NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the following Chattanooga-Hamilton County Hospital Authority, TN bonds issued on behalf of Erlanger Health System (EHS) at 'BBB+' :
--$149.9 million hospital revenue and refunding bonds series 2014A.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a pledge of gross revenues and a first mortgage lien on certain system property.
KEY RATING DRIVERS
SOLID CREDIT PROFILE: EHS ended fiscal 2016 (June 30 year-end) with operating income of $23.3 million, slightly ahead of its budgeted $18.2 million, producing operating margin of 2.8%, better than Fitch's 'BBB' of 1.8%. 2016 results were driven by robust volumes reflected by another year of over 15% revenue growth, successful physician recruitment, as well as the benefit of supplemental payments for which EHS qualified for the past three fiscal years.
REGIONAL SERVICE PLATFORM: EHS serves the tri-state region as the only academic medical center and the only provider of Level 1 trauma, Level IV NICU and other tertiary referral services. EHS has cemented its position as a safety-net provider, garnering local and state legislative support for its position as the area's public hospital. This has resulted in additional reimbursement through fiscal 2017, and EHS has already received the approximately $20 million from the Tennessee Public Hospital Supplemental Pool. However, this supplemental funding model is under review and is likely to change going forward.
MANAGEABLE DEBT BURDEN: EHS generated solid coverage of maximum annual debt service coverage (MADS) by EBITDA of 3.9x in fiscal 2016, exceeding Fitch's 'BBB' category median of 3x and MADS as a percent of revenues has further moderated to a low 1.8%. A current $50 million expansion project at the Erlanger East Hospital, funded with a portion of the series 2014A bonds, is expected to be completed on time and on budget by 2016 calendar year end. The largest component of the fiscal 2017 capital budget is $33 million for the second year of the EPIC electronic medical record implementation and the system is continuing to invest in facility renovations and expansion at the University Hospital campus to accommodate space for its centers of excellence.
MIXED LIQUIDITY INDICATORS: EHS reported $210.3 million of unrestricted cash and investments at June 30, 2016, level with the prior year, translating to 98.8 days cash on hand (DCOH), cushion ratio of 14x and cash equal to 98.8% of debt, consistent with the median levels with the exception of DCOH, which is unfavorable compared to Fitch's 161 DCOH median. Fitch has noted in prior analyses that a meaningful increase in liquidity metrics is not expected in the medium term given the system's elevated capital needs in support of its growing geographic and programmatic platform.
RATING SENSITIVITIES
NEED TO MAINTAIN PROFITABILITY: Fitch expects Erlanger Health System (EHS) to improve its profitability after the transitional period of increased spending over the next 12-18 months, while sustaining solid coverage of debt better than 'BBB' category medians, mitigating its light liquidity metrics and elevated capital spending requirements. However, a prolonged period of weak operating margin could pressure the rating.
EXPOSURE TO CHANGES IN SUPPLEMENTAL FUNDING: While EHS has benefited from receipt of supplemental funding, the level of such funding in the future is uncertain. A material reduction of the funding level that would impact profitability without commensurate revenue growth and/or expense adjustments could produce negative rating pressure.
The System
Founded as the Baroness Erlanger Hospital in 1889 in Chattanooga, Erlanger Health System (EHS) operates 643 staffed inpatient beds at five principal campuses; the University Hospital, Children's Hospital at Erlanger, Erlanger North Hospital (Erlanger North), Erlanger East Hospital (Erlanger East), and Erlanger Bledsoe Hospital, located in Pikeville, Tenn. EHS provides Level 1 trauma services, Level IV NICU services, and is affiliated with the University of Tennessee College of Medicine as the region's only academic teaching hospital. EHS serves the four-state region of eastern Tennessee, northeastern Alabama, northwestern North Carolina and northwestern Georgia. EHS recently entered into a clinical affiliation with Vanderbilt University Medical Center and is a member of the Vanderbilt Health Affiliation Network. Total revenues were $803 million in fiscal 2016 (year-ended June 30).
Solid Credit Profile
EHS ended fiscal 2016 with operating income of 23.3 million, equal to an operating margin of 2.8%. The system continues to leverage its role as the region's academic medical center and has been implementing several strategic initiatives, reflected in robust revenue growth of 15.3% in fiscal 2015 and a further 15.6% in fiscal 2016. Inpatient admissions increased by 7.3% system wide last year and were 7.7% higher at the University Hospital campus. Inpatient surgeries grew by 2.9% and outpatient surgeries increased by 9.8%. The inpatient surgery volumes do not reflect the full impact of the Orthopedic Institute with six new dedicated operating rooms, which had only been in operations for three months in 2016.
EHS has maintained and slightly improved its leading market share to 35.4% in the combined primary and secondary service areas. The expected completion of the Erlanger East campus with 58 additional beds is anticipated to further bolster market share in what is a demographically favorable area of Hamilton County with 80% commercially insured population. A concern regarding whether Volkswagen's problems would impact employment in that market has proven immaterial, as Volkswagen launched production of a new midsize sports utility vehicle and expects employment to be at its highest to date by mid-April 2017.
EHS is highly reliant on governmental sources of revenue, with combined Medicare and Medicaid accounting for 56.6% of gross revenues. EHS benefits from being included in the Tennessee Public Hospital Supplemental Pool, from which it received $18.2 million last year. The program is currently under review and will likely transition to a different model, but so far EHS received $20 million of funding for the current fiscal year.
The 2017 fiscal year operating income budget is a slim $5.4 million (0.6% operating margin) despite a projected more than 10% increase in admissions. The budget does not include funds for DSH, given the uncertainty surrounding the reform of the TennCare program. If received, the budget would likely be exceeded. The two major reasons for the attenuated performance in 2017 include approximately $28 million of additional expenses related to the opening of the Erlanger East expansion and the increase in staffing for the EPIC implementation, requiring the running of two parallel systems for a period of time. Management expects profitability to improve in fiscal 2018 as Erlanger East fully ramps up and EPIC expenses slowly moderate after a go live for the physicians in April of 2017 and for hospitals in November 2017.
Light Liquidity
EHS reported cash and unrestricted investments of $210.3 million at June 30, 2016. While absolute liquidity remained unchanged from the prior year, DCOH decreased to 98.8 days from 114.9 days in 2015 due to the larger expense base of the growing organization. Both cash to debt and cushion ratio are better than the rating category medians. Somewhat offsetting the light liquidity, as a governmental entity the system is subject to certain investment limitations and as such has a very conservative investment allocation with a 50%/50% split between cash and fixed income. Given the organization's capital needs over the medium term, material liquidity growth may be hampered despite solid cash flows.
Manageable Debt
EHS has approximately $206 million of long-term debt outstanding, which is 94% fixed rate and no derivative exposure. In addition to the fixed-rate series 2014A, the system has $36.2 million currently outstanding 2004 series (fixed rate and not rated by Fitch) and a $12 million 2014B taxable variable-rate note, due in 2021, also not rated by Fitch. MADS coverage by EBITDA was a solid 3.9x in fiscal 2016, favorable to Fitch's 'BBB' category median of 3x. The system's leverage is moderate, with MADS representing 1.8% of system revenues, as compared to the 3.6% median.
The capital budget for 2017 is $44.6 million (124% of depreciation), with the largest outlay $33 million for the second year of the EPIC implementation. In the preliminary stages is a Children's Ambulatory Center, half of which will be funded from existing bonds proceeds and the remainder is being raised by philanthropy, with naming rights constituting a major potential source. EHS was also chosen by the Tennessee Valley Authority (TVA) to partner in the construction of a co-generation plant at the main campus. EHS will plan to use a $24 million line of credit, currently not drawn on, to fund its $6.3 million portion of the construction costs.
EHS has received a certificate of need (CON) for a much needed 80-bed mental health facility planned as a joint venture with the for-profit Nashville based Acadia Healthcare. Acadia would provide the $25 million of capital, with EHS making available beds at Erlanger North. The CON has been challenged, and the appeal is scheduled for May 2017.
Disclosure
EHS has covenanted to provide annual disclosure within 150 days of FYE (June 30) and quarterly disclosure within 60 days of the end of the first three quarters of the fiscal year to the Municipal Securities Rulemaking Board's EMMA system. Disclosure will include financial statements, utilization, payor mix, 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=1014209
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014209
Endorsement Policy
https://www.fitchratings.com/regulatory
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