Fitch Affirms Seattle Children's Hospital (Washington) Bond Rating at 'AA'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the 'AA' rating on Seattle Children's Hospital's (SCH) outstanding debt, which is listed at the end of the press release.

The Rating Outlook is Stable.

SECURITY

Gross receivables pledge of the obligated group.

KEY RATING DRIVERS

SOLID MARKET POSITION: SCH is the only freestanding children's hospital in the state of Washington and provides high-acuity pediatric care to an expansive service area that covers four states. SCH maintains the leading market position in a competitive market. SCH is the primary pediatric teaching hospital for the University of Washington's School of Medicine (UWSOM). Fitch believes the partnership with UWSOM provides SCH valuable benefits in clinical care, research, and physician recruitment.

CONTINUED CAPITAL SPENDING: After significant investments in the expansion of its research facilities and ambulatory network, the implementation of its electronic medical record, and expansion of inpatient capacity (the 'Building Hope' project), continued strong demand is accelerating additional bed capacity plans. Building Hope, SCH's new patient tower, opened on time (April 2013) and within budget and initially added 80 new ICU and oncology beds as well as shelled space. SCH is in the process of building out an additional 64 beds.

STRONG FINANCIAL PROFILE: SCH's overall financial profile is strong and reflects its rating level with excellent profitability, growing liquidity and decreasing debt burden. Financial performance has consistently exceeded budgeted performance. Double-digit operating margins have been driven by strong revenue growth from volume as well as increasing acuity in conjunction with a continued focus on expenses.

CONSISTENT PHILANTHROPIC SUPPORT: SCH has a history of solid and consistent philanthropic giving. In 2014, SCH received its largest gift in its history, a $74 million estate gift for pediatric research.

HIGH MEDICAID EXPOSURE: Not unlike other children's hospitals, SCH has high exposure to Medicaid funding, with 45% of total gross revenues from Medicaid in fiscal 2013.

RATING SENSITIVITIES

AMPLE FINANCIAL CUSHION: Fitch believes that SCH's strong financial profile provides significant flexibility as it navigates a changing healthcare industry.

CREDIT PROFILE

SCH is a 323-bed freestanding children's hospital in Seattle, WA, that is a major provider of highly complex pediatric services to an expansive service area. SCH is consistently ranked as one of the top children's hospitals in the nation by U.S. News and World Report. The obligated group accounted for 99% of total assets and total revenue of the consolidated entity in fiscal 2013 (Sept. 30 year end). Fitch's analysis is based on the consolidated entity. In fiscal 2013, SCH had total revenue of $1 billion.

Solid Market Position

SCH provides tertiary and quaternary services for a pediatric population that covers four states including Washington, Alaska, Idaho, and Montana. The hospital has a number of pediatric specialty clinics in its service area as well as an extensive telemedicine program. Case mix index has increased to a very high 2.44 through the six months ended March 31, 2014, compared to 1.75 in 2007, due to continued increase in acuity of services provided. The specialty clinics are staffed by Children's University Medical Group (CUMG) physicians. CUMG is a faculty practice plan that is co-owned by SCH and UWSOM and accounted for 87% of SCH's admissions.

The hospital maintains a leading and growing market share position in Washington state of 29% through the nine months ended June 30, 2013, up from 26% in 2009. The next main competitor, Mary Bridge Children's Hospital in Tacoma, WA (part of MultiCare Health System, rated 'AA-' by Fitch) had a 13.1% market share. The market is relatively competitive with approximately 58% of the pediatric market split among four providers and the remaining 42% dispersed across all other hospitals in the state. While the consolidation of adult providers in the market could increase competition, SCH's clinical reputation and depth of pediatric subspecialties should insulate market share leadership. SCH maintains very high market share in transplants, cardiovascular surgery, otolaryngology, hematology/oncology and neurosurgery.

Continued Capital Spending

The Building Hope project opened in April 2013 at a total cost of approximately $200 million. Building Hope is a new patient tower that added inpatient capacity and a new emergency department and included shelled space for an additional 112 beds. Given the strong demand, SCH's plans for the additional bed capacity have been accelerated with 64 beds currently being built out.

In addition to increased inpatient capacity, other major capital plans include continued investment in information technology, additional ambulatory clinics, as well as preparing for an additional building (diagnostic and treatment) next to Building Hope. Total capital spending is projected to be $177 million in fiscal 2014, $100 million in fiscal 2015 and $89 million in fiscal 2016, which will be funded from cash flow.

Largest Philanthropic Gift Received

Philanthropic support has been consistent, with $55 million raised in fiscal 2011, $54 million in fiscal 2012, and $63 million in fiscal 2013. Through the six months ended March 31, 2014, SCH has raised $117 million, compared to $32 million the same prior year period, due to the receipt of the $74 million estate gift.

Excellent Profitability

One of SCH's main credit strengths is its strong and improving operating cash flow. Operating EBITDA totaled $208 million in fiscal 2013 compared to $133 million in fiscal 2010, which translated to operating EBITDA margins of 20.2% and 17.0%, respectively. Through the six months ended March 31, 2014, the trend was sustained with a 22% operating EBITDA margin which well exceeds Fitch's 'AA' category median of 11.8%. Strong operating performance has been driven by continuous performance improvement (CPI) initiatives and growth in volume and acuity. CPI (lean initiatives) is ingrained in SCH's culture with the philosophy of improving value and quality while eliminating waste. Total revenue experienced an 8.7% CAGR over the past five years while operating EBITDA had a 13.2% CAGR. Fiscal 2013 performance exceeded budget and year to date performance is in excess of budget and prior year performance. Management's projected year end fiscal 2014 operating income based on six months ended March 31, 2014 results is $135 million (11.8% operating margin).

Stable Payor Mix and Medicaid Exposure

SCH's payor mix has been relatively stable. Management stated that there was minimal financial impact with the introduction of insurance exchanges in January 2014 despite SCH being initially excluded from several narrow network products. SCH's management has been proactive about raising awareness regarding their exclusion from these insurance products as an essential provider of pediatric services and has filed an administrative appeal with the Office of Insurance Commissioner regarding what qualifies as an adequate network. Since January, SCH has been included in four of the six narrow network products.

Typical for children's hospitals, SCH's Medicaid exposure was 45% of gross patient revenue in fiscal 2013. A positive development is a new hospital safety net assessment program that should net SCH $13 million in fiscal 2014 if the program is approved by CMS. This is an improvement from the prior program, which resulted in hospitals being net payers into the program as a portion of the funds were diverted back to the state. The new program is expected to extend through June 30, 2017.

Growing Liquidity

SCH's liquidity position has been increasing despite healthy capital spending. Total unrestricted cash and investments were $1.06 billion at March 31, 2014, compared to $631.3 million at fiscal year-end 2010. SCH had 428.5 days cash on hand and 198.3% cash to debt at March 31, 2014. SCH's investment portfolio is liquid with approximately 83% available within 30 days.

Moderating Debt Burden

SCH's debt burden is moderating with maximum annual debt service (MADS) of 3.3% of total revenue in fiscal 2013 compared to the 'AA' median of 2.6%, but has improved from 4.4% in fiscal 2010. Debt service coverage is strong at 6.7x in fiscal 2013 compared to 7.2x the prior year and 8x through the six months ended March 31, 2014 and Fitch's AA category median of 5x.

Conservative Debt Profile

Total debt outstanding is $491 million with 72% underlying fixed rate and 28% underlying variable rate. The variable rate debt exposure is from two direct bank loans that are at an indexed floating rate ($65.2 million series 2012C with JP Morgan and $70.75 million series 2012D with Wells Fargo). The direct bank loans have initial terms till June 2022 and June 2019, respectively, and include additional financial covenants than those in the master trust indenture. SCH has two floating- to fixed-rate swaps outstanding and no collateral currently being posted.

Disclosure

SCH covenants to file quarterly financial information 45 days after its quarter-end and annual financial information within 120 days of its fiscal year-end.

Fitch affirms the following outstanding debt:

$28,015,000 Washington Health Care Facilities Authority (WA) (Seattle Children's Hospital) refunding revenue bonds series 2012B

$46,335,000 Washington Health Care Facilities Authority (WA) (Seattle Children's Hospital) revenue bonds series 2012A

$32,645,000 Washington Health Care Facilities Authority (WA) (Seattle Children's Hospital) revenue bonds series 2010B

$75,000,000 Washington Health Care Facilities Authority (WA) (Seattle Children's Hospital) revenue bonds series 2010A

$84,415,000 Washington Health Care Facilities Authority (WA) (Seattle Children's Hospital) revenue bonds series 2009

$88,755,000 Washington Health Care Facilities Authority (WA) (Children's Hospital & Regional Medical Center) revenue bonds series 2008C

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=829487

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Contacts

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

Sharing

Contacts

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