OREANDA-NEWS. Fitch Ratings has upgraded Hawaii Pacific Health's (HPH) outstanding debt to 'A+' from 'A'. A list of the outstanding debt follows at the end of this press release.

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group (OG).

KEY RATING DRIVERS

SUSTAINED STRONG FINANCIAL PERFORMANCE: The upgrade to 'A+' reflects HPH's sustained trend in strong financial performance following an upgrade to 'A' in December 2014. Fitch's main concern during the last review was the sustainability of the trend and a projected decline in operating performance. Given the strong improvement in balance sheet metrics, the projected decline in profitability would still be reasonable at the 'A+' rating level. Overall financial metrics are very strong with continued excellent profitability, growing liquidity and very good debt service coverage for the fourth consecutive year in fiscal 2015 (June 30 year end). Strong performance has been driven by increased acuity, higher volume, and continued focus on costs.

EFFECTIVE OPERATING PLATFORM: HPH is the largest healthcare provider in the state of Hawaii. Its inpatient and outpatient market footprint, in addition to its physician alignment initiatives and longstanding investment in an electronic medical record (EMR), positions the organization well for a value-based reimbursement environment. HPH's culture and focus on quality, service, employee engagement, growth and financial strength are also credit strengths.

TRANSFORMING PAYMENT MODELS: HPH signed a five-year accountable care agreement with its largest commercial payor, Hawaii Medical Service Association (HMSA)/Blue Cross Blue Shield), which includes additional reimbursement if certain quality metrics and cost containment measures are met. HPH is nearing the end of the second year of the agreement and performance measures have been in line with expected measures.

LARGE CAPITAL PROJECT: Capital spending over the next few years will be elevated due to the $180 million project at Kapi'olani Medical Center for Women and Children, which will modernize and expand its intensive care units. The construction is on time and within budget and HPH exceeded its fundraising goal and raised $35 million for the project. The new facility is expected to open in Spring 2016.

MODEST DEBT BURDEN: HPH's debt burden is modest, and, while there are currently no additional debt plans, the management team continues to evaluate strategic opportunities.

RATING SENSITIVITIES

FLEXIBILITY AT RATING LEVEL: Hawaii Pacific Health's strong financial performance provides the organization flexibility as it evaluates further areas of strategic investment. The projected decline in profitability with a lower rate of revenue growth due to transforming the delivery of care model is not as concerning given Hawaii Pacific Health's improved liquidity and debt metrics.

CREDIT PROFILE

Hawaii Pacific Health is the largest healthcare provider system in the state of Hawaii and is a major employer in the state. The system includes four hospitals (566 acute care beds and 66 bassinets) and 50 outpatient clinics and service sites. Through Hawaii Health Partners, a physician led accountable care organization, HPH is aligned with 705 physicians (450 employed) that have 85,901 attributed lives. Fitch's analysis is based on the consolidated system. The OG comprised 95% of total revenue and 95% of total assets of the consolidated system in fiscal 2015. Total revenue in fiscal 2015 was $1.2 billion.

Strong Financial Performance

The rating upgrade reflects continued strong performance in fiscal 2015, which exceeded expectations. In fiscal 2015, HPH had operating and operating EBITDA margins of 7.9% and 12.8% respectively, compared to 9.3% and 14.1% in fiscal 2014 and 6.3% and 11.5% in fiscal 2013 and the 'A' category medians of 3.6% and 10.3%.

Although HPH had significantly benefited from increased volume with the closure of one its competitors, Hawaii Medical Center - West (HMC), in December 2011, the facility was acquired by the next leading provider in the state (Queen's Health Systems), and they reopened the facility (Queen's West) in May 2014. Despite HPH's lower adjusted admissions in fiscal 2015 (66,891) compared to the prior two years (69,714 and 73,231), profitability remained strong.

Strong profitability has been driven by very strong revenue growth with an 8.5% CAGR over the last four years while managing expense growth. Performance through the first three months ended Sept. 30, 2015 continues to be strong with an 8.9% operating margin and 13.5% operating EBITDA margin. The fiscal 2016 budgeted operating margin is 5.5%.

Debt service coverage is very good due to strong cash flow and a modest debt burden. MADS coverage was 6.8x in fiscal 2015 compared to 7.7x in fiscal 2014, 5.8x in fiscal 2013 and the 'A' category median of 4.2x. MADS coverage was 5.9x for the three months ended Sept. 30, 2015. Debt burden is low with MADS accounting for 2.1% of total revenue in fiscal 2015.

HPH's balance sheet metrics have historically lagged the category medians; however, there has been a significant improvement in unrestricted cash and investments due to strong cash flow and manageable capital spending within available cash flow. Total unrestricted cash and investments were $601.8 million at Sept. 30, 2015 from $342 million at fiscal year end 2011. HPH had 199.4 days cash on hand and 170.3% cash to debt at Sept. 30, 2015.

Transforming Delivery of Care

HPH's main credit strengths include its market position and delivery network. This has allowed the organization to enter into alternative payer arrangements, which align incentives with its overall goals to improve quality and lower costs. HPH's main commercial payor is HMSA, which accounted for 29.4% of its gross revenue in fiscal 2015. The payer arrangement with HMSA includes measures that focus on quality metrics, patient management services, and medical cost. Management expects this initiative to bend the cost curve over time and its strategy of physician alignment and ability to obtain clinical information through its EMR are key to its performance, which have been in line with expectations.

Large Capital Project

HPH has a large capital project underway at Kapi'olani Medical Center for Women and Children. The project cost is $180 million and funded by series 2013 bond proceeds ($125 million), philanthropy ($35 million - $5 million over original target), and $20 million from operating cash flow. The project will significantly enhance the space for intensive care patients with private patient rooms. The NICU will be expanded to 70 beds from 46 and 14 existing PICU beds are being renovated. The project is on time and within budget and expected to open in the spring of 2016.

Capital spending has been healthy and averaged 1.9x depreciation expense over the last four years. Projected capital expenditures remain well within available cash flow and there are no plans for additional debt. Projected capital expenditures are $72 million in fiscal 2016, $66 million in fiscal 2017, $57 million in fiscal 2018, $60 million in fiscal 2019 and $63 million in fiscal 2020. The management team is evaluating various strategic opportunities that could require increased capital spending but these plans are preliminary with no specific timeframe regarding potential additional projects. In addition, Kapi'olani will likely require a replacement bed tower, which management says is at least seven years away.

Conservative Debt Profile

Total debt outstanding is $361.4 million with 86.7% underlying fixed rate and 13.3% underlying variable rate. MADS is $25.3 million and debt service is level. The variable rate exposure is a direct bank loan (series 2013C) with JP Morgan that has a mandatory tender date in 2020. The series 2013C bonds refinanced HPH's letter of credit backed variable rate demand bonds. Fitch notes that there are more restrictive covenants under the direct bank loan and the bank has specified a number of event of default triggers including the failure to provide financial statements. Although Fitch views these more restrictive covenants negatively, they are less of a concern given HPH's financial profile and rating level.

HPH has two fixed payor swaps outstanding, and there are no collateral posting requirements at its current rating level.

Disclosure

HPH covenants to provide annual and quarterly disclosure through the Municipal Securities Rulemaking Board's EMMA system.

Outstanding debt upgraded to 'A+' from 'A':

--$121,210,000 Department of Budget and Finance of the State of Hawaii, special purpose revenue bonds, Hawaii Pacific Health Obligated Group series 2013A;
--$34,045,000 Department of Budget and Finance of the State of Hawaii, special purpose revenue bonds, Hawaii Pacific Health Obligated Group series 2013B;
--$99,020,000 Department of Budget and Finance of the State of Hawaii, special purpose revenue bonds, Hawaii Pacific Health Obligated Group series 2010A;
--$59,050,000 Department of Budget and Finance of the State of Hawaii, special purpose revenue bonds, Hawaii Pacific Health Obligated Group series 2010B.