OREANDA-NEWS. Fitch Ratings has assigned a 'BBB' rating to the expected issuance of the following New Jersey Health Care Facilities Financing Authority bonds issued on behalf of University Hospital (UH):

--$266,320,000 revenue and refunding bonds university hospital issue series 2015A.

The Rating Outlook is Stable.

Bond proceeds will be used to refund outstanding debt, finance a variety of capital projects, fund a debt service reserve fund, and pay the costs of issuance. The bonds are expected to be issued as fixed rate obligations and price via negotiation the week of Dec. 9.

SECURITY
General revenues of UH, a lockbox on unrestricted state appropriations, and a debt service reserve fund. There is no mortgage.

KEY RATING DRIVERS
SERVICE ESSENTIALITY: The 'BBB' rating incorporates the essentiality and state statutory directives for UH's services, which Fitch believes well-positions UH to continue to receive direct, annual appropriations from the State of New Jersey (GO bonds 'A'/Stable Outlook), necessary to offset ongoing operating losses. These essential services include UH's objective to operate as the safety net hospital for Newark, NJ, the Level I trauma center for Northern New Jersey, and as the teaching hospital for the Newark-based schools of the Rutgers School of Biomedical and Health Sciences, New Jersey's only public medical school.

INDIVIDUAL SUPPLEMENTAL STATE APPROPRIATIONS: UH receives individual supplemental state appropriations that are in addition to the regular supplemental distributions that UH and other New Jersey hospitals receive. The individual supplemental appropriations relate to the 2012 state act that restructured the University of Medicine and Dentistry of New Jersey (UMDNJ) and spun off UH as a standalone facility. Language in the act provides that state funds should be sufficient to maintain UH as an acute care facility and trauma center.

THIN FINANCIAL PROFILE: UH financial profile is characterized by annual operating losses, weak liquidity, and a challenging payor mix, with over 60% of UH's gross revenues composed of Medicaid and self-pay, reflecting its role as the safety net hospital for Newark, NJ. UH has made progress on a performance improvement plan, but Fitch believes the structural challenges of UH's payor mix make the individual supplemental state appropriations necessary over the medium to long term.

CLOSE GOVERNMENTAL RELATIONSHIP: UH was established as an instrumentality of the State of New Jersey; three of its 11 board members are appointed by the governor, with advice and consent from the state senate (including the board chair), and the state is a signatory on the lockbox agreement described below. Fitch views these ties to the state as a credit strength, tempered by UH's need to obtain annual appropriations of state funds in a difficult state budget environment.

LOCKBOX STRUCTURE: Unrestricted state appropriations, which include state charity pools, Delivery System Reform Incentive Payment (DSRIP) funds, and the individual supplemental appropriations, will flow through a lockbox held by a trustee. Funds in the lockbox will pay debt service prior to being released to UH for operations, providing bondholders with an additional layer of security. Debt service coverage by the funds flowing through the lockbox is projected to be a solid 6.8x in fiscal year 2016 (FY16).

RATING SENSITIVITIES
STATE SUPPORT: A material decline in unrestricted state appropriations would likely lead to a downgrade. Movement in New Jersey's GO rating could also impact University Hospital's (UH) rating.

OPERATIONAL PERFORMANCE: While Fitch does not expect UH to reach breakeven performance without annual state appropriations, a material decline in UH's performance that would require increased state support could also lead to negative rating pressure.

CREDIT PROFILE
UH is a component unit and instrumentality of the State of New Jersey, operating a medical center in downtown Newark on a 63 acre campus that it shares with Rutgers New Jersey Medical School and the Rutgers School of Dental Medicine. UH has 519 licensed beds, an active medical staff of more than 500 physicians, and more than 3,100 employees. Total operating revenues in FY15 were $491.2 million.

Overview
As part of a 2012 state law that restructured UMDNJ, UH was spun off as a standalone hospital, effective in 2013. Prior to joining UMDNJ, UH had served the local Newark community for over 100 years and evolved over time to become a level I Trauma Center and teaching hospital for the region and the state. UH currently has one of the highest all payor case mix index in the state at 1.64, and the high acuity services that it provides, in addition to the trauma services, include a Level III neonatal intensive care unit, the largest liver transplant program in NJ, and a stroke center that was awarded the Certificate of Distinction for Advanced Certification in Comprehensive Stroke Center by The Joint Commission.

Language in the 2012 restructuring law specifies that state funding be provided to enable UH to continue the provision of community services to the local Newark population and that UH be maintained as a level 1 trauma center and teaching hospital. The act also provides for a five-year period in which any substantive changes to UH's essential health care services be subject to review by a community board established in the act, which is composed of local community members and is separate from UH's governance board, with approval by the New Jersey Department of Health.

UH's operations have been challenged by its central role as the safety net provider for the city of Newark, which has a weak economy and an unemployment rate of approximately 9.5%. In its first two years as a standalone hospital, UH incurred large operating losses and the additional individual supplemental state appropriations helped bring its performance to breakeven. The individual supplemental appropriations totaled $23.7 million in FY14 and $43.8 million in FY15. UH is budgeting for $43.8 million of these additional funds in FY16 (June 30 year end).

Fitch notes that UH's management has worked to reduce costs and improve efficiencies, with Barnabas Health System (general revenues 'A-') providing technical assistance in this effort under a consultancy engagement. However, the operating and reimbursement environment for UH is expected to remain challenging and operating losses are expected to persist.

State Appropriations
UH received total unrestricted appropriations from the state of $156 million in FY14, $150 million in FY15, and has budgeted for approximately $130 million in FY16. The anticipated drop in FY16 is due largely to the recalculation of state charity pools due to Medicaid expansion and the associated drop in charity care across the state. However, UH saw its share of charity pool funding decline by a larger percentage than the whole pool did, with UH's allocation, including the individual supplemental appropriations, dropping by 30% and the total pool dropping by approximately 25%.

The individual supplemental appropriations, which are included in the total yearly appropriations noted above, are critical in closing UH's operating losses and enabling UH to achieve a positive bottom line performance. Without the individual supplemental appropriations, UH's maximum annual debt service (MADS) coverage by EBITDA in FY15 would have been negative, instead of the 1.9x coverage it produced.

UH's reliance on annual state appropriations to sustain balanced operations will continue to expose UH to the state's budget challenges, in Fitch's view. However, this concern is offset by the essentiality of UH's services, the ability of the current management team to keep the operational losses manageable, and UH's close ties to the state.

Lockbox Provisions
A security feature for this obligation is provided by a lockbox that is being established with the 2015 debt issuance and through which all unrestricted state appropriations will flow. Under the lockbox provisions, debt service payments will be set aside from first-received state appropriations and then any excess funds will be released to UH for operations.

Given UH's thin financial profile, the debt service payments will accrue over the first three months of each six month period (with a third of the semi-annual interest and a sixth of the yearly principal held each of these first three months). This will allow for enough funds to be set aside for debt service payments and provide needed cash flow to UH for operations. Every six months a sufficiency certification will be issued attesting that debt payments have been received by the Trustee. Should there be a payment failure, a draw on the debt service reserve fund, or should the yearly coverage by the lockbox fall to below 2x, 100% of the unrestricted state appropriations will be intercepted until the deficiency is remedied.

Fitch notes that the lockbox does not improve UH's financial ability to pay debt service but does provide an extra layer of protection for bondholders, especially given the six-month sufficiency certifications. In addition, the state payment of annual appropriations, which occurs on a monthly basis, has been very steady; UH received no less than $12.2 million in 11 out of 12 months in FY15. January was the only month that UH received a lower payment ($5.8 million), as the state generally makes a larger payment to hospitals in December (UH received $18.3 million in December 2014); however, even this lower amount was sufficient to cover the month's debt service accrual of $3.2 million. Pro forma lockbox coverage, which is measured by the funds flowing through the lockbox, was solid at 8x and 7.8x, in FY14 and FY15, respectively.

Debt Profile/Cycle of Capital Spending
After issuance, the 2015 debt will represent all of UH's long-term debt. UH has no variable rate debt outstanding. Fitch views UH's conservative debt structure as a credit positive given UH's thin balance sheet and operating profile. MADS is expected to total $19.1 million, and the issue is structured to amortize interest only for the first five years, when debt service will be approximately $13.9 million, and then rise to MADS, staying fairly level for the rest of the life of the bonds. Fitch views the interest only payments as a credit neutral, but in the near term it will provide UH with more financial flexibility.

A portion of the 2015 bonds will be used to refund $147.5 million of debt issued in 2013 to fund UH's portion of UMDNJ's legacy debt. The remaining proceeds from the bond issue will support routine capital spending, allow for information systems and technology investments, and fund upgrades to infrastructure and key services lines, including cancer care and additional operating rooms. While the bond funds will help UH address a period of deferred maintenance, Fitch toured UH and found the hospital in reasonably good condition and believes the capital projects being funded should take care of major capital needs for the next three to four years.

Disclosure
UH covenants to provide annual and quarterly financial disclosure within 150 days and 45 days. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA system.