CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A-' rating to the following bonds issued by the Illinois Finance Authority, IL on behalf of Mercy Health Corporation (MHC):
--$484.94 million revenue bonds, series 2016.
In addition, Fitch assigns an 'A-' rating to the following outstanding revenue bonds issued through the Wisconsin Health and Educational Facilities Authority issued on behalf of Mercy Alliance Inc.:
--$169.5 million series 2012;
--$ 27.6 million series 2010A.
The series 2016 bonds are expected to be fixed-rated securities. Bond proceeds will primarily fund a portion of the construction of a new 188-bed hospital and ambulatory care building, refund Rockford Health's series 2008 and series 2012 bonds, advance-refund a portion of Mercy Alliance's series 2010A bonds and pay costs of issuance. The bonds are scheduled to sell via negotiated sale during the week of May 2, 2016.
The Rating Outlook is Stable.
SECURITY
The members of the obligated group (OG) are obligated jointly and severally under the master indenture for MHC. The series 2016 bonds are secured by pledged revenues of the OG and mortgaged property which includes the main Mercy hospital in Janesville, Rockford Memorial Hospital, and 97 acres of land where the new hospital facility will be built. Leases and liens created as permitted encumbrances may be superior to the lien of the master indenture.
KEY RATING DRIVERS
EVOLVING INTO A REGIONAL SYSTEM: The merger of Mercy Alliance, Inc. (Mercy) and Rockford Health System (Rockford) created a sizable $930 million healthcare provider drawing from a broad 13-county market. Mercy has long been a vertically integrated model with a large number of employed physicians and outpatient clinics, while Rockford is a higher acuity provider that enjoys a wider geographic reach with some of its clinical lines. The system will continue to combine these strengths and be in a position to leverage its new size, outpatient presence and insurance plan to capture more of the market and retain it within MHC hospitals.
SIZABLE CAPITAL PLAN FOR NEW HOSPITAL: A key part of MHC's vision for combining the new system is the construction of a new 532,000 square foot hospital (RMH-Riverside) which will include 110 adult beds and 78 women's and children's beds, 46 of those for the neonatal intensive care unit (NICU). The new hospital is intended as a destination hospital for patients from both main MHC hospitals as it will centralize many specialty services. The total cost of the project is expected to be $418.5 million and completed by 2019.
PRESENCE IN A COMPETITIVE MARKET: MHC faces significant competition from a number of providers in southern Wisconsin and in northern Illinois, thereby tempering its ability to easily capture incremental market share. The providers range from community hospitals to hospitals that are part of larger well-known systems.
HIGH LEVERAGE WILL REQUIRE INCREASED CASH FLOWS: With the 2016 financing, total debt will increase to approximately $670.5 million from $288 million as of Jan. 31, 2016. Pro forma maximum annual debt service (MADS) equates to 4.3% of fiscal 2015 system revenues. The elevated leverage stresses all debt metrics, resulting in light historical pro forma MADS coverage by operating EBITDA of 2.6x through the seven-month combined interim period ended January 31. Even with the system's projected improvement in the coming years, MADS coverage is forecast to be below 3.8x until fiscal 2020, which is light as compared to the 'A' category median of 4.2x.
IMPROVING FINANCIAL PERFORMANCE: MHC has improved profitability and operating cash flow over the past year mostly as a result of revenue increases as well as decreases in labor expense from integration savings and standardization of physician compensation. The operating and operating EBITDA margins improved in the seven months of fiscal 2016 to 4.8% and 10.8%, respectively, from 0.7% and 6.9% in the comparable period in fiscal 2015.
RATING SENSITIVITIES
CONSTRUCTION RISKS: The design phase on the Riverside Project is not expected to be completed until April 2017. Mercy Health Corporation expects to obtain a guaranteed maximum price (GMP) after the design development phase is complete. Given the stress of an already high debt burden, Fitch views the lack of a finished design and project costs as an elevated credit risk. A delay in project development and/ or material increase in project costs could pressure the rating.
SUSTAINED OPERATING IMPROVEMENT: MHC will need to sustain the recently improved operating margins to maintain its healthy liquidity reserves and cover the increased debt burden beginning in 2020 upon completion of the project.
CREDIT PROFILE
MercyRockford Health System Corporation was formed in 2015 as a result of the merger between Mercy in Janesville, WI and Rockford in Rockford, IL. The system is expected to formally change its name to Mercy Health Corporation (MHC) in May. MHC operates four separately licensed hospitals: 240-licensed bed Mercy Hospital and Trauma Center (MHTC), 282-licensed bed Rockford Memorial Hospital (RMH), critical access hospital Mercy Harvard Hospital (MHH) in Harvard, IL and critical access hospital Mercy Walworth Hospital (MWH) in Lake Geneva, WI. MHC also includes the MercyCare health plan, a network of 55 physician clinics throughout six counties in southern Wisconsin and northern Illinois, a free-standing emergency room, two home health programs, and a skilled nursing home on the MHH campus. The OG will consist of a majority of the system. MHH is not included in the OG.
MARKET POSITION AND OPPORTUNITIES
Fitch views the 2015 formation of the MHC system as favorable to both Mercy and Rockford. Mercy had grown significantly in past years under experienced leadership into a well-integrated system with referrals from a feeder network of 328 employed physicians. Mercy enjoys high-quality recognition and is a magnet-designated provider with MHTC as the only Level II trauma center in southern Wisconsin. However, NICU and certain perinatal and pediatric specialties are not offered at Mercy and were referred to Madison hospitals, UW Children's Hospital and Meriter Hospital.
RMH is a Level I trauma center, a Level III NICU, a state-designated Regional Perinatal Center for 11 counties and the only provider in northern Illinois offering advanced minimally invasive neuro-interventional procedures for stroke and aneurysm. Rockford had been challenged in recent years by uncertainty that resulted from previously unsuccessful merger attempts with other providers. The merger with Mercy provided stability for the organization, and introduced additional feeder clinics and an integrated physician model that is now being standardized throughout the MHC system. Mercy benefits from re-directing pediatric and perinatal volume to RMH that was previously going to Madison. Some of this volume has been re-directed through the system's MercyCare insurance vehicle.
Fitch believes that MHC will continue to successfully integrate its operations to operate less as a two-service-area provider (Mercy in its primary service area of Rock County and Rockford in its service area of Winnebago, Boone and Ogle counties) to eventually operate more fluidly as one five-hospital system. Core to this vision is the successful construction of the new hospital, RHS-Riverside, that is expected to attract patients from Wisconsin that have not been traditionally admitted to RMH.
The new planned hospital (RMH-Riverside) will be on I-90, which connects Rockford, IL and Janesville, WI, and therefore will be easily accessible from different MHC hospital sites and healthcare access points. The hospital, which is expected to open in early 2019, will provide specialty services, particularly in perinatal, pediatrics, women's health, surgery and cardiology. The number of beds at the current RMH will be reduced to 94 beds that will remain operational in the more recently renovated areas of the hospital. The current estimate for construction of the new hospital is $418.5 million, although the certificate of need (CON) that was granted by the state of Illinois allows the cost to be as high as $475.8 million without requiring additional approval.
Market share growth is a key part of MHC's plan for future success, although we note that this service area is highly competitive and saturated with other healthcare providers. The service area continues to exhibit strong population growth and MHC believes it is well positioned with its clinic locations. The system plans to expand two clinics and build two new clinics in the coming year.
FINANCIAL PERFORMANCE AND POSITION
The new hospital is not expected to be functional until 2019 and MHC will need to sustain its improved profitability from current operations for the next two years in order to prevent any erosion of its balance sheet metrics during the construction period for the new hospital. Fitch has reviewed the system's projections, which are based on the expectation that MHC will be able to generate annual operating margins of 3% in the next couple of years (in line with expectations for the 'A-' rating category). This has been and will be achieved by a combination of integration savings from synergies of scale, supply savings, improvements in managed care contracting, improved referral management, joint physician recruitment, and standardizing physician contracts and employee benefits. Fitch believes these targets are aggressive but achievable if carefully managed.
Even with the improvement year to date in 2016 and the sustained improvement reflected in MHC's projections, the system will remain highly leveraged in the coming years. The concerns on the debt side are partly alleviated by the system's liquidity position, which is a key credit strength. Days cash on hand (DCOH) as of Jan. 31, 2016 measured at 234.5 days based on unrestricted cash and investments of $608.7 million, and above the median of 205 days for this category. According to the feasibility study, cash is projected to decrease to 218 days by the end of fiscal 2016, but to increase again as of 2017, since the Riverside construction is mostly funded by the series 2016 bond proceeds.
DEBT PROFILE
Pro forma long-term debt of approximately $670.5 million includes fixed rate bonds of $484.9 million for the series 2016 bonds, $16.1 of outstanding 2010A bonds and $169.5 million of series 2012 bonds. With this financing, MHC will refund Rockford Health's Series 2008 and Series 2012 bonds, and advance refund a portion of Mercy Alliance's series 2010A bond, as well as terminate the swap agreement for the Series 2008 bonds. There are no other interest rate agreements in place.
DISCLOSURE
MHC covenants to disclose annual operating statistics and audited financial statements within 150 days and quarterly statistics and financial statements within 60 days, to the Municipal Securities Board's EMMA system.
Additional information is available at 'www.fitchratings.com'.
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. 09 Jun
2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866807
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