CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned a 'AA' Issuer Default Rating (IDR) to Harris County Hospital District (HCHD) and assigned a 'AA' rating to the expected issuance of $60.7 million Harris County Hospital District (HCHD), Texas certificates of obligation (COs), series 2016.
In addition, Fitch has upgraded the following revenue bonds issued by HCHD:
--$104.4 senior lien refunding bonds, series 2010, to 'AA' from 'A';
--$199.1 million senior lien refunding and revenue bonds, series 2007A, upgraded to 'AA' from 'A'.
The Rating Outlook is Stable.
The series 2016 COs will be issued as fixed-rate debt, with debt service secured by a pledge of tax revenues. The bonds are expected to price July 19, and will be used to fund capital improvements and pay costs of issuance.
SECURITY
The series 2016 bonds are secured by an annual property tax levy limited to $0.75 per $100 assessed valuation (AV). The series 2010 and 2007 bonds are secured by a lien on the pledged revenues of the HCHD(excluding ad valorem tax revenues) and a debt service reserve fund.
KEY RATING DRIVERS
TAXING MARGIN SUPPORTS REVENUE BASE: The 'AA' IDR and revenue bond ratings reflect the strength of the HCHD's expansive tax base, significant taxing margin to support both operations and debt service, as well as the operating security of its position as the safety net provider for Harris County. Tax revenues in fiscal 2015 represent a high 30% of operating revenues (which Fitch adjusts to include premium, tax, and net patient revenues). However, ample room in the tax margin could support up to a 340% increase in tax revenues, which provides a significant amount of revenue flexibility that is atypical for the sector.
DEDICATED TAX PLEDGE: The 'AA' rating on the series 2016 COs reflects ample room under the dedicated ad valorem tax pledge to support the additional $4.7 million in annual debt service. This rating is capped by the IDR given the security's exposure to the operating risk of HCHD.
STRONG SERVICE AREA FUNDAMENTALS: HCHD is coterminous with Harris County, for which Fitch maintains a 'AAA' IDR/Outlook Stable. While diversification into biomedical research, aerospace, and international trade via the Port of Houston is evident, energy, and petrochemical manufacturing remain major determinants of employment and tax base growth.
MANAGEABLE DEBT BURDEN: HCHD's total leverage remains manageable despite the additional $60.7 million in series 2016 debt. Pro forma debt to capitalization is a low 36.3% and pro forma maximum annual debt service (MADS) was a low 1.1% of fiscal 2016 revenues (excluding the benefit of the limited tax levy for this debt). Further, capital needs are diminishing (to near 110% of annual depreciation) and are expected to be funded via cash flow and philanthropy rather than debt over the medium term.
STEADY LIQUIDITY: Despite several years of significant expenditures, HCHD's balance sheet has maintained solid liquidity metrics and reflects its manageable debt burden. As per consolidated financials for the fiscal year ended Feb. 29, 2016, HCHD had 156 days of cash on hand (DCOH), a 37.5x pro forma cushion ratio, and will have 272.6% cash to pro forma debt.
PAYOR MIX CHALLENGES: Over 60% of HCHD's volume is uninsured or indigent care, and the system will likely see a decline in supplemental Medicaid reimbursement beyond 2017 absent the renewal of Texas' 1115 waiver program or without Medicaid expansion in the state. HCHD received $282 million in net supplemental funding benefit for federal fiscal year 2015, and expects level funding for the current fiscal year before the waiver program expires in December 2017.
RATING SENSITIVITIES
SUSTAINED FINANCIAL PROFILE: The 'AA' rating is supported by an expectation that Harris County Hospital District (HCHD) will preserve its balance sheet strength and coverage levels. With expected revenue pressure from reductions in Medicaid supplemental funding, HCHD will need to continue its work on operating efficiency and perhaps increase its tax revenues in order to maintain its financial profile. Unexpected erosion in HCHD's financial profile could pressure the rating.
CREDIT PROFILE
HCHD is the fifth largest metropolitan health system in the country, and consists of three hospitals: Ben Taub General Hospital (492 operated beds), Lyndon B. Johnson Hospital (235 operated beds), Quentin Mease Hospital (49 operated beds), 18 community care centers, six school-based clinics, and other ambulatory sites. Other component units of the HCHD system include a foundation and a Medicaid Health Maintenance Organization known as Community Health Choice (CHC).
Fitch's analysis is based on HCHD and its component units. In fiscal 2016 (February 29 year-end), HCHD generated $2.2 billion of revenues, including $361.5 million in net patient service revenue, $891 million of premium revenue, $180.6 million of DSH/UPL funding, and $635.4 million of ad valorem tax revenue and $73.8 million in delivery system reform incentive payment (DSRIP) revenue (both classified as non-operating revenue in the audited financials).
REVENUE FLEXIBILITY
The 'AA' rating is supported by the relative strength of HCHD's expansive tax base, significant taxing margin to support both operations and debt service, as well as the operating security of its position as the safety net provider for Harris County. HCHD's $2.2 billion in operating revenues consist of net patient and premium revenue (57%), property taxes (29%), and Medicaid supplemental revenue (12%). HCHD has the legal capacity to raise property tax revenues by a high 340%. This significant taxing capacity yields a level of flexibility which is atypical for most hospitals and health systems and offsets a material level of operating risk.
Fitch believes that HCHD's patient service revenue is likely to continue to be pressured by growing demand for healthcare services by a largely indigent population, limited inpatient capacity, and a shrinking pool of supplemental Medicaid funding from the state. HCHD has benefitted from the supplemental funding provided via the Texas 1115 Waiver program, which provided $255 million in Uncompensated Care (UC) Medicaid supplemental revenues and DSRIP revenues in fiscal 2016. However, these revenues are declining and the 1115 Waiver program has a December 2017 term. Funding beyond that is uncertain, and the state remains unlikely to expand Medicaid.
Property tax revenue growth has benefited from double-digit AV gains in recent years, aided by resurgent construction activity and reappraisal gains. Future growth in tax revenue is likely to be in line with historical performance - above the rate of inflation and national GDP growth - based on economic trends and the revenue streams' ability to capture that growth. Further, the ample margin in tax rate provides significant cushion against revenue pressure from other areas.
Thus, despite some likely pressures in supplemental revenue going forward HCHD's operating cash flow is likely to remain steady. Through fiscal 2016 HCHD generated a near-breakeven operating margin, which produced 3.1x coverage of pro forma debt service (excluding series 2016 pledged tax revenues). Cash flow near $75 million in EBITDA should be more than sufficient to support routine capital spending and debt service requirements without affecting liquidity.
DEBT PROFILE
The $60.7 million in series 2016 bonds is being issued to fund capital improvements at Ben Taub Hospital, which Fitch believes is necessary to support needed growth in surgical and perioperative space and to maintain its level I Trauma designation. Future capital needs are expected to be supported by routine expenditures near 110% of depreciation going forward, and by philanthropy, rather than additional debt.
With the series 2016 issuance, HCHD's total debt will be approximately $336 million, of which $104 million (30%) is series 2010 variable-rate demand bonds (VRDBs). Pro forma MADS is not level, declining from $24.4 million in 2018 to $18.8 million in 2042. The VRDBs are supported by a letter of credit provided by JP Morgan Chase, valid through Aug. 12, 2017. HCHD is also counterparty to a $103.5 million notional swap, which had a negative $19 million fair value at Feb. 28, 2016.
DISCLOSURE
HCHD covenants to provide only annual disclosure to bondholders, via the Municipal Securities Rulemaking Board's EMMA system. Fitch views the lack of a provision for quarterly disclosure as negative.
VARIATION FROM PUBLISHED CRITERIA
The analysis supporting the 'AA' Issuer Default Rating on HCHD includes a variation from the U.S. Nonprofit Hospitals and Health Systems Rating Criteria. Enhanced analysis under the variation relates to the evaluation of the strength of the tax revenues available to support operations. This evaluation is supported by Fitch's new U.S. Tax-Supported Rating Criteria dated April 21, 2016 that includes refinements to the analysis of both tax revenue volatility, through the new Fitch Analytical Sensitivity Tool (FAST), and the value of taxing capacity relative to the issuer's potential revenue stress in a downturn.
FAST LINK: www.fitchratings.com/site/re/880318
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
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478
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