NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA-' rating to the following series of bonds expected to be issued on behalf of UPMC:
--$300,000,000 Pennsylvania Economic Development Financing Authority (PEDFA) revenue bonds series 2016.
Fitch also affirms the 'AA-' rating on UPMC's outstanding parity debt issued through the Pennsylvania Higher Educational Facilities Authority, Allegheny County Hospital Development Authority, University of Pittsburgh Medical Center, Monroeville Finance Authority, and Pennsylvania Economic Development Financing Authority.
The Rating Outlook is Stable.
The series 2016 bonds are expected to be issued as fixed-rate, tax-exempt bonds and sold via negotiation the week of Sept. 19.. Proceeds of the 2016 bonds will be used to fund UPMC capital expenditures and provide funds to repay a $20.8 million draw on a line of credit that was used to refund Erie County Hospital Facilities Authority Hamot Health Foundation series 2006 (not rated by Fitch). The bonds will have a June 2046 final maturity, and maximum annual debt service (MADS) on all debt of $312.5 million occurs in 2018.
SECURITY
The bonds are secured by a revenue pledge of the obligated group (OG). UPMC standardized its bond covenants under the 2007 Master Trust Indenture (2007 MTI), and the series 2016 bonds will constitute parity debt under the 2007 MTI. UPMC (the parent corporation), UPMC Presbyterian Shadyside, Magee-Womens Hospital of UPMC, UPMC Passavant, and UPMC St. Margaret are members of the OG under the 2007 MTI, and accounted for 26% of consolidated system revenues and 66% of assets in fiscal 2016 (June 30 year-end).
KEY RATING DRIVERS
INTEGRATED DELIVERY MODEL: The 'AA-' rating reflects UPMC's integrated delivery model with an aligned physician base, large health plan, and extensive delivery network. Given the operating platform, profitability and liquidity metrics lag the 'AA' category medians of Fitch's rated hospital and health system portfolio.
STABILIZING COMPETITIVE LANDSCAPE: UPMC's strategy, following the non-renewal of the UPMC Highmark contract and the formation of the Allegheny Health Network, has been successful in maintaining a steady share of the Western Pennsylvania market with less reliance on Highmark enrollees. The recent data on UPMC sources of patient revenue confirms the slow but gradual shift of revenues from Highmark to UPMC Health Plan and to the national insurers.
MARKET LEADER IN WESTERN PENNSYLVANIA: One of UPMC's credit strengths continues to be its dominant market share of the Western Pennsylvania market with an estimated 58% share in Allegheny County and a 41% share of the 29 counties in Western Pennsylvania. Additionally, the large health plan (generates half of system revenues before eliminations) is viewed as a credit positive given its role as a powerful tool as health care delivery moves to a population health management model. UPMC was also recently awarded a contract as one of three insurers in Pennsylvania, for the care of the dual Medicare/Medicaid eligible population.
COMPRESSED PROFITABILITY: UPMC's operating profitability was slightly higher in fiscal 2016 (year-end June 30) with operating margin of 1.3%, after hovering at essentially breakeven for the prior three years. Operating income increased to $173.2 million in fiscal 2016 from $23.1 million in 2015. The improvement was partially driven by productivity gains resulting from initiatives undertaken in 2015 and the increase in the UPMC Health Plan premium revenue due to continued enrollment growth.
MANAGEABLE DEBT BURDEN: The system's leverage remains manageable with pro forma maximum annual debt service (MADS) remaining at a moderate 2.4% of revenues, in line with the Fitch 'AA' median, and MADS coverage of pro forma debt by EBITDA was at an adequate 3.0x, slightly higher than the 2.8x in the prior year, but lower than the category median of 5.7x. UPMC does not have any major capital plans in the near term and its capital budget of $510 million for 2017 will be partially funded from the 2016 issuance. Management projects a steady level of borrowing over the next several years in most years approximating debt amortization, which is not expected to materially increase long-term debt by more than approximately $3.2 billion. The proposed 2016 borrowing is higher than the typical $150 million to offset the commitment to assume the debt of the facilities added or expected to be added to the system later this year.
STABLE LIQUIDITY: While historically lower than Fitch's 'AA' medians, UPMC's level of absolute liquidity has grown consistently year over year and at June 30, 2016 the unrestricted cash and investments of $4.3 billion translate to days cash on hand (DCOH) of 129.4 days and cash-to-pro forma debt at 140.2%. Fitch views the lower liquidity as partially mitigated by the business model and geographic coverage, as well as 79% of system debt in fixed-rate mode.
RATING SENSITIVITIES
NEED TO MAINTAIN ADEQUATE OPERATING CASH FLOW: Maintenance of the 'AA-' rating is contingent on UPMC maintaining adequate operating cash-flow. Going forward, this depends on the continued successful execution of the strategy to replace some of the expected loss of revenue from Highmark with revenue generated from contracts with the national insurers and UPMC's own health plan, particularly as the end of the Highmark consent decree moves closer. A material decline in profitability, leading to thinner coverage or balance sheet deterioration, could lead to negative rating pressure.
CREDIT PROFILE
UPMC is the largest healthcare system in Pennsylvania, the largest employer in the region, and one of the largest nongovernmental employers in the state. It is also one of the world's leading organ transplant centers and one of the largest cancer networks in the country. The system has an academic affiliation with the University of Pittsburgh of the Commonwealth System of Higher Education.
UPMC owns and operates 21 hospitals with close to 4,600 beds in operation and more than 500 clinical locations in the region. With a total revenue base of $12.85 billion in fiscal 2016, 61,000 employees, including approximately 3,600 employed physicians and just shy of 3 million covered lives in its network of health insurance plans, UPMC ranks as one of the largest integrated healthcare delivery networks in the country.
Jameson Hospital in New Castle, PA was added to the system in May 2016 (238 beds). Pending regulatory approval, two additional hospitals will be added later this fall: Susquehanna Health (rated
'A-'), a four-hospital system based in Williamsport, PA (342 beds) and WCA Hospital in Jamestown, NY (317 beds), located just north of Pennsylvania border. UPMC has committed to assume the debt and pension obligations of the new facilities and to make certain capital investments, which Fitch views as not materially negative to the consolidated system profile, while increasing its geographic coverage.
UPMC HIGHMARK CONSENT DECREE
The maintenance of the rating and Stable Outlook are based on the evidence for the last 18 months that UPMC's strategy to replace some of the loss of Highmark subscribers by increased enrollment in its own Health Plan and the three national insurers is succeeding. The termination of the Highmark contract as per the consent decree, which precludes the access to UPMC in-network rates to Highmark subscribers, with some exceptions, became effective Dec. 31, 2014. The fiscal 2016 sources of gross patient revenue, reflecting a full year of the impact of the termination, show a further reduction of UPMC's gross revenue from Highmark subscribers to 10% in 2016 from 15% in 2015 (19% in 2014) and an increase to 12% from 10% in revenues from UPMC's own health plans, as well as an increase for the national insurers to 9% from 7%. Based on the results of the 18 months since the contract termination has been in effect, it appears that the loss of the Highmark enrollees has not had a material negative impact on UPMC's credit profile.
WEAK PROFITABILITY
UPMC's financial metrics have historically been below 'AA' category medians, with the Fitch rating based to a significant degree on the system's very strong market position in Western Pennsylvania with a closely aligned medical staff and a large portfolio of insurance products with a growing enrollment of now close to 3 million members in the UPMC Health Plan, an increase of 5.2%, following a 19.9% increase in enrollment in 2015. The consolidated system revenue increased by 7.9% in 2016, with the increase driven almost entirely by higher insurance enrollment revenue, which grew by 15.5%. Net patient revenues remained essentially level with the prior year despite a 1.9% decline in discharges.
Fiscal 2016 ended with a small improvement in operating performance, producing operating income of $173.2 million, equal to operating margin of 1.3%. Several factors contributed to the stronger results, including a reduction in force in the prior year, as well as the increased insurance enrollment. Despite the increase in enrollment, the Health Plan's medical ratio remained favorable to the prior year at 89.9%.
A dispute with Highmark over outpatient oncology billing underpayment, which went to arbitration, was decided in favor of UPMC and Highmark was required to pay UPMC $231 million plus interest of $23 million. Assuming these receivables to be fully collectible, management had included these in revenue all along. However, in December 2015, the Pennsylvania Supreme Court ruled in favor of Highmark in litigation that will require UPMC to remain an in-network provider to Highmark's Medicare Advantage enrollees through the end of the consent decree on June 30, 2019.
The budget for fiscal 2017 mirrors current levels of profitability. The main drivers on the positive side are improved payer mix including UPMC Health Plan enrollment growth and continued productivity enhancements and savings, such as elimination of clinical variation and improved physician productivity, offset by further investment in physician recruitment and inflation expense.
NO MATERIAL INCREASE IN DEBT AND STABLE LIQUIDITY
Following the issuance of the series 2016 bonds, UPMC will have approximately 79% of its debt at fixed interest rates. Management projects that the system will be issuing between $100 million and $300 million of debt annually over the next several years, roughly equivalent to its principal amortization during those years, with the target of keeping outstanding long-term debt at approximately $3.2 billion. The current issuance is somewhat larger than typical due to UPMC's commitment to assume the debt of the three recently acquired facilities. UPMC has a number of swaps, with notional par of $361.4 million and negative mark-to-market of $16.3 million at June 30, 2016. Currently, there are no collateral posting requirements.
Although UPMC's debt burden is moderate (pro forma MADS equated to 2.4% of fiscal 2016 total revenue), most of its debt metrics fall below the 'AA' category medians with 3.0x coverage of pro forma MADS by EBITDA in 2016 including the $300 million of new money, as compared to the median of 5.7x, and debt-to-EBITDA of 3.3x compared to the median of 2.4x. MADS is calculated per MTI definitions for the treatment of several balloon payments.
Unrestricted cash and investments were reported at $4.32 billion at June 30, 2016, a $224.5 million increase over the prior year, equating to 129.4 DCOH, cushion ratio of 13.8x and cash equal to 140.2% of debt, all not materially changed since the last Fitch review, but lower than the 'AA' medians. However, the system has not identified any major capital spending planned over the near term and its capital budget typically mirrors the system's depreciation expense. The largest single expenditure in the $510 million capital plan for 2017 is $100 million for IT.
DISCLOSURE
UPMC's quarterly and annual disclosures to industry participants (including EMMA) have been excellent and consist of full financial statements, utilization and other information, and management's discussion and analysis of results, which Fitch views favorably.
Additional information is available at www.fitchratings.com
Applicable Criteria
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/site/re/750012
U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)
https://www.fitchratings.com/site/re/866807
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011702
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