SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'AA-/F1+' ratings on Memorial Health Services' (MemorialCare) outstanding debt, as listed at the end of this release. The 'F1+' rating is based on MemorialCare's self-liquidity.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group (OG). The OG includes the parent corporation, Long Beach Memorial Medical Center, Orange Coast Memorial Medical Center, and Saddleback Memorial Medical Center. The OG accounted for 88% of total assets and 81% of total revenue of the consolidated entity in fiscal 2015 (June 30 year end; audited). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
STRONG LIQUIDITY: One of MemorialCare's main credit strengths is its strong liquidity, with 279.1 days cash on hand and 286% cash-to-debt at Sept. 30, 2015 comparing favorably to Fitch's 'AA' category medians of 289.4 and 201.7%, respectively. Capital spending is expected to increase in fiscal 2016 due to strategic investments that will pressure liquidity, but it should rebound as capital spending eases in fiscal 2017.
LOW DEBT BURDEN: Another primary credit strength is MemorialCare's low debt burden which results in solid debt service coverage despite inconsistent profitability in the last two years. There are no additional debt plans.
SYSTEM GROWTH: MemorialCare's strategic investments focus on physician partnerships, ambulatory growth, and transforming the payment model. MemorialCare continues to grow its accountable care arrangements and currently has 219,000 lives under management (full and partial risk).
VARIABLE PROFITABILITY: MemorialCare's year-over-year profitability has been somewhat inconsistent reflecting the timing delays related to the state provider fee program. While MemorialCare has received a significant net benefit from the program over the last four years, different phases of the program obtain approval at different times, which has created variability in profitability. Excluding the net impact of the provider fee program, operating profitability has declined mainly due to the strategic investments, but Fitch believes these will be accretive over the longer term.
COMPETITIVE MARKET: MemorialCare operates in the highly competitive Los Angeles and Orange County market, and Fitch will monitor developments there, as the landscape is changing with St. Joseph Health (rated 'AA-') and Providence Health and Services (rated AA') signing a definitive agreement to partner.
RATING SENSITIVITIES
FINANCIAL CUSHION AT RATING LEVEL: MemorialCare's strong liquidity and light debt burden provide ample financial cushion at the current rating level as the organization makes further investment in its strategic initiatives.
CREDIT PROFILE
MemorialCare is composed of five hospitals with a total of 1,586 licensed beds, an extensive ambulatory network, a medical foundation, a health plan (Seaside Health Plan) as well as other related entities. The organization has grown into an integrated delivery system with a geographic reach that covers southern Los Angeles County and Orange County. Total revenue in fiscal 2015 (June 30 fiscal year end) was $2.3 billion.
Strong Liquidity
Liquidity is one of MemorialCare's main credit strengths. Total unrestricted cash and investments was $1.6 billion at Sept. 30, 2015, which resulted in 279.1 days cash on hand, 40.8x cushion ratio, and 286.1% cash-to-debt, compared to Fitch's respective 'AA' category medians of 289.4 days, 27x, and 201.7%. The metrics are still favorable despite a decline since Fitch's last rating review in March 2015 due to weaker investment performance.
Variability in Profitability
California enacted a hospital provider fee in 2010 to draw down additional federal funds for Medi-Cal services and MemorialCare has benefited from the provider fee program. MemorialCare's profitability has fluctuated over the last four years, mainly driven by the timing of recording the provider fee net income in addition to its strategic growth investments, with increasing losses at its medical foundation and health plan. Operating margin was 3.3% in fiscal 2015, 0.7% in fiscal 2014, 6% in fiscal 2013, and 4% in fiscal 2012.
The organization has conservative budgeting and financial planning, which does not include the provider fee funds. For fiscal 2016, MemorialCare is budgeting an operating margin of negative 1% on a consolidated basis, which includes the losses of its medical foundation and health plan. Through the three months ended Sept. 30, 2015, the operating margin was negative 0.7% (includes $5.4 million of provider fee funds). Excluding the impact of the provider fee, MemorialCare is running under budget through the first quarter with revenue below targeted levels. The first-quarter financials also include a $33.4 million gain on sale of its lab business (excluded from operating performance).
Fitch believes the funds from the provider fee program have given MemorialCare more flexibility to invest in its strategic initiatives. The net benefit was $76.7 million in fiscal 2011, $11.4 million in fiscal 2012, $86.4 million in fiscal 2013, $6.2 million in fiscal 2014, and $50.5 million in fiscal 2015.
System Growth and Integration
Although MemorialCare's strategic investments have pressured operations in the short term, Fitch believes there will be realized benefits over the longer term as MemorialCare continues to transition to more at risk payment models.
MemorialCare has invested heavily in strategic physician acquisitions, building its electronic medical record, growing its ambulatory network, and adding additional capabilities including owning a health plan. MemorialCare has been proactive in managing the wellness of its employees and plans to extend this program to other employers in the area. Other areas of focus include continued clinical integration within its system across service lines.
Having made significant investments in its physician alignment strategy, MemorialCare has a strong base of affiliated physicians, which should allow it to better coordinate and deliver care in the most cost effective setting. Fitch believes that MemorialCare's strategic moves to date should allow it to perform well in a pressured and lower reimbursement environment.
MemorialCare has several accountable care arrangements which continue to grow and includes Vivity - a joint venture with Anthem Blue Cross, which offers a health maintenance organization plan (network of seven area local hospital systems) intended to align care delivery and in which the providers and the insurer will share financial risk and gain. The other hospitals in the Vivity network include Cedars Sinai Medical Center (rated 'AA-'; Stable), UCLA Health, PIH Health, Torrance Memorial, Huntington Hospital and Good Samaritan Hospital. In its first year, enrollment exceeded expectations.
Competitive Service Area
MemorialCare operates five acute-care hospitals in the densely populated Los Angeles and Orange counties. Market share information is dated; however, there has been a slight market share loss at its Orange Coast Memorial and Saddleback Memorial facilities, which are located in Orange County. There has been consolidation in the market with one of MemorialCare's competitors, Hoag, merging with St. Joseph Health in March 2013. In late 2015, St. Joseph and Providence announced their partnership plans and Fitch will continue to monitor market developments. MemorialCare has increased its primary care coverage in the Orange County area with its relationship with UC Irvine Health physicians.
MemorialCare has plans to transition its Saddleback Memorial -San Clemente campus to an ambulatory campus, which Fitch would view favorably as it should further enhance efficiency in the system. However, these plans have been impeded by opposition from the local community. Current plans are for a satellite ED at this site pending legislative approval.
Manageable Capital Plan
MemorialCare's 10-year capital plan is manageable and totals $1.3 billion; however, capital spending is elevated in fiscal 2016 at almost $300 million and then declines steadily, averaging over $100 million a year in fiscal 2017 - 2025. Major areas of spending in fiscal 2016 are information technology and the conversion of obstetric rooms at Orange Coast Memorial to all private rooms. Seismic requirements are minimal and total only approximately $25 million.
Low Debt Burden
Total par amount of debt outstanding at Dec. 31, 2015 was $548 million with 43% underlying fixed rate and 57% underlying variable rate. MemorialCare's debt structure has three bullet maturities ($65 million series 1991 variable rate demand bonds [VRDBs] in fiscal 2017, $100 million direct bank loan in fiscal 2019 and $100 million taxable bonds in fiscal 2022). Fitch believes MemorialCare has good market access and sufficient liquidity to handle the bullet maturities.
MemorialCare has a fixed payor swap for a notional amount of $100 million and one remaining basis swap with a notional amount of $50 million. There are no collateral posting requirements under the swaps. MemorialCare terminated two basis swaps in May 2015 and received $3.5 million.
MemorialCare's debt burden is low with maximum annual debt service (MADS) accounting for 1.8% of total revenue compared to Fitch's 'AA' category median of 2.4%. Fitch used MADS of $39.6 million, which was calculated according to the master trust indenture definition for the treatment of bullet maturities (amortized over 20 years) and assumes a variable rate at 2.2%. MADS coverage has fluctuated but remains solid despite inconsistent profitability in the last two years. MADS coverage was 6.9x in fiscal 2015, 4.7x in fiscal 2014, 7.1x in fiscal 2013 and 4.4x in fiscal 2012.
Self-Liquidity
The 'F1+' short-term rating is supported by the adequacy of MemorialCare's highly liquid resources available to fund any unremarketed puts on the $162 million series 1991, series 1994, and series 2013A weekly VRDBs. MemorialCare also has $50 million of series 2013B bonds in a windows mode. The windows mode provides a longer timeframe to handle any unremarketed puts (180 days after 30-day notice). Based on Fitch's rating criteria related to self-liquidity, MemorialCare's access to highly liquid resources to handle any potential unremarketed puts easily exceeds Fitch's 1.25x requirement. MemorialCare has liquidation procedures in place detailing the process by which internal funds would be liquidated to meet the tender obligations.
Disclosure
MemorialCare covenants to provide annual and quarterly financial statements through EMMA.
Outstanding debt affirmed at 'AA-':
--$135,990,000 California Health Facilities Financing Authority (CA) (Memorial Health Services) revenue bonds series 2012A;
--$100,000,000 Memorial Health Services (CA) taxable bonds series 2012.
Outstanding debt affirmed at 'AA-/F1+':
--$100,000,000 California Health Facilities Financing Authority variable rate revenue bonds (Memorial Health Services) series 2013A&B;
--$47,000,000 California Health Facilities Financing Authority (CA) (Memorial Health Services) variable-rate health facilities revenue refunding bonds series 1994;
--$65,000,000 Long Beach (CA) (Memorial Health Services) variable-rate health facilities revenue bonds series 1991.
Additional information is available at www.fitchratings.com.
Applicable Criteria
Rating U.S. Public Finance Short-Term Debt (pub. 17 Nov 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=873508
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun
2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866807
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=998127
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=998127
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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