CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned 'AA-' ratings to the following bonds expected to be issued by the California Health Facilities Financing Authority on behalf of Providence St. Joseph Health (PSJH):
--$498,000,000 revenue bonds series 2016A;
--$305,000,000 revenue bonds series 2016B.
Additionally, Fitch has downgraded the rating to 'AA-' from 'AA' on approximately $3.8 billion of revenue bonds issued by Providence Health & Services (PH&S) or issued on behalf of PH&S by various authorities. Fitch has also affirmed the 'AA-' rating on approximately $1.9 billion of revenue bonds issued by St. Joseph Health System (SJHS) or issued on behalf of SJHS by various authorities.
The series 2016A and 2016B bonds will be issued as tax-exempt fixed-rate bonds and tax-exempt variable-rate put bonds, respectively. Series 2016A bond proceeds will be used to refund SJHS's series 2007A-F bonds and to pay costs of issuance. Series 2016B bond proceeds will be used to refund SJHS's series 2011A-D bonds and to pay costs of issuance. The series 2016A and series 2016B bonds are expected to price the week of Aug. 22 and Sept. 5, respectively, via negotiation.
The Rating Outlook is Stable.
SECURITY
Bond payments are an unsecured corporate obligation of the obligated group.
KEY RATING DRIVERS
BROAD OPERATION PLATFORM: Fitch views PSJH's geographic diversity and business line diversity as key credit strengths. The increased breadth of operations subsequent to the combination of PH&S and SJHS, with 50 hospitals located in seven states, and resulting diversity of operations decreases the system's overall operating risk profile.
EXCELLENT MANAGEMENT PRACTICES: Fitch believes management is proactively transitioning the organization to maintain its leadership positions as key markets move to population health management payment models. PSJH's excellent management practices are reflected in a robust IT platform and continued centralization of shared services that allows for detailed operational reporting and extraction of further operational efficiencies.
COMPRESSED OPERATING PROFITABILITY: Consolidated operating profitability has been compressed over the past three years with operating EBITDA margin averaging 7.6% as both PH&S and SJHS pursued dilutive strategic initiatives that should be accretive in the mid-term. Operating EBITDA margin further compressed to 6% in the six-month interim period ending June 30, 2016 (the interim period) primarily due to increased compensation expenses, adverse shifts to the system's payor mix and weaker performance at the health plan.
MODERATE DEBT BURDEN: The pro forma debt burden remains moderate with pro forma MADS equal to 2% of fiscal 2015 operating revenue. However, MADS coverage is light for the rating category reflecting the compressed operating profitability.
ADEQUATE LIQUIDITY: Liquidity metrics remain adequate for the rating category given PSJH's size and scope of operations with 167.1% days cash on hand, 22.5x cushion ratio and 135.3% cash to pro forma debt at June 30, 2016.
RATING SENSITIVITIES
SUCCESSFUL INTEGRATION: Fitch expects PSJH to successfully integrate the operations of PH&S and SJHS, achieving economies of scale, while successfully executing operating improvement initiatives to bring the system's credit profile more in line with the 'AA-' rating. Failure to demonstrate incrementally improving operating performance through successful integration and operating improvement initiatives could lead to negative rating pressure.
CREDIT PROFILE
PSJH, headquartered in Renton, WA, became the sole member of PH&S and SJHS on July 1, 2016. Operations include 50 hospitals, 23 long term care facilities, 829 clinics, 14 senior housing facilities, 23,000 physicians, a health plan with 1.9 million covered lives and other related services. The system's operations cover seven states: Alaska, Washington, Oregon, Montana, California, New Mexico and Texas. The affiliation will be accounted for as an acquisition, but the accounting for the acquisition is not yet complete. Therefore, Fitch's analysis is based upon unaudited combined financial statements of PH&S and SJHS. Total consolidated operating revenue equaled $20.8 billion in fiscal 2015, of which PH&S accounted for $14.4 billion (69%) and SJHS accounted for $6.4 billion (31%). The obligated group accounted for approximately 84.2% of consolidated operating revenue and 90% of consolidated total assets in fiscal 2015.
As part of the system integration efforts, PSJH plans to refund certain SJHS bonds outstanding, utilize an MTI note substitution to bring the remaining SJHS bonds outstanding into the PH&S obligated group and refund certain PH&S bonds shortly after the series 2016A/B refunding. PSJH plans to issue series 2016C-K bonds which are expected to price in late September 2016. Bond proceeds are expected to: refund SJHS's series 2008A and series 2000 bonds and refund PH&S' series 2006A/B/H, 2009A and 2013F bonds and approximately $125 million of PH&S' commercial paper program. Additionally, bond proceeds will include approximately $380 million of new taxable bond proceeds to fund certain capital projects. The complete series 2016 bond financings are incorporated into Fitch's analysis. Fitch expects to rate the series 2016G-J bonds in mid-September. Pro forma MADS is expected to equal approximately $423 million and assumes the smoothing of certain bullet maturities per provisions in the master trust indenture.
BROAD OPERATION PLATFORM
PSJH's broad operating platform and strong market positions are key credit strengths, bolstering the system's overall credit profile. With 50 hospitals operating in 7 states generating over $20 billion in annual revenue, PSJH is one of the largest health systems in Fitch's portfolio. Operations are divided into eight geographic markets in which the system holds either the number one or two market shares. The broad operating platform and diverse service areas are expected to generate increased credit stability at the consolidated level.
EXCELLENT MANAGEMENT PRACTICES
Fitch views PSJH's management team's experience and practices as credit positives. The management team has significant industry experience both within the health system and at other diverse organizations including Trinity Health, Kaiser Permanente, Amazon and UnitedHealth Group. The management teams of PH&S and SJHS have been proactively transitioning each system to keep pace with changing industry dynamics.
COMPRESSED OPERATING PROFITABILITY
Despite increased utilization and revenue growth, operating profitability remained compressed in both fiscal 2015 and the interim period. Operating EBITDA margin decreased to 7.5% in fiscal 2015 and 6% in the interim period from 8% in fiscal 2014. The continued compression in operating profitability reflects a combination of health plan losses, increased compensation expenses due to favorable labor market conditions in PSJH's regional markets, deterioration in the system's payor mix and growth in less profitable areas such as outpatient and ambulatory services. Operating profitability had previously been pressured at both PH&S and SJHS due to strategic investments in IT systems and infrastructure to support population health management initiatives. Fitch views those strategic investments favorably despite the dilutive impact on profitability. The strategic investments are expected to enhance PSJH's position in its markets and improve operating stability over the long term. Additionally, management is in the process of implementing operating improvement initiatives.
MODERATE DEBT BURDEN
Despite the planned issuance of $380 million of new money with the series 2016 bond issuances, PSJH's debt burden remains moderate. Pro forma MADS equals a moderate 2% of fiscal 2016 operating revenue relative to Fitch's 'AA' category median of 2.4%. Despite the moderate debt burden, pro forma MADS coverage by EBITDA and operating EBITDA was a light 3.3x and 3.7x, respectively, in fiscal 2015 relative to Fitch's 'AA' category medians of 5.7x and 4.4x. Coverage metrics remained light in the interim period at 3.6x and 3.1x. MADS coverage by EBITDA has been additionally compressed due to realized investment losses and expenses related to the system's venture capital firm. Fitch expects coverage metrics to improve as both operating improvements and integration synergies are achieved.
ADEQUATE LIQUIDITY
Unrestricted cash and investments have fluctuated over the past 30 months due to volatility in the investment markets, lighter operating cash flows and continued capital spending. With $9.54 billion of unrestricted cash and investments at June 30, 2016, liquidity metrics of 167.1% days cash on hand, 22.5x cushion ratio and 135.3% cash to pro forma debt remain light relative to Fitch's 'AA' category medians of 289.4 days, 27x and 201.7%, respectively. However, given PSJH's size, scope of operations and continued reinvestment into its system, liquidity metrics remain adequate for the rating category
DEBT PROFILE
Subsequent to the series 2016 transactions, PSJH will have approximately $7.05 billion of total debt outstanding, including approximately $6.4 billion of bonds outstanding, revolvers, capital leases and other long-term debt. The pro forma bond portfolio is expected to be composed of 49% underlying fixed rate bonds and 51% underlying variable rate bonds. PSJH is counterparty to seven fixed payor swaps with a total notional amount of approximately $492 million. PSJH had approximately $55.7 million of related collateral posted at June 30, 2016.
DISCLOSURE
PSJH covenants to provide annual disclosure within 150 days of each fiscal year end and quarterly disclosure within 60 days of the end of each fiscal quarter. Disclosure is provided through both PSJH's website and 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
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