NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed its 'BBB' rating on the following hospital revenue bonds to be issued through the Rhode Island Health and Educational Building Corporation on behalf of Care New England Health System (CNE):
--$85.5 million series 2013A.
The Rating Outlook is revised to Negative from Stable.
Pledge of gross revenues, a mortgage interest in certain hospital facilities and debt service reserve fund.
KEY RATING DRIVERS
WEAKENING UNDERLYING PERFORMANCE: The Negative Outlook reflects the softening of CNE's operating performance since Fitch first rated CNE in 2013, with CNE likely posting a slightly negative operating margin in FY2015 (Sept. 30 year end) for the second consecutive year. A large driver of the negative performance has been the compression of managed care rates due to a Rhode Island state law passed in 2013 limiting the yearly increases hospitals can receive on their commercial health insurance reimbursement rates. CNE is working with a national consulting firm to implement an operational improvement plan.
FY16 TRANSITION YEAR: In FY16, CNE plans to reduce the organization's reliance on one-time revenue items, including dividends from its captive insurance company. In FY15, CNE had over $25 million in one-time revenue items (including approximately $17 million from the captive insurance companies). Even though Fitch expects a better underlying operational performance from CNE in FY16 due to implementation of the improvement plan, CNE's overall financial results are expected to be lower with the reduced use of these one-time revenue items.
LIGHT DEBT BURDEN KEY STRENGTH: Fitch believes CNE's lower debt burden provides CNE with a considerable amount of financial cushion. At June 30, 2015, maximum annual debt service (MADS) as a percent of revenues was a very modest 1.4%, relative to Fitch's 'BBB' category median of 3.6%, and MADS coverage was 2.7x, at the category median, in spite of a $7 million operating loss through the nine month FY15 interim period. Fitch does not expect CNE to issue any new debt over the next two years.
STRATEGY PROGRESSES: CNE continues to move forward on becoming a more integrated, physician-led health care delivery system and enhancing its ability to manage populations. In recent years, this has included the acquisitions of physician groups, Memorial Hospital of Rhode Island (Memorial), and The Providence Center, with CNE investing over $20 million in information technology and on accountable care development. While these strategic investments will continue to suppress CNE's operating performance over the next few years, Fitch believes that over the longer term it should position CNE well to compete in the Providence, RI market and should prove accretive to CNE's financial performance.
IMPROVED CORE OPERATING PERFORMANCE: Over the next two years, Fitch expects Care New England's (CNE) underlying operational performance to show improvement. Should CNE's operating EBITDA fail to improve over this period (its operating EBITDA was 3.1% at June. 30, 2015) or should CNE's debt service fall below its 1.1x covenant, a downgrade would be likely.
IMPACT OF STATE INITIATIVES: CNE is still absorbing the impact of the reimbursement increase limits for commercial payor contracts imposed by the state of Rhode Island. Rhode Island is exploring changes to other hospital reimbursement programs, including Medicaid, which could further impact hospital reimbursement. The longer-term impact of these programs could lead to a downgrade, especially if reimbursement rates continue to be pressured under these state programs.
Headquartered in Providence, RI, CNE operates 167-bed Women's and Infants Hospitals (167 beds), Butler Hospital (143 beds), Memorial Hospital (294 beds), and Kent Hospital (359 beds). In FY2014, CNE reported total operating revenues of $1.1 billion. Fitch's analysis and financial ratios are based on consolidated financial statements.
THIN OPERATING PERFORMANCE
CNE continues to produce thin operating margins, and its performance over the last two years has been further pressured by the compression of managed care reimbursement rates. In 2013, Rhode Island put into place limitations on the rate increases that hospitals can receive. The increases from commercial and manage care payors are tied to national price inflation indices, which have kept rate increase to below 2% over the last two years. Fitch believes this level of rate increases is unsustainable.
While Care New England has made adjustments in the near term to absorb the lower increases, the Negative Outlook reflects Fitch's belief that this level of reimbursement is unsustainable over the medium term and would pressure operations, likely leading to a downgrade. In addition, Rhode Island is exploring changes to other reimbursement programs, such as Medicaid, and the potential negative impact of these could also lead to a downgrade.
CNE is moving forward on an improvement plan focused on a number of areas across its hospitals, with a goal of between $75 to 90 million of improvements over the next two to three years. Successful implementation of the plan will be a key driver for sustaining the rating, especially given CNE's strategic plan, which requires ongoing investments, and the current challenges to its reimbursement.
A new CFO appointed in 2014 is implementing a goal of reducing CNE's reliance on one-time and non-core operating revenue items to support operations. Fitch views this move positively, believing that the near-term stress on financial performance will be outweighed by the longer-term operational stability that will be gained. The Negative Outlook reflects the stress expected to CNE's overall financial performance over the next two years. A downgrade would be likely if underlying performance fails to improve or CNE has a covenant violation.
Liquidity remains mixed, with days cash on hand at Jun. 30, 2015, at 60.3 days very thin for the rating level, but the cushion ratio of 11.3x and cash to debt of 108.2% are above Fitch's 'BBB' category medians, reflecting CNE's manageable debt burden. Fitch anticipates cash weakening over the next two years but does not expect CNE to violate its DCOH covenant of 45 days.
LIGHT DEBT BURDEN
CNE's light debt burden is a key credit strength. Maximum annual debt service (MADS) of $15.9 million equates to a very light 1.5% of FY14 revenues as compared to the 'BBB' median of 3.6%. As a result, MADS coverage by EBITDA was a solid 3.2x in FY2014 and adequate at 2.7x through the nine months ended June 30, 2015, relative to the 'BBB' category median of 2.7x. Fitch believes that CNE's light debt burden provides CNE with financial flexibility at the current rating level as it transforms its operational performance, moves forward on strategic initiatives, and adjusts to changes from the state of Rhode Island's reimbursement initiatives.
Fitch does not expect CNE to issue additional debt over the rating cycle. CNE is finishing up a $25 million EPIC implementation and also changed over the accounting and professional billing software. The hospitals within CNE are HIMSS Level 6, as CNE has invested in information technology.
CNE's debt mix is relatively conservative. Its $168 million in long term debt is approximately 75% fixed rate. CNE has no outstanding swaps.
CNE covenants to provide annual audited financial statements within 120 days of each fiscal year-end and quarterly unaudited financial statements within 45 days of each fiscal quarter end to the MSRB's EMMA system.
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