Fitch Rates Texas Children's Series 2015 Rev Bonds 'AA'; Stable Outlook
The Rating Outlook is Stable.
The series 2015 bonds will be structured as approximately \$194 million series 2015-1 fixed rate bonds; \$50 million series 2015-2 Windows VRDBs; \$50 million series 2015-3 floating rate notes (FRNs), \$60 million series 2015-4 FRNs and \$100 million direct bank loan (not rated). Proceeds will be used to fund approximately \$350 million of capital expenditures and refund the series 1999B-1 bonds. The fixed rate bonds are expected to price the week of May 11 and the Windows VRDBs and FRNs are expected to price the week of May 25. The 'F1+' short term rating on the Windows VRDBs reflects Texas Children's credit quality, market access and liquidity position in addition to the length of time available (seven months) to remarket any bonds that are put.
SECURITY
The bonds are a general and unsecured obligation, which is considered weak but expected for the rating level.
KEY RATING DRIVERS
LARGE INTEGRATED PEDIATRIC PROVIDER: Texas Children's is the largest freestanding children's hospital in the country and has significantly grown its revenue base through an ambitious capital plan (Vision 2010) that added capacity, invested in research, and expanded into women's services. The organization has broadened its geographic footprint and developed an additional campus (West campus) and outpatient facilities (clinics, urgent care, medical homes) in the greater Houston market. Texas Children's has an aligned medical staff, which is primarily the pediatric and Ob/Gyn faculty at Baylor College of Medicine (BCOM), in addition to its own employed medical group of almost 250 pediatricians and 18 obstetricians (plus six midwives and two nurse practitioners). Based on the Medicaid and CHIP managed care program, Texas Children's health plan has the third largest membership. The health plan covers approximately 380,000 lives.
CONTINUED CAPITAL EXPANSION: Texas Children's successfully completed its Vision 2010 capital plan in 2012 with a total of \$1.45 billion spent from fiscal 2007-2012 on the Pavilion for Women; West Campus (inpatient and outpatient capacity); and research facilities. All of the projects are performing in line with original expectations. Despite the added capacity, strong demand has necessitated additional capital spending. Texas Children's is now embarking on a \$1.65 billion capital plan from fiscal 2015-2019 that includes a 19-story special care tower (above Pavilion for Women), additional satellite campus (Woodlands) and renovation and expansion of existing space on the main campus in addition to routine capital expenditures. The sources of funding include \$350 million from the series 2015 bonds, \$147 million from philanthropy, and \$1.153 billion from cash.
SOLID OPERATING PERFORMANCE: After weaker operating performance in fiscal 2012 due to the initial expenses of the added capacity, operating performance rebounded in fiscal 2013 and 2014 and improved to a 5.3% operating margin through the five months ended Feb. 28, 2015. Strong profitability has been driven mainly by good volume growth and improving payor mix.
STRONG BALANCE SHEET: Texas Children's balance sheet is strong with \$2.15 billion in unrestricted cash and investments at Feb. 28, 2015 which translated to 310.6 days cash on hand and 222.7% pro forma cash to debt. With the substantial funding of its capital plan through cash, liquidity is expected to dip in fiscal 2016 and 2017 but then increase in fiscal 2018 and 2019.
MODERATE DEBT BURDEN: Despite the additional debt issuance, Texas Children's debt burden is moderate with MADS accounting for 2.3% of total revenue compared to the 'AA' category of 2.6%. MADS coverage is very strong through the five months ended Feb. 28, 2015 at 12.5x due to higher than normal realized gains.
HIGH EXPOSURE TO MEDICAID: Not unlike other children's hospitals, Texas Children's is highly exposed to Medicaid reimbursement which accounted for over 50% gross revenues. However, the payor mix has improved with an increase in commercial payors due to its expansion into women's services and West campus.
RATING SENSITIVITES
EXECUTION OF CAPITAL PLAN: Fitch expects Texas Children's to successfully execute this next phase of significant spend due to its track record and maintain a financial profile consistent for its rating level.
CREDIT PROFILE
Located in Houston in the Texas Medical Center, Texas Children's operates a 650-bed tertiary care pediatric facility. Fitch's analysis is based on the consolidated entity, which includes the hospital, Texas Children's Health Plan, TCH Foundation, TCH Insurance Company, Texas Children's Pediatrics, Texas Children's Physician Group, and Texas Children's Women's Specialists. Total operating revenue in fiscal 2014 (Sept. 30 year-end) was \$2.5 billion.
Plan of Finance
The series 2015 issue will fund \$350 million of capital expenditures and refund the \$123 million series 1999B-1 bonds. In conjunction with this financing, the series 2008-2 daily VRDBs will be converted to a direct bank loan at an indexed floating rate. The series 2015-3&4 FRNs will also be at an indexed floating rate. Total pro forma debt after this issuance is \$950 million and will consist of 42% underlying fixed rate and 58% underlying variable rate. Texas Children's expects to enter into another fixed payor swap, which would result in a debt mix of 63% fixed rate and 37% variable rate.
Proforma variable rate exposure will all be at an indexed floating rate of either SIFMA or LIBOR. There are two existing direct bank loans (series 2008-1 -BBVA; April 2018 mandatory tender and series 2008-3- Wells Fargo; April 2016 mandatory tender) and the direct bank loan documents include additional covenants not included in the MTI such as a 1.25x debt service coverage and 90 days cash on hand. Texas Children's has one floating to fixed rate swap outstanding for \$100 million notional and as of Feb. 28, 2015, \$7.1 million of collateral was posted.
Integrated Delivery System
Fitch views Texas Children's market position favorably as it is the leading pediatric provider in a growing service area with an aligned medical staff and a health plan that has a large share of the Medicaid HMO market. Fitch believes Texas Children's can utilize this platform to effectively manage the population it serves especially in a reduced reimbursement environment.
TCH's medical staff is comprised of both the BCOM pediatric and Ob/Gyn faculty as well as private physicians. The private physicians include two OB/GYN physician practices (Texas Children's Women's Specialists) that accounted for a large portion of St. Luke's OB/GYN volume. In addition, TCH employs almost 250 primary care pediatricians in 49 clinical sites throughout the service area (Texas Children's Pediatrics). The relationship with BCOM's Department of Pediatrics and Ob/Gyn has been streamlined since 2013 with a new affiliation agreement, which changed the reporting structure of the in chiefs to Texas Children's CEO and increased support for the academic and research mission.
Significant Capital Spending
Vision 2010, a \$1.45 billion capital plan, consisted of four main building projects in addition to investment in information technology (IT) and equipment. The four main building projects included the \$110 million Feigin Center (eight-floor research facility, opened April 2009), \$196 million Jan and Dan Duncan Neurological Research Institute (13 floor research facility, opened November 2010), \$229 million West Campus (48 bed freestanding children's hospital at I-10 and Barker Cypress, inpatient opened March 2011), and \$547 million Pavilion for Women (a 15-floor facility with 90 beds and 16 labor and delivery rooms opened in November 2011). Epic is fully installed and operational as of March 2012 and the total spend was \$96 million. The total capital plan was funded through a combination of debt, philanthropy, and cash, which will be same model for the current capital plan.
The fiscal 2015-2019 capital plan totals \$1.65 billion and includes \$525 million for Care First - a 19 story special care tower that will be added to the Pavilion for Women with 130 ICUs and 29 high acuity ORs, \$340 million for the Woodlands campus (satellite campus located north of Houston, similar to West campus), \$100 to add additional physician office space and parking, and \$610 million for routine capital spending over the five years. Woodlands is expected to be fully open by 2017 and Care First will open in 2018. After the opening of Care First, Texas Children's will move services from the West Tower to Care First and then renovate existing space and expand its emergency department, which will open in late 2020.
The sources of funds include \$350 million from the series 2015 bonds, \$147 million from philanthropy, and \$1.153 billion from cash. A capital campaign is underway with a target of raising \$475 million (\$350 million for capital) and the last capital campaign successfully raised over \$500 million. Funding from cash and cash flow is expected to be \$112 million in fiscal 2015, \$240 million in fiscal 2016, \$448 million in fiscal 2017, \$259 million in fiscal 2018 and \$95 million in fiscal 2019.
Strong Liquidity
One of Texas Children's main credit strengths is its strong liquidity. Cash and investments have exhibited solid growth after the period of heavy capital spending on Vision 2010. Total unrestricted cash and investments were \$2.15 billion at Feb. 28, 2015 compared to \$1.5 billion at FYE 2011. The investment portfolio is liquid with 71% available in under 30 days.
Solid Operating Performance
After weaker performance in fiscal 2012, Texas Children's had a 2.8% operating margin in fiscal 2013, 3.1% operating margin in fiscal 2014 and 5.3% operating margin through the five months ended Feb. 28, 2015. Year to date performance is well exceeding budget due to strong volume growth and improving payor mix. Management expects to maintain operating margins of at least 3%.
Revenue increased 8.4% in fiscal 2014 and of the \$2.5 billion in total revenue, \$1.2 billion was net patient revenue, \$877 million was premium revenue, and \$326 million was physician revenue. There has been solid inpatient growth with discharges increasing 3.7% in fiscal 2014 and very strong outpatient growth with a 13.5% increase in clinic visits. Total surgeries increased by 4.3%.
There is a Medicaid waiver in place from 2012 through 2016 and supplemental Medicaid payments have fluctuated due to the state's lagging administrative timeline. In addition, Texas Children's is not recognizing any disproportionate share payments going forward due to an ongoing lawsuit. Supplemental Medicaid funding (net of expenses) totaled \$42.6 million in fiscal 2010, \$32.5 million in fiscal 2011, \$42.8 million in fiscal 2012, \$34.9 million in fiscal 2013, \$2.1 million in fiscal 2014 and budgeted for \$26.4 million in fiscal 2015.
Manageable Debt Burden
Proforma MADS is \$57.6 million and increased from \$45.9 million. Debt service is fairly level to 2030 then declines to about \$50 million. MADS coverage was very strong through the five months ended Feb. 28, 2015 due to higher than normal realized gains at 12.5x compared to 5.2x in fiscal 2014 and 4.4x in fiscal 2013 and the AA category median of 5.4x.
Disclosure
Fitch notes that Texas Children's disclosure practices are very thorough and timely with annual and quarterly information posted on EMMA.
Outstanding Debt:
--\$64,800,000 Harris County Cultural Education Facilities Finance Corp. (TX) (Texas Children's Hospital Issue) hospital revenue bonds, series 2010;
--\$140,700,000 Harris County Cultural Education Facilities Finance Corp. (TX) (Texas Children's Hospital Issue) hospital revenue bonds, series 2009;
--\$94,900,000 Harris County Health Facilities Development Corp. (TX) (Texas Children's Hospital Issue) hospital revenue bonds, series 2008-2;
--\$123,100,000 Harris County Health Facilities Development Corp. (TX) (Texas Children's Hospital Project) hospital revenue bonds, series 1999B-1 (liquidity facility: JPMorgan Chase Bank, N.A.).
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