Fitch Rates Catholic Health System's (NY) Revs 'BBB ' & Affirms Outstanding; Outlook Stable
--\$95,720,000 Buffalo and Erie County Industrial Land Development Corporation Obligated Group revenue bonds (Catholic Health System, Inc. projects), series 2015.
The series 2015 bonds are expected to be issued as fixed rate debt. Proceeds will be used for the acquisition of a 140,000 square foot administrative building, adjacent parking ramp, and related land; various capital projects at Mercy Hospital of Buffalo (MHB), Sisters of Charity Hospital of Buffalo (SCHB), and Kenmore Mercy Hospital (KMH); system information technology improvements; refinancing project loans, and funding a debt service reserve fund. The series 2015 bonds are expected to price the week of April 13.
Simultaneously, Fitch affirms its 'BBB+' rating on outstanding system bonds listed at the end of this press release.
The Rating Outlook is Stable.
SECURITY
The current offering and series 2012A&B, 2008 and 2006 bonds are secured by a pledge of gross receipts, mortgage, and a debt service reserve fund. Additionally, the series 2008 and 2006 bonds are supported by their respective HSBC Bank (rated 'AA-/F1+'; Outlook Stable by Fitch) letters of credit (LOCs). The series 2007 bonds are supported by first mortgage liens on all property acquired by Our Lady Renaissance (OLV), all unrestricted accounts receivable, and an LOC from HSBC Bank.
KEY RATING DRIVERS
STRONG SYSTEM PERFORMANCE: CHS' performance has continued to strengthen over the past four years primarily due to the organization's continued focus on service line expansion, population health initiatives, efficiency improvements, and successful physician alignment strategy. The system reported a 4.3% operating margin and 9.5% operating EBITDA margin in 2014, well in excess of Fitch's 'BBB' category medians of 1.1% and 7.9%, respectively.
SOLID MARKET POSITION; FOOTPRINT GROWTH: CHS holds the leading market position in Buffalo, NY with a 45.6% market share in 2013, up from 43% in 2011. CHS' main competitor is Kaleida Health (KH), had a 38.3% share in 2013. Fitch views favorably the system's continued strategic growth into adjacent counties, and believes that its soon-to-be-completed acquisition of Mount St. Mary's Hospital (MSM) will be accretive for CHS.
ABILITY TO ABSORB ADDITIONAL DEBT: Fitch believes that CHS' increase in leverage will be easily absorbed, as indicated by adequate pro forma maximum annual debt service (MADS) coverage indicators. On a pro forma historical basis, EBITDA coverage of MADS in 2014 was in line with the category median at 2.7x. MADS as a percentage of total revenue was in line with 'BBB' category medians at 3.6%.
BALANCE SHEET GROWTH: CHS has grown its balance sheet over the past four years demonstrated by absolute unrestricted cash growth of 49.5% (\$228 million to \$341 million in 2014). Specifically, CHS had 143 days cash on hand (DCOH), cushion ratio of 10x, and cash to debt ratio 167%. On a pro forma basis, their balance sheet is comparable.
RATING SENSITIVITIES
BALANCE SHEET GROWTH: Fitch expects that the system should experience improved liquidity metrics in the long term given manageable capital plans and sustained operating cash flow. Positive rating momentum may result from material balance sheet growth.
UNEXPECTED NEGATIVE PERFORMANCE: Negative pressure may result from unexpected underperformance in cash flow or deterioration in liquidity.
CREDIT PROFILE
CHS is a large healthcare delivery system headquartered in Buffalo, NY. Maintaining a top-tier market position, CHS had total revenue of \$953 million in 2014. As a Catholic provider, CHS has close co-sponsor relationships with Trinity Health (Trinity; revenue bonds rated 'AA'; Outlook Stable by Fitch) and Ascension Health (revenue bonds rated 'AA+'; Outlook Stable by Fitch). CHS covenants to disclose annual audited financial statements and quarterly information to the MSRB's EMMA system. Obligated group assets and revenues were 89.5% and 92% of the consolidated entity in 2014, respectively.
NEW ISSUE DETAILS
The series 2015 bonds are expected to be issued as fixed rate debt. In tandem with a \$6.5 million equity contribution, proceeds will be used for the acquisition of a 140,000 square foot administrative building, adjacent parking ramp, and related land which CHS occupied currently under a capital lease and for which CHS has a purchase option. Additionally, proceeds will fund strategic investments: the construction of a cardiac pre- and post-operation procedure unit at MHB, augmenting a service line which has seen strong growth since 2011; a 16,000 square foot expansion to ambulatory surgery at SOCH; renovation of labor and delivery areas at MHB; and renovation of five and the addition of new operating rooms at KMH. The borrowing also funds an enterprise resource planning system, electrical modifications at MHB, various costs of issuance, refunding of temporary project financing, and funds a debt service reserve.
Fitch used pro forma MADS of \$34 million as provided by management and the underwriter which includes capital leases. MADS occurs in 2017 declines thereafter, which Fitch believes affords the system a degree of forward flexibility for borrowing.
CONTINUED OPERATIONAL GROWTH
CHS' performance has grown over the past four years, with the system reporting a 4.3% operating margin a 9.5% operating EBITDA margin in 2014, both favorable to Fitch's 'BBB' category medians. Continued strong year-over-year growth since 2011 has occurred despite declines in acute adult patient days and outpatient/clinic visits. Additional operational improvements have resulted from efficiency gains and disease-specific and shared savings measures cost-containment measures.
CHS budgeted a 3% operating margin for 2015, which Fitch thinks is reasonable given good volume at the beginning of the year and management's focus on efficiency through process improvements, continued productivity gains, and CHS' investment in an enterprise-wise resource planning system. CHS' close alignment with Catholic Medical Partners, an independent physician group with approximately 1,000 physicians in the region, remains a positive credit factor and Fitch believes that this relationship should continue to help drive strong operations.
The system has a somewhat unfavorable payor mix, with government payors constituting 64.2% of gross revenues but a more moderate 52.6% of net revenues. Fitch recognizes the risk of having a high base of governmental payors can expose the organization to reimbursement pressure at the state and federal level.
LEADERSHIP IN A COMPETITIVE MARKET
CHS remains market leader in Erie County, reporting 45.6% market share in Erie County in 2013, up from 43% in 2011. CHS' closest competitor, Kaelida Health, has simultaneously declined marginally to 38.3% in 2013 from 40.4% in 2011. Such growth reflects management's effective practices to expand key service lines and geographic footprint, while strengthening physician relationships in the broader service area. Fitch considers the Erie County market to be competitive, with a shrinking population and below-average wealth and income indicators.
SYSTEM HANDILY ABSORBS ADDITIONAL LEVERAGE
Fitch believes the system will be able to absorb the series 2015 additional debt. On a pro forma historical basis, EBITDA coverage of pro forma MADS in 2014 was in line with the category median at 2.7x and has grown from 1.9x in 2011. MADS as a percentage of 2014 total revenues equated to 3.6%, which is in line with 'BBB' category medians at 3.6%. However, one notable credit weakness is the increase in the system's debt to capitalization ratio of 64% on a pro forma basis, which compares unfavorably to Fitch's 'BBB' category median of 36.3%. This ratio is influenced materially by the system's sizable pension liability, which increased in 2014.
Future debt plans appear limited. CHS has consistently invested in its physical plant, highlighted by consistent above-average capital expenditures to depreciation. Further, debt is somewhat front-loaded, which affords some flexibility in future borrowing, although unexpected.
MODERATE DEBT PROFILE; UNDERFUNDED PENSION
CHS' debt profile will be approximately 63% fixed-rate, 12% synthetically fixed rate, and 25% variable-rate. The system has two outstanding cash-flow hedging swaps with HSBC Bank. As of Feb. 27, 2015, the aggregate notional amount of swaps outstanding was \$30.9 million with a negative mark-to-market valuation of \$6.3 million. However, CHS is not required to post collateral related to its swaps.
Fitch views with some concern the system's underfunded pension (54%), which does not operate under federal ERISA funding requirements. Management closed the DB plan to new participants in 2002 and, based on current projection models and current funding policy, management projects to have the plan's pension benefit obligation (PBO) funded status to 81% by fiscal 2023.
STRATEGIC ACQUISITIONS & DIVESTITURES
CHS is expanding the system's footprint into the Niagara County market with the acquisition of MSM, a 175-bed community hospital reporting over 5,000 discharges in 2014. CHS market share in the county has increased to 9.2% in 2013 from 7.6% in 2011, a trend which Fitch expects to continue with the system's acquisition of MSM. CHS expects to complete the acquisition by July 1, 2015 and does not expect to incorporate MSM into the obligated group in the near term. Management reports that the acquisition's plant will not require significant capital needs, which Fitch views positively.
Fitch views as a credit positive CHS' divestiture of two of its elder care facilities, St Francis and St Elizabeth, which management reports will mitigate associated losses. Management expects both sales will be closed by end of 2015.
OUTSTANDING RATED DEBT
Fitch's affirmation of outstanding system debt affects the following bonds issued through the Dormitory Authority of the State of New York and Erie County Industrial Development Agency:
--\$16.6 million, series 2012A&B;
--\$21.6 million, series 2008;
--\$10.1 million, series 2007A&B;
--\$43.1 million, series 2006.
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