NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a long-term rating of 'A-' to the approximately $59.5 million of series 2016 hospital revenues bonds issued by the Monroe County Hospital Authority on behalf of Pocono Health System (PHS). The rating has been placed on Rating Watch Evolving.
In addition, Fitch downgrades its rating on approximately $91 million of bonds issued by the authority on behalf of PHS to 'A-' from 'A'.
The series 2016 bonds are expected to be issued as fixed-rate. Proceeds will be used to current-refund PHS's series 2007 and series 2012B bonds, finance the termination of a swap associated with the 2012B bonds, and pay for costs of issuance. Pro forma maximum annual debt service (MADS) is expected to decrease to $7.5 million from $8.9 million primarily due to the extended amortization of the refunding bonds.
Bond payments are secured by a pledge of gross revenues of the obligated group and by a first-lien mortgage on Pocono Medical Center. There will not be a debt service reserve fund associated with the series 2016 bonds.
KEY RATING DRIVERS
DECREASED PROFITABILITY: The downgrade reflects PHS's lower operating profitability, with operating margin decreasing to 0.6% in fiscal 2016 from 3.1% in fiscal 2015. The decrease primarily reflects PHS's loss of its sole-community provider (SCP) status in 2015 and the related decrease in incremental operating revenues in fiscal 2016.
AFFILIATION WITH LEHIGH VALLEY: The Rating Watch Evolving reflects the pending merger between PHS and Lehigh Valley Health Network (LVHN). Fitch does not rate LVHN and therefore cannot currently assess the rating impact of the pending merger.
ADEQUATE DEBT SERVICE COVERAGE: PHS's debt burden is moderate with pro forma MADS equal to 2.4% of fiscal 2016 revenues. However, pro forma MADS coverage decreased to 3.4x in fiscal 2016 from 4.4x in fiscal 2015 due to the compressed profitability, comparing unfavorably to Fitch's 'A' category median of 4.5x.
SOLID LIQUIDITY: PHS's liquidity metrics remain solid for the category with 200.9 days cash on hand (DCOH), 21.5x pro forma cushion ratio and 144.2% cash-to-pro forma debt (net of premium), compared to Fitch's 'A' category medians of 215.5 days, 19.4x and 148.6%, respectively. Liquidity declined slightly from 2015 levels due to increased capital spending, unrealized losses, and one-time affiliation expenses.
STABILIZED OPERATING PROFITABILITY: Fitch expects Pocono Health System's operating profitability to stabilize at levels similar to fiscal 2016 performance over the medium- to longer-term. Large negative deviations from current performance could lead to negative rating action.
SUCCESSFUL COMPLETION OF MERGER: Fitch expects Pocono Health System to successfully complete its proposed merger with LVHN in 2017. The full impact of the merger will be assessed upon completion.
PHS operates a 239 licensed-bed acute care community hospital located in East Stroudsburg, PA, approximately 85 miles from Philadelphia and 75 miles from New York City. Additional operations include a cancer center, a community health center, and four immediate care centers. Total revenues equaled $310.9 million in fiscal 2016.
The downgrade to 'A-' is driven primarily by a decline in PHS's operating performance in fiscal 2016. Operating margin decreased to 0.6% in fiscal 2016 from 3.1% in fiscal 2015 and is light compared to Fitch's 'A' median of 3.8%. The thin operating performance is attributed to PHS's loss of its SCP status in 2015 which resulted in approximately $13 million decrease in operating revenue. The loss of revenue was partially mitigated by PHS's reclassification into a different MSA with a higher Medicare wage index, which resulted in a net negative impact on operating revenue of approximately $8 million.
PHS's fiscal 2017 budget anticipates a negative 2.6% operating margin, driven mostly by expected drops in volume associated with the opening of an 72-bed St. Luke's facility about six miles away from PHS's main campus. However, management reports that PHS's volumes improved significantly in the second half of fiscal 2016, after the budget was established. In addition, according to management, St. Luke's is facing bigger than initially anticipated challenges in recruiting physicians, and was not able to attain a Trauma designation in its emergency departments, which should mitigate some of the declining volume assumptions in the budget. The budget does not incorporate any incremental benefits from the LVHN affiliation.
PHS had approximately $4.8 million in one-time non-operating expenses in fiscal 2016, including a $2.7 million pension settlement and $2.1 million in affiliation expenses. Fitch's calculations have been adjusted to exclude the one-time expenses. PHS's defined benefit pension plan has been frozen since 2014 and with the pension settlement the plan is currently 98% funded, which Fitch views favorably.
AFFILIATION WITH LEHIGH VALLEY
PHS and LVHN entered into a definitive agreement on Dec. 11, 2015 to merge and the full merger is expected to be completed in the near term. It is expected that PHS will join the LVHN obligated group upon completion of the affiliation and PHS's outstanding bonds are expected to be refunded, defeased, or have their security substituted under the LVHN master trust indenture (MTI). In addition, the affiliation agreement calls for capital improvements at the PHS facilities over a 10-year period, with at least half being funded by LVHN.
LVHN is a large-scale provider with a significant physician group, which should benefit PHS in achieving operating efficiencies and strengthening its physician recruitment efforts. However, Fitch does not rate LVHN and therefore cannot assess the full impact of the merger at this time.
PHS's $161.3 million in unrestricted liquidity at June 30, 2016 equated to a solid 200.9 DCOH, 21.5x pro forma cushion ratio and 144.2% cash-to-pro forma debt (net of premium), compared to Fitch's 'A' category medians of 215.5 days, 19.4x and 148.6%, respectively. Fitch notes that unrestricted liquidity declined from $175.6 million at June 30, 2015, due largely to increased capital spending, unrealized losses, and one-time affiliation expenses. PHS is budgeting for a further decline in liquidity in fiscal 2017, due to the budgeted operating loss for the year.
ADEQUATE DEBT SERVICE COVERAGE
Despite a moderate pro forma debt burden, with pro forma MADS decreasing to 2.4% of fiscal 2016 revenue from approximately 2.9%, MADS coverage was only adequate in fiscal 2016. MADS coverage decreased to 3.4x in fiscal 2016 from 4.4x in fiscal 2015, comparing unfavorably to Fitch's 'A' category median of 4.5x. Based upon PHS's MTI covenant calculation, the system produced 1.9x coverage on an obligated group basis, in fiscal 2016, based on the $8.9 million MADS figure and including the one-time expenses.
Post-issuance, PHS will have approximately $112 million of total debt outstanding (net of premium) and one fixed-payor swap. PHS's pro forma debt composition will consist of 81% fixed-rate, 13% synthetically fixed-rate, and 6% floating-rate debt. The swap has no collateral posting requirements.
PHS covenants to provide annual and quarterly disclosure. Disclosure is provided on the Municipal Securities Rulemaking Board'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
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