Fitch Affirms UF Health-Jacksonville, FL Rev Bonds at 'BBB'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the 'BBB' rating on UF Health-Jacksonville, FL's (UFH-J) outstanding debt, which is listed at the end of the press release.

The Rating Outlook is Stable.

SECURITY

The master trust indenture (MTI) includes a gross revenue pledge and mortgage pledge and leasehold mortgage pledge on certain properties of the obligated group (OG). There is a debt service reserve fund for the series 2013A bonds. The obligated group includes Shands Jacksonville Medical Center (now dba UF Health - Jacksonville), Shands Jacksonville HealthCare, and Shands Jacksonville Properties. The OG accounted for essentially the entire consolidated entity's assets and revenue, respectively for fiscal 2016 (June 30 year-end; audit). Fitch's analysis is based on the consolidated entity.

KEY RATING DRIVERS

STRONG OPERATING PERFORMANCE: The affirmation of the 'BBB' rating reflects UFH-J's strong operating profitability, which has been sustained for three consecutive years despite its challenging payor mix. Fiscal 2016 operating margin was 4.7% and the operating EBITDA margin was 10.9%, compared to the BBB category medians of 1.5% and 8.7%, respectively. Performance has been driven by continued strong volume growth.

INTEGRAL COMPONENT OF UNIVERSITY OF FLORIDA: Fitch views UFH-J's relationship with University of Florida (UF; housing bonds rated 'AA') as its primary credit strength and believes that UFH-J serves an essential role as part of the UF system. UFH-J is one of two academic teaching sites for UF, and UFH-J has the third-largest post-graduate medical training program in Florida with over 300 residents and fellows and over 400 UF faculty. UFH-J is a component unit of UF and the board of UFH-J is appointed by UF. There are various transfers between the UF affiliates, and Fitch expects some of these transfers from UFH-J to affiliates could be postponed if needed, which provides a mitigant to UFH-J's weak liquidity position.

GROWTH STRATEGY: UFH-J's outpatient presence in the fast growing and better payor mix service area on the north side of the city has been successful with very good volume growth that has exceeded budget. At the time of Fitch's last review in November 2015, UFH-J issued $85 million of series 2015 bonds to fund the construction of a 92-bed hospital at the North campus. The project is on time and on budget and expected to open in July 2017. This growth strategy will better position UFH-J for the long term as it diversifies the organization from the high indigent care burden at the main campus.

INDIGENT CARE BURDEN: UFH-J has an extremely high percentage of Medicaid, Medicaid pending and self-pay payors that totals 40.1% of gross revenue in fiscal 2016 but has declined from last year as the North strategy resulted in commercial payor mix growth. Because of its payor mix, UFH-J receives a significant amount of supplemental funding and the exposure to changes in the funding environment remains a key credit concern.

WEAK LIQUIDITY: Liquidity is weak with 81.4 days cash on hand and 50.3% at June 30, 2016 compared to the BBB category medians of 161.2 and 90.8%, respectively. Fiscal 2017 will be a transition year as UFH-J will be bearing start up costs for the North hospital, which is expected to cause an erosion in absolute liquidity.

RATING SENSITIVITIES

EXPOSURE TO CHANGES IN SUPPLEMENTAL FUNDING: UFH-J remains highly susceptible to changes in supplemental funding. The funding distribution of the current low income pool (LIP)/disproportionate share (DSH) program is still to be finalized with the possibility of a modest reduction.

IMPROVED LIQUIDITY: Fitch expects liquidity to improve after the North hospital opens in fiscal 2018 and beyond; lack of improvement could result in negative rating pressure.

CREDIT PROFILE

UFH-J is an academic medical center located in Jacksonville, FL with 695 licensed beds. UFH-J has an extensive outpatient network with 41 primary care clinics in the service area. UFH-J is an integral component of UF and serves as one of their two academic teaching sites. Total revenue in fiscal 2016 (June 30 fiscal year end) was $665.4 million.

UF and Shands Relationship

UFH-J is an integral component of UF and the UF President has the rights to appoint and remove UFH-J board members. Shands Gainesville (Gainesville) is an 852-bed academic medical center and was UF's primary academic teaching hospital. This expanded to UFH-J in 2003 when UFH-J became part of the UF/Shands organization and Gainesville became UFH-J's sole corporate member. Since that time, there has been significant growth in UFH-J's teaching and clinical activities and, in 2010, there was a corporate reorganization which made Gainesville and UFH-J affiliates of UF. Through common governance and a shared mission with UF, there is a strong relationship between UF, Gainesville, and UFH-J, which Fitch views as UFH-J's primary credit strength. UF faculty accounts for the majority of UFH-J's medical staff.

UFH-J and Shands Gainesville (Gainesville) remain legally separate and distinct entities with separate obligated debt, but the organizations share a common strategic vision led by the UF&Shands Strategic Health Care Cabinet made up of key leadership from UFH-J, Gainesville, and UF. UFH-J and Gainesville have various shared services in addition to joint managed care contracting and supply chain management.

UFH-J has a subordinated note payable to Gainesville for its investment in UFH-J. In fiscal 2016, Gainesville approved a loan forgiveness of approximately 50% on the outstanding note, which Fitch believes demonstrates the close relationship between the organizations. The note payable balance was $17 million at June 30, 2016 from $35.8 million at June 30, 2015. The debt forgiveness resulted in a $16.1 million non-operating gain in fiscal 2016, which is excluded from Fitch's calculations.

North Campus

As a safety net provider, UFH-J is pursuing a growth strategy in a fast growing, favorable payor mix service area to better position the organization for the long term. In February 2015, UFH-J opened a 210,000 square foot medical office and outpatient services building in North Jacksonville. All the space has been leased and UF physicians account for approximately 70% of the space while 30% is leased to community physicians. The facility was developer financed and services currently offered include a 28 bed freestanding emergency department, outpatient surgery center, endoscopy procedure rooms, interventional radiology, cardiac catheterization, imaging and lab services.

Volume has exceeded budget and total patient service revenue increased 12.6% in fiscal 2016 from the prior year primarily related to new volume from UF Health North. In addition, commercial payor mix also improved to 26.3% of gross revenues in fiscal 2016 from 23.6% the prior year.

Due to the success of the outpatient strategy, UFH-J is in the process of constructing a 92 bed hospital at this site. The project cost is being funded entirely from the series 2015 bonds. Start up costs and benefits were initially projected for fiscal 2018, but the building is expected to open in July 2017 (could be earlier) and start up labor costs ($8 million) are now in the fiscal 2017 budget.

Sustained Strong Operating Performance

Fiscal 2016 was UFH-J's third year of sustained strong operating performance, which was aided by strong volume growth from UF Health North and the addition of infusion oncology operations. Operating margin was 4.7% in fiscal 2016 compared to 4.2% in fiscal 2015 and 4.2% in fiscal 2014.

Fiscal 2016 also included additional reserves related to potential penalties from discovered overpayments from inaccurate billings related to one physician, who is no longer on staff. These inaccuracies were reported through the Office of the Inspector General's Self Referral Disclosure Protocol. Fitch expects that the current reserves will be adequate to cover any potential penalties.

Operating performance excludes transfers to UF, which are negotiated annually for the support of clinical and research activities. There is a portion of funds that are paid to UF in professional fees for direct contract services and the remainder of the funds are in 'transfers and expenditures in support of UF' in non-operating. The transfers totaled $100 million over the last four years ($33.4 million in fiscal 2016), which also limits liquidity growth. The transfers are expected to remain around $33 million in fiscal 2017.

Fiscal 2017 will be a transition year as UFH-J prepares for the opening of the new hospital. Staffing and start up expenses will be borne in the last quarter of fiscal 2017 to prepare for the opening, which is expected July 1, 2017, but could be earlier. Fiscal 2017 also includes higher operating expenses mainly related to pharmaceutical costs.

Challenging Population

UFH-J is challenged by a high indigent population, which results in a dependence on supplemental funding. UFH-J's payor mix in fiscal 2016 (based on gross revenues) included 40.1% from Medicaid, self-pay and Medicaid pending but is down from 48.4% in fiscal 2012. UFH-J has an indigent care contract with the city of Jacksonville that provides funding for indigent care. This funding has been fairly flat and remains well below cost as UFH-J carries the majority of the burden of serving the indigent population in the service area. The city contract totaled $26.3 million a year in fiscal 2015 and 2016. Management has implemented several strategies in order to better manage the costs of the uninsured population including a patient-centered medical home model.

At the time of Fitch's last review in November 2015, there was uncertainty regarding the future of LIP/DSH funding as the federal government was trying to exert pressure on the state to expand Medicaid and reduced its funding for the LIP program. These funds were backfilled by the state general fund for fiscal 2016 so UFH-J's supplemental funding remained secure and flat in that year.

There is a new restructured LIP/DSH program for fiscal 2017 that has been approved by the federal government, but the final funding amounts are yet to be determined. Total supplemental funding (direct supplemental payments as well as enhanced Medicaid rates) is projected to decline by about $5 million in fiscal 2017 based on current information. Total supplemental funding for fiscal 2016 was $136.8 million compared to $140.8 million in fiscal 2015.

Weak Liquidity

UFH-J's liquidity is weak with $134.4 million unrestricted cash and investments at June 30, 2016, which translated to 81.4 days cash on hand and 50.3% cash to debt compared to 90.4 days and 64.6%, the prior year end period.

Capital investments (excluding North hospital) remain healthy and are budgeted at $33.3 million for fiscal 2017 (over 1x depreciation expense). Although UFH-J's liquidity is light, Fitch believes there is sufficient flexibility to preserve cash if needed. Fitch expects UFH-J to either reduce capital expenditures or postpone transfers to affiliates and at least meet its days cash on hand covenant (60 days) per bank documents for fiscal 2017. Once the North hospital is open, Fitch expects UFH-J to build liquidity beginning in fiscal 2018.

Debt Profile

Total outstanding debt is $260 million and includes the $85 million series 2015 fixed rate bonds, $64.2 million series 2013A fixed rate bonds, $53.5 million series 2013B variable rate (R-Floats), $38 million series 2015 direct bank loan and revolving line of credit with Compass Bank (variable rate), and $17 million note payable to Gainesville. The debt profile is approximately 65% fixed rate and 35% variable rate. UFH-J has several swaps outstanding and was posting $1.6 million in collateral at June 30, 2016.

Fitch believes the debt profile is fairly aggressive for the rating level, and the various risks include remarketing risk related to the R-Floats, bank renewal risk related to the Compass bank loans and exposure to collateral posting requirements under the swap.

The MTI includes maintaining maximum annual debt service (MADS) coverage of at least 1x (includes transfers to UF) and 45 days cash on hand (based on operating expenses, which excludes transfers to UF). Debt service coverage of below 1x for two consecutive years or failure to comply with the liquidity covenant would result in an event of default. The bank covenants include 1x MADS coverage, 60 days cash on hand (calculations per MTI definition), 70% debt to capitalization and a rating of BB or higher.

Fitch used MADS of $17 million, which was provided by management and is calculated per MTI definition. The debt burden is fairly moderate with MADS accounting for 2.6% of total revenue compared to the BBB category median of 3.6%. Debt service coverage is solid and likely understated compared to Fitch's portfolio since the transfers to UF are included in EBITDA. MADS coverage was 2.8x in fiscal 2016 compared to 3.3x in fiscal 2015, 2x in fiscal 2014 and the BBB category median of 3x.

Disclosure

UFH-J covenants to provide annual audited information within 120 days of fiscal year end and quarterly financial information within 45 days of quarter end for all four quarters.

Outstanding debt:

--$64,240,000 Florida Development Finance Corp. (FL) (UF Health-Jacksonville Project) healthcare facilities revenue bonds series 2013A;

--$53,535,000 Florida Development Finance Corp. (FL) (UF Health-Jacksonville Project) healthcare facilities revenue bonds series 2013B;

--$85,000,000 Florida Development Finance Corp. (FL) (UF Health-Jacksonville Project) healthcare facilities revenue bonds series 2015

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=1014861

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https://www.fitchratings.com/regulatory

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or
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Contacts

Fitch Ratings
Primary Analyst:
Emily Wong, +1-415-732-5620
Senior Director
Fitch Ratings, Inc.
650 California Street
San Francisco, CA 94108
or
Secondary Analyst:
Olga Beck, +1-212-908-0772
Director
or
Committee Chairperson:
Jim LeBuhn, +1-312-368-2059
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com