Fitch Affirms Anne Arundel Health System (MD) Revs at 'A-'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'A-' rating on the following revenue bonds issued by the Maryland Health and Higher Educational Facilities Authority on behalf of Anne Arundel Health System (AAHS):

-- $69,775,000 series 2012 fixed-rate bonds;

-- $78,145,000 series 2010 fixed-rate bonds;

-- $116,440,000 series 2009A fixed-rate bonds;

-- $60,000,000 series 2009B variable-rate demand bonds (Letter of Credit: Bank of America).

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group and a mortgage on certain property.

KEY RATING DRIVERS

STEADY OPERATING CASH FLOW: Profitability has been relatively stable over the last five years, most recently producing operating and operating EBITDA margins of 2.4% and 11.5%, respectively, in the fiscal year ended June 30, 2014 (unaudited interim results). Fiscal 2013 was weaker with 0.5% and 9.8% operating and operating EBITDA margins, but was consistent with expectations given low rate increases for that year. AAHS expects operating margin to remain above 2% in fiscal 2015 and on, which Fitch believes is achievable.

CHANGING OPERATING ENVIRONMENT: AAHS joined Maryland's Global Budget Revenue (GBR) program effective July 1, 2013. Under the new program, AAHS receives fixed annual revenues on its regulated service lines, which should provide operational and financial stability in a declining volume environment.

GROWING LIQUIDITY: As expected at the time of Fitch's last review, unrestricted liquidity exhibited robust growth (up 45% since June 30, 2012) driven by continued strong cash flows, decreased capital investments, and improved swap collateral posting requirements. Unrestricted cash and investments totaled $331.8 million at June 30, 2014 equating to 224.4 days cash on hand, a 12.6x cushion ratio and 80.5% cash to debt.

HIGH DEBT BURDEN: Debt burden remains high for the rating category, although significantly improved over the last two years. No additional debt is anticipated in the near- to medium-term.

JOHNS HOPKINS AFFILIATION: AAHS' ongoing strategic alliance with Johns Hopkins Health System (revenue bonds rated 'AA-', Stable Outlook) is an additional positive credit factor which yields benefits related to physician recruitment, development of clinical programs, and cost containment initiatives. Entered into in 2007, the current affiliation agreement runs to 2017.

SOLID MARKET SHARE IN FAVORABLE SERVICE AREA: Market share continued its steady growth and was most recently reported at 70.2% in the primary service area of Anne Arundel County (rated 'AA+').

RATING SENSITIVITIES

STABILITY EXPECTED: Fitch expects AAHS to successfully navigate the changing operating environment and sustain its sound operating and financial profile.

FURTHER IMPROVEMENT IN FINANCIAL PROFILE: Continued improvement in balance sheet resulting in moderating leverage and strengthening cushion and cash-to-debt metrics to levels more consistent with the 'A' category medians would lead to upward rating movement.

CREDIT PROFILE

Anne Arundel Health System, headquartered in Annapolis, MD, operates a 384 licensed bed acute care general hospital and several outpatient facilities in its primary service area of Anne Arundel County. The system generated total operating income of $591 million in fiscal 2014.

Solid Operating Platform

AAHS is the leading provider in a favorable service area with a steady to growing leading inpatient market share, most recently reported at 70.2% in its primary service area and 12.7% in its extended service area. Management has been successfully implementing its strategic expansion plans via growing select service lines and physician base. AAHS' operating profile is further enhanced by its affiliation with Johns Hopkins Health System (revenue bonds rated 'AA-', Stable Outlook) since 2007.

Maryland Global Budget Revenue Program

AAHS signed onto the Maryland GBR program in March 2014, retroactively effective to July 1, 2013. Currently under a five-year pilot period, the GBR program offers participants a fixed revenue stream designed to reimburse hospitals for avoiding unnecessary admissions and managing care in the most appropriate cost setting. The amount of hospital revenue is known before the start of the fiscal year and is adjusted annually. For fiscal 2014, the hospital's gross regulated revenue totaled $551 million (before contractual adjustments). For fiscal 2015, AAHS is targeting $571 million in gross regulated revenues, a 3% increase over the prior year.

Although continued enhancements to rate adjustment methodology is expected, Fitch believes GBR provides AAHS with increased stability during its transition to value-based care. Management is budgeting an operating income of $17 million (2.8% operating margin) for fiscal 2015, which Fitch believes is achievable.

Steady Profitability

Supported by its solid operating platform and GBR program, AAHS posted sound operating and operating EBITDA margins of 2.4% and 11.5% in fiscal 2014, which compare well against the respective 'A' medians of 2.5% and 9.5%. Operating margin remains relatively compressed due to a high level of depreciation and amortization associated with significant capital investments in recent years. Fitch expects AAHS to continue generating sound cash flows with added stability under the GBR program.

Growing Liquidity

At June 30, 2014, unrestricted cash and investments totaled $331.8 million which equated to 224.4 days cash on hand, up from 163.9 days two years prior and stronger than the median of 199.2 days. However, due to a high debt burden, cushion ratio of 12.6x and cash to debt of 80.5% lagged the respective medians of 17x and 131.2%. Robust liquidity growth was driven by strong cash flows, decreased capital investments, and improved swap collateral posting requirements, and is expected to continue.

High Debt Burden

At FYE 2014, AAHS had $412.4 million in total debt outstanding, of which $329.5 million is revenue bonds and the remaining non-obligated group, non-recourse bank loans. Of the bonds, $60 million is in variable-rate demand bonds supported by a letter of credit that expires May 2016. Approximately 82% of AAHS' debt is in fixed-rate mode. Fitch used maximum annual debt service (MADS) of $26.4 million, which incorporates the fixed swap rate on the variable-rate debt.

Debt burden is high, with MADS as a percentage of revenues of 4.5% and debt to EBITDA of 6x compared to the respective 'A' medians of 3.1% and 3.6x. As a result, MADS coverage was low at 2.6x in 2014 compared to the median of 3.8x, despite strong cash flows. However, debt burden has moderated significantly over the last five years, and is expected to continue improving given modest capital plans.

AAHS has one fixed payor swap outstanding with a notional value of $180 million and Citibank as counterparty. At Aug. 22, 2014, the swaps had a marked-to-market value of negative $56.8 million, which is significantly improved from a negative $81.9 million at the time of Fitch's last review.

DISCLOSURE

AAHS discloses annual financial statements within 120 days and quarterly unaudited financial statements within 45 days after the end of the first three quarters and no later than 60 days after the end of the fourth fiscal quarter through the MSRB EMMA website. Financial statements include an income statement, balance sheet, flow of funds, utilization data and management discussion and analysis.

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

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria', June 16, 2014

--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', May 30, 2014

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=885754

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Contacts

Fitch Ratings
Primary Analyst
Jennifer Kim, CFA, +1 212-908-0740
Associate Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dmitry Feofilaktov, +1 212-908-0345
Analyst
or
Committee Chairperson
James LeBuhn, +1 312-368-2059
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jennifer Kim, CFA, +1 212-908-0740
Associate Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dmitry Feofilaktov, +1 212-908-0345
Analyst
or
Committee Chairperson
James LeBuhn, +1 312-368-2059
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com