CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA ' rating to the following bonds expected to be issued on behalf of Partners HealthCare System (Partners):
--$325,000,000 Massachusetts Development Finance Agency revenue bonds, series Q (2016).
The 2016 bond issue will be issued as a combination of fixed-rate tax-exempt or taxable debt depending on market conditions. In addition, Partners expects to issue an additional $100 million of direct placement bonds in March 2016. Combined bond proceeds will be used to (1) fund various capital projects as well as a portion of Partners' lease replacement projects, (2) refinance Partners' series K-4 bonds, and (3) pay costs of issuance. The 2016 bonds are expected to price the week of January 18th through negotiation.
Additionally, Fitch affirms the 'AA' long-term rating on approximately $3.6 billion of bonds issued by Partners or through the Massachusetts Health and Educational Facilities Authority or the Massachusetts Development Finance Agency on behalf of Partners and affirms the 'F1+' short-term ratings on approximately $173.3 million of bonds supported by Partners' internal liquidity.
The Rating Outlook is Stable.
SECURITY
Bond payments are unsecured obligations of the Partners HealthCare System parent company, supplemented with guarantees for debt service payments provided by Partners' two large tertiary facilities, Brigham and Women's Hospital and The General Hospital (commonly known as Massachusetts General Hospital), and their respective parents.
KEY RATING DRIVERS
LEADING MARKET POSITION AND QUALITATIVE STRENGTHS: Partners' leading market share in a competitive service area and its national reputation for clinical excellence provides it latitude in financial performance lagging its rated peers. Partners' national reputation and market position are enhanced by its role as the primary teaching affiliate of Harvard University's schools of medicine and dentistry.
COMPRESSED PROFITABILITY: Profitability has always been light for the rating level, but has been extremely consistent. Fitch recognizes that Partners is now in a period of heavy investment in strategic initiatives in health insurance operations, information technology and facilities, which may continue to compress profitability in the near term until the investment benefits are realized. Fitch notes that fiscal 2015 performance was better than expected.
ADEQUATE LIQUIDITY: Unrestricted cash and investments declined 9.5% to $6.7 billion at Sept 30, 2015 as a result of investment performance. Certain liquidity metrics (cushion and cash-to-debt) have been affected negatively by the increased debt assumed in order to fund Partners' lease replacement strategy, which is expected to generate cash flow savings over the longer term.
MODERATE DEBT BURDEN: The pro forma debt burden remains moderate with pro-forma maximum annual debt service (MADS) equal to 2.7% of fiscal 2015 revenues, including the expected issuance of the direct placement bonds. However, pro forma MADS coverage by EBITDA remains weak at 2.5x in fiscal 2015, reflecting Partners' light profitability.
ELEVATED CAPITAL SPENDING: Capital spending is projected to remain at elevated levels with a five-year capital plan of $5.2 billion. However, it is not expected to materially impact liquidity metrics.
SHORT-TERM RATING: At Sept. 30, 2015, Partners' eligible cash and investments would cover the maximum mandatory put on self-liquidity bonds on any given date well in excess of Fitch's 1.25x threshold for the 'F1+' short-term rating.
RATING SENSITIVITIES
MAINTENANCE OF LIQUIDITY POSITION: While Partners HealthCare System absorbs a period of compressed profitability related to investments in various strategic initiatives, including its health plan, Fitch expects the system to maintain its liquidity position in order to mitigate concerns related to the compressed profitability.
LIGHT BUT STABLE PROFITABILITY: Fitch acknowledges that operating profitability over the near term will likely continue to be pressured due to the implementation of eCare, Partners' integrated electronic revenue and clinical management system, and as the costs of the lease replacement strategy temporarily outweigh the benefits. Fitch believes that these investments will produce positive results over the longer term. Since operating profitability is already light for the rating level, a deviation from planned targets could result in negative rating pressure. Management has budgeted a 1% operating margin for fiscal 2016.
CREDIT PROFILE
Based in Boston, Partners is the largest health system in eastern Massachusetts, operating two tertiary acute care hospitals, seven community acute care hospitals, four specialty hospitals, and Neighborhood Health Plan (NHP), a managed care organization acquired in 2012. The system withdrew its plans to acquire South Shore Hospital and Hallmark Health System in 2015 due to anti-trust concerns. Total operating revenue equaled $11.7 billion in fiscal 2015.
LEADING MARKET POSITION
The 'AA' rating incorporates Partners' national reputation, clinical excellence and leading market position which help to enhance the organization's operating stability. Partners' 22.4% market share in eastern Massachusetts has been extremely stable and is nearly twice that of its nearest competitor. However, the service area remains competitive.
Partners includes two of the nation's leading academic medical centers, Brigham and Women's Hospital (BWH) and Massachusetts General Hospital (MGH). Both hospitals consistently rank among the top 10 hospitals in U.S. News' Best Hospital Honor Roll, with MGH ranked No.1 and BWH ranked No.6 in 2015.
Partners' national reputation is enhanced by its large research operations and status as the primary teaching affiliate of Harvard University's schools of medicine and dentistry. Partners has the largest non-university-based non-profit private medical research enterprise in the nation with approximately $1.5 billion in research expenditures in 2015. Additionally, MGH and BWH are the top two independent hospitals receiving National Institutes of Health research funds.
ADEQUATE LIQUIDITY
Unrestricted cash and investments decreased 9.5% to $6.7 billion at Sept. 30, 2015. The decline was due to weaker investment performance primarily in August and September, despite outperforming market benchmarks. As a result, liquidity metrics fell to 223.3 days cash on hand, 141.5% cash-to-pro forma debt and 21.7x cushion ratio and are light relative to Fitch's 'AA' category medians of 289.4 days, 201.7%, and 27.0x. Fitch notes that Partners' large research expenditure is dilutive to its days cash on hand ratio. Fitch expects that liquidity metrics will improve as the investment markets rebound. Capital projects are not expected to impact liquidity. Fitch's analysis adjusts for unrealized gains that are not captured on the balance sheet at Sept. 30, 2015, due to Partners' cost accounting treatment of certain investments.
CONTINUED COMPRESSED PROFITABILITY
Consolidated operating profitability rebounded in fiscal 2015, with operating margin increasing to 1.8% (excluding non-recurring revenue and expenses) from negative 0.2% in fiscal 2014. Including non-recurring revenue and expenses, operating margin equaled 0.9%. Operating profitability has been historically light for the rating category, but prior to the decline in fiscal 2014, it was extremely stable with operating margins averaging 2.4% from 2009-2013. Excluding NHP and non-recurring items, core provider profitability was consistent with historical results in fiscal 2015 with operating margin improving to 2.3%.
The historically stable profitability has been a key credit factor, as management has consistently achieved their operating margin targets of between 2% and 3% each year. Fitch notes that Partners' historical profitability has been diluted by its large research operations which account for over $1.5 billion of operating revenue.
The decreased profitability in fiscal 2014 was primarily due to a $202 million operating loss at NHP in addition to costs related to Partners' lease replacement project and implementation of a new IT system (Partners eCare). The improvement in consolidated fiscal 2015 results was primarily due to increased health plan membership revenue, particularly among commercial members, and a stabilizing medical loss ratio as well as improvement in core hospital operations.
Fitch notes that profitability will continue to be hampered in fiscal 2016 especially due to expenses related to its eCare implementation. Management is budgeting for a 1% operating margin, or 1.8% excluding non-recurring these expenses.
Over the longer term, Fitch expects consolidated operating profitability to improve as Partners begins to realize the benefits of its Partners eCare and lease replacement projects and as NHP operations continue to improve. Additionally, management is targeting significant cost reductions over the next three to five years.
MODERATE DEBT BURDEN
Including the expected issuance of the direct placement bonds, the 2016 financing will increase total debt outstanding by approximately $350 million to $4.7 billion. Pro forma MADS is estimated to increase to $309.2 million from $287.7 million. Despite the additional debt, Partners' debt burden remains relatively unchanged with pro forma MADS equal to 2.7% of fiscal 2015 revenues due to revenue growth. However, pro forma leverage is elevated with pro forma debt-to-capitalization equal to 50.2%, exceeding Fitch's 'AA' category median of 28.1%.
Debt service coverage is weak for the rating category, reflecting Partners' light operating profitability. Coverage of pro forma MADS by EBITDA equaled 2.5x (excluding both non-recurring revenue and expenses) in fiscal 2015 and 2.5x in fiscal 2014, comparing unfavorably to Fitch's 'AA' category median of 5.7x.
ELEVATED CAPITAL SPENDING
Capital spending increased to $1.2 billion in fiscal 2015 and is expected to remain elevated, averaging approximately $1 billion per year through 2020. Historically, capital spending had averaged $637 million per year between fiscals 2008 and 2014. Because of the compressed profitability and recent investment losses, the system has decreased its total five-year capital plan through 2020 by approximately $667 million to $5.2 billion. Significant capital projects include implementation of Partners eCare, network development initiatives, and the system's lease replacement strategy.
The lease replacement strategy includes approximately $1.1 billion in capital spending under which the system will consolidate leased facilities into system-owned properties. Approximately $754 million of the total cost is expected to be debt-funded. While the lease replacement strategy is anticipated to generate significant net present value savings, profitability and leverage will be affected as Partners incurs the debt and associated interest expense and continues to pay lease expense on the buildings until the new projects are completed. Based on cash flow models provided by management, the lease replacement strategy will be cash-flow negative until 2018.
Capital expenditures are expected to be funded primarily with cash flows and anticipated debt issuances with limited impact to liquidity metrics. Partners actively manages its actual capital spending in any year relative to financial performance targets.
SHORT-TERM RATING
The affirmation of the 'F1+' rating reflects the strength of Partners' cash and investment position to pay any put or tender on the series 2003D-5 and 2003D-6 VRDBs and the series 2008H commercial paper. At Sept. 30, 2015, Partners' eligible cash and investment position as per Fitch's criteria would cover the maximum mandatory put on any given date well in excess of Fitch's 1.25x threshold for the 'F1+' short-term rating.
DEBT STRUCTURE
Upon completion of the 2016 plan of finance, Partners will have approximately $4.7 billion of total debt outstanding. The pro forma debt will be composed of approximately 70% underlying fixed-rate bonds, and 30% underlying variable-rate bonds. Approximately 20% of the total debt portfolio will be swapped to fixed rate via fixed payor swaps with a total notional amount of $938.6 million including a forward starting swap ($100 million notional) that will be effective in April 2016. At Sept 30, 2015, Partners had posted $128 million of collateral related to the swaps.
DISCLOSURE
Partners covenants to provide annual disclosure no later than 150 days following the fiscal year end and voluntarily discloses quarterly financials within 60 days of the end of the first three quarters and within 90 days of the end of the fourth quarter.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Rating U.S. Public Finance Short-Term Debt (pub. 17 Nov 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=873508
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. 09 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866807
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=997190
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=997190
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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