CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA-' rating to $154 million of series 2016 hospital revenue bonds expected to be issued by the Michigan Finance Authority (the authority) on behalf of McLaren Health Care (McLaren):
Fitch has also affirmed the 'AA-' rating on approximately $495 million of bonds issued either by the authority on behalf of McLaren or by McLaren. Fitch has withdrawn the 'AA-' rating on McLaren's series 2008A Michigan State Hospital Finance Authority bonds due to an advance-refunding in 2015.
The series 2016 bonds are expected to be issued as fixed-rate bonds. Bond proceeds will be used to fund certain capital projects, to reimburse for prior capital expenditures, to fund capitalized interest and to pay costs of issuance. Maximum annual debt service (MADS) is expected to increase to approximately $47 million from $43 million. The bonds are expected to price the week of July 25 through negotiation and will be privately placed with JP Morgan.
The Rating Outlook is Stable.
SECURITY
Bond payments are secured by a pledge of the gross revenues of the credit group.
KEY RATING DRIVERS
LIGHT DEBT BURDEN: McLaren's pro forma debt burden remains very light with MADS equal to 1.4% of fiscal 2015 operating revenue. The modest debt burden allowed for solid MADS coverage by EBITDA of 5.3x in fiscal 2015 despite light operating profitability.
LEADING MARKET SHARE: McLaren maintains a leading 25.9% market share in its total primary service area, but the service area remains competitive. McLaren has doubled in size over the last six years through acquisition activity, resulting in 12 acute care hospitals and a large health plan, covering 98% of Michigan's population.
LIGHT OPERATING PROFITABILITY: Concerns regarding McLaren's light operating profitability are mitigated by the system's light debt burden and consistency of profitability. Operating margin averaged 2.7% since fiscal 2009 and equaled 2.8% in fiscal 2015 and 3.0% in the six-month interim period ending March 31, 2016 (the interim period).
MIXED LIQUIDITY METRICS: Liquidity metrics remain mixed with a solid 28x cushion ratio, light 142.2 days cash on hand (DCOH), and 159.7% cash to pro forma debt. DCOH is diluted by the large expense base of McLaren's health insurance operations.
RATING SENSITIVITIES
SUSTAINED COVERAGE: Fitch expects that McLaren Health Care will continue to produce consistent operating cash flows which, in combination with the system's light debt burden, will provide for coverage consistent with the 'AA-' rating.
CREDIT PROFILE
McLaren, headquartered in Flint, MI, operates 12 hospitals in a 56-county combined primary service area in Michigan and a health insurance plan. The health plan has over 240,000 lives and a revenue base of $887 million in fiscal 2015. Total consolidated operating revenue equaled $3.4 billion in fiscal 2015, having increased 75.3% over the past five years primarily due to acquisition activity. The credit group accounted for 65.2% of consolidated operating revenue and 76.1% of consolidated unrestricted net assets in fiscal 2015 (Sept. 30 year end). Fitch's analysis is based on the consolidated entity.
The most recent acquisitions include Karmanos Cancer Institute (acquired in January 2014) and Port Huron Hospital (acquired in May 2014). Historical acquisitions include expansion in the following regions: Macomb (2007), Oakland (2007), Central Michigan (2010) and Northern Michigan (January 2012).
LIGHT DEBT BURDEN
McLaren's pro forma debt burden remains light and is a primary credit strength, allowing for solid MADS coverage despite light operating profitability. McLaren's light debt burden has benefited from the system's revenue growth over the past eight years. Pro forma MADS equals a light 1.4% of fiscal 2015 operating revenue. Pro forma MADS coverage by EBITDA and operating EBITDA, respectively, of 5.3x and 4.7x in fiscal 2015 are solid for the 'AA-' rating category. Both remained strong in the interim period at 5.4x and 4.9x.
LEADING MARKET SHARE
McLaren maintains a leading 25.9% market share in its combined primary service area (PSA). The combined PSA includes 56 counties across Michigan and covers 75% of the state's population. Including health plan operations, McLaren covers 98% of Michigan's population. Operations are broken out in nine geographic regions plus the Karmanos Cancer Institute which operates in all of the system's regions. Competitors vary by geographic region. McLaren holds the leading market position in seven regions including Karmanos. However, McLaren's service areas remain competitive.
LIGHT OPERATING PROFITABILITY
Operating profitability has been consistent but historically light for the rating category with operating margin averaging 2.7% between fiscal years 2009 and 2015 and equal to 2.8% in fiscal 2015. Operating margin equaled 3% in the interim period. The consistent profitability levels reflect effective management practices and cost controls. McLaren's personnel costs equaled a very low 36.5% of total revenues in fiscal 2016 and are among the lowest in Fitch's rated portfolio. The light operating profitability reflects McLaren's challenging payor mix and service area characteristics, with Medicare and Medicaid accounting for 67.9% of gross revenues in fiscal 2016. Concerns related to the light operating profitability are mitigated by McLaren's light debt burden.
MIXED LIQUIDITY METRICS
Despite turbulent financial markets, McLaren's unrestricted cash and investments continue to grow, increasing to $1.32 billion at March 31, 2016. Liquidity metrics are solid relative to McLaren's light pro forma debt burden, with 28x cushion ratio, exceeding Fitch's 'AA' category median of 27x. However, the system's 142.2 DCOH and 159.7% cash to pro forma debt remain light for the rating category and compare unfavorably to Fitch's 'AA' category medians of 289.4 days and 201.7%, respectively. McLaren's DCOH is compressed by the expense base of the system's large health insurance operations. Excluding approximately $1 billion of related expenses, DCOH would equal approximately 202 days at March 31, 2016.
CAPITAL PROJECTS
Series 2016 bond proceeds, plus an equity contribution, will be used to provide funding and reimbursement for the construction of a new McLaren Port Huron patient tower, a McLaren Port Huron cancer center and a new corporate services building in Grand Blanc, MI. The new corporate services building is projected to cost $25 million and is expected to be completed in 2017.
McLaren broke ground on the new Port Huron Karmanos Cancer Institute in summer 2015. The cancer center is expected to open in September 2016 and cost approximately $25 million. The project has been funded out of cash and cash flow to date and is currently on time and under budget. Approximately $25 million of the series 2016 bond proceeds will be used to reimburse McLaren for prior capital expenditures associated with the cancer center and to fund the remaining construction costs. The majority of the service area's cancer care currently outmigrates to southeast Michigan. Therefore, the new cancer center should position McLaren to capture additional volume by stemming outmigration.
The new McLaren Port Huron patient tower is projected to cost $121 million and is expected to open in December 2018. The project will be funded entirely by series 2016 bond proceeds. The new patient tower will provide the campus with 100% private rooms in addition to expanded ICU and ED capacity. Both the cancer center and new patient tower are expected to be accretive to consolidated operating profitability.
DEBT PROFILE
Subsequent to the series 2016 bond issuance, McLaren will have approximately $824 million of total debt outstanding. The pro forma debt portfolio will be composed of 59% underlying fixed-rate bonds and 41% underlying variable-rate bonds. The variable-rate bonds are swapped to synthetic fixed rates resulting in 100% fixed-rate exposure. McLaren is currently counterparty to two fixed payer swaps and a basis swap. No collateral was required to be posted as of March 31, 2016. In conjunction with the 2016 financing, McLaren will enter into an additional fixed payer swap and a total return swap, the combination of which will result in a lower fixed interest rate on the series 2016 bonds.
DISCLOSURE
McLaren covenants to provide annual disclosure within 120 days of the end of the fiscal year and quarterly disclosure within 45 days of the end of each fiscal quarter. Disclosure is provided through the Municipal Securities Rulemaking 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
Additional Disclosures
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1008838
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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