NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings on the following series of bonds issued by the Maryland Health and Higher Educational Facilities Authority (MHHEFA) on behalf of Anne Arundel Health System (AAHS) at 'A-'.
-- $122,580,000 series 2014 fixed -rate bonds
-- $67,380,000 series 2012 fixed-rate bonds;
-- $76,430,000 series 2010 fixed-rate bonds;
-- $60,000,000 series 2009B variable-rate demand bonds (letter of credit: Bank of America).
The Rating Outlook is Stable.
SECURITY
Debt payments are secured by a pledge of the gross revenues of the obligated group and a mortgage on certain property.
KEY RATING DRIVERS
SOLID PROFITABILITY: The maintenance of the 'A-' rating is based on AAHS's solid and stable profitability over the last three years, moderating debt burden and substantial market share in a market with favorable demographic characteristics. The solid operating profile is partially due to the benefit of AAHS's participation in Maryland's Global Budget Revenue (GBR) program starting with July 1, 2013, which provides a regulated revenue stream and results in a certain level of financial predictability and stability.
MODERATING DEBT BURDEN: Debt burden is still slightly higher than the median, but is slowly moderating. Maximum annual debt service (MADS) coverage by EBITDA was adequate at 3.6x in fiscal 2016 and MADS as percent of revenues is manageable at 3.6%. Management does not expect a material increase in debt from the planned construction of a freestanding mental health hospital, based on the expectation that it would require only a relatively small debt issuance.
ADEQUATE BUT VARIABLE LIQUIDITY LEVELS: Liquidity levels are generally below Fitch's 'A' category medians and exhibit variability related to AAHS's significant collateral posting requirements under its swap. Unrestricted cash and investments totaled $328.3 million at June 30, 2016 (net of the $69.3 million of collateral posting) representing 197.3 days cash on hand (DCOH), 13.6 cushion ratio and 79.5% cash-to-debt.
JOHNS HOPKINS AFFILIATION: AAHS's ongoing strategic alliance with Johns Hopkins Health System (revenue bonds rated 'AA-'/Stable) is an additional positive credit factor which yields benefits related to physician recruitment, development of clinical programs, and cost containment initiatives. A CON for an open-heart program in collaboration with Johns Hopkins is expected to be ruled on before the calendar year-end.
SOLID MARKET SHARE IN FAVORABLE SERVICE AREA: Market share is solid, most recently reported at 67.4% in the primary service area of Anne Arundel County (rated 'AA+') with strong underlying demographic characteristics. The hospital is experiencing capacity issues and just opened a 30-bed inpatient unit in a shelled in space, for which it had a CON approval. The strong volumes are considered a market shift under GBR, and AAHS will be compensated for the increase in volumes under GBR.
RATING SENSITIVITIES
FURTHER IMPROVEMENT IN FINANCIAL PROFILE: Anne Arundel Health System's continued improvement in balance sheet, resulting in moderating leverage and strengthening cushion and cash-to-debt metrics to levels more consistent with the 'A' category medians, would lead to upward rating movement.
CREDIT PROFILE
Anne Arundel Health System, headquartered in Annapolis, MD, operates a 384-licensed bed acute care general hospital and several outpatient facilities in its primary service area of Anne Arundel County. The system generated total operating income of $635.7 million in fiscal 2016, a 13% increase since 2014 year-end.
AAHS is the leading provider in a favorable service area, with a steady inpatient market share. Management has been successfully implementing its strategic expansion plans via growing select service lines and physician base.
Solid Profitability
AAHS has been operating under the Maryland GBR program since fiscal 2014. Currently in a five-year pilot period, the GBR program offers participants a fixed revenue stream designed to reimburse hospitals for avoiding unnecessary admissions and managing care in the most appropriate cost setting. The amount of hospital revenue is known before the start of the fiscal year, providing a level of predictability, and is adjusted annually. For fiscal 2016, the hospital's gross regulated revenue totaled $576 million (before contractual adjustments), equal to 86% of its total revenue for that year. Regulated revenues are projected at $592 million in 2017.
Operating performance since the implementation of GBR has been solid and stable. The 2015 and 2014 fiscal years (year-end June 30) ended with operating income of $25 million and $25.4 million, respectively. Operating income for 2016 equated to operating and operating EBITDA margins of 3.8% and 11%, both consistent with Fitch's respective category medians of 3.8% and 10.3%. Although continued enhancements to rate adjustment methodology are expected, Fitch believes GBR provides AAHS with increased stability during the transition to value-based care. Management is budgeting operating income of $24.6 million (3.5% operating margin) for fiscal 2017, which Fitch believes is achievable.
Liquidity Growth Limited
At June 30, 2016, unrestricted cash and investments totaled $328.3 million, which equated to 197.3 days cash on hand, 13.6 cushion ratio and cash equal to 79.5% of debt, all lower than Fitch's respective 'A' medians of 215.5 days, 19.4x and 148.6%. Absolute liquidity has remained flat with 2014 and DCOH were lower due to increased expense base of the growing enterprise and investment losses. Additionally, capital spending was higher in 2015 compared to historical levels. AAHS has a low swap-posting threshold and was posting $69.3 million at June 30, 2016, which continues to pressure liquidity metrics. The swap is long-dated with a final maturity of 2048.
Moderating Debt Burden
At fiscal year-end 2016, AAHS had $412.8 million in total debt outstanding, of which $326.4 million is revenue bonds and the remainder non-obligated group, nonrecourse bank loans. Of the bonds; $60 million is in variable-rate demand bonds supported by a letter of credit that expires July 2020. Approximately 82% of AAHS's debt is in fixed-rate mode. Fitch uses maximum annual debt service (MADS) of $24.2 million, which incorporates the fixed swap rate on the variable-rate debt and the bank loans.
AAHS's debt burden has been moderating but is still below category medians, with MADS as a percentage of revenues at 3.6%, down from 4.5% in 2014 and debt-to-EBITDA at 4.7%, compared with the respective 'A' medians of 2.7%% and 2.9x. As a result, MADS coverage has improved to 3.6x at fiscal 2016 year-end, as compared to 4.5x for the category median. AAHS has applied for a CON to construct a 16-bed mental health hospital adjacent to its Pathways substance abuse facility. The cost is estimated at approximately $25 million, but it will be offset by philanthropy, as well as par and coupon savings that might be realized from refunding of existing debt. While it will likely require some issuance of debt, management does not anticipate a material increase in their debt level. Construction would not start before fall of 2017.
AAHS has a fixed payor swap with notional par of $180 million, which was novated in April 2016 with Wells Fargo assuming the first five years with no collateral posting and Citi remaining on the swap to maturity. The swap restructuring resulted in reduction of collateral posting by $29.2 million. At Aug. 31, 2016, the swaps had a marked-to-market value of negative $79.6 million.
Disclosure
AAHS discloses annual financial statements within 120 days and quarterly unaudited financial statements within 45 days after the end of the first three quarters and no later than 60 days after the end of the fourth fiscal quarter through the MSRB EMMA website. Financial statements include an income statement, balance sheet, flow of funds, utilization data and management discussion and analysis.
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=1013553
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013553
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https://www.fitchratings.com/regulatory
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