SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'AA' long-term rating on Scripps Health's outstanding debt. In addition, Fitch has affirmed the 'F1+' short-term rating on Scripps Health's series 2012B&C bonds based on self-liquidity. Scripps Health's outstanding debt is listed at the end of the press release.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group (OG). The OG accounted for 99% of total assets and 94% of total revenue of the consolidated entity in fiscal 2015 (Sept. 30 year-end). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
SUSTAINED STRONG FINANCIAL PROFILE: Scripps Health has sustained its strong financial performance since the rating upgrade to 'AA' from 'AA-' in April 2015. Scripps Health has good liquidity, strong profitability, very good debt service coverage and low debt burden despite additional debt issuance in the first quarter of 2016. Scripps Health's maintenance of its strong financial profile in a competitive market reflects its excellent management practices.
EXCELLENT MANAGEMENT PRACTICES: One of Scripps Health's main credit strengths is its track record and consistency in delivering results as planned and is a reflection of strong management practices. Annual performance improvement targets that focus on cost reduction and revenue improvements have consistently been exceeded. Scripps Health has also been implementing initiatives to prepare for a greater shift to value based reimbursement including physician alignment, expanding access, developing its own health plan, entering into more risk based arrangements, and implementing a care management system for population health.
GOOD MARKET FOOTPRINT: In addition to its four hospitals in San Diego County, Scripps Health has an extensive ambulatory network, an aligned physician base, as well as a growing health plan division. Fitch views this favorably especially due to the competitive service area. Key competitors include Sharp HealthCare, Kaiser, and University of California San Diego Medical Center. New facility expansions by its competitors will be opening in the next one to two years, which Fitch will monitor. The missing component in its delivery system is an integrated electronic medical record (EMR) and Scripps Health will be implementing Epic over the next few years with completion in 2018.
STRONG PROFITABILITY AND LOW DEBT BURDEN: Scripps Health's operating performance has been consistently solid. Operating and operating EBITDA margins were 5% and 10.3% in fiscal 2015 (Sept. 30 year end), respectively, compared to 6.2% and 10.8% the prior year and the 'AA' category median of 3.9% and 11%. Strong profitability combined with a low debt burden produced very strong maximum annual debt service (MADS) coverage of 8.6x in fiscal 2015 and 8.2x the prior year. Debt metrics are still favorable despite a $200 million new money issuance in 2016, mainly for the reimbursement of prior capital expenditures. Scripps Health's debt burden is still low with MADS accounting for 2% of total revenue in fiscal 2015.
IMPROVED LIQUIDITY DESPITE HEALTHY CAPITAL SPENDING: Unrestricted cash and investments at fiscal year end (FYE) 2015 has grown to $2.2 billion (304 days cash on hand [DCOH] and 242% cash to debt) from $1.8 billion at FYE 2012 (287.1 DCOH and 195.7% cash to debt) despite healthy capital investment funded from operating cash flow. Scripps Health's capital spending has been robust and major projects, including the Prebys Cardiovascular Institute (Prebys) opened on time and under budget. Capital spending is expected to remain high over the next few years due to the investment in Epic and the construction of a medical office building (MOB) adjacent to Prebys. Scripps Health's six-year capital plan (FY 2016-2021) is still healthy at $2 billion; however, capital spending is always balanced against financial performance and available cash flow.
AMPLE CUSHION RELATED TO SELF-LIQUIDITY: The 'F1+' rating on the series 2012B&C variable-rate demand bonds (VRDBs) is based on self-liquidity, and reflects Scripps Health's long-term credit quality, as well as its strong position of liquid cash and investments to fund any potential unremarketed puts.
RATING SENSITIVITIES
SUSTAINED FINANCIAL PERFORMANCE: Fitch believes that Scripps Health will continue to meet or exceed its targeted financial goals as the organization implements Epic and continues to transition to a more risk-based revenue model due to the management team's track record in successfully executing on its initiatives.
CREDIT PROFILE
Scripps Health is a regional health system located in San Diego County, CA. The system is comprised of four hospitals on five campuses (1,495 licensed beds: Scripps Memorial Hospital La Jolla, Scripps Green Hospital, Scripps Memorial Hospital Encinitas, Scripps Mercy Hospital Chula Vista, Scripps Mercy Hospital San Diego), the medical foundation with various medical groups that have over 700 physicians including Scripps Clinic Medical Group, an extensive ambulatory network, home care, hospice as well as a health plan. Total operating revenue in fiscal 2015 was $2.9 billion.
Transitioning to Risk-Based Revenue
Scripps Health has been preparing for the shift to more value based reimbursement and initiatives to date include developing its clinically integrated network that aligns independent physicians, obtaining a full Knox Keene license to be able to offer its own health plan products, collaborating with managed care payors on value based contracts, and developing other alternative payment models. Scripps Health continues to expand access points with the growth in a retail strategy and expanded clinic and urgent care hours. Currently, Scripps Health has approximately 93,000 commercial and senior lives with the expectation of continued growth. Fitch views Scripps Health's actions to date positively as it aligns the reimbursement with the organization's goals to bend the cost curve, standardize care and medical management, improve quality outcomes, and manage population health.
Good Market Footprint
Scripps Health maintains the second leading market share in the service area (24.5%) and competes against Sharp HealthCare (29% market share), Kaiser Permanente (8.9% market share; rated 'A+'), University of California San Diego Medical Center (10.3% market share), Palomar Health (10.7% market share; rated 'BB+'), and several other independent community hospitals.
Fitch views Scripps Health's market footprint favorably, however, the market is competitive and several competitors have expansion projects opening in the next two years. However, Fitch believes Scripps Health is well positioned and with its new Prebys facility open, two prior cardiovascular programs are now consolidated on one site. A MOB will be opening in June 2016 attached to Prebys and will house catheterization labs (one of only two allowed in the state) in an outpatient setting. Prebys was completed significantly under budget and with the savings, a new emergency department at Prebys is being built and is expected to open in October 2016.
Scripps Health maintains a higher market share in cardiac surgery and the organization has an exclusive agreement to provide cardiac services to Kaiser members. The most recent agreement expires in 2020; however, the relationship has been in place for over 30 years. Kaiser is building a new hospital in the service area, but a shift in cardiac business is not expected.
Healthy Capital Plan
Scripps Health has had a healthy level of capital spending at 1.8x of depreciation expense in fiscal 2015, 2.6x in fiscal 2014, and 3.4x in fiscal 2013, which have all primarily been funded from operating cash flow or philanthropy. The 2016 debt financings will reimburse $150 million of prior capital expenditures. Philanthropy has been a consistent funding source with $39.6 million raised in fiscal 2015, $28.5 million in fiscal 2014 and $38.1 million in fiscal 2013.
Near term large capital projects include the Epic implementation and the completion of the MOB adjacent to Prebys. The MOB is expected to cost $133 million and open in June 2016. There are other various strategic projects in the capital plan including a large multispecialty clinic in Oceanside, hospital replacement planning for Mercy, expansion at Encinitas, and another patient tower at La Jolla. Total spending is projected to be $2 billion from fiscal 2016-2021, which will be funded mainly from cash flow and other sources of funds include $500 million of debt ($200 million already issued in 2016) and $191 million from fundraising. The organization is also consolidating support functions into owned buildings versus leased facilities, which should result in annual savings.
Scripps Health is in the early stages of implementing a new clinical and revenue cycle platform (Epic) and the total cost is expected to be $406 million ($262 million capital, $144 million operating). There are various go live dates starting in April 2017 with full implementation by January 2018. The impact on operating expense will be concentrated in fiscal 2017 and 2018 due to training costs.
Consistently Strong Operating Performance
Scripps Health reported $143.5 million in operating income for fiscal 2015 or 5% operating margin, and 10.3% operating EBITDA margin and performance exceeded budget. Scripps Health consistently budgets for a targeted level of performance improvement initiatives needed to maintain around a 10% operating EBITDA margin. The areas of focus have been in labor productivity, supplies expense, and coding and documentation initiatives. The performance improvement initiatives are roughly 60% cost reduction and 40% revenue improvement initiatives. Areas of focus include labor productivity, supplies, documentation improvement, denial management, point of service collections and other revenue initiatives.
California enacted a hospital provider fee in 2010 to draw down additional federal funds for Medi-Cal services and Scripps Health has benefited from the provider fee program. However, given the varying program lengths and timing of approvals, the net benefit recorded year to year has been volatile. The net benefit of the provider fee was $22.6 million in fiscal 2011, $43.2 million in fiscal 2012, $8.7 million in fiscal 2013, $6.3 million in fiscal 2014 and $29.3 million in fiscal 2015. Without the provider fee, operating margin was 7.8%, 7.3%, 5.8%, and 4.2% in fiscal 2012-2015. The current provider fee program is for the period Jan. 1, 2014 - Dec. 31, 2016 and there is a ballot initiative in November 2016 to make the program permanent.
Through the three months ended Dec. 31, 2015, operating margin is lower at 2.7% due to increased depreciation expense with the opening of Prebys and higher expenses due to Epic. Operating EBITDA margin was 8.6% and Fitch expects Scripps to meet or exceed its fiscal 2016 budgeted goal of 3.7% operating margin and 9.6% operating EBITDA margin.
Strong Liquidity Growth
Scripps Health's liquidity has grown significantly over the last three years and has been driven by strong cash flow and a 5.7% investment return over the three year period despite healthy capital spending. Unrestricted cash and investments totaled $2.152 billion at FYE 2015 and was $2.177 billion at Dec. 31, 2015. At Dec. 31, 2015, Scripps Health had 296.5 DCOH, 38.1x cushion ratio and 248% cash to debt, compared to Fitch's respective 'AA' category medians of 289.4 days, 27x, and 201.7%. Scripps Health increased its target to maintaining at least 300 days cash on hand (from 250 during last review).
Low Debt Burden Despite 2016 Issuance
Scripps Health did not have plans to issue the $200 million of additional debt in early 2016, but given the low interest rate environment, the management team capitalized on the opportunity, which lowered its overall cost of capital on its total debt to 2.8%. The $200 million series 2016 was all fixed rate and included $50 million taxable term loan with Union Bank, $50 million tax exempt direct placement with Union Bank and $100 million tax exempt direct placement with JP Morgan. There is no renewal risk as the maturity on all three loans is 10 years and no additional covenants were added. The financing provides $50 million of taxable proceeds for general corporate purposes and $150 million of reimbursement for prior capital expenditures. The structure of the series 2016 financings also accounted for Scripps Health's plan to redeem approximately $90 million of its series 2008A bonds when it is callable in October 2018.
Total debt outstanding is approximately $1 billion and is 57% fixed rate, 13% synthetic fixed rate, and 30% variable rate. Scripps Health has a total of $440 million variable rate demand bonds (VRDBs) and $340 million are supported by letters of credit (LOC), which exposes Scripps Health to renewal, remarketing and put risks. However, the LOC banks are diversified and the expiration dates are staggered. In addition, Fitch believes Scripps Health's liquidity position mitigates these risks.
With the series 2016 financing, MADS increased to $57 million from $46 million. MADS as a percentage of revenue is still low at 2% in fiscal 2015 compared to Fitch's 'AA' category median of 2.4%. MADS coverage is strong at 8.6x in fiscal 2015 and 8.2x in fiscal 2014 and was 6.2x through the three months ended Dec. 31, 2015.
Scripps Health has a notional amount of $132 million of fixed payor swaps outstanding. The collateral posting threshold is $60 million and no collateral is being posted.
Short-Term Rating based on Self-Liquidity
The affirmation of the 'F1+' short-term rating is supported by the adequacy of Scripps Health's highly liquid resources available to fund any unremarketed puts on the $100 million series 2012B&C weekly VRDBs. Based on Fitch's rating criteria related to self-liquidity, Scripps Health's position of eligible cash and investments available for same-day settlement easily exceeds Fitch's 1.25x requirement to cover the maximum tender exposure on any given date.
Disclosure
Scripps Health has covenanted to provide annual and quarterly disclosure through the Municipal Rule Making Board's EMMA system.
Outstanding Debt:
--$40,000,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2012C;
--$60,000,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2012B;
--$175,000,000 California Health Facilities Financing Authority hospital revenue bonds series 2012A;
--California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2010C (Bank Bonds);
--$40,000,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2010C (LOC: Northern Trust Company (The));
--$60,000,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2010B (LOC: JPMorgan Chase Bank, N.A.)';
--$111,725,000 California Health Facilities Financing Authority hospital revenue bonds series 2010A;
--$10,150,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008G (LOC: Wells Fargo Bank, N.A.);
--$33,840,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008F (LOC: Northern Trust Company (The));
--$33,670,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008E (LOC: Union Bank, N.A.);
--$33,645,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008D (LOC: Bank of America, N.A.);
--$33,670,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008C (LOC: Union Bank, N.A.);
--$33,670,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008B (LOC: Wells Fargo Bank, N.A.);
--$89,755,000 California Health Facilities Financing Authority hospital revenue bonds series 2008A;
--$11,100,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2001A (LOC: JPMorgan Chase Bank, N.A.).
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
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Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1001808
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