OREANDA-NEWS. Fitch Ratings has assigned an 'F1+' short-term rating to the $200 million of taxable commercial paper notes (CP), series A authorized by Children's Health Services of Texas (CHST) and supported by the corporation's internal liquidity.

Additionally, Fitch has affirmed the 'AA' ratings on approximately $357.6 million of bonds issued by the North Central Texas Health Facilities Development Corporation on behalf of CHST.

The Rating Outlook is Stable.

The series A CP notes are expected to be used to fund various capital projects, including property acquisitions, and to pay costs of issuance. The CP program is expected to launch the week of February 8; however, CHST does not expect to immediately draw on CP funds upon closing.

SECURITY

Bond payments are secured by a pledge of the gross revenues of the obligated group.

KEY RATING DRIVERS

STRONG PROFITABILITY: Profitability has been consistently strong with operating EBITDA equal to 17% in fiscal 2014 and 13.4% in the 10-month interim period ending Oct. 31, 2015 (the interim period).

DEBT BURDEN EXPECTED TO INCREASE: CHST expects to draw approximately $175 million of CP by the end of 2017. However, the system's strong cash flows are expected to maintain maximum annual debt service (MADS) coverage at levels consistent with the 'AA' rating.

ROBUST LIQUIDITY: Liquidity metrics are robust with 435.8 days cash on hand, 47.9x cushion ratio and 363.3% cash-to-debt at Oct. 31, 2015.

LEADING MARKET POSITION: CHST holds a dominant market share in its service area, with limited competition for high acuity pediatric services. The leading market position is bolstered by CHST's status as the primary pediatric teaching hospital for the University of Texas Southwestern Medical Center at Dallas (UTSW).

SHORT-TERM RATING: At Dec. 31, 2015, CHST's eligible cash and investments would cover the maximum mandatory put on self-liquidity debt on any given date well in excess of Fitch's 1.25x threshold for the 'F1+' short-term rating.

RATING SENSITIVITIES

MAINTENANCE OF CURRENT PROFILE: Fitch expects liquidity metrics will remain robust while Children's Health System of Texas' profitability will remain strong and continue to provide for MADS coverage consistent with the 'AA' rating despite the expected increase in debt.

CREDIT PROFILE

CHST (fka Children's Medical Center of Dallas) operates two pediatric acute care hospitals and a pediatric rehabilitation hospital located in Dallas and Plano. Additional operations include a pediatric research institute, a health maintenance organization, an integrated regional pediatric network with over 340 physicians, a telemedicine network, eight outpatient rehabilitation clinics, 10 specialty centers, two ambulatory surgical centers and a range of community health programs. CHST has provided pediatric services in the Dallas community for over 100 years and is nationally recognized as one of the nation's leading children's hospitals. CHST changed its name from Children's Medical Center of Dallas in 2014 to reflect the system's evolution from a standalone pediatric medical center to a clinically integrated pediatric health system. Total consolidated operating revenue equaled $1.24 billion in fiscal 2014.

STRONG PROFITABILITY AND COVERAGE

Operating profitability has been consistently strong, with operating EBITDA margin averaging 14.9% since fiscal 2009. Operating EBITDA margin increased to 16.1% in fiscal 2013 and 17.0% in fiscal 2014. The strong operating results in fiscal 2013 and 2014 primarily reflect continued operating improvement initiatives and increased supplemental government funding (see below). Profitability moderated slightly in the interim period with operating EBITDA margin equal to 13.4% but remains strong, exceeding Fitch's 'AA' category median of 11.5%. The slight moderation was due to a shift from inpatient admissions to observation stays, continued investments in population health initiatives and decreased supplemental funding.

As is typical with children's hospitals, CHST has a high exposure to Medicaid, equal to 64% of gross revenue in fiscal 2014. Additionally, CHST receives significant supplemental government funding. Total disproportionate share, upper payment limit and delivery system reform incentive payments received increased from $49.2 million in fiscal 2012 to $101.4 million in fiscal 2013, $147.6 in fiscal 2014 and $114.6 million in fiscal 2015. CHST expects to receive approximately $104 million of supplemental funding in fiscal 2016.

DEBT BURDEN EXPECTED TO INCREASE

The 2016 transaction will authorize up to $200 million of taxable CP, but no CP is expected to be drawn upon closing. CHST expects to draw approximately $175 million of CP by the end of 2017. CP draws are expected to fund various capital projects (see below) and the acquisition of additional parcels of property.

The system's current debt burden is moderate with MADS equal to 2.3% of fiscal 2014 operating revenue relative to Fitch's 'AA' category median of 2.4%. CHST's moderate debt burden and strong profitability combine to produce robust MADS coverage. MADS coverage by EBITDA and operating EBITDA equaled 10.8x and 7.4x, respectively, in fiscal 2014, and 7.4x and 6.1x in the interim period, easily exceeding Fitch's 'AA' category medians of 5.7x and 4.4x.

Assuming that the entire $200 million of authorized CP is drawn and amortized over 30 years with level debt service and an interest rate of 3.5%, pro forma MADS would increase to $39.1 million from $28.4 million (provided by the underwriter). Fitch views this assumption as conservative. Pro forma MADS as a percent of fiscal 2014 revenue would increase to 3.2% and debt-to-capitalization would increase to 24.4% from 17.4% at Oct. 31, 2015. Despite the significant increase in debt burden, pro forma MADS coverage by EBITDA and operating EBITDA remains solid for the rating category at 7.8x and 5.4x, respectively, in fiscal 2014, and 5.4x and 4.4x in the interim period.

ROBUST LIQUIDITY

Unrestricted liquidity metrics continue to strengthen from already robust levels, with cash and investments increasing 8.4% since fiscal 2013 to $1.36 billion at Oct. 31, 2015. The continued increase in liquidity primarily reflects CHST's strong operating cash flows. Liquidity metrics are robust with 435.8 days cash on hand, 47.9x cushion ratio and 363.3% cash-to-debt, easily exceeding Fitch's respective 'AA' category medians of 289.4 days, 27x and 201.7%. The robust liquidity metrics provide significant financial flexibility and capacity for CHST to absorb the expected CP issuance as funds are drawn while maintaining liquidity metrics consistent with the 'AA' rating.

Capital plans are not expected to materially impact CHST's absolute unrestricted liquidity. Capital spending is projected to increase to $283.1 million in fiscal 2016 (428.4% of budgeted depreciation) after averaging approximately $88 million (149% of depreciation) between fiscal 2012 and 2015. Significant capital projects include construction of a new ambulatory care pavilion on the Plano campus, which will house CHST's Andrew's Institute for Orthopaedic and Sports Medicine, and various property acquisitions in the Dallas area. The capital projects will initially be funded by CP draws. As the CP is drawn, Fitch expects cash-to-debt and cushion ratio to remain consistent with the 'AA' category rating.

LEADING MARKET POSITION

The 'AA' rating is further supported by CHST's leading market share in high acuity pediatric services in its two primary service areas, Dallas and Plano. The system has developed into the dominant provider of complex, high acuity pediatric services in both service areas. CHST maintained leading market shares of 72% in Dallas and 49% in Plano, well ahead of its nearest competitors. Fitch views the development of the Andrew's Institute favorably as it should further enhance CHST's market position and reputation for specialized pediatric care.

ACADEMIC AFFILIATION

The leading market position is further enhanced by CHST's status as UTSW's exclusive pediatric teaching hospital and its affiliation with the Texas A&M Baylor College of Dentistry. The academic programs include over 100 pediatric residents, 128 pediatric subspecialty fellows and 22 pediatric dental residents. CHST also has facility agreements with five nursing schools for clinical education of nursing students in the area of pediatric/critical care nursing. Fitch views the academic affiliations favorably as they provide valuable benefits in clinical care, research, and recruitment of nurses and physicians.

SHORT-TERM RATING

The 'F1+' rating reflects the strength of CHST's cash and investment position to pay any put or tender on the series A CP notes. At Dec. 31, 2015, CHST's eligible cash and investment position as per Fitch's criteria would cover the maximum mandatory put on any given date well in excess of Fitch's 1.25x threshold for the 'F1+' short-term rating. Fitch received a written internal procedures letter from CHST, which outlines the corporation's policies to meet any funding requirements.

DEBT PROFILE

CHST had $374 million of total debt outstanding at Oct. 31, 2015. The debt portfolio currently consists of 100% underlying fixed-rate bonds. The system is not counterparty to any swap agreements.

DISCLOSURE

CHST covenants to provide audited financial statements within 150 days of each fiscal year-end and quarterly unaudited financial statements within 60 days of the first three quarters. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA website.