Fitch Rates MedStar (MD) Series 2015 Rev Bonds 'A'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'A' rating to the following revenue bonds:

--$103,000,000 MedStar Health Inc., MD taxable bonds, series 2015;
--$255,910,000 (est.) Maryland Health and Higher Education Facilities Authority (MedStar Health) revenue bonds, series 2015.

In addition, Fitch affirms at 'A' the rating on the series of bonds issued by Maryland Health and Higher Educational Facilities Authority and District of Columbia on behalf of MedStar Health (MedStar) listed at the end of this press release.

The Rating Outlook is Stable.

Both 2015 series will be issued as fixed rate bonds. Proceeds of the taxable 2015 series will be used for general corporate purposes, including expansion of MedStar's ambulatory network. The proceeds of the tax-exempt 2015 series will be used to effect partial refundings, depending on market conditions, of District of Columbia (Medlantic/Helix) Multi-modal revenue bonds series 1998B and 1998C bonds, Maryland Health and Higher Education Facilities Authority (MedStar Health) series Maryland Health and Higher Education Facilities Authority (MedStar Health) 2004 and series 2007 bonds. Sources of funds will include the release of all or a part of $12.9 million of the series 2004 debt service reserve fund. The taxable 2015 series is expected to have a 2031 final maturity and the tax-exempt series 2015 will have a 2046 final maturity. Maximum annual debt service (MADS) was estimated at $84.5 million, assuming that approximately $255 million of the currently outstanding $424 million of the four series of bonds will be refunded.

SECURITY
The bonds will be issued as parity debt under MedStar's 1998 master trust indenture, as supplemented, and are secured by pledges of gross revenues of the system hospitals and by mortgages on the system hospitals and parking facilities.

KEY RATING DRIVERS

CONSISTENT PROFITABILITY: MedStar's operating metrics have historically been somewhat lower than the 'A' category medians, but the system has maintained a consistent level of profitability, with operating margins of around 2% and operating EBITDA margins averaging 7.3% over the last four years, generating a robust cash flow from operations. Fiscal 2014 performance (year-end June 30) ended with the strongest performance in years, generating operating income of $127.2 million, equal to an operating margin of 2.8% and operating EBITDA margin of 7.8%. The system has benefited from the increased predictability of revenues from seven of its hospitals now participating in Maryland's Global Budget Revenue (GBR) Program.

SIGNIFICANT MARKET PRESENCE: Led by a strong and stable management team, the system has a solid footprint in the Baltimore - Washington D.C. corridor, which includes a large ambulatory network, a significant and increasing level of physician alignment and a reputation for clinical excellence, garnering MedStar a stable 21.6% market share.

GROWING BUT MODEST LIQUIDITY METRICS: At Sept. 30, 2014, Medstar's had $1.66 billion of unrestricted cash and investments equating to 133.6 days cash on hand (DCOH) and 124.1% of cash to pro forma debt, lighter than the category medians. However, liquidity growth has been limited by the substantial investment in system growth, which has largely been funded from operating cash flow.

MANAGEABLE DEBT LOAD: The system's coverage of pro forma maximum annual debt service (MADS) at 5.2x at fiscal year-end (FYE) 2014 and 4.3x through the first quarter of 2015 (1Q'15) was better than the 'A' category median of 3.8x, MADS is a light 1.8% of revenues, and the system has a conservative debt structure with close to 90% of its long-term debt in fixed-rate mode.

WELL-POSITIONED FOR HEALTH CARE REFORM: MedStar's geographic coverage of its market, its robust and growing ambulatory network and 6,000 affiliated physicians, and close alignment with 1,700 employed and 700 employed advance practice clinicians provide a solid base for participating in population-based health management programs.

RATING SENSITIVITIES

STABLE PROFITABILITY EXPECTED: The Stable Outlook and maintenance of the 'A' rating is based on MedStar's ability to maintain profitability at the historical level in order to generate sufficient cash flow from operations to support the planned ongoing investments in system facilities and programs.

CREDIT PROFILE
MedStar is a large, integrated health care system composed of 10 hospitals (nine acute care and one rehabilitation hospital) with a total of 2,959 licensed acute care beds and several other health care-related organizations. MedStar had total operating revenues of $4.6 billion in FYE 2014.

Significant Market Presence
MedStar maintains a leading 21.6% market share (2013 data) of its primary service area, which encompasses the cities of Baltimore and Washington D.C. and the 11 surrounding Maryland counties. The system has the leading market position in several high-end specialty areas including cancer (21%), cardiac services (28.9%), neurology (21.7%), and orthopedics (22.9%), services for which it competes with University of Maryland Medical System (rated 'A' by Fitch) and Johns Hopkins Health System (rated 'AA-'). Its market share is supported by a large employed physician component with 1,700 physician employees as well as a comprehensive and still growing ambulatory network which includes a number of urgent care centers, ambulatory surgery centers and freestanding oncology site. The ambulatory footprint is being further bolstered by a planned addition of eight multispecialty centers, part of MedStar's continuous investment in the system's distributive care network, one of which has just recently opened in North Baltimore County.

Consistent Profitability
MedStar has generated a modest but steady level of profitability over the last four years, with operating margin averaging 2.3% and operating EBITDA margin averaging 7.3%. Fiscal 2014 was a very successful year with MedStar reporting operating income of $127.2 million, exceeding budgeted $88 million and well ahead of the prior year's $73.9 million. The 2.8% operating margin in FY2014 and 7.8% operating EBITDA margin compare to Fitch 'A' category medians of 2.5% and 9.5%, respectively. Through the first quarter of fiscal 2015, MedStar's income from operation was reported at $21.9 million, ahead of the budgeted $9.9 million, for operating margin of 1.8% and operating EBITDA margin of 6.7%, and the system is budgeted to end the 2015 fiscal year with operating income of $90.5 million which Fitch believes is likely. Management credits the solid results to expense control, focus on bad debt management and more predictable revenue stream, partially arising from seven of their hospitals under Maryland's GBR program starting with January 2014, which accounts for close to half of the system's total revenues. Under GBR, which is designed to align incentives with a population-based health care delivery model, the participating providers are paid a predetermined level of revenues regardless of volumes based on their market position and demographic profile of the populations they serve.

MedStar's operating metrics have historically been lighter than Fitch's 'A' category medians, partially due to the system focus on physician recruitment and expansion of the ambulatory network, and the reimbursement constraints imposed by the Maryland all-payor system. Management is projecting to maintain a 1.9% operating margin through the 2015-2018 period, while continuing to fund a portion of their capital needs from operating cash flow.

Manageable Debt Load
MedStar's debt burden remains light with coverage of MADS by EBITDA of 5.2x in 2014 and 4.3x through 1Q'15, better than the 'A' category median of 3.8x. MADS as a percent of revenues at 1.8% is significantly lower than the 3.1% category median. Management has planned additional debt issuance in 2015 and 2016 totaling approximately $275 million to fund portions of their capital investment plan, of which the proposed $100 million taxable series is a part. Fitch considers the rating stable even when assuming the potential additional debt issuance.

Modest but Improving Liquidity
Fitch views MedStar's liquidity, which has been slowly growing, to be mixed relative to the 'A' category medians. The liquidity levels, however, need to be seen in the context of the investment in system growth that was accomplished to a large degree from internally generated cash flow. MedStar's debt increased by only approximately $209 million since 2011, which included the acquisition of Southern Maryland Hospital Center in 2012, funded with $180 million of debt. Unrestricted cash and investments of $1.66 billion at Sept. 30, 2014 translate to 133.6 DCOH, 19.6x cushion ratio and 124.1% cash to pro forma debt, as compared to Fitch's 'A' category medians of 199 days, 17x cushion and 131% cash to debt, respectively. MedStar's lower liquidity metrics are partially mitigated by a modest debt load, the system's considerable geographic diversification, and advanced level of system integration. Fitch does not anticipate liquidity to increase significantly over the next several years based on the capital needs of the system.

Debt Profile
MedStar has a conservative debt structure with close to 90% of its long-term debt in fixed rate. The three letters of credit backing the District of Columbia 1998A, B and C bonds have May 2015 and March and May 2017 expiration dates with repayment terms over five years and management is in the process of renegotiating the LOC with May 2015 expiration. MedStar has a $250 million line of credit, with $129.8 million drawn as of Sept. 30, 2014 (included in debt and MADS in Fitch's metrics calculation). The mark-to-market of its one swap with notional par of $97.5 million was a negative $14.2 million at September 30, 2014.

DISCLOSURE
MedStar covenants to provide annual disclosure to bondholders within six months of year-end and quarterly disclosure within 75 days of quarter-end. Quarterly disclosure is very good and includes a balance sheet, income statement, cash flow statement, utilization, and management discussion and analysis.

Fitch affirms the following bonds at 'A':

--$117,800,000 Maryland Health and Higher Education Facilities Authority (MedStar Health) revenue bonds, series 2013A;
--$177,800,000 Maryland Health and Higher Education Facilities Authority (MedStar Health) revenue bonds, series 2013B;
--$85,700,000 Maryland Health and Higher Education Facilities Authority (MedStar Health) revenue bonds, series 2011;
--$82,000,000 Maryland Health and Higher Education Facilities Authority(Medlantic/Helix) revenue bonds, series 1998A;
--$57,000,000 Maryland Health and Higher Education Facilities Authority (Medlantic/Helix) revenue bonds, series 1998B;
--$145,000,000 Maryland Health and Higher Educational Facilities Authority (MedStar Health issue) revenue bonds, series 2007;
--$151,400,000 Maryland Health and Higher Education Facilities Authority (Medstar Health issue) revenue refunding bonds, series 2004;
--$253,400,000 District of Columbia (Medlantic/Helix) multi-modal revenue bonds, series 1998A, 1998B, 1998C.

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

Applicable Criteria and Related Research:
--'Fitch Affirms MedStar Health (MD) Revs at 'A'; Outlook Stable' dated July 11, 2014;
--'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
Not-for-Profit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=779548

Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=969956
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Contacts

Fitch Ratings
Primary Analyst
Eva Thein, +1 212-908-0674
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jennifer Kim, +1-212-908-0740
Associate Director
or
Committee Chairperson
James LeBuhn, +1-312-368-2059
Senior Director
or
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Eva Thein, +1 212-908-0674
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jennifer Kim, +1-212-908-0740
Associate Director
or
Committee Chairperson
James LeBuhn, +1-312-368-2059
Senior Director
or
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com