Fitch Upgrades Central Washington Hospital (WA) Rev Bonds to 'BBB'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has upgraded the rating for the approximately $112.2 million Washington Health Care Facilities Authority series 2009 revenue bonds issued on behalf of Central Washington Health Services Association (dba) Central Washington Hospital (CWH) to 'BBB' from 'BBB-'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a gross revenue pledge and mortgage pledge of CWH. In addition, there is a debt service reserve fund.

KEY RATING DRIVERS

SUSTAINED SOLID CASH FLOW: The rating upgrade is due to CWH's sustained solid financial performance. CWH had financial difficulties due to a decline in patient volume as well as the opening of its new patient tower in May 2011, but exhibited a financial turnaround in fiscal 2012 (December 31 year end), which has been sustained in fiscal 2013 (draft audit). Improved cash flow has been driven by a rebound in volume as well as a reduction in costs, which has led to growth in unrestricted cash and investments and better debt service coverage.

BENEFITS FROM AFFILIATION REALIZED: CWH affiliated with the major multispecialty physician clinic in town (Wenatchee Valley Medical Center (WVMC)) and Confluence Health (CH) was created and began operations on Jan. 1, 2013. WVMC operated a 20-bed hospital (Wenatchee Valley Hospital (WVH) and several outpatient clinics, which were transferred to CH in 2013. The affiliation aligns the goals of these healthcare entities, which should allow for better coordinated and cost effective care. The affiliation has resulted in $11 million of annual savings to date; mainly in the areas of consolidation of emergency department services, prescription drug savings, and joint implant contracting, among other consolidation initiatives.

MINIMAL CAPITAL NEEDS: There are no major capital needs after the completion of its new patient tower. Capital spending declined to 34% of depreciation expense in fiscal 2013 from a very high 872.8% in fiscal 2010. Future capital spending approximates depreciation expense.

DOMINANT MARKET POSITION: CWH benefits from a dominant market position with inpatient market share of over 76%, which has been increasing. The organization is focused on growing its market share in the secondary service area and reducing outmigration to Spokane and Seattle. However, CWH's payor mix has high exposure to Medicare and Medicaid, which totaled almost 70% of gross revenues in fiscal 2013.

RATING SENSITIVITIES

SUSTAINED FINANCIAL PERFORMANCE: Fitch expects CWH to sustain its improved financial profile and continue to benefit from the affiliation.

CREDIT PROFILE

CH is the sole corporate member of CWH and WVH and the hospitals contract with WVMC for physician services under a professional services agreement. WVMC's goals are further aligned with CH through a co-management agreement that includes an annual incentive payment related to contributions to the overall success of CH, quality, patient satisfaction, and financial measures. CH includes the 176-staffed bed CWH, 20-bed WVH, and 11 outpatient clinics. WVMC includes 258 physicians. CWH is located in Wenatchee, Washington, approximately 150 miles east of Seattle and 170 miles west of Spokane. CWH is the only obligated group member and all numbers referenced in this report relate to CWH only. In fiscal 2013 (draft audit), CWH had approximately $232 million of revenue and accounted for 64% of the system's total revenue in fiscal 2013.

Benefits of Affiliation Realized

The affiliation resulted in a coordination of resources, which will be key in a reduced reimbursement environment. Management's current focus is on optimizing the capacity of the system, eliminating duplication of services, implementing lean methodology and adopting staff benchmarking. Total affiliation savings were estimated at $21 million annually, which are expected to be fully realized over a three year period.

Sustained Solid Cash Flow

CWH exhibited a financial turnaround in fiscal 2012 after a three year trend of successively worsening financial performance and shrinking liquidity. The improved performance was largely due to a reduction in expenses as well as a rebound in volume. Profitability was sustained in fiscal 2013 with a 3.5% operating margin and 13.1% operating EBITDA margin compared to 2.7% and 13.7% respectively in fiscal 2012 and its lowest point in fiscal 2011 with a negative 4.6% operating margin and 5.6% operating EBITDA margin. Sustained solid cash flow was mainly due to strong volume growth, which led to revenue being $6.7 million over budget. Volume growth has been due to its efforts in expanding its reach in its secondary service area, increased capacity from the new facility, implementing a referral center, and hiring additional surgeons. Acuity also increased with Medicare case mix index of 1.95 compared to 1.84 in fiscal 2012.

Fitch notes that CWH and WVMC were part of a malpractice suit in late 2013 that resulted in a $30 million award to the plaintiff. The award also included a portion related to the then independent 19-member anesthesiologist group, which has since become part of WVMC. The case has heightened patient safety and procedures and the portion related to CWH was $12 million with $2 million paid in 2013 and the remainder covered by insurance. Fitch does not expect this event to have a further negative impact on CWH's financial performance.

CWH's fiscal 2014 budget is for a 2.7% operating margin and 11.6% operating EBITDA margin, which Fitch believes is achievable. CWH's performance through the two months ended Feb. 28, 2014 was 3% operating margin and 12.3% operating EBITDA margin. Challenges to profitability include rising bad debt and a high governmental payor mix.

Adequate Liquidity

As of Feb. 28, 2014, CWH had $82 million of unrestricted cash and investments that translated to 139.1 days cash on hand and 73% cash to debt compared to the BBB category medians of 144.7 and 91.7%, respectively. The balance sheet was depleted after significant capital spending and has been slowly rebuilding. In addition, days in accounts receivable (66.7 days) have risen due to temporary billing issues related to the affiliation, however, is expected to return to 52 days by the end of the fiscal year. The balance sheet is expected to continue to strengthen due to limited capital needs.

Moderating Debt Burden

The improved financial performance has moderated CWH's high debt burden with debt to EBITDA reducing to 3.5x in fiscal 2013 from 8.7x in fiscal 2010. However, MADS still accounted for a relatively high 4% of total revenue in fiscal 2013. Debt service coverage is solid at 3.4x in fiscal 2013 compared to 3.7x in fiscal 2012 and the BBB category median of 3.1x.

Manageable Capital Needs and Conservative Debt Profile

Following the May 1, 2011 opening of its new five-story 176-bed patient tower, CWH's capital needs are minimal. Historical spending totaled $122 million for the new tower plus $16 million on its electronic medical record. Projected capital spending approximates depreciation expense and totals $10.5 million in fiscal 2014, $15.5 million in fiscal 2015, $15.5 million in fiscal 2016, $16.5 million in fiscal 2017 and $18.5 million in fiscal 2018. The capital spending is roughly for 40% routine maintenance, 30% information technology needs, and 30% facility projects/strategic capital. Total outstanding debt as of Dec. 31, 2013 was $112.2 million and is 100% fixed rate.

Disclosure

CWH covenants to provide annual disclosure within 150 days of fiscal year end and quarterly disclosure within 45 days of quarter end for the first three quarters and within 60 days of the fourth quarter.

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 July 23, 2012 to May 20, 2013

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=683418

Additional Disclosure

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Contacts

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

Sharing

Contacts

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