CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'AA-' rating assigned to approximately $820 million of bonds issued on behalf of Allina Health System (Allina, or the system). The rating affirmation affects the bonds listed at the end of this press release.
The Rating Outlook is Stable.
Bondholders have a security interest in pledged revenues and a negative lien pledge on property of the obligated group (OG). The OG includes Allina's owned hospitals and other subsidiaries and accounts for virtually all of the consolidated system's revenue. Fitch's analysis is based on the consolidated Allina Health System.
KEY RATING DRIVERS
LARGE, COMPREHENSIVE DELIVERY MODEL: Allina is a large and diversified health system and maintains a leading 31% market share in the broad Twin Cities metropolitan service area. Fitch believes Allina is well positioned for a dynamic healthcare environment with a focus of improving total cost of care and quality.
PROTRACTED STRIKE RECENTLY ENDED: Allina's nurses engaged in a seven-day strike in June 2016 and an open-ended strike beginning Sept. 5, 2016. Nurses ratified a contract on Oct. 13, 2016 and returned to work Oct. 16. Management estimates the cost of the strikes approached $105 million through Sept. 30, 2016. Including strike expenses, Allina recorded a negative 0.5% operating margin through unaudited nine-months fiscal 2016.
CORE OPERATING RESULTS REMAIN SOUND: Excluding strike expenses from operating results, Allina's operating margins remain sound. Through nine-months fiscal 2016, adjusted operating margin measures 3.1% and operating EBITDA margin 8.3%. Allina's volumes have held steady in interim fiscal 2016 despite the strike.
TRANSFORMATIONAL STRATEGIC INITIATIVES: Allina has committed to redesigning patient care, implementing several care models, and continues to phase risk into its managed care contracts. While these investments are expected to improve outcomes and total cost of care, to date these initiatives have pressured Allina's operating margins, with benefits expected over a longer-term horizon.
LIGHT DEBT BURDEN LEADS TO GOOD DEBT COVERAGE: Allina's debt load is light, as maximum annual debt service (MADS) as a percentage of total revenue measures 1.6%. The system's debt coverage ratios are favorable, as MADS coverage from EBITDA is 6.6x (based on nine-months fiscal 2016, excluding strike costs).
GENERALLY FAVORABLE LIQUIDITY: Allina's liquidity ratios are generally good. At Sept. 30, 2016, cash-to-debt measured nearly 220% and cushion ratio 30% (both in-line with or better than 'AA' medians), although cash on hand measured 192 days (which lags medians).
STABLE OPERATING PERFORMANCE: Now that the nurse strike is resolved, Fitch believes Allina Health System will continue to benefit from its comprehensive delivery model and leading market share to generate stable and adequate operating margins resulting in sustained strong debt coverage.
Allina is a comprehensive delivery system consisting of 13 hospitals, including tertiary referral hospitals in Minneapolis and St. Paul, nearly 1,400 employed physicians, and dozens of clinics throughout the Twin Cities metropolitan area and eastern Minnesota. Total operating revenue in fiscal 2015 (Dec. 31 fiscal year-end) approached $3.8 billion. There was a planned CEO transition in January 2015. Also, the current CFO is leaving Allina effective Dec. 31, 2016 and will be replaced by the SVP who has CFO experience at other healthcare organizations across the U.S.
LARGE, COMPREHENSIVE DELIVERY MODEL WITH LEADING MARKET SHARE
Allina is a large and diversified health system with a comprehensive delivery model and geographic reach. The system includes 13 acute care hospitals throughout eastern Minnesota, including tertiary referral hospitals in Minneapolis (Abbott Northwestern Hospital) and St. Paul (United Hospital). Allina employs nearly 1,400 physicians and operates dozes of clinics in the area. Fitch believes Allina is well positioned for a dynamic healthcare environment as the system has capitalized on information technology investments with a focus of improving total cost of care and quality.
Allina maintains a distinctly leading 31% inpatient market share of the broad and economically favorable Twin Cities metropolitan service area. The area is competitive; competing health systems include Fairview Health Services (approximately 20% market share), HealthPartners (approximately 16% share), HealthEast (10% share), and North Memorial Health Care (9% share, inclusive of Maple Grove).
Allina Health System has a joint venture for pediatric care with Children's Hospitals and Clinics of Minnesota (rated 'AA') known as the Mother Baby Centers. The Mother Baby Centers are co-located with Allina perinatal programs.
PROTRACTED STRIKE RECENTLY ENDED
Like most area hospital systems, Allina's nurses are represented by the Minnesota Nurses Association (MNA). Allina's nurses engaged in a seven-day strike in June 2016 and an open-ended strike that began Sept. 5, 2016. The nurses ratified a new contract on Oct. 13 that expires in May 2019. Nurses returned to work Oct. 16. Management estimates that the cost of the strikes approached $105 million through nine-months fiscal 2016 as of Sept. 30, 2016 (additional expenses are expected in the fourth quarter, since the strike ended in October). If strike expenses are included as an operating expense, Allina's operating margins in interim fiscal 2016 are thin; through nine-months unaudited fiscal 2016, the operating margin measures negative 0.5% and operating EBITDA margin measures 4.7%.
CORE OPERATING RESULTS REMAIN SOUND
Excluding strike expenses from operating results, Allina's operating margins remain sound. Through nine-months fiscal 2016, Allina's adjusted operating margin measures 3.1% and operating EBITDA margin 8.3%, in line with the same period of fiscal 2015 (3.7% and 8.4%, respectively). Allina's volumes have held steady in interim fiscal 2016 despite the strike. Through nine-months fiscal 2016, inpatient admissions decreased a modest 0.1% (total hospital stays including admissions and observation cases increased 0.5%), inpatient surgeries increased 1.5%, and total outpatient visits increased 2.3%.
Allina's operating margins have been very stable, as its operating EBITDA margin ranged between 8.7% and 8.8% between fiscal 2012 and fiscal 2015. While stable, the operating EBITDA margin lags the 'AA' median of 11.7%, reflective of the system's investments in total cost of care and quality initiatives. Long-term, management expects Allina to sustain an operating margin of around 3%.
TRANSFORMATIONAL STRATEGIC INITIATIVES
Allina has been focused on maximizing its market position and delivery network in the changing reimbursement environment. These efforts include investing in changing the delivery of care with the goal of providing quality care and improving total cost of care. Patient care redesign and care management initiatives include the development of care teams and use of predictive modeling to prevent adverse outcomes and high cost utilization. While Fitch believes these strategies will benefit the system as the market transitions to a more value-based reimbursement environment and these investments are expected to improve outcomes and total cost of care, to date they have pressured Allina's operating margins.
LIGHT DEBT BURDEN LEADS TO GOOD DEBT COVERAGE
Allina's debt load is very manageable within its scope of operations. MADS as a percentage of total revenue measured 1.7% in fiscal 2015 and 1.6% based on nine-months fiscal 2016 annualized ('AA' median is 2.2%). Consequently, Allina's debt coverage ratios are favorable, despite somewhat modest operating margins. MADS coverage from EBITDA measured 6.1x in fiscal 2015 and 6.6x through nine-months fiscal 2016 (excluding strike expenses) ('AA' median is 6.0x). Debt-to-EBITDA measured 2.3x in fiscal 2015 and 2.1x in interim fiscal 2016 ('AA' median is 2.5x).
Approximately 37% of Allina's debt is variable-rate. The majority of variable-rate debt is variable rate demand bonds (VRDBs) supported by letters of credit (LOCs) from JPMorgan and Wells Fargo, which expire January 2018. Allina also still has two small series of auction-rate securities.
Financial covenants in Allina's bond documents include minimum MADS coverage of 1.0x, minimum cash on hand of 55 days, and maximum debt-to-capitalization of 60%.
Allina has five fixed payor swaps, with a total notional amount of $350 million (more than Allina's variable-rate debt outstanding). Counterparties are well diversified among four providers: Wells Fargo, JPMorgan, US Bank, and Goldman Sachs. At Sept. 30, 2016, the net termination value of the swaps was a negative $118 million to Allina and the system posted $15.5 million of collateral.
Allina has two small defined benefit pension plans directly under its control (one of which was frozen in 2009). At fiscal year-end 2015, the pension plans were 82% funded compared to a projected benefit obligation (PBO) of $43.5 million. The bigger pension issue is Allina's participation in the Twin City Hospitals MNA defined benefit pension plan. Allina's flexibility to make changes to the defined benefit pension plan is limited given that it is a multi-employer plan.
GENERALLY FAVORABLE LIQUIDITY RATIOS
Allina's liquidity ratios are generally good. At Sept. 30, 2016, cash-to-debt measured a favorable 219% ('AA' median is 198%) and the cushion ratio measured a good 30% (in line with the 'AA' median of 30%). While cash on hand measured an adequate 192 days, the ratio lags the 'AA' median of 277 days. Allina's investment portfolio is diversified with assets among multiple investment categories. Investments are allocated relatively conservatively and its portfolio is liquid, with cash and fixed income representing over 50% of unrestricted cash and investments. Also, Allina divested of its fund-of-funds equity hedge funds (the system continues to use direct multi-strategy equity hedge funds that represent less than 4% of the portfolio).
Allina's management reduced capital spending in the second half of fiscal 2016 as the system managed through the nurses' strike. Fitch expects Allina's capital spending will be manageable in the coming years and its average age of plant was a palatable 12.5 years at fiscal year-end 2015. Key current projects include completing a new OB unit at United Hospital in St. Paul, information technology, outpatient development, and the system is contemplating an upgrade of the east tower at Abbott Northwestern in Minneapolis. Management may consider refunding or other debt opportunities in the next two years, depending on market conditions.
Allina covenants to disclose annual and quarterly financial information to bondholders. Fitch notes that Allina's disclosure is one of the best in its rated portfolio because of the quality of the information provided. All of Allina's disclosure documents are posted on EMMA. Quarterly and annual financial information consists of a balance sheet, income statement, and statement of cash flows and is supplemented by a management discussion and analysis plus updated market share information, utilization statistics, debt and investment summaries and general organizational information.
--$250,000,000 taxable fixed-rate revenue bonds, series 2015 bonds;
--$50,000,000 Minneapolis & St. Paul Housing & Redevelopment Authority VRDBs, series 2009C*;
--$114,525,000 Minneapolis & St. Paul Housing & Redevelopment Authority VRDBs, series 2009 B-1 & B-2*;
--$173,415,000 Minneapolis & St. Paul Housing & Redevelopment Authority fixed-rate revenue bonds, series 2009 A-1& A-2;
--$120,500,000 Minneapolis & St. Paul Housing & Redevelopment Authority VRDBs, series 2007C-1&C-2*;
--$97,030,000 Minneapolis fixed-rate revenue bonds, series 2007A (insured by MBIA);
--$14,575,000 Minneapolis auction-rate bonds, series 1998A.
*Supported by LOCs from Wells Fargo Bank, N.A. (series 2009C and series 2007C-1&C-2) and JPMorgan Chase Bank, N.A.
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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