NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the following series of bonds issued by the Hospital and Higher Education Facilities Authority of Philadelphia on behalf of Temple University Health System (TUHS) at 'BB+':
--$302,905,000 series 2012A and B;
--$203,985,000 series 2007 A and B.
The Rating Outlook has been revised to Stable from Positive.
SECURITY
The bonds are secured by a pledge of gross revenues of the obligated group, mortgages on certain properties of the obligated group, and a debt service reserve fund. The obligated group represented approximately 95% of the assets and 100% of the revenues of the consolidated system in fiscal 2016 (June 30 year-end). Fitch reports on the performance of the consolidated system.
KEY RATING DRIVERS
REVISION OF THE OUTLOOK TO STABLE: The revision of the Outlook to Stable from Positive, despite a second year of positive operating results in fiscal 2016, was driven by higher maximum annual debt service (MADS) of $49.5 million, related to inclusion of several equipment loans and capitalized leases, which were not included in the MADS used by Fitch in the prior analysis. The resulting 1.8x MADS coverage is lower than expectations since coverage during Fitch's last review was based on bonded debt only.
MAINTAINING POSITIVE OPERATING RESULTS: Temple produced a second year of positive operating results in fiscal 2016, and management is projecting further strengthening of operating performance in the next year. The system ended fiscal 2016 with operating income of $3.6 million for an operating margin of 0.2%, on par with the prior year, despite operating in a very difficult and competitive market, significant investment in EPIC implementation, increased transfers to the School of Medicine (SOM) and decreased support from Temple University (University). Management budgets to end the fiscal 2017 with $15.8 million in operating income.
ESSENTIALITY AND HIGH DEPENDENCE ON SUPPLEMENTAL PAYMENTS: TUHS's flagship facility - Temple University Hospital (TUH) - serves both as a provider of high-end specialty services and as a de facto safety net hospital for North Philadelphia. As such, its continued viability is of critical importance to the greater Philadelphia market, which has been reflected in the significant support the institution has been receiving in the form of supplementary revenues, which in 2016 remained significant and slightly higher than in 2015, though not all of it was received before the end of the fiscal year. While there are uncertainties about the composition and level of the supplemental funding, management anticipates that it will be maintained at close to the historical level in 2017.
GOOD VOLUMES AND HIGHER ACUITY: Despite the competitive nature of the market and the general decreasing volume trend in the greater Philadelphia area, TUHS was able to maintain a stable level of discharges in fiscal 2016 and increased its share of the high acuity discharges by 1.8%, which was one of the drivers of the positive operating performance. TUH's overall case mix index increased to 1.77 in fiscal 2016, as compared to 1.59 in fiscal 2013 and the system has increased its share of the high-end cases to 6%, from 4.9% in fiscal 2011.
MIXED LEVERAGE: The system's coverage of maximum annual debt service (MADS) by EBITDA was 1.8x in fiscal 2016, but the system's MADS as a percent of revenues is still a moderate 3% of revenues, lower than Fitch's 'BBB' median of 3.6%. Further mitigating the slim coverage, TUHS has an all fixed rate debt structure, no swap exposure and no additional debt plans in the near term.
MODEST LIQUIDITY: Liquidity remains light, unrestricted cash and investments were $336.1 million at 2016 year-end, slightly below budget due to delay in the receipt of $22 million of the supplemental funding. Unrestricted cash and investments at 2016 year end translate to 77.6 days cash on hand (DCOH), cushion ratio of 6.9x and cash equal to 64.9% of debt.
RATING SENSITIVITIES
NEED TO STRENGTHEN OPERATING PERFORMANCE: A return to the investment grade rating category would require Temple University Health System to generate meaningful improvement in operating performance leading to strengthened coverage and balance sheet metrics.
CREDIT PROFILE
TUHS is a Philadelphia based health care system, whose flagship is TUH, a 722-bed teaching hospital located on the campus of Temple University (University) in North Philadelphia. TUH sits on the University's health science campus, along with the University's School of Medicine and its other research and educational facilities. TUHS also owns and operates Jeanes Hospital (Jeanes), a 146-licensed bed community hospital located in a residential area in Northeast Philadelphia and the adjoining 100-bed American Oncologic Hospital d/b/a Fox Chase Cancer Center (Fox Chase), one of only 41 National Cancer Institute designated Comprehensive Cancer Centers in the nation. TUHS reported $1.64 billion revenues in fiscal 2016.
MAINTAINING POSITIVE OPERATING RESULTS
Led by a strong and stable management team, TUHS produced a second year of positive operating results in fiscal 2016, recording operating income of $3.5 million, equal to a slim, but positive 0.2% operating margin and 5% operating EBITDA margin compared to sizeable operating losses of $15.8 million and $24.8 million in 2014 and 2013. Fitch's calculation of TUHS's metrics excludes the non-preferred appropriations ($6.2 million in both 2016 and 2015), for which TUHS only serves as a conduit for Temple University. The improved performance was partially driven by an increase in the high acuity discharges based on continued recruitment and retention of high caliber physicians, as well as improved performance at both the Fox Chase and Jeanes.
Constraining profitability was the $19 million increased expense related to the implementation of EPIC at TUH, as well as increased pharmaceutical expense, and increased transfers to the SOM - at $89.3 million, almost twice the level two years ago. At the same time, as planned, the University cut back its support for physician recruitment from $36 million two years ago to $0.5 million. Management budgeted a stronger $15.8 million operating income (0.9% operating margin) for the system for fiscal 2017, which includes the last year of Epic implementation expense of $20.9 million.
SUPPLEMENTARY PAYMENTS MECHANISM EVOLVING
The supplementary payments are essential to supporting the organization's position as a safety net provider to inner city Philadelphia with close to 40% of gross revenues from Medicaid. Management has historically worked closely with the Commonwealth for the critically needed supplemental payments. The 2016 funding was $138.6 million, up from $131 million in 2015, but only $75 million of that amount had been received by the fiscal year end, impacting the liquidity level. The balance of the 2016 funding was remitted in the first quarter of fiscal 2017. There continues to be concern regarding the level and sources of the supplemental funding, but management is fairly optimistic in expecting that the level in fiscal 2017 will be close to prior year levels.
MODEST LIQUIDITY
The $336.1 million of unrestricted cash and investments at 2016 year end was a slight decline from $374.3 million in the prior year with the variance including higher amounts owed from the Commonwealth, as well as increased spending on IT and higher volumes resulting in higher net receivables. The supplemental funding expected to be received by June 30, 2016 was $22.6 million less than had been budgeted. Management has budgeted liquidity at $350 million for fiscal 2017 and set a goal of 100 DCOH by 2019.
WEAK COVERAGE
TUHS had $517.8 million of long-term debt at 2016 fiscal year-end, which is 100% fixed rate and the system has no swaps. Consolidated MADS is $49.5 million and occurs in fiscal 2017. The increase in MADS from $38.9 million (at the time of Fitch's last review in December 2015) is due to the debt service related to several equipment loans and capitalized leases, which were not included in the MADS used by Fitch in the prior analysis. Coverage of MADS based on the TUHS consolidated EBITDA was 1.8x in fiscal 2016. The obligated group reported higher coverage of 2.4x in fiscal 2016 based on the master trust indenture calculation, which is on annual debt service.
DISCLOSURE
TUHS covenants to provide timely annual quarterly financial and operating data to MSRB'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/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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