NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB' rating on the following Indiana Finance Authority bonds issued on behalf of The Methodist Hospitals (TMH):
--$47.1 million revenue refunding bonds series 2014.
The Rating Outlook has been revised to Stable from Positive.
The bonds are secured by a pledge of gross revenues and a debt service reserve fund.
KEY RATING DRIVERS
LOWER PROFITABILITY: The Outlook Revision to Stable reflects profitability below Fitch's expectations and the agency's belief that the current level of operating performance will likely continue, which is reflected in TMH's 2015 budget. TMH's operating EBITDA margin fell to 8% in 2014 (Dec. 31 fiscal year end) from 9% in 2013, and is budgeted at 7.7% for fiscal 2015, equal to current levels through the three months ended Mar. 31, 2015. Uncertainties regarding the impact of recent changes to Indiana Medicaid, as well as expected reductions to Medicare disproportionate share hospital (DSH) funding pose further concern.
STRONG LIQUIDITY: The 'BBB' rating is supported by TMH's robust liquidity metrics well above 'BBB' category medians, demonstrated by 190 days of cash on hand (DCOH) and 207% cash to debt at March 31, 2015, in comparison to category medians of 145 DCOH and 94% cash-to-debt.
LOW DEBT BURDEN: TMH's debt position is low, with MADS as a percent of 2014 revenue and debt to EBITDA at 1.9% and 2.2x, comparing favorably to the respective 'BBB' category medians of 3.6% and 3.9x. Operating cash flow produced solid 4.2x operating EBITDA coverage of MADS, in comparison with 2.3x category median. Future capital plans may include an increase in long-term debt, which Fitch believes may be manageable against TMH's balance sheet strength.
UNFAVORABLE PAYOR MIX: TMH has an unfavorable payor mix with 73% of gross revenues from government payors, which results in the dependence on supplemental funding. Indiana's Medicaid expansion waiver in early 2015 will likely mean reduced exposure to supplemental funding over time, partially offset by an increase in Medicaid revenue.
FUTURE CAPITAL PLANS: Future borrowing for capital expenditures may prove substantial, limiting the expectation of upward rating movement. While The Methodist Hospitals' financial profile could absorb some additional debt at a higher rating level, additional clarity on The Methodist Hospitals' capital and debt plans will be key in determining the direction of the rating.
Serving northwest Indiana, TMH operates a 302-bed acute care facility in Gary (Northlake campus), IN and a 313-bed acute care facility in Merrillville, IN (Southlake campus), and other various clinical entities. The system is also supported by a foundation. Total revenues for 2014 were $329.7 million, excluding investment income.
WEAKER CASH FLOW
Fitch believes that TMH's performance has stabilized at a lower level than historic highs. 2014 results were weaker than expected at 0.6% operating margin and 8% operating EBITDA margin. TMH is budgeting a 7.7% operating EBITDA in 2015, and well below prior levels (e.g., 14.9% in 2011). Interim performance appears in line with budget despite below-budget discharges, though some one-time revenues in the form of cost report settlements for 2014 and 2015 may help augment 2015 performance. In the longer term, Fitch believes that urgent and strategic ambulatory care expansion should help stabilize operations and ultimately reduce TMH's reliance on supplemental funding, which remains a notable credit risk.
STRONG LIQUIDITY POSITION
TMH's liquidity position remains strong. DCOH as of March 31, 2015 was 190 days, well above the 'BBB' category median of 145. Cash to debt has improved markedly over the past four years, to a strong 207% at March 31, 2015, as TMH has both deleveraged and grown its unrestricted cash position mainly through limited capital spending (average less than 1x depreciation expense over last four years). Unrestricted cash has grown 11% since 2011, to $153 million at March 31, 2015.
CAPITAL PLANNING UNDERWAY
TMH is undertaking substantial capital plans as expected, which could total up to $74 - 78 million; however, some of the projects have not been approved. Current projects underway include approximately $10 million budgeted to be invested in 2015 and 2016 in the Northlake campus for renovations to the emergency department and intensive care units in addition to routine capital investment of approximately $20 million or 77% of 2014 operating EBITDA. Management is considering other expansion and renovation projects at Northlake and Southlake over the medium term, which will be further defined as the new CEO develops his strategic plan. Fitch believes TMH's low debt position could accommodate increased spending and debt at a higher rating level. Any rating movement will depend upon review of finalized capital and financing plans.
HIGH GOVERNMENT PAYORS AND SUPPLEMENTAL REVENUES
TMH's payor mix is highly concentrated in government payors, with 73% of gross revenues from government payors in 2014. Indiana's expansion of Medicaid under a section 1115 waiver, effective Feb. 1, 2015 will increase this proportion and decrease TMH's reliance on the at-risk federal and state DSH programs. However, management believes that margins may not improve as much for TMH as for other Indiana safety net providers, as TMH has been highly effective at securing supplemental funding. Management reports that bad debt and charity care have improved since Feb 1. Fitch views this transition mildly positively, as it will mean more reliable if ultimately lower revenue via Medicaid.
TMH has historically relied upon supplemental revenues via the state and federal DSH program, which are being pressured under health reform. DSH payments represented 15% of budgeted net hospital revenues in 2015. Medicaid DSH funding has declined 15% over the past two years, to a budgeted $38 million in 2015, and is at-risk for program renewal after June 2017. With Medicaid expansion partially offsetting reduced DSH payments, Fitch expects Medicaid reimbursement combined with Medicaid DSH payments to be neutral to slightly negative to TMH going forward. Medicare DSH will remain consistent at approximately $10 million in 2015, but is likely to decline as programmatic cuts impact Medicare spending in 2016 and beyond.
CONSERVATIVE DEBT PROFILE
TMH had $73.8 million in fixed rate long-term debt and capital lease obligations as of March 31, 2015. Leverage is low, with MADS as a percent of revenues at 1.9% in 2014. Debt to EBITDA in 2014 was 2.2x, well below the 'BBB' category median of 3.9x. TMH's defined benefit pension plan has been frozen since 2005 and is currently 78% funded (on a GAAP basis) and is expected to require ongoing funding (approximately $5 million to $6 million a year).
TMH covenants to disclose audited financial statements within 150 days of fiscal year end. Annual disclosure is posted to the Municipal Securities Rulemaking Board's EMMA system. While TMH does not covenant to disclose quarterly statements, it does so voluntarily to bondholders via EMMA. Quarterly disclosure includes balance sheet, income statement, statement of cash flows, utilization, and management discussion and analysis.
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