Fitch Rates $209.6MM Providence Health & Services' (WA) Ser 2014D 'AA'; Outlook Stable

CHICAGO--()--Fitch Ratings assigns a 'AA' rating to the expected issuance of $209.6 million Washington Health Care Facilities Authority revenue bonds, series 2014D issued on behalf of Providence Health & Services (PH&S).

In addition, Fitch affirms the 'AA' long-term ratings on approximately $3.6 billion in outstanding debt issued through various issuing authorities and the 'F1+' short-term rating based on the self-liquidity provided by PH&S on the series 2013F Providence Health System Obligated Group (WA) taxable commercial paper (CP) note program authorized up to $200 million.

The Rating Outlook is Stable.

PH&S expects to issue approximately $209.6 million of series 2014D fixed-rate revenue bonds through negotiated sale the week of October 20. Proceeds from the series 2014D bonds will be used to refund the outstanding debt of Kadlec Regional Medical Center (a 236 staffed-bed acute care hospital located in Richland, WA) and pay costs of issuance.

SECURITY

Unsecured corporate obligation of the Obligated Group.

KEY RATING DRIVERS

STRONG MARKET POSITION: Fitch views PH&S' geographic diversity and business line diversity as key credit strengths. The increasing breadth of healthcare services across Washington State and in southern California is viewed favorably as it positions the organization for the evolution and development of population health management services.

WEAK 2013 PROFITABILITY: Operating profitability continued to decline in fiscal 2013. Although Fitch expected PH&S' profitability to be compressed in 2011 and 2012, the poor operating results in 2013 were not anticipated and reflect, in part, continued challenges in reacting to changing clinical volumes throughout the system, lower than expected reimbursement from governmental payors and continued investment in IT. However, through the six-month interim period ended June 30, profitability has improved as a result of benefits from Medicaid expansion, continued cost reduction initiatives and decreased IT implementation costs.

EXCELLENT BUSINESS PRACTICES: Despite the poor operating performance in 2013, Fitch believes management is proactively transforming the organization in order to maintain its leadership positions as key markets move to population health management payment models. PH&S' excellent management practices are reflected in a robust IT platform and continued centralization of shared services that allows for detailed operational reporting.

MODEST DEBT BURDEN: Fitch used pro forma maximum annual debt services (MADS) of $263.6 million (as provided by management) which is a modest 2.3% of 2013 combined system revenues. Historical coverage of pro forma MADS by EBITDA was a light 3.6x in 2013 but was a much improved 5.0x through the six months ended June 30, 2014.

LIGHT LIQUIDITY METRICS: At June 30, 2014, PH&S had $5.59 billion of unrestricted cash and investments which equates to 184.0 days cash on hand, a 21.2x cushion ratio (based on pro forma MADS) and 143.8% cash to long-term debt, which lag the respective 'AA' category medians of 277.1 days, 26.5x and 178.5%. However, Fitch notes that internal cash flow has been used to fund a portion of the costs of the system's ongoing capital projects as well as its substantial investment in a system-wide IT platform.

RATING SENSITIVITIES

PROFITABILITY IMPROVEMENT: Fitch expects that operating profitability will improve in fiscal 2014, providing cash flows sufficient to increase MADS coverage by operating EBITDA to levels consistent with Fitch's 'AA' medians. Through the six months ended June 30, 2014, PH&S generated a 2.2% operating margin and a 9.0% operating EBITDA margin compared to operating and operating EBITDA margins of 0.7% and 7.3%, respectively, in the prior year period.

CREDIT PROFILE

PH&S is a large, multi-state health system made up of 34 acute care hospital facilities located across five states, an Oregon health insurer with over 500,000 members, and over 3,200 employed physicians. In 2013, PH&S generated total revenues of $11.1 billion. Fitch analysis is based on the consolidated financial results of PH&S which includes certain non-obligated entities.

STRONG MARKET POSITION

PH&S owns or leases 34 hospitals in Washington, Oregon, Alaska, Montana and California. PH&S maintains strong competitive positions in most of its service areas, with facilities in Seattle, Everett, Olympia and Spokane, WA; Portland, OR; Anchorage, AK and Missoula, MT holding leading or substantial market share positions. PH&S has been increasing its presence in the competitive southern California marketplace through acquisitions of acute care facilities (including 266-bed Providence St. John's Hospital in Santa Monica in March 2014) and physician alignment. The acquisition of the 235 staffed-bed Kadlec Regional Medical Center in Richland, WA will further fill out PH&S' coverage across Washington State. While Fitch has viewed PH&S' geographic and business line diversity as key credit strengths, the strategy to increase the breadth of healthcare services across Washington State and in southern California is viewed favorably as it is increasingly important to position the organization for the development of population health management services.

In 2013, roughly 42% of total system revenues were generated in Washington State, 31% in Oregon (including the health plan), 17% in California and 10% from Alaska and Montana.

WEAK 2013 PROFITABILITY

Although Fitch expected PH&S' profitability to be compressed in 2011 and 2012, the poor operating results in 2013 were not anticipated and reflect, in part, continued challenges in reacting to changing clinical volumes throughout the system, lower than expected reimbursement from governmental payors, and the on-going costs associated with a system-wide IT implementation. In 2013, PH&S reported $37.6 million in operating income compared to $204 million in income from operations in 2012 and $220 million budgeted for 2013. As a result operating margin in 2013 fell to 0.3% from 1.9% in 2012 while operating EBITDA margin slipped to 6.9% from 8.6% in the prior year.

Through six-month interim period ended June 30, operating profitability has improved with operating and operating EBITDA margins of 2.2% and 9.0%, respectively. The profitability improvement reflects management's administrative cost reduction initiatives, the benefit of Medicaid expansion in WA, OR and CA and the net benefit from the Washington provider tax program of $27 million, of which $10 million is related to 2013. Fitch expects the improved operating performance to be sustained throughout 2014.

EXCELLENT BUSINESS PRACTICES

Fitch believes management is proactively transforming the organization in order to maintain its leadership positions as key markets move to population health management payment models. From discussions with management Fitch believes that PH&S is closely attuned to the changing demands of employers and patients in certain markets for greater transparency, value and service. Continued consolidation of corporate services is likely to generate increased efficiencies and allow for improved and timely decision-making. The investment in its system-wide clinical and financial information systems is expected to allow the system to react more quickly to changes in clinical volumes and payor mix, and preserve profitability.

MODERATE DEBT BURDEN

With the issuance of the series 2014D bonds, PH&S' debt burden remains modest with pro forma MADS of $263.6 million equating to 2.3% of 2013 combined system revenues. Debt-to-capitalization of 33.4% at June 30, 2014 is moderate and consistent with the 'AA' category median of 31.1%. Historical coverage of pro forma MADS in 2013 is light at 3.6x when compared to the 'AA' category median of 5.4x. However, Fitch notes that historical pro forma coverage through the six-month interim period was a solid 5.0x. Coverage of pro forma MADS by operating EBITDA through the six-month interim was 4.1x, which is improved from 2.9x in 2013 and more in line with the 'AA' median of 4.4x. The ability to improve coverage by operating EBITDA to levels consistent with Fitch's 'AA' category median is a key rating factor in maintaining the 'AA' rating.

LIGHT LIQUIDITY METRICS

PH&S' liquidity metrics reflect the system's use of operating cash flow to help fund substantial capital investments. Since 2010, PH&S has spent over $2.74 billion in capital additions (equating to 164% of annual depreciation expense) while total debt has increased roughly $1.6 billion and unrestricted cash has grown by $2.2 billion. At June 30, 2014, PH&S had $5.59 billion of unrestricted cash and investments which equated to 184 days cash on hand, a 21.2x cushion ratio (pro forma)and 143.8% cash-to-debt, which lag the respective 'AA' category medians of 277.1 days, 26.5x and 178.6%. Fitch believes that liquidity growth will be constrained due to ongoing capital spending and pension funding requirements.

SELF-LIQUIDITY RATING

The 'F1+' rating reflects the sufficiency of PH&S' cash and investments position relative to the potential funding obligations on its $200 million taxable CP program, of which there were no amounts outstanding. As of June 30, 2014, PH&S had over $1.2 billion of cash and highly liquid short-term investments available on a same-day basis. Based on Fitch's rating criteria related to self-liquidity, PH&S' position of 'eligible cash and investments' available for same-day settlement easily exceeds Fitch's 1.25x threshold to cover the maximum tender exposure on any given date. PH&S provides Fitch with regular liquidity reports that are used to monitor its cash and investment position relative to the corporation's total self-liquidity exposure.

DISCLOSURE

PH&S disseminates annual audited financial statements and quarterly unaudited financial statements through the MSRB's EMMA system, Digital Assurance Certification (DAC) and on its web site, 'www.providence.org', which is viewed positively by Fitch. Quarterly information includes balance sheet, income statement, cash flows, management discussion and analysis and utilization statistics.

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

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 3, 2013);

--'US Nonprofit Hospitals and Health Systems Rating Criteria' (May 30, 2014);

--'Rating US Public Finance Short Term Debt' (Dec 9, 2013).

Applicable Criteria and Related Research:

Rating U.S. Public Finance Short-Term Debt

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724680

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=893154

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Contacts

Fitch Ratings
Primary Analyst:
Jim LeBuhn, +1-312-368-2059
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Adam Kates, +1-312-368-3180
Director
or
Committee Chairperson:
Eva Thein, +1-212-908-0674
Senior Director
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Jim LeBuhn, +1-312-368-2059
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Adam Kates, +1-312-368-3180
Director
or
Committee Chairperson:
Eva Thein, +1-212-908-0674
Senior Director
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com