Fitch Affirms Care New England (RI) Revs at 'BBB'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed its 'BBB' rating on the following hospital revenue bonds to be issued through the Rhode Island Health and Educational Building Corporation on behalf of Care New England Health System (CNE):

--$85.5 million series 2013A.

The Rating Outlook is Stable.

SECURITY

Bonds are secured by a pledge of gross revenues, a mortgage interest in certain hospital facilities and debt service reserve fund.

KEY RATING DRIVERS

STRATEGIC REALIGNMENT PROGRESSING: CNE continues to implement its strategy begun in 2010 to become a more integrated, physician-led health care delivery system. CNE is moving forward on a number of fronts, including continuing to reconfigure its senior management team, and it plans to expand its Accountable Care Organization to include Medicare patients in January 2015. While these strategic investments will continue to pressure CNE's operating performance over the next few years, Fitch believes that over the longer term they should prove accretive to CNE's financial performance.

LIGHT DEBT BURDEN KEY STRENGTH: In spite of the weak operating performance, maximum annual debt service coverage was 3.8 times (x) in FY2013 and 4.2x in the nine-month interim period. MADS as a percent of revenue of 1.6% at June 30, 2014, is materially below the median of 3.6% and is further evidence of the light debt burden. Fitch believes the light debt burden provides significant financial flexibility at the current rating level, reducing the pressure on its operational performance as it advances on its strategic repositioning.

THIN OPERATING PERFORMANCE: Over the last three audited years, CNE's operating margins have been essentially breakeven and its operating EBITDA has averaged a thin 4.2% relative to a median of 7.9%. CNE is running a slight negative operating margin through the nine month interim period and is budgeting for breakeven operations for fiscal 2015.

MEMORIAL INTEGRATION NEARING COMPLETION: Upon acquiring Memorial Hospital of Rhode Island (294 beds) in late fiscal 2013, CNE began execution of an extensive integration plan that is nearly complete. The largest outstanding component is an information technology implementation over the next year, with approximately $3 million in costs. Fitch views the acquisition positively believing the short term integration and capital costs will be outweighed by the longer-term value of an increased primary care base and larger clinical service offering in eastern Rhode Island,.

MIXED LIQUIDITY: At June 30, 2014, CNE had approximately $148.2 million in unrestricted cash and investments, which equated to 53.2 days cash on hand (DCOH), a 10.8x cushion ratio, and cash to debt of 86.3%. DCOH is very light for the rating level but both the cushion ratio and cash to debt are above category medians.

RATING SENSITIVITIES

STABLE FINANCIAL PERFORMANCE: Fitch expects CNE's operating performance to remain stable, at approximately breakeven performance over the next two years. A deterioration in operating performance or liquidity would likely lead to negative rating pressure.

CREDIT PROFILE

Headquartered in Providence, RI, CNE operates 167-bed Women's and Infants Hospitals, 143-bed Butler Hospital, 294-bed Memorial Hospital, and 359-bed Kent Hospital. In fiscal 2013 (year-ended Sept. 30) CNE reported total operating revenues of $893.2 million

Fitch's analysis and financial ratios are based on consolidated financial statements.

NEW STRATEGIC DIRECTION

CNE continues to move forward on repositioning the system into an integrated, physician-led health system. Historically, CNE had operated under a federation model with individual hospitals operating more or less independently with separate boards, separate management teams, and separate budgeting and financial processes. In 2010, the board undertook the new strategic direction restructuring CNE's governance and appointing a new CEO in 2011. In fiscal 2013, CNE acquired Memorial Hospital of Rhode Island (294 beds), which expanded CNE's primary care base and clinical service offerings in eastern Rhode Island.

In the current fiscal year, CNE executed its plan it to integrate Memorial, with the largest outstanding item being an IT implementation. Separately, CNE has continued to build the infrastructure for its ACO., moved around some senior management positions and had some other turnover in senior management, and installed a back office business software system to further integrate its hospitals. The level of turnover in senior management is not a concern as it provided the opportunity for CNE to refill the positions with individuals that can further the new strategic vision, including a new CFO and a new head of information technology, who has a background in completing IT installation projects.

However, over the next few years the strategic investments will continue to stress CNE's operating margins and suppress liquidity growth. Fitch expects CNE's operations to remain stable over this time and any weakening from the breakeven operating margins could lead to negative rating pressure. Over the longer term, Fitch believes that CNE's financial and operating performance should improve as it operates more as an integrated system particularly in light of its market presence as the second largest hospital system in Rhode Island, with over $1 billion in operating revenue.

LIGHT DEBT BURDEN

CNE's light debt burden is a key credit strength. Maximum annual debt service (MADS) of $13.8 million equates to a very light 1.3% of annualized 2014 revenues as compared to the 'BBB' median of 3.6%. As a result, MADS coverage by EBITDA was a solid 3.8x in fiscal 2013 and 4.1x through the nine months ended June 30th, relative to the 'BBB' category median of 2.6x. Fitch believes that CNE's light debt burden provides CNE with financial flexibility at the current rating level as it moves forward on its strategic transformation. Over the medium term, even a slight improvement in operating performance would further strengthen CNE's above median coverage.

Fitch does not expect CNE to issue additional debt over the rating cycle. CNE will make a larger capital investment in Memorial than was anticipated at last year's rating action, but the investments are largely infrastructure related and should not require a debt issuance.

THIN OPERATING PERFORMANCE

CNE's operating profitability has deteriorated since fiscal 2010. In the nine months ended June 30, 2014, CNE's generated an operating EBITDA margin of 3.9% compared to operating EBITDA margins of 4.3%% in fiscal 2013 and 4.1% in fiscal 2012, all of which are below the 'BBB' category median of 7.9%. CNE has improved the operating margin at Memorial, which lost $15.5 million in fiscal 2012.

CNE will benefit from Medicaid expansion in Rhode Island and a change in the disproportionate share program for Medicare and Medicaid that will lead to additional funding in FY2014 and 2015. In addition, CNE has received dividend payments from one of its captive insurance companies, which has improved CNE's bottom line performance in the last two years and through the interim period.

Separately, CNE had recent recruitments in thoracic surgery, hand surgery, and cardiology, and in the current fiscal year affiliated with a primary care group with 115 physicians. CNE management reports that the majority of group's referrals currently do no go to CNE hospitals, so there will be opportunities for volume growth from this group. CNE has budgeted little additional volume from the group in FY2015, which should help build a cushion into the 2015 budget. Overall, Fitch believes the additional governmental funding and recruitment should help CNE sustain current levels of performance.

DEBT STRUCTURE

CNE's debt mix is relatively conservative. Its $171 million in long term debt is 75% fixed rate. In fiscal 2014, CNE issued $42.4 million of series 2014A variable rate bonds in a direct placement which amortizes over 30 years with no bondholder put provisions. CNE has no outstanding swaps.

DISCLOSURE

CNE covenants to provide annual audited financial statements within 120 days of each fiscal year-end and quarterly unaudited financial statements within 45 days of each fiscal quarter end to the MSRB's EMMA system.

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

Applicable Criteria and Related Research:

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

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=746860

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=903694

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Contacts

Fitch Ratings
Primary Analyst
Gary Sokolow
Director
+1-212 908-9168
Fitch Ratings, Inc.
One State Street
New York, NY 10004
or
Secondary Analyst
James LeBuhn
Senior Director
+1-312-368-2059
or
Committee Chairperson
Eva Thein
Senior Director
+1-212-908-0674
or
Media Relations
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Gary Sokolow
Director
+1-212 908-9168
Fitch Ratings, Inc.
One State Street
New York, NY 10004
or
Secondary Analyst
James LeBuhn
Senior Director
+1-312-368-2059
or
Committee Chairperson
Eva Thein
Senior Director
+1-212-908-0674
or
Media Relations
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com