NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB+' rating on the $198 million Health, Educational and Housing Facility Board of the County of Knox (TN) (University Health System, Inc.) series 2007 revenue bonds.
The Rating Outlook is Stable.
SECURITY
Debt payments are secured by a pledge of the gross revenues of the obligated group.
KEY RATING DRIVERS
STRONG MARKET PRESENCE: University Health System (UHS) is the area's only academic medical center with a regional draw providing tertiary and quaternary services, some of which are unique to UHS. UHS's market share has increased every year in the last five years, and the utilization trend has been strong, to a large degree owing to its significant clinical integration with its large medical staff.
IMPROVING OPERATING PERFORMANCE: UHS's operating performance in fiscal 2014 (year-end Dec. 31) and through the third quarter of the current fiscal year ended Sept. 30, 2015 (the interim period) has been significantly better than budgeted. UHS reported operating income of $10.4 million fiscal 2014 (1.5% operating margin) and $7.3 million for the 2015 interim period, equal to an 1.3% operating margin, better than the category median. Management projects to end fiscal 2015 with a slightly higher operating margin of 1.5%.
ADEQUATE COVERAGE AND MANAGEABLE CAPITAL NEEDS: Coverage of maximum annual debt service (MADS) by EBITDA was 2.5x both in 2014 and through the third quarter interim period, consistent with the category median. UHS's balance sheet metrics are weaker than Fitch's 'BBB' medians, but UHS completed a major facility update and a 2015 transaction (not rated), included in MADS, provided $40.4 million of new money for several ongoing renovation and improvement projects.
RATING SENSITIVITIES
NEED TO MAINTAIN OPERATING PERFORMANCE: Fitch expects University Health System to maintain a sufficiently profitable operating performance, which combined with manageable capital spending, should continue to build up its balance sheet. Deterioration in operating performance, resulting in lower coverage, could lead to downward rating pressure.
CREDIT PROFILE
UHS is a 581-staffed-bed academic teaching facility affiliated with, but separate from, the University of Tennessee, which provides a diverse array of clinical services to 21 counties in eastern Tennessee. UHS had revenues of $707.1 million in fiscal 2014, an increase of 12% over the prior year.
Market Dynamics
UHS operates in a competitive market; its major competitors are the multi-facility systems Covenant Health (rated 'A' by Fitch) and for-profit Tennova, which was acquired by Community Health System (CHS), both of which operate nine hospitals in the service area. Despite this, UHS was able to increase its market share in each of the last five years in the 21 county metropolitan service area and its 15.7% market share (2014 data) was the highest of any individual hospital in the Knoxville market. Based on admission growth through the third quarter of 2015, it is expected that UHS's market share for 2015 will go up as well. UHS's volume of inpatient admissions increased by 8.7% between 2010 and 2014, while total service area admissions decreased by 4.8%. UHS provides a broad array of services, some of which are unique in the market, and has a closely aligned medical staff of approximately 750 physicians located on the UHS campus.
Inpatient admissions increased by 2.1% in fiscal 2014 and a sharp 8.5% increase was registered through the third quarter of fiscal 2015, despite an almost 30% increase in observation cases during 2014 as well as the interim period. The organization is leveraging its closely aligned medical staff to focus on quality, efficiency and standardization of processes, with approximately 80% of all care processes now under standardized pathways, accounting for 80% of admissions and the critical pathways are now being gradually introduced in individual physician offices.
Historically Thin, But Improving Operating Performance
UHS's operating performance has historically been relatively thin, reflecting management's philosophy of investing in programs, clinical integration and facility expansion, a strategy which has paid off resulting in the solid utilization trend. For fiscal 2014, UHS recorded an improved operating income of $10.4 million, double that of the prior year and equal to an operating margin of 1.5% and operating EBITDA margin of 7.2%, as compared to Fitch's 'BBB' medians of 0.6% and 7.7%, respectively and well exceeding its conservatively budgeted breakeven performance. Driven by solid inpatient volumes and high Medicare case mix index of 1.97, operating gain through the third quarter of 2015 was $7.3 million - 1.3% operating margin versus a 1% operating margin for the same period last year. Management projects to end fiscal 2015 with a slightly better 1.5% operating margin. Budgets have historically been conservative, but typically exceeded, and management has budgeted operating income of $3.9 million for 2016.
Mixed Liquidity
UHS reported $249.4 million of cash and unrestricted investments at Sept. 30, 2015, translating to 125.3 days cash on hand (DCOH), slightly lower than the 140 DCOH at 2014 year-end, cushion ratio of 11x and cash equal to 84.9% of debt. Cash to debt and cushion ratio are in line with Fitch's 'BBB' category medians of 11.1x and 89.5%, but DCOH lag the median of 161.5 DCOH. Management expects to end the 2015 year with approximately $270 million of unrestricted cash and investments as payables are typically somewhat slowed down towards the end of the fiscal year. The relatively weak liquidity is partially offset by a conservative portfolio allocation, with 64% in fixed income and no exposure to alternative investments.
Manageable Leverage
UHS's coverage of $22.6 million MADS by EBITDA and operating EBITDA was 2.5x and 2.2x in fiscal 2014, close to Fitch's 'BBB' category medians of 2.7x and 2.4x, respectively and EBITDA coverage was 2.5x though the third quarter of fiscal 2015. MADS as a percentage of revenues, which was historically elevated vis-a-vis the Fitch median, is now at 3% lower than the 'BBB' median of 3.6%. UHS has a relatively conservative debt structure with 86% fixed-rate debt. UHS completed a $90 million direct bank purchase transaction in June 2015 with Regions Bank. The transaction consisted of two series, a $32 million variable rate series based on one-month LIBOR plus 1.03% and a $58 million fixed rate series. Both series have a 15 year final maturity. The proceeds were used to pay off a $49.3 million series 2010 Sun Trust bank loan and provided $40.4 million of new money as reimbursement and funding for several ongoing projects. The organization also has a bank qualified (SunTrust) bank loan with an interest rate at one-month LIBOR plus 80 basis points which requires UHS to have MADS coverage of 1.2x, DCOH of 60 days minimum and a rating of 'BBB-'; these additional covenants also apply to the Regions Bank borrowing.
As part of the projects being carried out and partially financed with draws on the 2015 new money proceeds, UHS will be able to increase its staffed bed complement to 625 beds by calendar 2016 year-end. Capital expenditures are projected at $30 million-$33 million over the next three years, slightly above depreciation expense, and will not require debt issuance over the near term. UHS has one fixed-to-variable-rate swap ($176 million notional par) with a positive mark-to-market of $4.8 million as of the end of Dec. 31, 2015 and no required collateral posting ($10 million threshold).
Disclosure
UHS covenants to provide bondholders with annual and quarterly financial disclosure through the Municipal Securities Rulemaking Board EMMA system. UHS also provides management discussion and analysis and utilization statistics with their quarterly financials.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
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=998272
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=998272
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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