SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A+' rating to the approximately $386 million District of Columbia Hospital Refunding Revenue Bonds series 2015 issued on behalf of Children's National Medical Center (CNMC). In addition, Fitch has upgraded the rating on CNMC's outstanding debt to 'A+' from 'A'. The outstanding debt is listed at the end of this press release.
The Rating Outlook is Stable.
The series 2015 bonds will be fixed rate and will refund the series 2005 and 2008 bonds, dependent on market conditions and targeted net present value savings. The current plan of finance includes the release of the debt service reserve fund ($27 million). The bonds are expected to price the week of June 22 via negotiation.
SECURITY
The bonds are secured by a gross revenue pledge and mortgage pledge of the obligated group (OG). The OG includes the hospital and foundation, which accounted for 95% of the consolidated entity's total assets and 93% of total revenue in fiscal 2014 (June 30 year end). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
SIGNIFICANT POSITIVE TRAJECTORY: The upgrade to 'A+' from 'A' reflects CNMC's sharp improvement in financial performance since Fitch's last rating review in Dec. 2013 (when the rating was upgraded to 'A' from 'A-') with performance exceeding expectations and the expectation of sustaining the higher level of performance. The majority of CNMC's financial ratios exceed Fitch's 'A' category medians. The sharp improvement through the nine months ended March 2015 is due to the realization of the benefits of the strategic initiatives put in place by a management team led by a physician CEO who has been in place for less than four years and replaced over two thirds of the executive management team with recruitments from renowned organizations and high performers from within the organization.
STRONG MARKET POSITION: CNMC maintains a leading and growing market position in its service area for pediatric services. There has been improved market share in key clinical services lines due to program investments. Growth is expected to continue due to ongoing partnerships with adult providers and two fairly new relationships include a joint venture with Inova and a pediatric radiation oncology and proton therapy program with Sibley Memorial Hospital (part of Johns Hopkins Health System, rated 'AA-'). Given its location in the nation's capital, advocacy and public health policy are strategic imperatives, which will continue to differentiate the organization and assist in the shift to value based reimbursement.
MOVE TO VALUE BASED ENVIRONMENT: CNMC is in the process of developing an integrated network and aligning with community/independent physicians to be able to manage population health. CNMC is part of a Center for Medicare and Medicaid innovation award for a population health demonstration project to promote better care for children with medically complex diseases while lowering costs.
ONGOING CAPITAL NEEDS: CNMC's master facility plan resulted in a significant renovation and expansion of its facility that included the construction of a new patient tower, which is all complete. Volume growth has been solid and Fitch believes one of CNMC's challenges will be meeting demand. Management states that there are no major projects on the horizon and no additional debt plans. The three year capital plan remains relatively healthy at over 1x depreciation expense with various projects at the main facility, growth of regional outpatient centers and urgent care, as well as information technology.
HIGH EXPOSURE TO MEDICAID: Like most children's hospitals, CNMC is vulnerable to reductions in governmental funding with approximately 55% of its gross revenues from Medicaid. CNMC is exposed to three different programs given its location and the funding is flat for the current year. CNMC is in discussions with various Medicaid payors regarding alternative Medicaid payment strategies, which could be in place by next year.
RATING SENSITIVITIES
SUSTAINED PERFORMANCE EXPECTED: Fitch expects Children's National Medical Center's current run rate to continue due to the ongoing investment in its clinical enterprise and aligned medical staff (all employed physicians) as well as other operational improvement initiatives to provide greater efficiency, value and quality. An increase in debt or return to historical performance, although not expected, would likely result in negative rating pressure.
CREDIT PROFILE
Located in Washington, DC, CNMC is a nationally recognized full-service tertiary and quaternary pediatric hospital with 313 licensed beds (54 NICU beds) and a level I pediatric trauma center. CNMC has a regional network of eight outpatient centers and over 700 employed physicians (900+ including affiliated pediatricians). A major gift funded a strong investment in research and total research grants were $73 million in fiscal 2014 ($40 million from NIH). CNMC had 21,502 admissions and observation visits, 493,073 outpatient visits, 17,449 operating room cases and $1.052 billion in total revenue in fiscal 2014.
Higher Level of Financial Performance
After a rating upgrade in December 2013, CNMC's performance continues a sharp positive trajectory with performance through the nine months ended March 31, 2015 exceeding expectations and projections presented in 2013. The current rating upgrade to 'A+' reflects the expectation that the higher level of performance will be sustained.
Through the nine months ended Mar. 31, 2015, CNMC had a 5.6% operating margin compared to 1.1% the same prior year period, 3.4% in fiscal 2014 and 1.2% in fiscal 2013. Operating EBITDA margin was 13.1%, 9.1%, 10.8% and 8.5%, over the same time period. The strong improvement in profitability has been driven by continued volume growth and realization of operational improvements mainly in the areas of revenue cycle and labor productivity as well as reduced losses on employed physician practices. Also aiding profitability is the reduction in malpractice expense due to the organization's safety program, which encourages incident reporting and the serious safety event rate declined 60% over the last three years. Fitch notes that CNMC does not rely on any supplemental funding and disproportionate share funds totaled less than $500,000 for fiscal 2015 compared to $20.6 million in fiscal 2010. CNMC expects to end fiscal 2015 with a 13.1% operating EBITDA margin compared to the A category median of 9.5%.
Strong revenue growth has been driven by affiliations with other providers as well as physician recruitment and improved physician productivity. CNMC has had a long history of employing its entire medical staff, which pressures expenses, however, management has been focused on reducing the losses, which has been achieved year to date through nine months ended Mar. 31, 2015, with an opportunity for further improvement.
The fiscal 2016 operating EBITDA margin projection is 11.6%, which includes some conservatism related to the operational improvement initiatives (no additional improvements achieved) and no volume increases. Fitch expects the projection to be met or exceeded.
Growing Liquidity
Total unrestricted cash and investments were $670.8 million as of Mar. 31, 2015 and have markedly improved since fiscal 2009. Days cash on hand was 255.7 and cash-to-debt was 144.3% compared to 142 and 68%, respectively, at fiscal year end 2009 and the A category medians of 199.2 and 131.2%. Liquidity has improved partially due to the issuance of $75 million of taxable debt, which is being used to build the balance sheet. The funds are in a separate board designated account and there are no current plans to spend the funds. CNMC's investment portfolio is conservative and very liquid with approximately 60% cash and fixed income and 40% equities.
Strong Market Position
CNMC is a freestanding pediatric teaching facility that maintains a strong market position as the leading pediatric provider in its service area. In the combined primary service area and secondary service area (accounts for over 90% of discharges), market share has increased to 44.1% in fiscal 2014 from 39.1% in fiscal 2012. The competitors are adult facilities that provide pediatric services and the second leading provider is Inova-Fairfax. Market share in specific specialties are higher especially in neonatal, cardiac and neurosurgery. CNMC's ongoing strategies include hospital partnerships with the adult providers in the service area to increase tertiary referrals to its facility while keeping primary pediatric care local as well as providing pediatric subspecialty coverage and management of certain high-acuity service lines, such as neonatal intensive care. Management states that the joint venture with Inova-Fairfax is yielding the results expected as a higher level of pediatric subspecialty care is being provided to the Northern Virginia market.
Fully Aligned Medical Staff
A key part of its growth strategy relies on CNMC's strong breadth of physician subspecialists on staff, all of which are employed. The medical staff has been growing and there were over 700 employed physicians in fiscal 2014. CNMC's medical staff serves as the Department of Pediatrics for George Washington University. Fitch views the alignment with the medical staff positively as it should further assist CNMC in redesigning patient care that could lead to lower costs and improved quality. The physician group generates large operating losses, which have been reduced through the nine months ended Mar. 31, 2015 due to improved managed care rates and ability to assess time allocation to various physician duties (clinical, administrative, research, teaching).
Growth in Philanthropic Support
In addition to its clinical activities, CNMC maintains a strong presence in education and research, which generates philanthropic activity. CNMC trains approximately 100 residents a year and has over 150 pediatric subspecialty fellows.
The organization received its largest gift in its history in 2009, which was a $150 million gift from the United Arab Emirates. CNMC created the Sheikh Zayed Institute for Pediatric Surgical Innovation and the gift funded an endowment that provides operational support for the institute. The total gift has been received. CNMC has invested in growing its development staff and the amount of annual giving increased to $56 million in fiscal 2014 from $30 million in fiscal 2011. This is expected to increase to $90 million a year.
Ongoing Capital Needs
After the investment in its inpatient facility that was mainly funded by the series 2005 and 2008 bonds, ongoing capital needs total $218 million for fiscal 2016-2018 for ongoing main campus improvements, increasing the number of regional outpatient centers and urgent care facilities, as well as equipment and information technology. Total capital spending is projected to be $68.9 million in fiscal 2016, $72 million in fiscal 2017 and $77 million in fiscal 2018. Management indicates that there are no major expansion plans and despite solid volume growth, CNMC maintains capacity within its system. CNMC outsourced its information technology (IT) to Cerner to create a predictable level of IT spend and has partnered with Cerner on the nation's first pediatric research institute devoted to health IT. These initiatives include linking genomic profiles for personalized care, increasing patient engagement, and creating interoperability among various IT systems.
Conservative Debt Profile
CNMC has targeted net present value savings on the proposed refunding of the series 2005 and 2008 insured bonds and either one or both of the series of bonds are expected to the refinanced dependent on market conditions.
CNMC's total outstanding debt is expected to total $456 million after the series 2015 issuance and would be 83.6% underlying fixed rate and 16.4% underlying variable rate. The variable rate exposure is on a $75 million taxable direct bank loan that is at an indexed floating rate through an initial term to March 2018. CNMC's $17.5 million series 1992 bonds (purchased by one of CNMC's subsidiaries) will be cash defeased by the end of the fiscal year.
CNMC has orphan floating- to fixed-rate swaps, which will remain outstanding and insured after the series 2015 transaction. The swaps do not require collateral posting at CNMC's current rating level. The current mark-to-market valuation as of March 31, 2015 was negative $25.9 million. CNMC would be required to post collateral if its rating was downgraded to 'BBB+' or below.
There are more restrictive financial covenants related to the bank loan and insured swap agreement compared to the master trust indenture (MTI) (i.e. MTI rate covenant is 1.2x MADS, bank loan/insurer is 1.5x plus days cash on hand and debt to capitalization tests).
Current maximum annual debt service (MADS) is $31.4 million and would drop to $29.5 million with the series 2015 refinancing. Debt service coverage has improved significantly through the nine months ended Mar. 31, 2015 due to improved financial performance with 5x coverage compared to 3.8x in fiscal 2014 and 3.1x in fiscal 2013 based on the current MADS. Debt service coverage would improve to 5.3x, 4x and 3.3x for the same time period based on the proforma MADS compared to the A category median of 3.8x.
Disclosure
CNMC covenants to provide audited annual financial statements within 150 days of fiscal year end and quarterly disclosure within 75 days of the quarter end for the first three quarters to the Municipal Securities Rulemaking Board's EMMA system.
Outstanding Debt
$143,300,000 District of Columbia Hospital Revenue Bonds (Children's Hospital Obligated Group Issue) Series 2005
$250,000,000 District of Columbia Hospital Revenue Bonds (Children's Hospital Obligated Group Issue) Series 2008
Additional information is available at 'www.fitchratings.com'.
In addition to the source(s) of information identified in the Revenue Supported Rating Criteria, this action was additionally informed by information from the underwriter.
Applicable Criteria
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 30 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860
Additional Disclosures
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985902
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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