NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded to 'A+' from 'AA-' the rating on the following series of bonds issued by the Kentucky Economic Development Finance Authority for the benefit of Baptist Healthcare System (BHS).
--$140 million series 2011;
--$189.7 million series 2009A;
--$284.4 million series 2009B.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a pledge of the gross revenues of the obligated group consisting of BHS and Baptist Healthcare Affiliates, Inc. (BHA). The obligated group represents approximately 71% of system revenues and 94% of system assets. Fitch reports on the performance of the consolidated system.
KEY RATING DRIVERS
WEAKENED PROFITABILITY: BHS's profitability declined over the last two years with a weak fiscal 2012 and a projected loss of $26.3 million in fiscal 2013 (year-end Aug. 31). The weak performance is driven by increasing subsidy to the system's employed physician groups and losses at two recently acquired hospitals (the physician groups and the new hospitals are not in the obligated group) resulting in an operating profitability which is now more consistent with Fitch's 'A' category.
MAJOR PHYSICIAN LOSSES: Management is projecting a loss of $89 million related to its physician strategy in fiscal 2013. BHS has retained Huron Consulting Group to address a number of system-wide issues, including the physician losses, and is expecting a minimum two year margin improvement of $56 million at the system level. The physician subsidy remains a major concern for the system.
MAINTAINED LIQUIDITY: BHS's liquidity metrics continue to be strong with management projecting the 2013 year-end to finish with over 210 days cash on hand (DCOH), cushion ratio of 29.5x and cash equal to 172% of debt.
MANAGEABLE DEBT LEVEL: Coverage of maximum annual debt service (MADS) by EBITDA was 3.7x through the third quarter ended May 31, 2013, and is projected to remain at that level for year-end 2013. MADS as a percent of revenues, at 1.9%, is light for the 'A' category.
RATING SENSITIVITIES
NEED FOR OPERATIONAL IMPROVEMENT: Fitch expects management's recent actions addressing the weak operating results to produce improved operating performance. Failure for the initiatives to reverse the loss over the near term would likely result in further negative rating pressure.
CREDIT PROFILE
BHS, headquartered in Louisville, is a large integrated healthcare system with seven hospitals and revenues of approximately $1.9 billion. Two hospitals were added to the system in the fall of 2012, but not to the obligated group - the 105-bed Baptist Health Richmond (BHR; f/k/a as Pattie A. Clay Infirmary) and the 410-bed Baptist Health Madisonville (BHM). The assets of the two hospitals were contributed to the system; no money changed hands as part of the transaction as BHS assumed ownership of the two institutions. However, BHS has made a $50 million five-year capital commitment to BHR, as well as a commitment to BHM to spend the value of the working capital that existed at the time of the acquisition within the service area of the hospital. Following the retirement of long term CEO, a new system CEO was recruited in the spring of 2013 with over 30 years of experience in healthcare leadership, most recently as regional operations manager with Texas Health Resources.
The downgrade to 'A+' reflects the system's weakened financial results following lower volumes at the obligated group hospitals in 2013, its large investment in a physician alignment strategy and the losses related to the two recently acquired hospitals. The maintenance of the 'A+' rating and the Stable Outlook is based on a still solid balance sheet and leverage commensurate with Fitch's 'A' rating category.
WEAKENED PROFITABILITY:
BHS reported a loss from operations of $28.1 million for the third quarter of fiscal 2013 ended May 31, 2013, equal to a negative operating margin of 2% and a 4.3% operating EBITDA margin. While the 2013 audit is not yet available and the system does not prepare fourth quarter interim statements, management is expecting to end the 2013 fiscal year with a loss of $26.3 million, translating to a negative 1.4% operating margin and 5.1% operating EBITDA margin, as compared to Fitch's 'A' category medians of 3.3% and 10.7%, respectively. The most significant contributor to the loss is the system's investment in expansion of its employed physician strategy. Close to 60 physician positions were added in fiscal 2013 and the loss from the five physician groups is projected at $89 million and at $109 million in 2014. Management engaged the services of the Huron Consulting Group to address both revenue and expense issues, including the consolidation of the physician groups under a single leadership. Huron has projected to deliver a minimum $56 million operating margin improvement at the system level over a two year period. The system budget for fiscal 2014 is a loss of $15.1 million before any assumed improvement from the Huron engagement. Management also recently renegotiated a new three-year contract with Anthem, which is expected to generate over $16 million of incremental revenues.
LIQUIDITY MAINTAINED
Despite the recent operational challenges, the system liquidity levels have been maintained. The system reported $1.1 billion of unrestricted cash and investments at May 31, 2013, and management projects that the 2013 fiscal year will end with cash and investments essentially unchanged, equating to DCOH of 217 days, cushion ratio of 29.5x and cash equal to 172% of debt. With the exception of DCOH, these compare well with Fitch's 'AA' category medians of 254.3 DCOH, 23.4x cushion ratio and 173.6% cash to debt, respectively.
ADEQUATE DEBT SERVICE COVERAGE AND MODEST DEBT BURDEN
The system coverage by EBITDA was a solid 4.3x in 2012 and based on the expected results for 2013 EBITDA coverage at 3.7x would be consistent with the 'A' category median of 3.8x. Coverage based on operating EBITDA in 2013 would be a weaker 2.7x, compared to the 'A' median of 3.4x. MADS as a percent of revenues is a relatively moderate 1.9%. Of the system's approximately $605 million of outstanding long term indebtedness, 47% is variable rate and there are no swaps. The variable series 2008 bonds are secured by direct letters of credit with JPMorgan Chase and Branch Banking and Trust, with expirations in December 2015 and February 2016, respectively.
The system does not have any debt plans in the near future. The only major project underway is the conversion to all-private rooms and construction of a new NICU and obstetrics unit at Baptist Health Lexington. The $260 million project slated to be completed in 2016 is half-way completed and there are still $40 million of bonds funds remaining. The system's capital budget for 2014 is $179 million.
DISCLOSURE
The system covenants to disclose audited financial statements no later than 150 days after the fiscal year end and quarterly statements no later than 60 days after each quarterly end. Both audited and quarterly financial statements include management's discussion and analysis, income statement, balance sheet, cash flow statements and utilization statistics.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--Nonprofit Hospitals and Health Systems Rating Criteria, May 20, 2013.
Applicable Criteria and Related Research:
U.S. Nonprofit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=808997
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