Fitch Downgrades Einstein Healthcare (PA) Revs to 'BBB'; Outlook Stable

NEW YORK--()--Fitch Ratings has downgraded the following Pennsylvania Economic Development Financing Authority (PA) health system revenue bonds issued on behalf of Einstein Healthcare Network (EHN) to 'BBB' from 'BBB+':

--$107.5 million Pennsylvania Economic Development Financing Authority health system revenue bonds, series 2009A.

The Rating Outlook is Stable.

Additionally, Einstein Medical Center Montgomery (EMCM), an affiliate of EHN, has approximately $303 million of Federal Housing Administration (FHA) insured mortgage revenue bonds, series 2010 outstanding. The FHA bonds are non-recourse to the EHN obligated group and are not rated by Fitch. In total, the consolidated system had outstanding debt of approximately $430 million as of Dec. 31, 2014.

SECURITY

The bonds are secured by a gross revenue pledge, lien on property of the EHN obligated group, and a debt service reserve fund. The EHN obligated group comprised approximately 64% of total assets and 83% of total revenue of the consolidated entity in fiscal 2014. Fitch's analysis is based on the consolidated entity.

KEY RATING DRIVERS

CONTINUED LOSSES GREATER THAN BUDGETED TARGETS: In fiscal 2014 (June 30; audited) EHN recorded an operating loss of approximately $20.8 million (negative 1.9% operating margin and positive 5.7% operating EBITDA margin), which was significantly below management's expectation of near breakeven performance by year-end. The significant negative variance in financial results, which has occurred for the second consecutive year, partially reflects continued start-up expenses related to the opening of EMCM, below-budgeted levels of productivity in conjunction with the rollout of EHN's electronic health record, further declines in utilization coupled with increased observation stays, and large one-time professional liability expenses. Overall, Fitch views EHN's profitability indicators as weak when compared against Fitch's 'BBB' category medians and as a primary contributor to the rating downgrade.

PRESSURED FISCAL 2015 PERFORMANCE: Through the Dec. 31, 2014 (unaudited) six-month interim period, EHN recorded an operating loss of approximately $10.7 million (negative 1.9% operating margin), which was slightly more than the original budgeted loss of $8.3 million. The operating loss is primarily driven by several factors that include continued declines in inpatient utilization along with increased observation stays, severance expenses related to a reduction in force (175 positions), and higher than expected drug and medical device expenses. Management's original fiscal 2015 budget was to incur an operating loss of approximately $3 million, but that has now been revised to a slightly larger loss of $4-$5 million by year-end.

LIQUIDITY DECLINE: At Dec. 31, 2014 EHN had $307 million of unrestricted cash and investments, which equated to 103.5 days cash on hand, and 71.4% cash to debt. EHN's days cash on hand and cash to debt metrics are below Fitch's 'BBB' category medians of 145 days and 93.6%, respectively. EHN's absolute unrestricted cash position has declined from fiscal 2013's high of $393.6 million, which Fitch views as an additional credit concern. Management attributes the cash decline primarily to various expenses and lack of profitability but expects the sale of its Belmont behavioral health operations to bolster the absolute total by approximately $35 million.

GROWTH STRATEGY: Management's strategy to grow inpatient and outpatient services in the northwest portion of EHN's service area is viewed favorably. Fitch expects this strategy to increase EHN's market share in a better payor mix environment, allowing the organization to continue serving its challenged downtown service area.

HIGH MEDICAID PATIENT LOAD: EHN has a very high Medicaid patient load, which accounted for approximately 30.5% of gross revenues through Nov. 30, 2014 and is reflective of the main facility's (Einstein Medical Center Philadelphia) challenged service area in North Philadelphia.

RATING SENSITIVITIES

BALANCE SHEET STABILITY: Fitch does not expect EHN's liquidity to decline any further but if this occurs, negative rating pressure is likely since there is limited cushion at the current rating level.

IMPROVED OPERATING PERFORMANCE NEEDED: Fitch views EHN's history of missed budgeted targets negatively, and EHN will need to demonstrate consistent improvement in reducing operating losses. A reversal in this trend would likely result in negative rating pressure.

CREDIT PROFILE

EHN operates Einstein Medical Center - Philadelphia, a 509-bed tertiary and quaternary teaching hospital in northern Philadelphia; EMCM, a new 170-bed facility in East Norriton Township; Elkins Park Hospital, a 66-bed general hospital; and MossRehab, a nationally recognized inpatient rehabilitation hospital located in nearby Elkins Park. Additionally, EHN operates several other ambulatory and specialized facilities. In fiscal 2014, EHN had total revenues of nearly $1.1 billion.

RATING DOWNGRADE TO 'BBB'

The rating downgrade to 'BBB' reflects fiscal 2014's large operating loss of approximately $20.8 million (negative 1.9% operating margin and positive 5.7% operating EBITDA margin), which was significantly below management's expectation of near breakeven performance by year-end. The significant negative variance in financial results, which has occurred for the second consecutive year, partially reflects continued start-up expenses related to the opening of EMCM, below-budgeted levels of productivity in conjunction with the rollout of EHN's electronic health record, further declines in utilization coupled with increased observation stays, and large one-time professional liability expenses.

Through the six-months ended Dec. 31, 2014, EHN recorded an operating loss of approximately $10.7 million (negative 1.9% operating margin), which was slightly more than the original budgeted loss of $8.3 million. The operating loss is primarily driven by several factors that include continued declines in inpatient utilization along with increased observation stays, severance expenses related to a reduction in force (175 positions), and higher than expected drug and medical device expenses. Management's original fiscal 2015 budget was to incur an operating loss of approximately $3 million, but that has now been revised to a slightly larger loss of $4-$5 million by year-end.

EHN continues to have a leading market presence in the greater Philadelphia area (not including EMCM) at 16%. Fitch views favorably management's strategy of expanding services into the northwest portion of its service area, which should improve EHN's payor mix and profitability over the long-term.

Fitch believes EHN's capital plans are manageable. Management plans to spend approximately $261.6 million on various routine and clinical information system needs from FY15-FY19. Additionally, EHN has a $150 million capital campaign that extends through 2016, which will help fund the system's capital needs.

EHN is in the middle of a $150 million capital campaign, which began in July 2010. To date, EHN has received $127 million in commitments and management fully expects to meet its campaign goal by 2016. Fitch believes the solid fundraising and community support should assist in rebuilding the balance sheet.

WEAKENED BALANCE SHEET

At Dec. 31, 2014 EHN had $307 million of unrestricted cash and investments, which equated to 103.5 days cash on hand and 71.4% cash to debt. EHN's days cash on hand and cash to debt metrics are below Fitch's 'BBB' category medians of 145 days and 93.6%, respectively. EHN's absolute unrestricted cash position has declined from fiscal 2013's high of $393.6 million, which Fitch views as an additional credit concern. Management attributes the cash decline primarily to various expenses and lack of profitability but expects the sale of its Belmont operations to bolster the absolute total by approximately $35 million. Fitch believes a continued decline in unrestricted balance sheet resources could trigger additional rating pressure.

CONSOLIDATED DEBT SERVICE COVERAGE

MADS of $44.1 million includes the non-recourse FHA debt and results in 2.4x coverage by EBITDA and 1.4x coverage by operating EBITDA (fiscal 2014) compared to the respective 'BBB' category medians of 2.6x and 2.3x. A decline from existing all-in debt service coverage metrics would be viewed negatively by Fitch. Fitch notes that debt service coverage on an obligated group basis was stronger, with MADS of only $15.9 million, which resulted in coverage by EBITDA and operating EBITDA of 6.6x and 3.9x, respectively, in fiscal 2014.

DISCLOSURE

EHN provides annual and quarterly disclosure to the MSRB's EMMA system. Overall, Fitch views EHN's disclosure favorably, which consists of a balance sheet and statement of profitability and loss, cash flow statement, and utilization information.

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

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria' (May 2014).

Applicable Criteria and Related Research:

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=978747

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Contacts

Fitch Ratings
Primary Analyst
Michael Burger
Director
+1-415-659-5470
Fitch Ratings, Inc.
650 California Street, Fourth Floor
San Francisco, CA 94108
or
Secondary Analyst
Eva Thein
Senior Director
+1-212-908-0674
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Michael Burger
Director
+1-415-659-5470
Fitch Ratings, Inc.
650 California Street, Fourth Floor
San Francisco, CA 94108
or
Secondary Analyst
Eva Thein
Senior Director
+1-212-908-0674
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com