Fitch Affirms Dartmouth Hitchcock (NH) Rev Bonds at 'A '; Outlook Stable
The Rating Outlook is Stable.
SECURITY
Debt payments are secured by a pledge of the gross revenues of the obligated group (OG). The DH OG includes Mary Hitchcock Memorial Hospital and Dartmouth Hitchcock Clinic. Historically, there were two other members of the OG - Central Vermont Medical Center, which withdrew from the OG as of Nov. 1, 2011 and Cooley Dickinson Hospital, which withdrew from the OG as of October 1, 2013. The OG accounted for 94% of total assets and 96% of total revenue of the consolidated entity (Dartmouth Hitchcock Health and Subsidiaries (DH)) in fiscal 2014 (June 30 year end). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
STRONG MARKET PRESENCE: DH provides high acuity care to an extensive geographic area through its flagship academic medical center (Mary Hitchcock Memorial Hospital) and its physician clinic (Dartmouth Hitchcock Clinic). DH has a close relationship with the Geisel School of Medicine at Dartmouth College (Fitch rated 'AAA'; Stable Outlook) to further its mission in education and research. DH is the largest provider of healthcare services in the state of NH and the second largest provider of healthcare services in the state of VT. DH has been growing its system and added two community hospitals since Fitch's last review in February 2013. DH continues to pursue additional affiliations to grow its regional footprint.
NATIONAL LEADER IN FOCUS ON VALUE AND QUALITY: DH has consistently been a top performer in quality and efficiency with a lower Medicare spending rate compared to the nation. DH's strategic focus is on population health management and transforming payment models to a more value based system. There are additional collaborations with other providers and payers on various initiatives such as ElevateHealth, which is a narrow network product.
MODEST FINANCIAL PROFILE FOR RATING LEVEL: DH's financial ratios are adequate especially with the improved operating performance over the last two years. Fitch weighs DH's qualitative factors heavily as we believe the organization is a leader in its approach to healthcare delivery and believes that DH's goals position the organization well in a value based reimbursement environment.
IMPROVED PROFITABILITY: DH has a targeted goal of a 4% operating margin (for the OG) while continuing to reduce costs in line with Medicare rates, which Fitch believes will be challenging to achieve. Although these targets have not been met, operating performance has improved over the last two years. A positive development is the resolution of lawsuits against the state of New Hampshire regarding the Medicaid Enhancement Tax (MET). The MET, along with the elimination of disproportionate share funding (DSH) to non-critical access hospitals in the state since July 2011 had a negative impact to DH of approximately \$40 million a year. With the resolution of the lawsuits, this funding is expected to be reinstated in fiscal 2016.
AGGRESSIVE DEBT PROFILE: Approximately 65% of the obligated group's debt is exposed to put/bank renewal risk. These dates are staggered and DH is building an internal sinking fund (included in unrestricted cash and investments) for one of the loans with \$128 million due in 2019. DH does not have any major capital needs or additional debt plans. There may be a refinancing issue sometime in 2015.
PENSION LIABILITY ADDRESSED: In July 2012, DH used proceeds from a \$150 million bank loan to fund its defined benefit (DB) plan. To date, the pension financing strategy has been successful and the plan is now 89% funded. Part of the strategy included settling approximately \$320 million of its term vested and retiree participants' pension liabilities from 2013 to 2019 and over \$140 million has been settled. The pension plan assets are invested in a liability driven investing strategy, which helped mitigate a drop in the discount rate in fiscal 2014. Management will continue to fund the pension plan above ERISA requirements and expects ongoing funding to be approximately \$40 million a year. DH will hard freeze the DB plan at the end of 2017.
RATING SENSITIVITIES
CONTINUED FOCUS ON IMPROVED PROFITABILITY: Fitch views management's goals of achieving continued improved profitability favorably and a reversal in this trend could lead to negative rating pressure.
CREDIT PROFILE
DH is the state's only academic medical center, Level I trauma center and NCI designated comprehensive cancer center. DH had total revenue of \$1.4 billion in fiscal 2014. The consolidated results include New London Hospital (NLH; 25 beds) as of October 1, 2013 and will include Mt. Ascutney Hospital (25 beds), which affiliated with DH as of July 1, 2014. DH has reached an affiliation agreement with Cheshire Medical Center that is expected to close in early March 2015 and DH is in affiliation discussions with Alice Peck Day Memorial Hospital.
National Leader in Focus on Value and Quality
DH has consistently demonstrated lower utilization rates in imaging and surgeries compared to national averages, lower Medicare spending compared to national averages, and has been ranked highly by UHC regarding efficiency, which focuses on per case cost performance and length of stay. DH founded the High Value Healthcare Collaborative, which shares data on value based care models across the nation with at least 17 other providers.
The organization is focused on population health management and shifting payment models to be value based versus volume based. DH has been growing its regional footprint and adding community hospitals, which should help decant the main facility, which is at capacity. Other collaborations are in progress to create a wider network that can leverage support services such as information technology and management is interested in managing lives across NH, VT and ME. DH has 236,396 at risk lives in fiscal 2015, which has increased from 68,547 in fiscal 2010.
Improved Operating Performance
DH's operating performance has improved over the last two years with a 2% operating margin in fiscal 2014 and 2.7% in fiscal 2013 compared to the A category median of 2.5%. Although DH has missed its budget the last two years, Fitch believes the improved operating trend from much weaker performance in prior years favorably. In addition, DH has had to absorb the elimination of DSH funding from the state.
Historically, the state funded its DSH program through a MET on providers and DH had a MET expense of approximately \$40 million a year and would receive DSH funding of approximately \$40 million a year. As of July 1, 2011, the state continued to collect the MET with no offsetting revenue. There was a lawsuit filed against the state and the state has to reinstate the DSH funding.
Operating performance is behind budget for the first three months ended Sept. 30, 2014 due to higher labor expense than expected. Management expects to achieve a 3.4% operating margin (internal calculation - includes some investment income in operating revenue) by year end due to various cost savings and additional bed capacity that was previously taken off line for renovations.
Improved Liquidity
Total unrestricted cash and investments was \$547.8 million (OG only) as of Sept. 30, 2014, which equated to 154.2 days cash on hand and 102.2% cash to debt, which improved from the same prior year period with 152.8 days cash on hand and 92.2% cash to debt but still below the A category medians of 199.2 and 131.2%, respectively. Management projects cash to grow over the next five years with manageable capital needs of approximately \$84 million a year from fiscal 2015-2019 in addition to pension funding of \$40 million a year over the same time period.
DH is building an internal sinking fund and has \$20 million designated in unrestricted cash and investments, which will grow over the next five years to prepare for the \$128 million loan due in 2019. However, the board has given management flexibility to use the funds for another purpose if the loan is refinanced/extended by 2019.
Aggressive Debt Profile
DH's total outstanding debt was \$565 million as of June 30, 2014. Of this amount, \$18 million is NLH's debt, which remains separately obligated. Of the DH OG debt, only 17% is variable rate, however, 65% is exposed to put/bank renewal risk. The puts are \$79 million in 2018, \$128 million in 2019 and \$102 million in 2022. Fitch believes DH's access to capital and liquidity position somewhat mitigates this risk. DH recently refinanced the callable portion of its series 2009 bonds (approximately \$40 million) with two direct bank loans that do not have any additional covenants than what is in the master trust indenture (MTI) and the loan maturity matches the bond maturity. DH has one floating to fixed rate swap outstanding that does not have any collateral posting requirements.
Fitch used MADS of \$33.5 million, which includes the debt of the non-obligated entities. The DH OG MADS is \$31.5 million and the balloon indebtedness is amortized over 20 years for debt service calculation purposes under its MTI. Debt service coverage has improved significantly with improved profitability and was 3.6x in fiscal 2014 compared to 4.1x in fiscal 2013 and the A category median of 3.8x. Debt service coverage is weak in the first three months ended Sept. 30, 2014, which Fitch expects to improve by end of fiscal year 2015. Debt service coverage (OG only) was 2.5x compared to the same prior year period with 3.7x.
Disclosure
DH covenants to provide annual and quarterly financial statements to bondholders through the MSRB's EMMA system.
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