NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms its 'BBB+' rating on Health and Educational Facilities Board of the City of Johnson City, Tennessee, revenue bonds issued on behalf of Mountain States Health Alliance (MSHA) and the parity debt issued on behalf of MSHA listed at the end of the press release:
The Rating Outlook is Stable.
Bonds are secured by pledged assets and a mortgage on Johnson City Medical Center and Sycamore Shoals Hospital. In addition, there is a debt service reserve fund on certain series of debt.
KEY RATING DRIVERS
STRONG PROFITABILITY FROM CORE OPERATIONS: Despite a slight erosion in operating EBITDA margins since fiscal 2011, MSHA's operating EBITDA of 11.8% in fiscal 2014 well exceeds the 'BBB' category median of 7.9%. Through the first quarter ended September 30, (1Q'15) MSHA posted an improved 1.8% operating margin and 12.9% operating EBITDA margin compared to the prior year period.
IMPROVED MANAGEMENT PRACTICES: Fitch believes the new CEO, who started in FY2014, has had a positive impact on performance by instituting a variety of changes and initiatives designed to leverage MSHA's credit strengths and maximize the return on system assets. MSHA is budgeting for a 2.7% operating margin in FY2015, which Fitch believes is achievable.
HIGH DEBT BURDEN: MSHA's debt burden remains a key credit concern which allows little room for erosion in MHSA's strong historical profitability. Maximum annual debt service (MADS) as a percent of revenue at 7% and debt-to-EBITDA of 7.6x are significantly higher than Fitch's' 'BBB' category medians of 3.6% and 3.9x, respectively. MADS coverage by EBITDA in FY2014 was an adequate 2.1x, compared to a median of 2.6x.
MIXED LIQUIDITY METRICS: Days cash on hand (DCOH) has averaged 240 through the four-year historical period, in line with management's target and good for the rating level. However, liquidity metrics relative to debt (cushion ratio and cash-to-debt) are weaker, reflecting the elevated debt burden.
DELEVERAGING PLAN VIEWED POSITIVELY: Management has stated its intent to reduce its leverage position beginning in fiscal 2015. MSHA has developed a plan to pay down roughly $350 million of debt (above the $177.4 million of amortizing principal payments) from FY2016 through FY2022 through excess cash flow. The debt reduction plan would mitigate MSHA's debt burden, which continues to be a major credit concern for Fitch. At Sept. 30, 2014, MADS was a very high 7% of revenue relative to a median of 3.6%.
CONTINUED STRONG PERFORMANCE: Sustained strong profitability - MSHA is projecting higher operating margins over the next five years - combined with manageable capital plans and execution of the system's deleveraging plans would likely result in positive rating momentum. Conversely, a material compression of historical operating performance over the near term could pressure the rating.
Headquartered in Johnson City, Tennessee, MSHA was formed in 1998 from the acquisition of six hospitals in Tennessee from Columbia/HCA and has grown into a large regional health care system with 13 hospitals (1,671 licensed beds) and other related entities, primarily serving northeast Tennessee and southwest Virginia. MSHA has a membership interest (ranging from 50.1%-80%) in three of the hospitals in the system (Smyth County Community Hospital, Norton Community Hospital, Johnston Memorial Hospital). In FY2014 (June 30 year-end), MSHA had total operating revenue of $1 billion.
STRONGER 2015 PERFORMANCE AFTER SOFT 2014
Fiscal performance has rebounded in 1Q'15 from the year prior. Admissions in the interim period were up 8.2% from the year prior, which led to net patient revenue growth of 5.8% year-over-year (YOY). The system posted a 1.8% operating margin through 1Q'15 which is improved from the negative 1.6% generated in the prior year. Management is projecting improved performance in FY2015 compared to FY2014, which will include the impact of an estimated $4 million in supply chain savings, as well as the reestablishment of a contract with Cigna, effective October 2014. MSHA had been out of network with Cigna for almost three years, which impacted revenues in FY2012 to FY2014. Longer-term initiatives, around physician recruitment, service line enhancement, quality, safety, patient satisfaction, and efficiencies, should help sustain the improved operating performance.
Operating margin declined to 0.2% in FY2014 from 1.1% in FY2013 reflecting the impact of a shift from inpatient admissions to observation stays. YOY acute admissions fell by 1.8% from FY2013 to FY2014, while observation stays increased 2.8%. However, Fitch notes system financial performance improved in the latter half of the fiscal year and that momentum has continued into FY2015.
Operating cash flow remains strong, which is key to maintaining the rating because of MSHA's high debt burden. In FY2014, operating EBITDA weakened YOY to 11.8% from 13.2%, but was strong relative to category median of 7.9%. Through 1Q'15, operating EBITDA was 12.9%; an improvement from 11.1% in the prior year period.
Strong 1Q'15 performance was driven by strong admissions growth in MSHA's northeast market, where admissions grew over 11% YOY to 2,969, and net patient revenue was up 6.7%. Improvements were offset somewhat by weakness in the northwest and southeast markets. System-wide observation cases declined 1.8% YOY, following MSHA's efforts relative to clinical documentation. Additionally, cost-containment measures begun in FY2014, such as a 6% reduction in workforce and continued Lean processes, appear to have borne fruit.
HIGH DEBT LOAD
MSHA's debt burden is elevated for the rating level which puts added pressure on it to sustain its strong cash flow. Both MADS as a percent of revenue at 7% and debt-to-EBITDA of 7.6x are significantly higher than Fitch's' 'BBB' respective category medians of 3.6% and 3.9x. MADS coverage by EBITDA in FY2014 was an adequate 2.1x, compared to the median of 2.6x.
DELEVERAGING PLAN CREDIT POSITIVE
Management has stated its intention to reduce its high debt burden (60.5% debt-to-capitalization in 2014) through 2022 by using excess operations cash flow to prepay outstanding debt. The deleveraging plan follows an extended period of intense capital spending, which averaged 180% of depreciation in the six years leading up to 2013.
Management is targeting a 43% debt-to-capitalization ratio in 2019 while maintaining liquidity of at least 250 DCOH as part of its deleveraging plan. These efforts feature a good degree of flexibility should operational performance become pressured or capital needs increase from current lower projections. MSHA's capital spending is projected at a more manageable level, closer to 100% of depreciation. Fitch views positively management's plan to lower its debt burden and thus mitigate a key credit concern.
AGGRESSIVE DEBT PROFILE
Fitch continues to view MSHA's debt structure as aggressive relative to its rating level, with a number of swaps and approximately $473 million in variable rate debt representing 42% of MSHA's total outstanding long-term debt. Roughly half of the variable rate debt ($211 million) is privately placed with three different banks, and put dates for the private placements and letters of credit are adequately staggered. The maximum amount of debt coming due on any single day is a manageable $106 million in July 2018.
MSHA's outstanding swaps have a notional amount of $590 million, composed of basis swaps, constant maturity basis swaps, and total return swaps. Bank of America is the counterparty for all of the swaps, elevating counterparty risk. As of Nov. 24, 2014, the aggregate mark-to-market of the swaps was a negative $12.2 million. No collateral is currently being posted for the swaps.
As of Sept. 30, 2014, MSHA had $645.6 million of unrestricted cash and investments, equating to a solid 252 DCOH, which compares favorably to Fitch's 'BBB' category median of 145 days. Cash-to-debt of 59.6% compared unfavorably to the 'BBB' category median of 93.6%, reflecting MSHA's sizeable debt load. Positively, unrestricted cash and investments continue to grow, up 21.5% since 2012, when it was at $531.2 million (representing 212 DCOH).
MSHA covenants to provide annual and quarterly financial and operational disclosure to EMMA.
Fitch affirms the following debt:
--$55,000,000 hospital revenue bonds (Mountain States Health Alliance), series 2012A;
--$5,415,000 hospital revenue bonds, series 2009A;
--$167,730,000 hospital first mortgage revenue bonds, series 2006A;
--$20,400,000 hospital first mortgage revenue bonds, series 2001A;
--$34,645,000 hospital first mortgage revenue refunding bonds, series 2000A;
--$30,750,000 hospital first mortgage revenue bonds, series 2000C.
In addition, Fitch affirms the following parity debt issued on behalf of MSHA:
--$5,400,000 Industrial Development Authority of Smyth County hospital revenue bonds, series 2009B;
--$111,265,000 Industrial Development Authority of Washington County Virginia, hospital revenue bonds, series 2009C;
--$13,245,000 Mountain States Health Alliance taxable note, series 2000D.
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