NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A+' rating on the following bonds issued by the Berks County Municipal Authority on behalf of the Reading Hospital and Medical Center Project (RHMC):
--$160,065,000 series A of 2012 fixed rate bonds;
--$91,775,000 series B of 2012 floating rating bonds;
--$107,610,000 series 2009A-3 fixed rate bonds.
The Rating Outlook is Stable.
RHMC also has outstanding approximately $44.7 million in 2012 series C and approximately $175.1 million in 2016 series A-D variable rate revenue bonds, which are privately placed with commercial banks and not rated by Fitch.
Bondholders have a lien on and a security interest in the gross revenues of the obligated group, which includes Reading Health System (RHS; parent) and Reading Hospital.
KEY RATING DRIVERS
IMPROVED PERFORMANCE IN FISCAL YEAR (FY) 2016: Growth in RHS' volumes and rates, as well as ongoing implementation of its Performance Improvement Plan (PIP) in FY 2016 has reversed a three-year trend of very weak profitability. For fiscal 2016, RHS exceeded its targeted PIP improvements by more than $5 million and achieved a 1.2% operating margin, compared to -5.3% in fiscal 2015 and -3.4% in fiscal 2014. RHS is targeting a 1.1% operating margin for fiscal 2017.
STABLE CORE OPERATIONS: RHS' underlying operations remain sound despite the financial volatility of the past few years, which had been driven by persistent revenue cycle issues from its IT conversion launched in February 2013. Core operations are supported by a solid employed physician base, steady growth in utilization across clinical lines and a primary service area (PSA) market share that has been steady at around 62% for several years.
JOINT VENTURE WITH UPMC HEALTH PLAN: RHS has entered into a joint venture with the UPMC Health Plan to form a provider-payor insurance plan, effective in 2017. Fitch generally views this alliance with a strategic regional partner, as well as the added benefits of revenue diversification, brand connectivity and further build-out of its integrated delivery model, as credit positive for RHS.
SOLID LIQUIDITY: RHS' liquidity position remains robust for the rating despite some recent declines from weak cash flows and heightened capital spending. Liquidity is expected to weaken further in 2017 as a period of heavy capital spending comes to a close. Fitch believes there is sufficient room to absorb planned capital demands at the 'A+' rating.
LARGE CAPITAL PROJECT NEARING COMPLETION: Capital projects are proceeding as planned, with $125 million of expenditures budgeted for fiscal 2017 primarily to complete construction of a new surgical tower, which is expected to be fully operational by January 2017. RHS expects to fund the entire project using internal equity.
CONTINUED RECOVERY: Fitch expects Reading Health System (RHS) to sustain its operational improvement and meet its budgeted profitability of 1.1% operating margin in fiscal 2017.
PROJECT EXECUTION: Fitch expects RHS to meet its current budget and timeline for its new surgical tower. Material cost overruns or operational delays could lead to negative rating pressure; however, this is unlikely, as construction is very nearly complete and the tower is expected to be fully operational by January 2017.
Reading Health System comprises the parent organization and various subsidiaries including Reading Hospital (713 operated-bed acute care hospital located in Reading, PA, Reading Health Partners, The Highlands at Wyomissing (a continuing care retirement community), Reading Health Physician Network (a physician group with 357 employed physicians), and RHS Foundation.
Total operating revenue was $978.5 million in the fiscal year ended June 30, 2016. The obligated group comprised 89% of the consolidated entity's total revenue in 2016. Fitch's analysis is based on the consolidated entity, RHS.
IMPROVED FINANCIAL PERFORMANCE
Volume and rate growth, as well as RHS' ongoing implementation of its PIP in FY 2016 has reversed a three-year trend of very weak profitability (after write-downs), which had been driven by persistent revenue cycle issues from the Epic conversion launched in February 2013. In FY 2016, RHS achieved PIP improvements of $47.4 million, exceeding targeted improvements of $42.3 million by more than $5 million. Operating margin has improved to 1.2% in FY 2016 from -5.3% in FY 2015 and -3.4% in FY 2014.
Affirmation of the 'A+' rating reflects Fitch's expectation that RHS will sustain its operational improvements and meet or exceed its FY 2017 budget. For fiscal 2017, RHS is targeting an additional $32.3 million in PIP improvements and is budgeting a 1.1% operating margin. Through the first quarter of 2017 (quarter ended Sept. 30), RHS is on budget.
Over the longer term, upward rating movement would be contingent on achieving sustained operating EBITDA margins consistent with the higher rating category and further strengthening of balance sheet liquidity from higher cash flow and moderating capital spending.
OPERATING PLATFORM AND MARKET POSITION REMAIN STABLE
RHS' operating platform includes an extensive delivery network that has remained solid through the recent period of financial volatility. RHS experienced modest growth in its utilization trends for 2016 and inpatient market share has been stable at around 62% in the PSA and 8% in the secondary service area for several years.
A large part of RHS' market strength is supported by Reading Health Physician Network, an extensive employed physician network that has grown to 357 physicians from 329 in 2015. Further, RHS created Reading Health Partners, a joint venture with the medical staff aimed to create a clinically integrated network among both employed and non-employed physicians at RHS.
Management is in the process of updating its three-year strategic plan, which is expected to be implemented by March 2017. Generally, RHS' operational strategies continue to include pursuing partnerships to expand its market and diversify lines of business; growing clinical service lines to mitigate outmigration; further collaboration with its network of physicians; capital investments; maintaining excellence in quality outcomes; and improving operating performance.
JOINT VENTURE WITH UPMC HEALTH PLAN
In November 2016, RHS announced that it has finalized an agreement with UPMC Health Plan to form a provider-payor joint venture. The new health plan will commence operations in January 2017, beginning with providing Third Party Administrator (TPA) and FSA Spending Account (FSA) administrative services to employees of RHS and expanding throughout the year to include a full suite of health insurance plans, including Medicare Advantage and Children's Health Insurance Program (CHIP).
Health plan operations are expected to have a neutral effect on RHS' overall profitability; however, RHS' operating profile and market footprint should benefit from this alliance with a strategic regional partner. Additionally, the JV structure of the health plan is expected to offer RHS the strategic benefits of provider-payor insurance plans, such as revenue diversification, brand connectivity and build-out of its integrated delivery network, while mitigating some of their operational and financial risks, such as scalability and the need to fund risk-based capital requirements. Fitch generally views this alliance with the UPMC Health Plan as a credit positive for RHS.
OPENING OF NEW SURGICAL TOWER
In September 2013, RHS broke ground on a new surgical tower that will house 24 surgical suites with updated technological capabilities, expanded emergency rooms, and 150 private beds. Construction and operation of the new surgical tower continues as planned. The tower commenced surgical services in October 2016 and is expected to begin inpatient services in January 2017.
The project is expected to cost approximately $343 million, with $246.2 million already spent. RHS has budgeted to spend the remaining $99.8 million in FY 2017. Combined with other routine and project spending, total capital expenditure is estimated at $125 million for FY 2017, which is approximately 163% of depreciation.
All of the capital spending is expected to be funded from cash flow and equity. As a result, liquidity decline is inevitable in the near term. However, Fitch believes projected capital demands are manageable at the 'A+' rating and expects RHS' balance sheet to recover as profitability stabilizes.
Fitch calculates unrestricted cash and investments totaling $885.1 million as of Sept. 30, 2016, compared to a level that had been above $1 billion as recently as 2014. The decline was partly attributable to weaker cash flows, but was more heavily affected by heightened capital spending that has averaged 171.8% of depreciation since fiscal 2014. Nevertheless, days cash on hand of 345.9, 25.6x cushion ratio and 151.4% cash-to-debt compare favorably against the respective 'A' category medians of 215.5 days, 19.4x and 148.6%.
At FYE 2016, long-term debt totaled $580.9 million with 46% underlying fixed rate and 54% underlying variable rate. Underlying variable-rate bonds consist of $91.8 million in publicly traded FRNs and $220 million in privately placed indexed loans all with initial terms in 2022 and 2023. Debt service is relatively level at around $25 million to $27 million through 2022, then increases to over $34 million with maximum annual debt service (MADS) of $34.6 million.
During FY 2016, RHS refinanced $174.2 million of its 2012 series D bonds, originally a direct placement with RBC, as 2016 series A-D with four other banks (Santander, J.P. Morgan, Northern Trust, and Barclays). The refinancing is expected to generate $0.9 million in annual interest expense savings and mitigated the risk of a 30-day redemption event by lowering the event ratings trigger to below either 'BBB' or 'BBB-' from below 'A' previously.
Although the total amount of debt has declined consistently, debt ratios are weak for the rating category due to the financial deterioration experienced in recent years. MADS equated to 3.5% of 2016 revenues, debt-to-EBITDA was 4.2x and debt-to-capitalization was 44.8%, compared to the respective 'A' category medians of 2.7%, 2.9x and 36.0%. MADS coverage improved from 3.0x in FY 2015 to 4.0x in FY 2016, which is more in line with RHS' historic average of 4.0x to 5.0x, but remains unfavorable to Fitch's 'A' category median of 4.5x.
RHS has several swaps outstanding, but collateral posting requirements are only triggered if the rating is downgraded below 'A-'. As of June 30, 2016, the mark to market was negative $61.4 million.
RHS covenants to provide annual (within 150 days of fiscal year end) and quarterly (within 60 days of each quarter end) disclosure, which are posted on the MSRB's EMMA system and DAC.
Additional information is available at 'www.fitchratings.com'.
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)
Dodd-Frank Rating Information Disclosure Form
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