Fitch Upgrades Nicklaus Children's Hospital (FL) Revs to 'A '; Outlook Stable
--\\$104.4 million fixed rate bonds, series 2013;
--\\$25.6 million fixed rate bonds, series 2011;
--\\$40.7 million fixed rate bonds, series 2010A;
--\\$63.2 million privately placed indexed floating rate bonds, series 2010B.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a gross revenue pledge and mortgage pledge.
KEY RATING DRIVERS
CONTINUED FINANCIAL STRENGTHENING: The upgrade to 'A+' is supported by solid improvement in financial metrics, driven by robust revenue growth generated by NCH's solid operating platform and expansion strategy. In the fiscal year ended Dec. 31, 2014, nearly all key metrics measuring profitability, liquidity, and debt improved and compared favorably against Fitch's 'A' medians.
LEADER IN PEDIATRIC SERVICES: Strong financial results reflect NCH's position as the leading provider of pediatric medicine within a sizable service area, with particularly strong market share in high acuity service lines. Market share in the primary service area (PSA) has been stable for over a decade at above 40%, more than double that of the leading competitor. NCH is entering into numerous partnerships with other regional providers to expand inpatient and outpatient care, which should further increase patient draw and referrals.
ONGOING CONSTRUCTION PROJECTS: Sizable capital projects are ongoing, including the construction of the Advanced Pediatric Care Pavilion and expansion of the emergency department. The projects are expected to be funded by a combination of existing bond funds, philanthropy, and cash flows without materially affecting liquidity levels.
HIGH MEDICAID EXPOSURE: Not unlike other children's hospital, NCH is highly exposed to changes in Medicaid funding. Medicaid contributed 66% to gross revenues in 2014. Fitch notes that while NCH remains susceptible to Medicaid and related supplemental funding cuts, the organization has not been materially affected in the last decade.
RATING SENSITIVITIES
SUSTAINED FINANCIAL PERFORMANCE EXPECTED: Fitch expects NCH to continue generating solid cash flows to support its capital projects and produce debt service metrics consistent with the higher rating.
CREDIT PROFILE
Effective March 20, 2015, the hospital changed its name to Nicklaus Children's Hospital from Miami Children's Hospital, recognizing a \\$60 million gift received from Nicklaus Children's Health Care Foundation. Located in Miami, Florida, NCH is a pediatric specialty hospital with 289 beds and is the only freestanding children's hospital in South Florida. MCH provides a comprehensive range of specialty and subspecialty services, and is one of two pediatric trauma referral centers in Miami-Dade County. In 2014, NCH generated \\$559.2 million in total operating revenues.
In 2012, NCH completed a corporate restructuring to create Miami Children's Health System, Inc. (MCHS), which is now the parent corporation of NCH, Miami Children's Health Foundation, Children's Health Ventures, and Pediatric Specialists of America (PSA). Effective Jan. 1, 2015, corporate leadership and central support services were transferred from the hospital to MCHS. Concurrently, PSA, the physician group previously a part of the hospital, became a fully owned subsidiary of MCHS. NCH pays management fees to MCHS at cost. NCH will begin making intercompany transfers to support the PSA on a quarterly basis. Given that these expenses have been historically recorded at NCH, the net financial impact is not expected to be material. NCH remains the sole obligor on the bonds, and the restructuring is not considered to cause any withdrawals from the obligated group.
NCH is supported by Miami Children's Health System Foundation and Miami Children's Hospital Foundation, whose sole purpose is to raise funds to support the activities of NCH. The beneficial interests in net assets of the foundations are recognized in NCH's balance sheet, but the foundations are not consolidated into NCH's financials. As of Dec. 31, 2014, a total of \\$75.8 million of cash and investments were held by the two foundations.
Continued Market Leadership
The upgrade to 'A+' is driven by improved financial profile that is supported by NCH's market position as the premier pediatric care provider in South Florida. NCH maintains a dominant market position particularly in tertiary and quaternary services, including neuroscience, cardiac care, and bone marrow transplant. NCH's extensive medical staff base of 724 physicians (186 employed) represents 35 subspecialties and is a core differentiating factor against its competitors.
Management has been focused on expanding outpatient services both organically and via partnerships with adult acute care hospitals, children's hospitals, physicians groups, and schools. Several projects are underway including a collaboration with Jupiter Medical Center, a co-branded ambulatory care center with Golisano Children's Hospital in Naples, a joint venture ambulatory surgery center with Florida International University (FIU), and a joint venture to transform a hospital/surgical center with Nueterra (a healthcare facility owner, developer, and manager). Focus on technological innovation also continues via Miami Children's Research Institute and Children's Health Ventures.
Robust Profitability
Strong profitability continued in fiscal 2014 and through the three-month interim period ended March 31, 2015, with operating margins of 6.2% and 17.9% compared to Fitch's 'A' median of 2.5%. Similarly, operating EBITDA margins were robust at 14.7% in 2014 and 25.7% in the interim period, compared to the respective median of 9.5%. Profitability was supported by continued growth in outpatient volume and diligent expense control. The PSA support, which is projected to be \\$21.4 million in fiscal 2015, has not been taken into account for the first quarter of 2015. Including this in operating expenditures would have produced an operating margin of 14.1%, still very strong for the rating. In 2015, management is targeting an operating income of \\$61.2 million (11.3% operating margin before intercompany transfers) for the obligated group and \\$49.2 million (8% operating margin) for the system, which is higher than historical performance, but Fitch believes is achievable given the strong trajectory signaled by interim results.
Supported by solid cash flow generation, coverage of maximum annual debt service (MADS) was excellent at 7.4x in fiscal 2014 compared to Fitch's 'A' median of 3.8x. While strong core operating performance drove cash flows, unusually strong coverage was buoyed by significant realized gains on investments. Debt burden has moderated significantly over the last two years with MADS as a percentage of revenues of 2.9% and debt to capitalization of 32.5% in fiscal 2014, now stronger than the respective medians of 3.1% and 36.3%.
High Medicaid Exposure.
As is typical of other children's hospitals, NCH's exposure to changes in Medicaid funding remains a concern, particularly given the political climate in Florida. Historically, the freestanding children's hospitals in the state have been relatively unharmed from Medicaid reimbursement reductions. Fitch views positively that profitability does not rely on supplemental payments such as low income pool (LIP) and disproportionate share funding (DSH). LIP and DSH receipts totaled \\$4-5 million in the last two fiscal years, a small contributor to total operating income around \\$35 million.
Ongoing Capital Plans
NCH has completed sizable expansion and renovation projects in the last several years, with more on the way. The completion of a new six-story bed tower was delayed by two years, as NCH management and board refined its overall facilities plan. The estimated expenditure increased nominally to \\$145 from \\$130 million, to be spent largely in 2015 and 2016. There is \\$40 million remaining in bond funds available for this project, and the balance is expected to be funded by a combination of philanthropy and cash flow. Construction for partnership projects for Jupiter Medical Center, Golisano Children's Hospital, and FIU are underway, with \\$7.5 million set aside (excluded from unrestricted liquidity) to fund the project with Jupiter Medical Center. Additionally, expansion of the emergency department at the main facility is proceeding, with completion expected at the end of 2015. Routine capital is annually budgeted near depreciation levels. Including the major capital projects, \\$120.3 million is budgeted for 2015 and \\$87.5 million for 2016. There are no near term plans to issue additional debt.
Solid Liquidity
Unrestricted cash and investments totaled \\$391.6 million at March 31, 2015, equating to 327 days cash on hand, 24.3x cushion ratio, and 166% cash to debt, strong compared to the 'A' medians of 199 days, 17x, and 131%. While robust cash flow is expected to continue, liquidity growth will likely slow as NCH funds the construction of its new bed tower. However, Fitch expects liquidity metrics to remain consistent with the 'A+' rating. Not included in Fitch's ratios are \\$75.8 million of cash and investments held at the foundation level.
DEBT PROFILE
Long-term debt totaled \\$236 million at March 31, 2015, consisting of 73% fixed rate and 27% floating rate bonds. Debt service is relatively level, with annual debt service requirements of \\$16-17 million. Debt portfolio has been significantly restructured to reduce put and variable rate risk. Only the \\$65 million series 2010B bonds privately placed with Wells Fargo remains subject to a put, with an initial tender date in December 2020.
NCH has one fixed rate payor and four basis swaps outstanding. The fixed rate payor swap with outstanding notional amount of \\$180.4 million was restructured in 2012 with more favorable collateral posting requirements. There are also \\$300 million of basis swaps outstanding. Wells Fargo is counterparty to all outstanding swaps. The mark-to-market at March 31, 2015 was negative \\$41.5 million, and no collateral was posted as of this date.
Guaranteed Debt
NCH is a co-guarantor on various obligations related to Miami Medical Center (MMC), a joint venture with Nueterra (a healthcare facility owner, developer, and manager). NCH's guarantee is capped at \\$70 million, which translates into \\$8-9 million annual debt service. This is a potential liability given that MMC is a brand new project with no history of operations. However, should NCH be required to assume its portion of the MMC's obligations, Fitch believes NCH is able to manage the increased liability at the 'A+' rating given its strong balance sheet and cash flows. The guarantee obligations (or related revenue projections) are not included in Fitch's ratios.
DISCLOSURE
NCH covenants to provide annual disclosure within 150 days of year-end and quarterly disclosure within 45 days of quarter-end to the Municipal Securities Rulemaking Board's EMMA system. Disclosure has been timely and thorough, and includes a balance sheet, income statement, cash flow, utilization statistics, and management discussion and analysis.
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