OREANDA-NEWS. Fitch Ratings assigns a 'BBB' rating to the approximately $85 million Florida Development Finance Corporation healthcare facilities revenue bonds, (UF Health-Jacksonville Project), series 2015.

In addition, Fitch has downgraded the rating on UF Health-Jacksonville's (UFH-J) outstanding debt listed below to 'BBB' from 'BBB+':

--$64.24 million Florida Development Finance Corporation healthcare facilities revenue bonds (UF Health-Jacksonville Project), series 2013A;
--$56.5 million Florida Development Finance Corporation healthcare facilities revenue bonds (UF Health-Jacksonville Project), series 2013B (R-FLOATs).

Fitch placed the bonds on Rating Watch Negative on Oct. 5, 2015 due to the upcoming bond issuance. The bonds are removed from Rating Watch Negative. The Rating Outlook is Stable.

The series 2015 bonds will be fixed rate and will be purchased by Bank of America and UFH-J will enter into a total return swap for an initial period of five years to convert the interest rate to a floating rate. The bond proceeds will be used to construct a 92 bed hospital at UFH-J's North campus (North Tower project).

SECURITY

The master trust indenture (MTI) includes a gross revenue pledge and mortgage pledge and leasehold mortgage pledge on certain properties of the obligated group (OG). There is a debt service reserve fund for the series 2013A bonds. The obligated group includes Shands Jacksonville Medical Center (now dba UF Health - Jacksonville), Shands Jacksonville HealthCare, and Shands Jacksonville Properties. The OG accounted for essentially the entire consolidated entity's assets and revenue, respectively for fiscal 2015 (June 30 year end; audit). Fitch's analysis is based on the consolidated entity.

KEY RATING DRIVERS

ADDITIONAL DEBT: The rating downgrade to 'BBB' from 'BBB+' reflects UFH-J's limited debt capacity for the $85 million series 2015 debt issuance. Although Fitch views the project favorably and despite operating performance improvement, UFH-J's balance sheet remains weak.

INTEGRAL COMPONENT OF UNIVERSITY OF FLORIDA: Fitch views UFH-J's relationship with University of Florida (UF; housing bonds rated 'AA') as its primary credit strength and believes that UFH-J serves an essential role as part of the UF system. UFH-J is one of two academic teaching sites for UF, and UFH-J has the third-largest post-graduate medical training program in Florida with over 300 residents and fellows and over 400 UF faculty. UFH-J is a component unit of UF and the board of UFH-J is appointed by UF.

GROWTH STRATEGY: UFH-J has been developing its presence on the north side of the city, which is fast growing with a better payor mix and there are opportunities to partner with unaffiliated community physicians. The first phase included a medical office and outpatient services building (MOB), which opened in February 2015, and volume has far exceeded initial projections. UFH-J is now moving forward with the construction of a 92-bed hospital at the North campus given the strong volume growth. This growth strategy will be key to UFH-J's long term viability given its high indigent care burden at the main campus.

SOLID OPERATING PERFORMANCE: UFH-J's solid operating performance was sustained in fiscal 2015; however, its liquidity and debt metrics are weak for the rating level. Improved profitability has been driven by increased volume and commercial payor mix, continued focus on expenses and ongoing management of its uninsured population.

CHALLENGING PAYOR MIX: UFH-J has an extremely high percentage of Medicaid, Medicaid pending and self-pay payors that totals approximately 42% of gross revenue in fiscal 2015 but has declined over the last two years. Because of its payor mix, UFH-J receives a significant amount of supplemental funding, and the funding environment has been volatile especially in the last year as the federal government exerts pressure on the state to expand Medicaid. The federal government reduced funding for the LIP (low income pool program) for fiscal 2016, however, funding stayed flat because the reduction ($400 million) was made whole by the state through its general fund.

RATING SENSITIVITIES

EXPOSURE TO CHANGES IN SUPPLEMENTAL FUNDING: Although UFH-J remains highly susceptible to changes in supplemental funding, Fitch believes its role as a safety net provider should provide some influence in the political discussions.

EXECUTION OF NORTH STRATEGY: Fitch expects UFH-J to realize the strategic benefits with its North campus, which should translate into better financial performance.

CREDIT PROFILE
UFH-J is an academic medical center located in Jacksonville, FL with 695 licensed beds. UFH-J has an extensive outpatient network with 38 primary care clinics in the service area. UFH-J is an integral component of UF and serves as one of their two academic teaching sites. Total revenue in fiscal 2015 (June 30 fiscal year end) was $590 million.

UF and Shands Relationship
UFH-J is an integral component of UF and the UF President has the rights to appoint and remove UFH-J board members. Shands Gainesville (Gainesville) is an 852-bed academic medical center and was UF's primary academic teaching hospital. This expanded to UFH-J in 2003 when UFH-J became part of the UF/Shands organization and Gainesville became UFH-J's sole corporate member. Since that time, there has been significant growth in UFH-J's teaching and clinical activities and, in 2010, there was a corporate reorganization which made Gainesville and UFH-J affiliates of UF. Through common governance and a shared mission with UF, there is a strong relationship between UF, Gainesville, and UFH-J, which Fitch views as UFH-J's primary credit strength. UF faculty accounts for the majority of UFH-J's medical staff.

UFH-J and Shands Gainesville (Gainesville) remain legally separate and distinct entities with separate obligated debt, but the organizations share a common strategic vision led by the UF&Shands Strategic Health Care Cabinet made up of key leadership from UFH-J, Gainesville, and UF. UFH-J and Gainesville have various shared services in addition to joint managed care contracting and supply chain management.

UFH-J has a subordinated note payable to Gainesville for its investment in UFH-J. As of Sept. 30, 2015, Gainesville approved a loan forgiveness of approximately 50% on the outstanding note ($17.7 million), which Fitch believes further demonstrates the close relationship between the organizations.

North Campus
As a safety net provider, UFH-J is pursuing a growth strategy in a fast growing, better payor mix service area to ensure its long term viability. In February 2015, UFH-J opened a 210,000 square foot medical office and outpatient services building in North Jacksonville. All the space has been leased and UF physicians account for approximately 70% of the space while 30% is leased to community physicians. The facility was developer financed and services currently offered include a 28 bed freestanding emergency department, outpatient surgery center, endoscopy procedure rooms, interventional radiology, cardiac catheterization, imaging and lab services.

Volume has significantly exceeded projections with approximately 55-60% of the volume being new volume and the remaining being cases that would have gone to the main campus. Average daily volume by month since the opening has resulted in incremental visits. The payor mix is also much better with a higher commercial/managed care and Medicare payor mix than the main campus.

With the success of the outpatient services, UFH-J is moving forward with the construction of its 92 bed hospital at this site and a CON for this was received in July 2014. The construction is expected to begin by the end of the year with an opening in July 2017. The cost of the project is $85 million and will be funded entirely by the series 2015 bonds.

Although this increases UFH-J's leverage, Fitch views the project favorably as it will further diversify the organization from the heavy indigent burden at its main campus and the North campus is expected to be profitable in the first full year of operations.

The total capital budget for fiscal 2016 is approximately $116 million with $85 million related to the North Tower project.

Good Operating Performance
After very poor performance in fiscal 2012, UFH-J's operating performance has significantly improved and was sustained in fiscal 2015 and exceeded budget. Operating margin was 4.2% in fiscal 2015 ($24.8 million operating income) compared to 4.7% in fiscal 2014, 3% in fiscal 2013 and 0.6% in fiscal 2012. Operating performance excludes transfers to UF, which are negotiated annually for the support of clinical and research activities and were $23 million in fiscal 2015, $23.1 million in 2014 and $22.3 million in fiscal 2013. There is a portion of funds that are paid to UF in professional fees for direct contract services and although the transfers to UF is projected to be $33.3 million in fiscal 2016, this is not an increase in support as UFH-J changed the classification of some funds between professional fees and transfers to UF.

Good operating performance in fiscal 2015 has been driven by increased volume (4% increase in admissions and 7.2% increase in outpatient visits), continued focus on expenses and care management of its uninsured population.

The operating income budget for fiscal 2016 is $35 million or 5.3% operating margin and includes a full year of the North outpatient facilities being open, flat supplemental funding, and a reduction in length of stay.

Challenging Population
UFH-J is challenged by a high indigent population, which results in a dependence on supplemental funding. UFH-J's payor mix in fiscal 2015 (based on gross revenues) included 42.1% from Medicaid, self-pay and Medicaid pending but is down from 46.9% in fiscal 2013. UFH-J has an indigent care contract with the city of Jacksonville that provides funding for indigent care. This funding has been fairly flat and remains well below cost as UFH-J carries the majority of the burden of serving the indigent population in the service area. The city contract totaled $26.3 million a year in fiscal 2014 and 2015. Management has implemented several strategies in order to better manage the costs of the uninsured population including a patient-centered medical home model.

Florida's Medicaid program and the funding of its lower income pool (LIP) program have been under critique and the federal government has been trying to exert pressure on the state to expand Medicaid. The federal government reduced the amount of funding for the LIP program for fiscal 2016, which was subsequently made whole through the general fund of the state. The funding of the LIP program and Medicaid expansion remains a politically charged issue and it is unknown what the funding environment will be post fiscal 2016. The legislature is in session through March 2016 so there should be more clarity, at least for fiscal 2017's situation, then.

The Medicaid supplemental funding is in the form of direct supplemental payments as well as enhanced Medicaid rates. Total supplemental funding (cash basis) for fiscal 2016 remained flat at $103.4 million compared to $104.7 million in fiscal 2015 and $94.8 million in fiscal 2014.

Increased Leverage
Total pro forma outstanding debt is $274 million and includes this proposed issue ($85 million series 2015 fixed rate bonds), $64.2 million series 2013A fixed rate bonds, $56.4 million series 2013B variable rate (R-Floats), $40 million series 2015 direct bank loan and revolving line of credit with Compass Bank (variable rate), $18 million note payable to Gainesville, and approximately $10 million of capital leases. The debt profile is approximately 65% fixed rate and 35% variable rate and the bonds are parity indebtedness under the MTI.

UFH-J plans to enter into a total return swap in conjunction with the series 2015 bonds to swap the bonds to a variable rate over a five year period. UFH-J also has two fixed payor swaps outstanding. There are collateral posting requirements at the current rating level and $1.6 million was posted as of June 30, 2015.

UFH-J is exposed to various risks in its debt profile including remarketing risk related to the R-Floats, bank renewal risk related to the Compass bank loans and exposure to collateral posting requirements under the swap, which Fitch believes pressures an already weak balance sheet position.

The MTI includes maintaining maximum annual debt service (MADS) coverage of at least 1x and 45 days cash on hand (excludes transfers to UF from operating expenses). Debt service coverage of below 1x for two consecutive years or failure to comply with the liquidity covenant would result in an event of default. The bank covenants include 60 days cash on hand, 70% debt to capitalization and a rating of BB or higher.

Pro forma MADS according to the MTI treatment is $18.4 million and excludes the subordinated note payable to Gainesville and smooths the $20 million bullet maturity on the revolving line of credit (due in 2020). MADS occurs in fiscal 2017 and drops to $16.7 million in fiscal 2018 and debt service steadily declines thereafter.

The debt burden is still fairly moderate even with the increased debt with MADS comprising 3.1% of total revenue in fiscal 2015 compared to the 'BBB' category median of 3.6%. However, debt service coverage is pressured due to the inclusion of transfers to UF in EBITDA. MADS coverage was 3x in fiscal 2015, 2x in fiscal 2014 and 1.2x in fiscal 2013. Fiscal 2015 coverage is bolstered by a gain on sale of a Medicaid HMO plan ($13.8 million received in cash). Projected debt service coverage is 2.2x in fiscal 2016 and improves to 2.6x in fiscal 2018 with a full year of the North Tower open compared to the 'BBB' category of 2.7x.

Weak Liquidity
UFH-J's liquidity is weak with $133 million unrestricted cash and investments at June 30, 2015, which translated to 90.4 days cash on hand and 64.6% cash to debt compared but was improved from the prior year end. UFH-J's liquidity fluctuates due to pending receivables from city/state funding. At fiscal 2015 year-end only $3 million was pending versus $15.8 million at fiscal year-end 2014. In addition, in FY 2015 UFH-J received $15.8 million related to the sale of its Medicaid HMO plan and there is potentially a final cash distribution of approximately $9 million by fiscal 2017. Liquidity is projected to decline mainly driven by the conservative assumption of a decline in supplemental funding of approximately $20 million. This would result in days cash on hand close to the bank covenant, which would be concerning as it would result in an event of default under the bank documents.

Disclosure
UFH-J covenants to provide annual audited information within 120 days of fiscal year end and quarterly financial information within 45 days of quarter end for all four quarters.