NEW YORK--(BUSINESS WIRE)--Fitch Ratings upgrades to 'A' from 'A-' the rating on approximately $836 million of outstanding bonds issued on behalf of Bon Secours Health System, Inc. (BSHSI) .
The Rating Outlook is Stable.
The bonds are secured by a pledge of unrestricted receivables of all obligated group members. Fitch metrics refer to the performance of the BSHSI consolidated system, of which the Obligated Group in fiscal 2014 (year-end August 31) represented substantially all of the assets and 77.5% of revenues.
KEY RATING DRIVERS
STEADY OPERATING PROFITABILITY: The upgrade to 'A' from 'A-' is based on the system's steady operating performance over the last three years, consistent with Fitch's 'A' category medians, combined with moderate leverage and slowly improving liquidity. For the most recent fiscal year ended Aug. 31, 2014, the system had operating income of $123.6 million, equal to operating margin of 3.6% and operating EBITDA margin of 8.4%. The solid profitability was accomplished despite declining volumes and continued losses at the two New York divisions.
MODERATE DEBT BURDEN: maximum annual debt service (MADS) is a modest 2.1% of fiscal 2014 revenues as compared to the 'A' category median of 3.1%. As a result, BSHSI has generated solid MADS coverage by EBITDA of 4.0x and 4.5x in fiscal 2014 and 2013, respectively, despite EBITDA margins that lag the 'A' category medians. Additionally, there are no plans for debt issuance in the near term.
LARGE DIVERSIFIED SYSTEM: BSHSI is a large system with significant geographic dispersion with favorable payor mix, presence in several markets with good demographics, increasing clinical integration and a strong and stable management team.
LIQUIDITY SLOWLY IMPROVING: Liquidity metrics have been slowly improving and, while still lagging the 'A' category medians, are adequate in view of the system's manageable debt load. Days cash on hand (DCOH) were reported at 129.8 days at fiscal 2014 year end, and cushion ratio and cash to debt were 15.3x and 115.6%, respectively.
NEED TO MAINTAIN OPERATING PERFORMANCE: Fitch expects BSHSI to sustain the recent level of profitability supporting good debt coverage and to slowly grow its balance sheet. A material worsening of the losses at the underperforming New York divisions or erosion of liquidity could pressure the rating.
BSHSI, headquartered in Marriottsville, MD, is a diversified system with facilities in Florida, Kentucky, Maryland, New York, South Carolina and Virginia, and operates 19 owned and joint-ventured hospitals, as well as several other non-acute entities. BSHSI has 2,529 acute care beds and 995 long-term care beds in operation and reported total revenues of $3.5 billion in fiscal 2014.
STEADY OPERATING PROFITABILITY
The decision to upgrade to 'A' is based on management's ability to produce consistently solid operating results, the improving balance sheet ratios and the system's moderate leverage position. For the most recent fiscal year ended Aug. 31, 2014, the system had operating income of $123.6 million, equal to operating margin of 3.6%. Operating margins have exceeded the 'A' category median of 2.5% consistently over the last three years (at 3.7% in both fiscal 2012 and 2013). Operating EBITA margin in fiscal 2014 was 8.4%, slightly lower than the 9.5% 'A' median.
The solid results and operating stability are a product of significant investment in the system wide EHR 'ConnnectCare', increased clinical integration, as well as a major focus on expense control. The Stewardship Program, formulated in 2011 following a consultant engagement, produced $200 million savings to date, exceeding the original projections, and is expected to generate further $240 million of cost reductions over the next three years. The solid profitability was accomplished despite declining volumes and continued losses at the two New York divisions. Inpatient volumes declined by 3.3% in fiscal 2013 and 3.6% in fiscal 2014, partially driven by a shift to observation days, which rose by 15% in 2014. Outpatient volumes were also negatively impacted in several markets, but system revenues increased by 3.1% in 2014 due to growth in physician visits, urgent care access, and higher inpatient acuity and rates.
The Virginia markets, which account for 56.5% of system revenues and over 80% of operating profit, have continued to perform well in 2014. A difficult contract negotiation in the Virginia markets will be completed shortly. Management credits the presence of 500 Bon Secours aligned providers in the market and solid relationships with employers, as being key to these negotiations.
CHALLENGES AT NEW YORK DIVISIONS, IMPROVEMENT IN BALTIMORE
The system continues to struggle with persistent losses at the two New York divisions, neither of which are in the obligated group and together account for 15% of system revenues. The Bon Secours Charity Health System, Inc. (Charity) had an operating loss of $11 million in 2014, a slight increase over the $9.8 million loss in the prior year and better than the high $27.5 million loss in 2012. The loss in part reflects the $7 million expense related to the implementation of ConnectCare in fiscal 2014. The system is working on increasing clinical integration through new affiliations. Charity is listed on the Westchester Medical Center application for Delivery System Reform Incentive Payment [DSRIP], a New York state program to promote collaboration and system reform in concert with ACA. In addition, Bon Secours Community Hospital was awarded $4.2 million ($1.2 million was received to date) from the Interim Assistance Assurance Fund.
The Bon Secours New York Health System, Inc., which operates several non-acute and housing facilities in the Riverdale section of the Bronx in New York City, experienced a loss of $8.9 million; double that of the prior year due to volume challenges and the discontinuation of a New York state home health program. The system leadership is focused on finding rational solutions for both divisions and is in the process of evaluating all available options. In Fitch's view it is essential for BSHSI to stem the continuing losses in the New York market.
A positive development has been the implementation of the Global Budget Revenue (GBR) reimbursement for the Bon Secours Hospital Baltimore, which guarantees a predetermined level of revenues based on anticipated level of utilization. After a large loss in fiscal 2013 of $11.2 million, Baltimore returned to positive operating income of $1.6 million in fiscal 2014 and the GBR should provide for relative stability, unless volumes increase, which is not expected.
SLOWLY IMPROVING LIQUIDITY
Fitch notes that the system's liquidity metrics are still lower than Fitch's 'A' rating medians, but liquidity has been improving incrementally. At Aug. 31, 2014 BSHSI had $1.14 billion of unrestricted cash and investments, equal to 129.8 DCOH, cushion ratio of 15.3x and cash equal to 115.6% of long-term debt, respectively, all improved from 119.1 DCOH, 12.6x and 87 in fiscal 2011, but below the 'A' medians of 199.2 days, 17% and 131.2%. The solid profitability, coupled with no plans for additional debt over the near term, should lead to gradual increase in liquidity and management has set a target of 140 DCOH and 150% cash to debt by 2018. Improvement in liquidity is important for the system given its presence in several growth, but competitive, markets, such as the two Virginia markets, requiring continued investment in facilities, physician alignment and services in order to remain competitive.
MODERATE DEBT BURDEN
The system's light liquidity and adequate profitability is mitigated by a relatively modest leverage position. Coverage of debt by EBITDA was a solid 4x in fiscal 2014 and MADS represents a very modest 2.1% of revenues, both of which are favorable to Fitch's 'A' rated medians of 3.8x and 3.1%, respectively. The light leverage and absence of any planned debt issuance over the next three years should further moderate the debt metrics. BSHSI has a fairly high exposure to operating leases - $81.3 million - and management includes leases in the 'comprehensive debt portfolio', which results in cash-to-debt reduced to 106.8%.
BSHSI had approximately $1 billion of long-term debt outstanding at 2014 fiscal year end with 37% in variable debt mode. MADS of $74.3 million occurs in 2019 and MADS declines fairly significantly to $31.6 million in 2032. Liquidity for the variable rate series is provided by LOCs with four liquidity providers, with renewals staggered between 2017 and 2019. The total notional amount of swaps outstanding is $1.05 billion, well diversified among several counterparties, and collateral posting is required only on $409 million of the notional par. The mark-to market at Aug. 31, 2014 was a negative $67.8 million, and the system currently posts $4.6 million of collateral.
BSHSI covenants to supply both audited annual and unaudited quarterly financial data to bondholders at 'www.dacbond.com'. Financial disclosure to bondholders has been excellent in terms of content and timeliness and includes detailed management discussion and analysis, a balance sheet, an income statement, utilization statistics, and consolidating statements.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 30, 2014.
Applicable Criteria and Related Research:
U.S. Nonprofit Hospitals and Health Systems Rating Criteria