsylvania Economic Development Financing Authority (PEDFA) revenue bonds series 2013A;
--$100,000,000 Monroeville Finance Authority (Allegheny County, PA) revenue bonds series 2013B.
Fitch also affirms the 'AA-' rating on UPMC's outstanding parity debt (issued through the Pennsylvania Higher Educational Facilities Authority, Allegheny County Hospital Development Authority, University of Pittsburgh Medical Center, Monroeville Finance Authority and Allegheny County Industrial Development Authority).
The Rating Outlook is revised to Negative from Stable.
The series 2013 bonds are expected to be issued as fixed-rate bonds and sold via negotiation the week of Sept. 23, 2013. Proceeds of the 2013A Bonds will be used to fund various capital expenditures and proceeds of the 2013B Bonds will be used to refund the following series of bonds: Blair County Hospital Authority Hospital Revenue Bonds Series 1998A and series 2009 (Altoona Hospital Project) and the Erie County Hospital Authority Revenue Bonds, Series 2010A, 2010B and 2010C (Hamot Health Foundation) subject to acceptable savings levels. The 2013A bonds will have a July 1, 2044 final maturity and the 2013B bonds will have a July 1, 2040 final maturity; MADS on parity indebtedness of $260.1 million, provided by the underwriters, occurs in 2015.
The bonds are secured by a revenue pledge of the Obligated Group. UPMC standardized its bond covenants under the 2007 Master Trust Indenture (2007 MTI), and the series 2013 bonds will constitute parity debt under the 2007 MTI. UPMC (the parent corporation), UPMC Presbyterian Shadyside, Magee-Womens Hospital of University of Pittsburgh Medical Center, UPMC Passavant and UPMC St. Margaret are members of an obligated group under the 2007 MTI.
KEY RATING DRIVERS
MARKET LEADER IN WESTERN PENNSYLVANIA: UPMC's main credit strength is its dominant market share of the Western Pennsylvania market with an estimated 40.4% share and a 41.2% share of the 10 immediately surrounding counties, more than twice that of its main competitor.
INCREASED COMPETITIVE PRESSURE: The formation of the Allegheny Health Network (AHN), combining the dominant Western Pennsylvania insurer Highmark with the former WPAHS hospitals (rated 'C', Rating Watch Evolving by Fitch) and two other community providers and the decision by the UPMC board not to renew the Highmark contract effective December 31, 2014 has introduced an elevated degree of competition in this market.
STRATEGY TO REPLACE HIGHMARK VOLUME: UPMC's strategy is to replace the Highmark volumes, which now account for approximately 21% of UPMC gross hospital revenues, with contracts with national insurers including Aetna, Cigna, United and HealthAmerica (national insurers). There is already an aggressive marketing campaign by both UPMC and AHN for the Highmark subscribers in play, who would not have access to the UPMC facilities under the AHN insurance plan.
COMPRESSED PROFITABILITY: UPMC's profitability for 2013 (year-end June 30) was a decline from historical levels. Fiscal 2013 ended with a slim $3.2 million operating gain (0% operating margin), compared to the prior year's $230.7 million (2.4% operating margin) and management projects operating margin to hover around 1% for the near term as the system tackles competitive issues and shrinking governmental reimbursement.
MANAGEABLE DEBT BURDEN: The system's debt metrics are still moderate with MADS coverage of pro forma debt by EBITDA of 3.4 times (x) and MADS remaining at a moderate 2.6% of revenues. UPMC has completed its major capital investments with only a moderate level of borrowing planned over the next five years, which is not expected to materially increase long-term debt beyond the current level of approximately $3.3 billion.
MODEST BUT STABLE LIQUIDITY: While historically lower than Fitch's 'AA' medians, UPMC's liquidity has remained stable with cash equal to 101% of pro-forma debt, days cash on hand (DCOH) of 130.7 days and cushion ratio of 13.4x.
FAILURE TO IMPROVE FINANCIAL PERFORMANCE: While UPMC's financial ratios have consistently lagged the 'AA' category medians, the recent decline in operating performance, combined with the changing managed care market, will make efforts to improve profitability more challenging. The failure to improve financial performance would likely result in negative rating pressure.
UPMC is the largest healthcare system in Pennsylvania, the largest employer in the region, and one of the largest nongovernmental employers in the state. It is also one of the world's leading organ transplant centers and one of the largest cancer networks in the country. The system is affiliated with the University of Pittsburgh of the Commonwealth System of Higher Education (University), which is among the top 10 recipients of National Institutes of Health research funding. UPMC owns and operates more than 20 hospitals in Pennsylvania with over 5,000 beds in service and more than 400 clinical locations in the region. With a total revenue base of $10.2 billion in 2013, 60,000 employees, including approximately 3,400 employed physicians and 2.2 million covered lives in its network of health insurance plans, UPMC ranks as one of the largest integrated healthcare delivery networks in the country.
The most recent addition to the system was the 350-bed Altoona Regional Health System, which became part of UPMC on July 1, 2013 (but is not reflected in either the financial or utilization metrics); the affiliation involves a capital commitment of $250 million over the next 10 years and an additional commitment of $10 million to the hospital's foundation. UPMC assumed Altoona's debt, outstanding in the amount of approximately $100 million, part of which will be refunded through the Monroeville series 2013.
REVISION OF OUTLOOK TO NEGATIVE
The revision of the Outlook to Negative is driven by the uncertainty of the changing managed care market in Pittsburgh and the Western Pennsylvania region and the decline in operating performance. UPMC has historically been the market leader, and its medical surgical market share of the 10-surrounding counties increased to 41.1% in 2013 from 39.8% in 2012, and 41.2% including the Altoona acquisition. The competitive landscape, however, has been altered as Highmark, the dominant insurer in western Pennsylvania, created its own integrated delivery system by partnering with the financially very weak WPAHS, acquiring Jefferson Regional Medical Center in Jefferson Hills, and most recently adding Saint Vincent in Erie, as well as planning to add its own network of medical malls throughout the region. Highmark has made a $475 million commitment to WPAHS in the form of loans and grants and in April 2013 purchased approximately 85% of WPAHS's outstanding debt.
UPMC and Highmark were unsuccessful in negotiating the renewal of a 10-year contract for hospital services, which would have expired in June of 2012 (with a one-year run-off period). Through subsequent involvement of the Pennsylvania Governor, the two parties agreed to an extension of the contract to December 2014. The UPMC Board passed a resolution on June 12, 2013 announcing that UPMC cannot extend its Highmark contract beyond the Dec. 31, 2014 termination date or enter into a new commercial contract covering hospitals in Southwestern Pennsylvania. This means that no Highmark commercial subscribers will have in-network access to UPMC facilities after that date with the exception of geographic areas where UPMC is the sole provider or sole provider of services, such as Children's Hospital and Western Psychiatric Hospital, as well as UPMC Northwest and UPMC Bedford.
Fitch views the potential loss of the Highmark subscribers, who accounted for 21% of UPMC gross hospital revenues in fiscal 2013, as heightened credit risk. UPMC management has formulated a plan to replace the Highmark volumes with contracts with the national insurers, which had previously had a relatively negligible share of the Pittsburgh market. Both UMPC and Highmark are engaged in an aggressive marketing campaign for the Highmark subscribers in play. UPMC management believes that the strong UPMC brand name, its significant employed physician component, combined with what may be a more open plan offered by the national insurers versus the narrower Highmark network, should result in a shift of a sufficient number of the former Highmark subscribers to the national insurers.
There has already been discussion by the City of Pittsburgh to potentially move from an exclusive contract with Highmark to a multicarrier plan for its employees. However, the magnitude of the shift will not be known with any certainty until the close of the open enrollment period for 2015.
Failure to replace the Highmark subscribers could lead to downward rating pressure.
In addition, there are various lawsuits outstanding where UPMC is the defendant and the estimated potential effect, if any, from the litigation is unknown at this point
UPMC's financial metrics have historically been below 'AA' category medians, with the Fitch rating based to a significant degree on the system's very strong market position with an aligned medical staff and a two million member health plan. The system reported weaker than historical operating results for 2013, ending the year with a $3.2 million operating gain, an essentially breakeven performance given its $10.2 billion total revenues, falling short of the 1.5% budgeted operating margin. Net patient revenues decreased 1.7% year over year, but total revenues grew by 5.7% due to health plan revenues, which increased by nearly 17% and accounted for 42% of system revenues in 2013. The prior fiscal year operating gain of $230.7 million, however included approximately $73 million of non-recurring items, including the rural floor settlement and $36 million more of meaningful use dollars than were received in 2013. Profitability in 2013 was additionally impacted by increased spending on physician recruitment and retention, increased depreciation expense related to the completion of UPMC East and cuts in reimbursement. Management is implementing an expense reduction plan and has budgeted improved operating income for 2014.
The financially struggling WPAHS closed two of its facilities to acute care services as part of its urban consolidation at the end of 2010, which had a positive impact on UPMC's inpatient and emergency department volumes. Admissions increased by 6% in fiscal 2012 but only by 0.8% in 2013, but emergency visits increased by 6.8% in 2013. The partial reopening of West Penn Hospital after the Highmark WPAHS affiliation has not had a negative impact on the nearby UPMC Shadyside volumes.
NO INCREASE IN DEBT AND STABLE LIQUIDITY
Following the issuance of the series 2013 bonds, UPMC will have approximately 80% of its debt at fixed interest rates. Management projects that the system will be issuing between $100 million and $300 million of debt annually over the next five years, roughly equivalent to its principal amortization during those years, with the target of keeping outstanding long-term debt at the current level of approximately $3.3 billion. Although UPMC's debt burden is moderate (pro-forma MADS equated to 2.6% of fiscal 2013 total revenue), most of its debt metrics fall below the AA category medians with 3.4x coverage of pro-forma MADS by EBITDA (includes $125 million of new money from the series 2013 financing) in fiscal 2013, as compared to the 'AA' category median of 5x, and debt to EBITDA of 3.7x in fiscal 2013 compared to the AA category median of 2.9x. MADS is calculated per MTI definitions for the treatment of several balloon payments.
Unrestricted cash and investments were reported at $3.5 billion at June 30, 2013, equating to 130.7 DCOH on hand and cash equal to 101% of pro forma debt, lower than the 'AA' medians, however, there is relatively modest capital spending planned over the next couple of years. The most recently completed project, the $250 million UPMC East facility, located within a short distance of AHN's Forbes Hospital in Monroeville, which opened in July 2012, is operating 126 of its licensed 150 beds. UPMC had plans to build a $300 million Center for Innovative Science near the Shadyside campus, which have been put on hold. The system has no other major capital projects planned for next year. The largest expenditure in the $560 million capital plan for 2014 is $100 million for IT.
UPMC's quarterly and annual disclosures to industry participants (including EMMA) have been excellent and consist of full financial statements, utilization and other information, and management's discussion and analysis of results, which Fitch views favorably.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Nonprofit Hospitals and Health Systems Rating Criteria'(May 20, 2013).
Applicable Criteria and Related Research:
Nonprofit Hospitals and Health Systems Rating Criteria - Effective Aug. 12, 2011 to July 23, 2012