News Column

Fitch Downgrades National Jewish Health (CO) Revs to 'BB+'; Outlook to Stable

February 20, 2014

Fitch Ratings has downgraded to 'BB+' from 'BBB-' the rating on the following revenue bonds issued by the Colorado Health Facilities Authority on behalf of National Jewish Health (NJH):

--$24,145,000 series 2012 fixed-rate bonds

--$11,100,000 series 2005 variable-rate demand bonds

The series 2005 bonds are secured by a letter of credit (LOC: UMB Bank, National Association).

The Rating Outlook is revised to Stable from Negative.

SECURITY

Pledge of gross revenues excluding restricted charitable donations and grants.

KEY RATING DRIVERS

GROWING OPERATING LOSSES: The downgrade to 'BB+' reflects persistent large operating losses in fiscal 2013, which weakened further through the 2014 interim period. Operating margin was negative 4.4 percent in fiscal 2013 and negative 9.6 percent through the six-month interim period. Further rating movement is precluded at this time given NJH's adequate liquidity position and coverage of debt service as calculated under the Master Trust Indenture (MTI), and the joint operating agreements (JOA) underway.

HIGHLY SPECIALIZED SERVICES: NJH is a national leader in the treatment of respiratory and related diseases with a focus on research and teaching. Over the last five years, NJH has significantly expanded its clinical capabilities to provide more comprehensive care to its patients with the majority of its services currently provided in an outpatient setting.

ADEQUATE BALANCE SHEET: Liquidity and leverage indicators are satisfactory at the 'BB+' rating. However, a sizable line of credit is utilized for operating expenditures, diluting NJH's overall balance sheet position.

JOA WITH EXEMPLA ST. JOSEPH HOSPITAL: In September 2013, NJH signed a letter of intent with Exempla St. Joseph Hospital (ESJH; part of Sisters of Charity of Leavenworth, revenue bonds rated 'AA- ') to form a JOA to collaborate in providing inpatient and outpatient services. Through a newly created not-for-profit entity, the two hospitals will provide services at multiple locations including NJH's campus and ESJH's new facility to be named and opened in December 2014. Fitch believes this JOA is a favorable opportunity for NJH to grow its clinical capacity with minimal capital outlay.

RATING SENSITIVITIES

ADEQUATE MTI COVERAGE OF DEBT: The Stable Outlook is predicated upon Fitch's expectation that NJH will continue producing sufficient net income available for debt service as calculated under the MTI. Inability to do so could lead to further negative rating action.

SUCCESSFUL EXECUTION OF JOA: Fitch believes the JOA with ESJH will provide growth opportunities in NJH's clinical business, and can lead to increased revenue growth. Effective execution leading to improved operating profitability could result in a return to the investment-grade rating category.

CREDIT PROFILE

NJH is a national referral medical institute engaged in patient care, medical research, and teaching, primarily in the areas of respiratory, cardiac, allergic, and immunologic medicine. NJH only has 46 licensed beds and the majority of its services are provided on an outpatient basis. The medical staff currently provides inpatient care at Denver area hospitals. Total revenue for fiscal year ended June 30, 2013 was $197.7 million, approximately 80 percent of which was generated by clinical and research activities.

Increasing Operating Losses

Operating profitability further weakened in fiscal 2013 with a negative 4.4 percent operating margin compared to negative operating margins of 4 percent in 2012 and 1.5 percent in 2011. Deterioration in profitability accelerated through the six-month interim period ended Dec. 31, 2013, with a negative operating margin of 9.6 percent as compared to a negative 5.5 percent operating margin in the prior year period.

Historically, NJH's highly profitable clinical operations, along with philanthropic contributions, have offset substantial operating losses incurred by the organization's research activities. Losses from research activities exceeded $20 million over the last several years. While management noted various strategies are in place to bring annual losses below $20 million, meaningful progress is not expected in the near term. In 2013, clinical operations were negatively affected by a one-time write-off of receivables resulting from changes in Medicare Molecular Diagnostic reimbursements.

Management is projecting profitability to improve in fiscal 2014, supported by enhanced clinical operations and philanthropic contributions. However, due to heightened expenditures in physician investments and timing of certain funds released from restriction, net income was negative through the six-month interim period and will likely remain weak through the end of fiscal 2014.

Philanthropy activity has been solid, with annual fundraising levels of over $20 million. NJH is currently in the process of completing its largest campaign yet, with the goal of raising $250 million that includes $150 million to fund outpatient facility expansions and other clinical and research projects.

Joint Operating Agreement with Exempla St. Joseph Hospital

In September 2013, NJH and ESJH signed a letter of intent to form a JOA to partner in providing inpatient and outpatient care. The JOA will be co-governed and named to reflect both the NJH and ESJH brands. ESJH is in the process of constructing a new facility, which is expected to be occupied by both NJH and ESJH.

Fitch believes this opportunity should yield clinical and financial advantages to NJH, as the organization had initially planned to build an inpatient tower to expand inpatient capabilities. This JOA will provide the physical capacity needed for NJH. Additionally, NJH should be able to capitalize on revenue growth opportunities by having access to a larger network and develop a continuum of care. Research should benefit as well through increased access to patients and clinical trials.

NJH management indicated the transaction is currently undergoing due diligence review, with the goal of signing a definitive agreement in the first quarter of calendar year 2014. NJH is expected to continue operating outpatient and some inpatient programs on its existing campus and begin admitting patients at the new facility in December 2014. Financial reporting should remain relatively similar to prior years, as assets and liabilities will remain separate.

10-Year Strategic Plan

NJH is continuing its strategic plan begun in 2007, which focuses on clinical and research capabilities as well as philanthropy. NJH has increased the depth and breadth of services offered over the last several years, and the JOA with ESJH is consistent in executing existing goals.

In addition, NJH is partnering with Icahn School of Medicine (SOM; part of Mount Sinai Hospital, revenue bonds rated 'A', Stable Outlook) to create a respiratory institute in New York City. This venture is NJH's first major project outside of Colorado, and will be located on the SOM campus. Fitch believes this partnership should enhance NJH presence and brand as well as revenues and fundraising.

Adequate Liquidity

As of Dec. 31, 2013, unrestricted cash and investments totaled $52.1 million including available earnings from the Permanent Endowment, which is fully accessible to NJH with board approval. Liquidity metrics equating to 100.1 days cash on hand, 9.4x cushion ratio, and 85.4 percent cash-to-debt are sound for the rating category, and provide some cushion as NJH executes strategic plans.

Weak Debt Metrics

Total outstanding debt as of Dec. 31, 2013 was $61 million, which included $49.2 million in bonds and capital leases and $11.8 million drawn on an operating line of credit. Fitch is treating the line of credit as long-term debt based on NJH's intentions to leave it outstanding for the foreseeable future. The bonds and capital leases are 77 percent fixed rate and 23 percent floating rate. The $11.1 million series 2005 variable-rate demand bonds are supported by an LOC from UMB bank that renews automatically (current expiration date is March 1, 2015).

Fitch used a maximum annual debt service (MADS) of $5.6 million occurring in 2015. There is a $6.3 million bullet maturity due in 2017 related to the 2011 Gove School Property Note, which Fitch excluded for MADS purposes due to management's stated goals to pay off the note with fundraising and NJH's history of success with philanthropy. MADS comprised $3.5 million for bonded debt, $980,000 for capital leases, $780,000 for the 2011 note, and $325,000 in interest payments estimated for the line of credit. MADS drops to $4 million in 2018. Coverage of MADS by EBITDA was weak at 1.4x in fiscal 2013, and deteriorated significantly to negative 0.3x in the six-month interim period (based on unrestricted funds).

While debt service coverage metrics calculated per Fitch's definition are concerning, the MTI allows for inclusion of certain displacements of restricted funds in net income available. In addition, coverage is tested only on bonded debt. MADS coverage calculated under the MTI using a MADS of $3.2 million was 6.4x in 2013 and 3.1x in 2012. MTI calculations are performed and disclosed only on an annual basis, but using the same methodology, management estimated MADS coverage of 2.4x through the six-month interim period.

Modest Capital Needs

Routine capital expenditures are around $3 million-$4 million annually, and budgeted at $4 million in fiscal 2014. Capital plans have been scaled back due to the JOA and planned outpatient facility expansion is contingent upon success of the capital campaign. Other capital plans will be evaluated after the initial implementation process of the JOA.

DISCLOSURE

NJH covenants to disclose audited financial statements within 150 days of the end of the fiscal year. Quarterly unaudited financial information is disclosed within 45 days of the close of the first three quarters of the fiscal year and within 90 days of the close of the fourth quarter. Financial statements are posted to the Municipal Securities Rulemaking Board's EMMA system.

Additional information is available at 'fitchratings.com'.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', June 3, 2013

--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', May 20, 2013

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=709499

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=708361

Additional Disclosure

Solicitation Status

http://fitchratings.com/gws/en/disclosure/ solicitation?pr_id=820676

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