Fitch Rates Rex Healthcare's (NC) 2015A Revs 'AA-'; Outlook Revised to Negative

SAN FRANCISCO--()--Fitch Ratings has assigned an 'AA-' rating to the expected issuance of $50 million of series 2015A North Carolina Medical Care Commission Health Care Facilities revenue bonds issued on behalf of Rex Healthcare (Rex). In addition, Fitch has affirmed $110.3 million of Rex's outstanding series 2010A bonds.

The Rating Outlook has been revised to Negative from Stable.

In conjunction with the series 2015A issuance, Rex intends to issue $100 million of series 2015B bonds in a variable rate mode that will be a direct bank loan with TD Bank. Proceeds from the series 2015 issuance will be used to fund a portion of the construction costs related to Rex's North Carolina Heart and Vascular Hospital (NCHVH), provide $55 million reimbursement for prior capital expenditures for the NCHVH, and pay associated costs of issuance. The series 2015A bonds are expected to price the week of March 23, 2015 through negotiated sale.

SECURITY

The bonds are secured by a pledge of and a lien on the accounts receivable and the proceeds thereof derived from the ownership and operation of the obligated group (Rex Healthcare, Inc. and the Hospital).

KEY RATING DRIVERS

STRONG CORE OPERATIONS: The 'AA-' rating reflects Rex's solid historical operating profitability, which is expected to be sustained going forward. Six-months through fiscal 2015 (Dec. 31, 2014; unaudited) Rex recorded an improved $24.5 million in operating income, which is up from the prior year's $14.2 million gain, and equated to a 6% operating margin and 10.3% operating EBITDA margin. Rex has rebounded from its softened performance in fiscal 2014 ($14.4 million gain from operations) and expects to finish 2015 year-end ahead of its 4% operating margin budget target, which is consistent with the organization's historical levels of profitability.

NEGATIVE RATING OUTLOOK: The Outlook revision to Negative from Stable reflects Fitch's concern about the dilutive impact on Rex's liquidity and capital metrics since the organization's rating upgrade to 'AA-' in June 2014. The unexpectedly large debt issuance combined with historical cash transfers to University of North Carolina Health Care System (UNCHCS) result in pro forma liquidity metrics that are weak relative to 'AA' category medians.

SUBSTANTIAL INCREASE IN DEBT: While pro forma maximum annual debt service (MADS) of $16.9 million equates to a modest 2.3% of fiscal 2014 revenues, pro forma debt-to-EBITDA and pro forma debt-to-capitalization of 3.5x and 36.8%, respectively, at Dec. 31 are elevated compared to the 'AA' category medians of 2.9x and 31.1%. However, sustained profitability should support sound cash flow, and allow the organization to meet its targeted MADS coverage levels at above 5x.

WEAK LIQUIDITY: At Dec. 31, 2014 (unaudited), Rex had pro forma unrestricted cash and investments of approximately $377.3 million, which translated into 185 days cash on hand (DCOH), 22.3x cushion ratio, and 134.6% cash to debt; each of which compare unfavorably against Fitch's 'AA' category medians of 277.1 DCOH, 26.5x, and 178.5%, respectively. Fitch views Rex's limited balance sheet cushion as a primary credit concern at the 'AA-' rating level and expects the organization to maintain balance sheet metrics at current levels going forward.

LARGE CAPITAL SPENDING PLAN: Rex's long-term capital plan is large as the organization plans to spend approximately $569 million in fiscal 2015-2019 on various items including the development of its North Carolina Heart & Vascular Hospital. The remaining monies will be used towards funding a new Holly Springs Hospital ($70 million), system transfers to UNCHCS, and fund routine maintenance and replacement ($173.5 million). Management has indicated only a small portion of the capital plan may be debt financed (for Holly Springs Hospital). Fitch believes Rex's balance sheet relative to the organization's leverage position is at its limit for the rating level.

MEMBER OF UNC HEALTH SYSTEM: UNCHCS (not rated by Fitch) is Rex's sole corporate member and is operated as part of UNCHCS including system-wide strategic and capital planning. While Fitch views the relationship between Rex and UNCHCS positively from a strategic, operational and clinical standpoint, Rex and UNCHCS remains separately obligated on their respective debt.

COMPETITIVE SERVICE AREA WITH GOOD DEMOGRAPHICS: Fitch views Rex's growing and affluent service area positively. However, it remains highly competitive with primary competitors being Duke University Health System (revenue bonds rated 'AA' by Fitch) and WakeMed (revenue bonds rated 'AA-' by Fitch).

RATING SENSITIVITIES

MAINTENANCE OF OPERATING PROFITABILITY: Due to the dilution of Rex's liquidity and capital related metrics, it's critical that Rex maintain EBITDA margins in line with fiscal 2015's interim performance to generate satisfactory levels of debt service coverage consistent with 'AA' category peers.

MAINTENANCE OF BALANCE SHEET: Rex's long-term capital plan is large as the organization plans to spend approximately $569 million in fiscal 2015-2019 on various projects of which $469 million is projected to be funded through operations. Further erosion of balance sheet metrics due to additional debt and/or cash transfers to UNCHCS would likely generate a rating downgrade.

CREDIT PROFILE

Rex operates a 433-licensed bed acute care tertiary hospital and two nursing care facilities with 227 beds. Rex is a controlled affiliate of UNCHCS, which operates a 830-bed academic medical center located in Chapel Hill, NC. In fiscal 2014 (audited), Rex had total revenues of approximately $750 million.

RATING AFFIRMATION OF 'AA-'

The rating affirmation of 'AA-' is primarily supported by Rex's improved operating profile six-months through fiscal 2015, satisfactory levels of pro forma MADS coverage, and tight relationship with UNCHCS.

Six-months through fiscal 2015 (Dec. 31, 2014; unaudited) Rex recorded $24.5 million in operating income, which is up from the prior year's $14.2 million gain, and equated to a 6% operating margin and 10.3% operating EBITDA margin. Rex has rebounded from its softened performance in fiscal 2014 ($14.4 million gain from operations) and expects to finish 2015 year-end ahead of its 4% operating margin budget target, which is consistent with the organization's historical levels of profitability. Despite Rex's additional debt issuance, current profitability levels support satisfactory MADS coverage of 4.8x by EBITDA and 5x by operating EBITDA through the six-month 2015 period. Management is forecasting coverage of MADS by EBITDA above 5.0x annually from 2015-2019 which Fitch believes is achievable.

Profitability in 2014 was down from historical performance primarily related to the large EPIC EHR expense and associated implementation. Specifically, Rex earned $14.4 million in operating income, which produced a low 1.9% operating margin and 6.7% operating EBITDA.

Fitch notes that Rex's debt service coverage ratio calculations exclude transfers to UNCHCS which totaled approximately $38 million for 2013 and $34 million in 2014. Contributing to the Negative Rating Outlook is the fact that Rex contributes sizeable asset transfers to UNCHCS, which are ultimately dilutive to Rex's financial profile. However, management expects system transfers to moderate to approximately $14.1 million by 2019 from a high $39.5 million in fiscal 2015.

MEMBER OF UNCHCS

UNCHCS approves Rex's board and Rex benefits from being part of UNCHCS. In addition to benefits from a strategic and resource allocation perspective, UNCHCS assists in negotiation of managed care contracts and approves operating and capital plans. Fitch believes that Rex's position as part of the UNCHCS system has resulted in strong historical financial performance and is a primary credit strength.

LARGE CAPITAL SPENDING PLAN

Rex's long-term capital plan is large as the organization plans to spend approximately $569 million in fiscal 2015-2019 on various items including a remaining approximate $180 million towards the development of its North Carolina Heart & Vascular Hospital. Management has indicated only a small portion of the capital plan may be debt financed (for Holly Springs Hospital located in Wake County) and Fitch does not expect any further material weakening of Rex's liquidity metrics or weakening of pro forma MADS coverage goals, which range from 5.2x in 2015 to 6.3x in 2019. Fitch believes Rex's balance sheet relative to the organization's leverage position is at its limit for the rating level. Any significant increase in leverage without commensurate growth to revenue and balance sheet resources would be viewed unfavorably.

PRO FORMA DEBT PROFILE

On an obligated group basis, Rex's pro forma outstanding debt after the series 2015 issuance will be approximately 62% fixed-rate and 38% variable-rate, which is a shift from the prior all fixed-rate debt composition in Fitch's last review. Rex has no outstanding interest-rate swaps.

DISCLOSURE

Rex covenants to submit annual and quarterly financial and utilization information to the MSRB's EMMA system.

For more information please see Fitch's press release, 'Fitch Upgrades Rex Healthcare's (NC) Revs to 'AA-'; Stable Outlook', dated June 9, 2014.

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

Applicable Criteria and Related Research:

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

-- 'Revenue-Supported Rating Criteria', dated June 16, 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

Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980921

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Michael Burger, +1-415-659-5470
Director
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Jennifer Kim, +1-212-908-0740
Associate Director
or
Committee Chairperson
Jim LeBuhn, +1-312-368-2059
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings, Inc.
Primary Analyst
Michael Burger, +1-415-659-5470
Director
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Jennifer Kim, +1-212-908-0740
Associate Director
or
Committee Chairperson
Jim LeBuhn, +1-312-368-2059
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com