Fitch Affirms Orlando Health's (FL) Revs at 'A'; Stable Outlook

SAN FRANCISCO--()--Fitch Ratings has affirmed the 'A' rating on approximately $848 million of Orlando Health's (OH) outstanding debt issued through the Orange County Health Facilities Authority (FL) and South Lake Hospital District (FL). The South Lake Hospital District bonds are guaranteed by OH.

The Rating Outlook is Stable

SECURITY

Pledge of obligated group revenues and a mortgage pledge.

KEY RATING DRIVERS

GOOD MARKET POSITION: OH is a regional hospital system that has consistently held the second-tier position in its service area while operating in a competitive marketplace. As of June 30, 2013, OH had a 35.2% share, which followed Florida Hospital's (FH; part of Adventist Health System/Sunbelt, rated 'AA/F1+' by Fitch) 51.8% position. However, OH's market share has slightly eroded from 38.6% in 2011.

OPERATIONAL DECLINE: Beginning in fiscal 2012 (Sept. 30 year-end), OH's profitability metrics have been pressured and declined from previous highs primarily due to significant Medicaid reimbursement reductions and specific service line volume losses, and integrating two major acquisitions. In 2013, OH recorded an operating loss of $9.5 million, which translated into a negative 0.5% operating margin and 7.3% operating EBITDA and compared negatively against Fitch's 'A' respective category medians of 3.3% and 10.7%. Fitch views the historical decline in operating profitability unfavorably, which leaves the organization limited financial flexibility at the current rating level.

SIGNIFICANT IMPROVEMENT IN FISCAL 2014 : A financial improvement plan was implemented in the fourth quarter of 2012 with steady improvement quarter over quarter (excluding expense of consulting engagement). Through the three-month interim period (Dec. 31, 2013; unaudited), operational performance has been at the strongest level within the last five years. OH has a budgeted profitability goal of $36.4 million in fiscal 2014, which Fitch anticipates will be exceeded, as year-to-date performance is well in excess of the budget.

SIZEABLE CAPITAL PLANS: OH's capital plan over the next four years totals approximately $584 million and will be primarily funded from cash flow, tax-exempt debt, and philanthropy. The main capital project continues to be the renovation and expansion of OH's flagship facility, Orlando Regional Medical Center (ORMC), which is expected to be completed in 2016. No additional debt is expected and an increase in leverage would be viewed negatively.

CONSERVATIVE DEBT PROFILE: OH's debt profile is approximately 87% fixed rate and 13% variable rate, which Fitch views as conservative.

RATING SENSITIVITIES

SUSTAINED OPERATIONAL IMPROVEMENT: Fitch believes it is necessary for OH to at least meet its budgeted 2014 profitability goals. Any significant departure from management's profitability targets would be viewed negatively and may lead to rating pressure.

CREDIT PROFILE

Orlando Health owns and operates five hospitals in the greater Orlando area with 1,861 licensed beds and includes Orlando Regional Medical Center, an 808-bed teaching hospital. Total revenue in fiscal 2013 was $1.9 billion.

OPERATING PROFITABILITY DECLINE IN FISCAL 2012 AND 2013

In fiscal 2012, OH began to experience financial deterioration; the organization earned $26.6 million from operations, which equated to a 1.5% operating margin and 9% operating EBITDA margin and was more than 50% down from the prior year's 3.5% and 11.3% margins, respectively. OH's operational decline continued in fiscal 2013, when the system lost $9.5 million from operations. Management attributed the operational decline to approximately $75 million in Medicaid reimbursement reductions and specific volume losses in pediatric and newborn services as a competing facility opened. Additionally, OH had two significant transactions in 2012 (Health Central acquisition in April and Physician Associates acquisition in December) that required senior management attention and time, and consequently contributed to the poor financial performance. Certain members of the executive leadership team were replaced at the end of fiscal 2013.

Due to the financial decline in 2013, OH's maximum annual debt service (MADS) coverage indicators fell to a low 2.3x by EBITDA and 1.8x by operating EBITDA and compared unfavorably against Fitch's 'A' respective category medians of 3.8x and 3.4x.

FISCAL 2014 FINANCIAL IMPROVEMENT

A financial improvement plan was implemented in the fourth quarter of 2012 and Deloitte was engaged to identify areas for performance improvement. The total targeted annual benefit from the improvement plan is $174 million a year. Specific cost reductions are related to labor, supplies, and maintenance.

Through the three-month interim period 2014 (Dec. 31, 2013; unaudited), OH generated a 6% operating margin and 13% operating EBITDA margin ($30.9 million), which Fitch views favorably. The strong performance has also been driven by higher Medicare disproportionate share funds, which are expected to total $44.7 million in fiscal 2014 compared to $28 million in fiscal 2013. Management's budgeted goal for fiscal 2014 is to generate $36.4 million (1.9% operating margin), which Fitch believes will be exceeded given year- to-date performance.

Overall, 2014's financial improvement is viewed positively and as a stabilizing credit factor at the current rating level. Although unexpected, a return to poor financial performance may spur negative rating action.

GOOD MARKET POSITION

OH has a solid market position in a consolidated and competitive market. It maintains a second-leading market position against FH for all discharges and has a leading share in pediatrics and newborns despite some recent market share erosion. Through June 30, 2013, OH had a 35.2% overall market share (down from 38.6% in 2011) and 46.7% and 53.8% positions specific to pediatrics and newborns, respectively (down from 54.8% and 56.7% in 2011).

CONSERVATIVE DEBT PROFILE

OH's debt profile is approximately 87% fixed rate and 13% variable rate, which Fitch views as conservative and appropriate for the rating level. In 2011, OH refinanced variable rate demand obligations (VRDOs) with a variable rate bank purchased issuance (due 2016). The only VRDO exposure remaining totals $54 million and is backed by a letter of credit from BB&T that expires June 18, 2016. OH has three fixed payor swaps outstanding and two of the swaps require collateral posting above the $20 million threshold at OH's current rating level. At Feb. 28, 2014, OH was posting $4.2 million in collateral.

DISCLOSURE

OH covenants to provide annual and quarterly disclosure to EMMA. OH's disclosure has been excellent with comprehensive information provided as well as very timely audits (within 60 days of year-end).

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2013.

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=827225

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Contacts

Fitch Ratings
Primary Analyst
Michael Burger, +1 415-659-5470
Director
Fitch Ratings, Inc.
650 California Street, Fourth Floor
San Francisco, CA 94108
or
Secondary Analyst
Emily Wong, +1 415-732-5620
Senior Director
or
Committee Chairperson
Jim LeBuhn, +1 312-368-2059
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Michael Burger, +1 415-659-5470
Director
Fitch Ratings, Inc.
650 California Street, Fourth Floor
San Francisco, CA 94108
or
Secondary Analyst
Emily Wong, +1 415-732-5620
Senior Director
or
Committee Chairperson
Jim LeBuhn, +1 312-368-2059
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com