Fitch Ratings affirms the 'BBB+' rating on the following Health and Educational Facilities Board of the City of Johnson City, Tennessee, bonds issued on behalf of Mountain States Health Alliance (MSHA):
--$55,000,000 hospital revenue bonds (Mountain States Health Alliance), series 2012A;
--$5,415,000 hospital revenue bonds, series 2009A;
--$167,730,000 hospital first mortgage revenue bonds, series 2006A;
--$20,400,000 hospital first mortgage revenue bonds, series 2001A;
--$34,645,000 hospital first mortgage revenue refunding bonds, series 2000A;
--$30,750,000 hospital first mortgage revenue bonds, series 2000C.
In addition, Fitch affirms the following parity debt issued on behalf of MSHA:
--$5,400,000Industrial Development Authority of Smyth County hospital revenue bonds, series 2009B;
--$111,265,000Industrial Development Authority of Washington County Virginia, hospital revenue bonds, series 2009C;
--$13,245,000Mountain States Health Alliance taxable note, series 2000D.
The Rating Outlook is Stable.
Pledged assets and a mortgage on Johnson City Medical Center and Sycamore Shoals Hospital. In addition, there is a debt service reserve fund on certain series of debt.
KEY RATING DRIVERS
SOFTER FY2013 OPERATING PERFORMANCE: Net patient service revenue fell 2 percent year over year, which led to a drop in MSHA's operating margin to 1.1 percent from 1.7 percent. The weaker performance was driven by lower inpatient volumes and a continued rise in observation days.
OPERATING CASH FLOW SUFFICIENT: In spite of the weaker operating margin, MSHA's operating EBITDA margin remained steady at 13.2 percent, exceeding Fitch's 'BBB' category median of 9.9 percent.
HIGH DEBT BURDEN: MSHA's high debt burden remains a key credit concern. It pressures MSHA to maintain the strong cash flow levels in order to support debt service that has historically been adequate for the rating level.
MARKET FOOTPRINT A CREDIT STRENGTH: MSHA is a 14-hospital system that covers a 29 county service area and maintains a leading 53 percent market share in its primary service area.
MIXED LIQUIDITY INDICATORS: Through the four-year historical period days cash on hand (DCOH) has been solid at over 200 days; however, liquidity metrics relative to debt (cushion ratio and cash to debt) are weaker reflecting the elevated debt burden.
CAPITAL SPENDING SLOWING: After several years of heavy capital investment, a moderation of capital spending is expected beginning in fiscal 2014, which should provide MSHA with a measure of financial flexibility.
THINNER OPERATING PERFORMANCE: MSHA has been challenged by lower inpatient volume, which has eroded its operating margin. While first quarter volumes are still down year over year, patient service revenue is up along with inpatient surgery volumes. Additionally, MSHA continues to aggressively manage expenses, but a further erosion of its operating margin could lead to negative rating pressure.
REFORM INITIATIVES: MSHA has made material investments in positioning the organization for health care reform. These initiatives include starting up a health plan, forming a Medicare ACO, and increasing physician engagement across the organization. A key for MSHA will be its ability to realize a financial return on these strategies after the initial investment for these initiatives.
Headquartered in Johnson City, Tennessee, MSHA was formed in 1998 from the acquisition of five hospitals in Tennessee from Columbia/ HCA and has grown into a large regional health care system with 14 hospitals (1,623 licensed beds) and other related entities, primarily serving northeast Tennessee and southwest Virginia. MSHA has a membership interest (ranging from 50.1 percent-80 percent) in three of the hospitals in the system (Smyth County Community Hospital, Norton Community Hospital, Johnston Memorial Hospital). In fiscal 2013 (June 30 year end), MSHA had total operating revenue of $1 billion.
At the end of calendar year 2013, MSHA's long serving CEO retired and a new CEO started. Fitch views the transition as a credit neutral. The retirement was planned in advance, providing MSHA ample time to undertake a thorough search. The new CEO, whom Fitch met with, has extensive industry background, including most recently managing a group of hospitals at a for profit health care organization.
Softer FY13 Performance
From fiscal 2012 to fiscal 2013, MSHA's operating margin fell to 1.1 percent from 1.7 percent. The drop in operating performance was driven by a decline in inpatient volume coupled with a rise in observation days, especially at its main tertiary hospital, Johnson City Medical Center (JCMC). In fiscal 2013, JCMC's inpatient volume declined 6.4 percent from the prior year (compared to a system decline of 5 percent), while observation days, which are reimbursed at a lower rate than inpatient days, increased 6.2 percent at both JCMC and across the system.
The lower inpatient volumes led to a year over year decline in net patient service revenue, which declined 4.8 percent at JCMC (JCMC accounts for approximately 51 percent of MSHA's patient service revenue) and 2 percent system wide. Total operating revenue at MSHA did increase but was helped by an additional $17 million of federal meaning full use funds in fiscal 2013.
As a result, in fiscal 2013, system operating income fell to $11.5 million from $16.9 million in fiscal 2012. MSHA is budgeting for an operational improvement in fiscal 2014. To achieve this, MSHA has a strategy to address observation stays through improved physician documentation and physician education and is also implementing cost reductions, including a recent layoff of 161 full- time equivalents. MSHA continues to manage expenses through its LEAN practices as well.
First quarter performance is generally the weakest quarter and in the first quarter of 2014, MSHA operating margin was negative 1.6 percent, an improvement from a negative 2.6 percent in the first quarter of fiscal 2013. As important, net patient service revenue grew year over year. Fitch believes that MSHA will be able sustain the rate of operating improvement through the rest of the fiscal year.
Also helping to mitigate the operating margin concerns is MSHA's operating EBITDA, which has remained above category medians. In fiscal 2013, MSHA's operating EBITDA was 13.2 percent, and it was 11.1 percent in first quarter 2014, both above the category median of 9 percent.
HIGH DEBT BURDEN/CAPITAL SPENDING ABATING
MSHA's debt burden is elevated for the rating level and puts added pressure on MSHA to sustain solid cash flow. Both maximum annual debt service (MADS) as a percent of revenue at 7.6 percent and debt to EBITDA of 9.1x are significantly higher than Fitch's' 'BBB' category medians of 3.5 percent and 3.8x, respectively. MADS coverage by EBITDA in fiscal 2013 was an adequate 2.1x, compared to a median of 3.1x.
However, MSHA is ending an extended period of intense capital investment. Over the last six years, capital spending averaged approximately 180 percent of depreciation relative to a median of 110.1 percent. Major capital projects completed over this time include the building of three replacement hospitals. Moving forward, Fitch expects MSHA's capital spending to reduce to a more manageable level, closer to 100 percent of depreciation. This should help ease MSHA's leveraged position and provide a measure of financial flexibility as MSHA's works to improve operations.
As of Sept. 30, 2013, MSHA had $606.3 million of unrestricted cash and investments, equating to a solid 244.6 days cash on hand, which compares favorably to Fitch's 'BBB' category median of 144.7 days. Cash-to-debt of 54.7 percent compared unfavorably to the 'BBB' category median of 91.7 percent and also reflects MSHA's sizeable debt load. Unrestricted cash and investments have grown approximately 14 percent since fiscal year end 2012, when it was at $531.2 million.
Fitch continues to view MSHA's debt structure as aggressive relative to its rating level, with a number of swaps and approximately $425 million in variable rate debt. In the last year, MSHA did restructure most of its variable rate debt to mitigate some of the put, renewal, and remarketing risk. Prior to the restructuring, the vast majority of MSHA's variable debt was supported by bank letters of credit (LOCs), with the LOCs expiring on the same date for approximately $400 million of the debt.
Post-restructuring, MSHA directly placed about half of the variable rate debt ($211 million) with three different banks, removing near-term put and remarketing risk for that debt. MSHA also negotiated to stagger the timing of the mandatory put dates for the private placements and the expiration dates on the LOCs. These dates now range from three to 10 years, with a maximum amount of debt coming due on any single date at a much more manageable level of $192 million. Fitch views these changes positively.
MSHA's total outstanding long term debt is approximately $1.1 billion with approximately 58 percent fixed rate and 42 percent variable. MSHA has approximately $570 million in outstanding swaps, which are composed of basis swaps and constant maturity basis swaps. Bank of America is the counterparty for all of the swaps. The lack of counterparty diversity exposes MSHA to a higher level of counterparty risk. As of November 30, 2013, the aggregate mark to market of the swaps was a negative $14.1 million. No collateral is currently being posted for the swaps.
MSHA covenants to provide annual and quarterly financial and operational disclosure to EMMA.
Additional information is available at 'fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria' (May 20, 2013).
Applicable Criteria and Related Research:
U.S. Nonprofit Hospitals and Health Systems Rating Criteria
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