SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA' rating to the approximately $100 million Washington Health Care Facilities Authority, Seattle Children's Hospital, revenue bonds series 2015A and potentially the approximately $167 million Washington Health Care Facilities Authority, Seattle Children's Hospital, refunding revenue bonds series 2015B. In addition, Fitch has affirmed the 'AA' rating for Seattle Children's Hospital's (SCH) outstanding debt, which is listed at the end of the press release.
The series 2015A bond proceeds will provide approximately $54 million for future capital expenditures and $46 million for reimbursement of prior capital expenditures. The series 2015B bonds may be issued to refund SCH's outstanding series 2008C and 2009 bonds depending on market conditions. The series 2015A and B bonds are expected to be fixed rate and will price the week of Jan. 19.
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 although the area is competitive. SCH has a close relationship with the University of Washington's School of Medicine (UWSOM) and 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, implementation of its electronic medical record, and expansion of inpatient capacity (Building Hope), continued strong demand is accelerating additional bed capacity plans. Building Hope is SCH's new patient tower that opened on time (April 2013) and within budget that 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 DESPITE ADDITIONAL DEBT: SCH's overall financial profile is strong and reflective of its rating level with excellent profitability, growing liquidity, and manageable debt burden that has created debt capacity for the series 2015 issuance. 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 and SCH has used lean methodology for well over a decade.
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. In addition, SCH just launched a $100 million campaign targeted to raise funds for cancer immunotherapy.
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 2014.
RATING SENSITIVITIES
FINANCIAL FLEXIBILITY AT CURRENT RATING LEVEL: Fitch believes that SCH's strong financial profile provides significant flexibility as it begins to manage population health and enter into more risk based payer arrangements.
CREDIT PROFILE
SCH is a 323 licensed 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 2014 (Sept. 30 year end; draft audit). Fitch's analysis is based on the consolidated entity. In fiscal 2014, SCH had total revenue of $1.2 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 2.45 in fiscal 2014, compared to 1.99 in 2011, 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 83% of SCH's admissions.
The hospital maintains a leading and growing market share position in Washington state of 29.3% through the nine months ended June 30, 2013, up from 26.8% in 2011. The next main competitor, Mary Bridge Children's Hospital and Health Center in Tacoma, WA (part of MultiCare Health System, rated 'AA-' by Fitch) had a 12.8% 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 secure its market position since it remains the exclusive provider of heart, kidney and liver transplants and maintains very high market share in bone marrow transplants and cardiovascular surgery. One of SCH's strategic initiatives is to expand these and other unique services, which currently account for over 50% of SCH's patient revenue.
Changing Health Care Environment
SCH has been preparing for a shift in reimbursement and these initiatives include growing its ambulatory network and establishing a clinically integrated network (CIN) that aligns SCH with pediatric specialists and independent community pediatricians. The CIN is expected to enter into risk based and high value network payer arrangements in the near term.
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. These beds are expected to open in June 2015.
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 $232.7 million in fiscal 2015 (including carry forward capital for projects underway), $93 million in fiscal 2016, and $102 million in fiscal 2017. A portion of the capital expenditures will be funded by the series 2015A bond proceeds and the remainder from operating cash flow and philanthropy.
Largest Philanthropic Gift Received
SCH received its largest gift in its history in fiscal 2014 - an estate gift of $74 million for pediatric research. Without the estate gift, philanthropy has increased to $75 million in fiscal 2014 from $63 million in fiscal 2013 and $54 million in fiscal 2012. SCH launched a $100 million capital campaign in November 2014 - Strong Against Cancer- for curing childhood cancer with immunotherapy. SCH has had 13 patients in immunotherapy clinical trials with 11 in complete remission.
Excellent Profitability
One of SCH's main credit strengths is its strong and improving operating cash flow. Operating EBITDA totaled $261 million in fiscal 2014 compared to $133 million in fiscal 2010, which translated to operating EBITDA margins of 22.4% and 17.0%, respectively, which well exceeds Fitch's 'AA' category median of 11%. 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 a 9.5% CAGR from fiscal 2009 - 2014 while operating EBITDA had a 15.5% CAGR over the same time period. At the time of Fitch's last review in May 2014, management was projecting to end fiscal 2014 with an 11.8% operating margin and actual results exceeded these expectations with a 15.1% operating margin.
Stable Payor Mix and Medicaid Exposure
SCH's payor mix has been relatively stable. SCH was initially excluded from several narrow network products on the state's insurance exchange beginning in January 2014 and management was proactive about raising awareness regarding their exclusion from these insurance products as an essential provider of pediatric services and has since been included in the various insurance plans.
Typical for children's hospitals, SCH's Medicaid exposure was 45% of gross patient revenue in fiscal 2014. A positive development is a new hospital safety net assessment program that was enacted for the period July 1, 2013 - June 30, 2017. There are two components to the program - fee for service and Medicaid managed care- and the Medicaid managed care component is still awaiting CMS approval. For fiscal 2014, SCH booked a net benefit of $9.2 million (only fee for service component) and is expected to have a net benefit of $22 million for fiscal 2015.
Growing Liquidity
SCH's liquidity position has been increasing despite healthy capital spending. Total unrestricted cash and investments were $1.16 billion at Sept. 30, 2014, compared to $631.3 million at Sept. 30, 2010. SCH had 456.7 days cash on hand and 218.4% cash to debt at Sept. 30, 2014. SCH's investment portfolio is liquid with approximately 83% available within 30 days.
Ability to Absorb Additional Debt at Current Rating Level
Although this debt issuance was not expected, Fitch believes SCH has created debt capacity due to its strong financial performance. In addition, the series 2015A debt issuance is expected to preserve balance sheet strength as bond proceeds will fund and reimburse capital spending.
SCH's debt burden has historically been high, but had been moderating with strong revenue growth. The only debt metric that compares unfavorably to the AA category medians is MADS as a percentage of revenue and with the additional debt, MADS increases to $39 million from $34 million. MADS as a percentage of revenue for fiscal 2014 is now 3.4% compared to 2.9% without the additional debt and the AA category of 2.6%. Debt service coverage is strong at 7.3x in fiscal 2014 compared to 5.8x the prior year and Fitch's AA category median of 5.4x.
Conservative Debt Profile
Total proforma debt outstanding is $583 million with 77% underlying fixed rate and 23% underlying variable rate. The variable rate debt exposure is from two direct bank loans that are at an indexed floating rate ($63.6 million series 2012C with JP Morgan and $67.9 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 is 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:
$27,975,000 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
$29,380,000 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
$83,540,000 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
Applicable Criteria and Related Research:
--'Nonprofit Hospitals and Health Systems Rating Criteria' (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=963275
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