NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB-' rating on the following revenue bonds issued on behalf of East Texas Medical Center Regional Health System (ETMC):
--$35.8 million Wood County Central Hospital District hospital revenue bonds, series 2011;
--$250 million Tyler Health Facilities Development Corporation hospital revenue bonds, series 2007A.
The Rating Outlook remains Negative.
SECURITY
The bonds are secured by a pledge of gross revenues of the obligated group, a first mortgage lien on certain property and debt service reserve funds on the series 2007A and 2011 bonds.
KEY RATING DRIVERS
LAWSUIT SETTLEMENT: ETMC's June 2015 lawsuit against Blue Cross Blue Shield of Texas (Blue Cross) and two other insurers was resolved with the August 2016 settlement between ETMC and Blue Cross. After years of exclusion, the system now participates in the preferred provider networks for Blue Cross, Aetna and United Healthcare. Litigation continues against Cigna, but credit concerns are muted by the fact that Cigna is a smaller insurance provider in this market.
WEAK FINANCIAL PROFILE FOR THE RATING: Despite ETMC's predominantly below-investment grade financial profile, Fitch's maintenance of the 'BBB-' rating is based on the expectation that future long-term performance will begin to improve with the settlement, albeit slowly. The Negative Outlook reflects Fitch's view that operating challenges may persist for a period of time while shifts in referral patterns begin to take hold. With high operating losses and depleting cash position, there is limited margin for further compression at the investment grade rating.
DECLINING SHARE OF COMPETITIVE MARKET: ETMC's declining market share within its eight-county primary service area (38.5% of total admissions in 2015, down from 39.7% in 2014 and 41.2% in 2013) is partly a result of being excluded from the preferred provider network for four large insurance providers. Its position is pressured by Trinity Mother Frances (TMF, rated 'BBB+'/Outlook Positive), who has an almost equal market share and was acquired by CHRISTUS Health in 2016. TMF is a formidable competitor in Tyler and shifting significant market share from this provider will require well-developed, long-term strategies.
RELIANCE ON SUPPLEMENTAL FUNDING: ETMC's thin margins (operating EBITDA margin of 7.5% in 2015 and 5.9% through the nine months of fiscal 2016) were significantly supplemented by higher payments from the Texas Waiver 1115 program in 2015. Net waiver funds of $25.3 million in 2015 are expected to decrease to $22.1 million in 2016. The program has been extended until December 2017, but the future of the program, or its funding levels, remain uncertain. Fitch continues to view this as a credit concern.
ELEVATED DEBT LOAD: ETMC's debt profile is elevated in relation to cash flow, revenue and liquidity. Coverage improved with the reduction of maximum annual debt service (MADS) from debt amortization as well as the early payment of almost $20 million in bank debt in February 2016. MADS coverage is now calculated at 1.7x for fiscal 2015 and 1.6x through the nine months of fiscal 2016 (July 31). As of July 31, MADS represents 4.3% of revenues and 75.6% cash-to-debt, all below the rating category medians. There are no plans for additional debt.
RATING SENSITIVITIES
CONTINUED PRESSURE BEFORE POSSIBLE IMPROVEMENT: Given the competitive landscape, there remains uncertainty as to how quickly referral patterns may change now that East Texas Medical Center's (ETMC) Tyler hospital is in network with the large commercial payors. If liquidity or coverage decreases further from the low levels in 2016, negative rating pressure should be expected. An Outlook revision to Stable is possible if ETMC is able show increased revenue, temper the current losses, and begin to rebuild liquidity.
CREDIT PROFILE
ETMC is an integrated health system servicing the east and northeastern regions of Texas. ETMC's network consists of a tertiary care and level-one trauma center in Tyler (Smith County), six smaller acute care hospitals (as of December 2016), and a rehabilitation and specialty hospital. The system also has 40 rural clinics covering an eight-county area centered on Smith County. Total revenues were $867.4 million in fiscal 2015.
SETTLEMENT WITH COMMERCIAL PAYORS
ETMC had been excluded from the preferred provider organization (PPO) network for the largest private payer in the market, Blue Cross, as well as United Healthcare, Aetna and Cigna for multiple years, although the impact of this situation escalated in 2014 and 2015. With rising deductibles for out-of-network care, decreasing out-of-network reimbursement from the payors, and increasing pressure to refer non-emergent procedures to network providers, ETMC experienced declining utilization and increasing financial constraints in recent years. This led ETMC to file a lawsuit on June 2, 2015 against Blue Cross, Aetna, and Cigna, alleging that the insurers violated state law by unreasonably denying ETMC's Tyler hospital an opportunity to join their preferred networks. The lawsuit claimed that as the only hospital in Texas that was excluded from the Blue Cross' PPO network, the insurer was singling out the Tyler flagship.
ETMC and Blue Cross finally settled out of court in August and have since signed a multi-year agreement. Similarly, the Tyler hospital entered into PPO agreements with Aetna in June and United Healthcare in May. These settlements represent a key credit development as it resolves a long-period of uncertainty for the hospital's patient base, clinical staff, and ultimately ETMC's financial future. It also bolsters the referral stream for insured patients coming from ETMC's rural hospitals (all of ETMC's other hospitals were already in network) that are referred for tertiary services to Tyler.
ETMC is the only Level I trauma center in Tyler and a provider of a broad range of high-acuity services. Management believes that it has strong ties to the community and physicians, and its reputation as well as good quality outcomes should allow the hospital to regain market share. Management has begun an active outreach and marketing campaign to key constituents letting them know that ETMC's Tyler hospital is now an option for most commercial patients. Fitch expects this will yield positive outcomes in the long-run, but the timing for a significant financial turnaround remains uncertain.
WEAKENED FINANCIAL PROFILE
Profitability in the nine months of fiscal 2016 (July 31) was prevented by non-recurring legal expenses related to the lawsuit, constrained reimbursement, and declining inpatient utilization at its rural hospitals. Financial results deteriorated in the current nine month period with a negative 1.9% operating margin and 5.9% operating EBITDA margin, as compared to a negative 0.9% operating margin and 7.6% operating EBITDA in the comparable period in 2015. Pressure persists despite expense reductions, and the termination of operating lease agreements at several rural hospitals in Clarksville, Crockett, Gilmer, and Mt Vernon locations in 2014 and 2015. Two additional operations (Fairfield and Trinity) will be discontinued before calendar year end. ETMC booked a $36 million loss on impairment and discontinued operations related to these six facilities, which Fitch excluded from ETMC's operating performance in 2014.
ETMC's decision to downsize its rural hospital footprint will reduce its exposure to dilutive performance at those facilities. Nevertheless, ETMC has maintained a large outpatient rural clinic presence to preserve its referral patterns in its multi-county service area. Closer to its Tyler flagship, ETMC has opened six urgent care facilities this year and plans to continue to build its primary care physician base with the goal of enhancing its market presence.
LIQUIDITY AND DEBT PROFILE
ETMC's cash grew in fiscal 2015 to $291.6 million (129.4 days cash on hand [DCOH]) from $266.4 million (125.3 DCOH) due to the receipt of approximately $40 million in supplemental 1115 Waiver funds and Meaningful Use payments, which were accrued at fiscal year-end 2014. Texas is now timelier at processing 1115 Waiver payments, resulting in reduced receivables for the system and less volatility. However, cash decreased in 2016 to a low 108.6 DCOH (significantly below the 161.2 day rating category median) as a result of the ongoing losses, capital lease repayments, and the pre-payment of approximately $20 million in bank loans to reduce pressure on the debt service coverage covenant. MADS coverage of 1.6x for the nine months of fiscal 2016 is calculated using lower MADS of $38.9 million. MADS will decrease to $33.8 million in 2017 and $31 million in 2018.
ETMC has a conservative investment and debt profile with all fixed rate debt. However, the system's pension contributions have been modest in the past couple of years, and as a result the pension's funded level declined to 73% in 2015 from 82% in 2013.
CONTINUING DISCLOSURE
ETMC covenants to provide bondholders with annual audited financial information to the Municipal Securities Rulemaking Board's EMMA system within 150 days of fiscal year end and quarterly financial statements within 45 days of fiscal quarter end.
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
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1012068
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012068
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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