Fitch Upgrades Salem Health (OR) Bonds to 'A '; Stable Outlook
--\\$75,000,000 Salem Hospital Facility Authority (OR) (Salem Hospital Project) variable rate revenue bonds series 2008B (LOC: U.S. Bank National Association);
--\\$39,185,000 Salem Hospital Facility Authority (OR) (Salem Hospital Project) revenue bonds series 2008A;
--\\$111,930,000 Salem Hospital Facility Authority (OR) (Salem Hospital Project) revenue bonds series 2006
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group (OG). Salem Hospital is the only member of the OG and accounted for 98% of total assets and 96% of total revenue of the consolidated entity (Salem Health) in fiscal 2015 (Sept. 30 fiscal year end). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
STRONG PROFITABILITY: The rating upgrade to 'A+' from 'A' reflects Salem's strong operating profitability in fiscal 2015 (year-ended Sept 30) and expected continued operating EBITDA margins around 12%. Salem generated a 7.8% operating margin and 15.4% operating EBITDA margin in fiscal 2015 reflecting strong volume growth and cost reductions through implementation of lean management techniques. Fiscal 2015 was the third consecutive year with operating EBITDA margins above 12%.
AFFILIATION WITH OHSU: Effective November 2015, Salem affiliated with Oregon Health and Science University (OHSU; rated 'AA-'/Stable Outlook) under a Joint Management Agreement. While Salem and OHSU will remain separately obligated on their debt, the clinical enterprises will be operated a single entity with a single management team and a shared bottom line (operating income).
DOMINANT MARKET SHARE: Salem maintains a dominant market share position of almost 80% in its primary service area, which includes the cities of Salem (the state capital) and Keizer. Volume growth has been strong and Salem has experienced a positive impact from expanded Medicaid eligibility under the Affordable Care Act.
SOLID LIQUIDITY POSITION: Liquidity metrics have consistently grown over the last four years and compare favorably to Fitch's A category medians. At Sept. 30, 2015, Salem had 299 days cash on hand and 165.6% cash to debt compared to the A category medians of 205.3 and 143.7% cash to debt, respectively.
MODERATING DEBT BURDEN AND CAPITAL PLAN: Salem's debt burden has been moderating due to good revenue growth. Debt service coverage improved sharply in fiscal 2015 due to improved profitability with MADS coverage by EBITDA of 5.6x. There are no current plans for additional debt but a master facility plan by OHSU Partners is underway. Capital spending is expected to be higher than normal in fiscal 2016 (2x depreciation expense) due to the addition of 40 beds and IT spending which be absorbed at the current rating level.
RATING SENSITIVITIES
STABILITY AT CURRENT RATING LEVEL: Fitch believes that Salem Health can maintain operating cash flow at the level projected (12% operating EBITDA margin). Fitch views Salem's relationship with OHSU positively and believes it should provide stability in a consolidating and evolving reimbursement environment.
CREDIT PROFILE
Salem Health includes Salem Hospital, a 413-staffed bed hospital located in Salem, OR, approximately 45 miles south of Portland, as well as other healthcare related entities. Salem Health had \\$694 million in operating revenue for fiscal 2015. Salem will be changing its fiscal year end to June 30 for fiscal 2016.
OHSU Affiliation
OHSU is based in Portland, Oregon and is the state's only health science university and major academic health center. In addition to the Schools of Medicine, Nursing, and Dentistry, OHSU operates 564 beds in its two hospitals (OHSU Hospital and OHSU Doernbecher Children's Hospital) and provides highly complex tertiary and quaternary care with a case mix index over 2.0. OHSU has trained over a third of the physicians in the state, which provides a good foundation for the physician integration expected with the affiliation.
OHSU and Salem entered into a 40-year joint management agreement, which states that the clinical enterprise will be jointly managed by a common management team (OHSU Partners). The academic and research missions of OHSU are excluded from this. OHSU Partners' executive management team includes individuals from both OHSU and Salem and the hospitals of both entities will be managed on a combined basis with integrated financial and capital planning. The OHSU Partners budgets have to be approved by both the OSHU board and Salem board. The profitability (operating income) of the combined entity is split based on each entity's historical share of financial performance (Salem 19%, OHSU 81%). The expectation is that growth will be greater as a combined entity as the entities leverage each other's resources, capacity, and capabilities.
Fitch views this relationship favorably as it allows Salem to be part of a larger system while maintaining local control. However, effective implementation and consensus on a shared strategic vision can be challenging achieve.
Strong Fiscal 2015 Performance
Salem's operating performance significantly improved in fiscal 2015 due to very strong volume growth, benefits from Medicaid expansion, and continued focus on reduction in costs through lean management practices. Salem's emergency room had 103,849 visits in fiscal 2015 and was up 8% from the prior year while discharges increased 6.5%. Through lean management and other action plan projects, Salem achieved efficiency improvement through reducing waste and reducing costs in the management of heart failure, sepsis and diabetes. Operating income was \\$54 million (7.8% operating margin; 15.4% operating EBITDA margin) compared to 4.2% and 12.2%, respectively in the prior year.
The ten year financial plan for OHSU Partners is expected to be complete in spring 2016; however, Salem has long term targets of maintaining at least 12% operating EBITDA margins.
Solid Liquidity
Salem's liquidity metrics are solid for the rating level and unrestricted cash and investments have steadily increased year over year since fiscal 2012. Unrestricted cash and investments totaled \\$491.6 million at Sept. 30, 2015, which equated to 299 days cash on hand and 165.6% cash-to-debt from 255.1 and 114.6%, respectively at fiscal year end 2012.
Elevated Capital Spending in Fiscal 2016
There are several large projects planned in fiscal 2016 and include a new outpatient rehabilitation building, adding 40 beds in currently shelled space, and investing in information technology (Epic) for its community connect program for independent physicians. Capital spending is elevated in fiscal 2016 and projected to total \\$66.6 million (for full year; 1.9x depreciation expense) with \\$51.4 million total expected in the shortened fiscal 2016 with a new June 30 fiscal year end. This compares to capital spending at 1.2x depreciation expense in fiscal 2015, 1.4x in fiscal 2014 and under 1x in fiscal 2013 and 2012. Fitch believes the elevated capital spending is manageable based on Salem's financial profile. There are currently no plans for additional debt; however, a master facility plan is underway.
Moderating Debt Burden
Salem's debt burden has been moderating with maximum annual debt service (MADS) accounting for 3.2% of total revenue in fiscal 2015 down from 4.2% in fiscal 2012 but still above Fitch's A category median of 2.8%. MADS coverage has also improved over the same time period due to better profitability with 5.6x in fiscal 2015, 4x in fiscal 2014, 3.7x in fiscal 2013 and 2.8x in fiscal 2012 compared to Fitch's A category of 4.2x. MADS is \\$22.4 million and debt service is fairly level and declines to about \\$20 million at final maturity in 2036.
As of Sept. 30, 2015, Salem had \\$294.4 million of bonded debt outstanding; with a debt mix of 75% underlying fixed rate and 25% underlying VRDBs. Salem's VRDB exposure totals \\$75 million (series 2008C) and is supported by a letter of credit (LOC) from US Bank that expires April 2018. There is an 18-month term-out period under the reimbursement agreement if there is a draw on the LOC.
Salem issued two direct bank loans in June 2013 that totals \\$70 million (\\$35 million series 2013A with JP Morgan and \\$35 million series 2013B with US Bank) to refinance \\$50 million series 2008C VRDBs and provide \\$20 million of new money. The direct bank loans are fixed rate and have an initial term to June 2020. The covenants under the direct bank loan are more restrictive than the covenants in the master trust indenture.
Including the impact of Salem's fixed payor swap, Salem has 100% fixed-rate debt. The swap is with UBS and the collateral posting threshold is \\$20 million. Currently, no collateral posting is required.
Disclosure
Salem Health only covenants to provide annual audited financial statements to the Municipal Securities Rule Making Board's EMMA system, which is viewed negatively; however, quarterly disclosure has been provided voluntarily.
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