CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'AA-' rating on approximately $239 million of Wisconsin Health and Educational Facilities Authority bonds issued on behalf of ThedaCare. The rating affirmation affects the following bonds:
--$123,855,000 fixed-rate revenue bonds series 2015;
--$18,515,000 fixed-rate revenue bonds series 2010;
--$81,720,000 fixed-rate revenue bonds series 2009A;
--$14,815,000 fixed-rate revenue bonds series 2009B.
The Rating Outlook has been revised to Negative from Stable.
SECURITY
Debt payments are secured by a joint and several gross revenue pledge of the obligated group. All seven system hospitals are members of the obligated group.
KEY RATING DRIVERS
WEAKER MARGINS IN FISCAL 2015 AND 2016: ThedaCare has consistently generated operating margins above 2% since fiscal 2002. The system's operating margins softened notably in fiscal 2015 (7.8% operating EBITDA margin) and through nine-months fiscal 2016 (6.2% operating EBITDA margin).
FAVORABLE LIQUIDITY RATIOS: ThedaCare's liquidity remains a credit strength. Cash on hand measured 254 days at fiscal year-end 2015 (240 days at Sept. 30, 2016). Cash-to-debt measured 180% at Sept. 30, 2016.
LEADING MARKET SHARE: ThedaCare maintains the leading market share of its quality primary service area (PSA). ThedaCare faces competition in the broader service area, notably from Affinity Health System (a member of Ascension Health).
MODEST DEBT COVERAGE FOR RATING CATEGORY: With modest operating results in interim fiscal 2016, debt coverage ratios are somewhat thin for a 'AA-' rated health system. Based on results through nine-months fiscal 2016, maximum annual debt service (MADS) coverage from EBITDA measured 3.3x.
RATING SENSITIVITIES
MODEST OPERATING TRENDS: If ThedaCare fails to show marked improvement in operating and operating EBITDA margins in fiscal 2017, a rating downgrade is likely.
CREDIT PROFILE
ThedaCare is a seven-hospital system operating in northeast Wisconsin. Acute care hospitals include two flagship facilities, ThedaCare Regional Medical Center-Appleton (TCA) and ThedaCare Regional Medical Center-Neenah (TCN). The other hospitals are all critical access hospitals (CAH), each with 25 staffed beds: ThedaCare Medical Center-Berlin (TCB), ThedaCare Medical Center-Shawano (TCS), ThedaCare Medical Center-New London (TCNL), ThedaCare Medical Center-Wild Rose (TCWR), and ThedaCare Medical Center-Waupaca (TCW). ThedaCare's newest additions are TCB and TCWR, which joined the system in 2014. ThedaCare is also the sole corporate member of ThedaCare Physicians, which operates dozens of clinics throughout the service area and employs approximately 220 physicians. Total revenue in fiscal 2015 was just over $885 million. ThedaCare is a Mayo Clinic Network member.
WEAKER OPERATING MARGINS IN FISCAL 2015 AND INTERIM FISCAL 2016
While ThedaCare has a track-record of profitability with an operating margin consistently above 2% since fiscal 2002, the system's operating margins have softened notably in the last two years. In audited fiscal 2015, ThedaCare recorded an operating margin of 1.2% and operating EBITDA margin of 7.8%. Through nine-months unaudited fiscal 2016 (as of Sept. 30, 2016), ThedaCare recorded a -0.5% operating margin and 6.2% operating EBITDA margin. The 'AA' median operating margin is 5.2% and operating EBITDA margin is 11.7%.
Factors contributing to softer operating results include: management planned for declining inpatient admissions due to shifting industry dynamics, which did not materialize as expected, and resulted in increased contract labor; operating disruption at the new TCS hospital, due to flooding from a municipal public works error, which resulted in approximately $500,000 of business interruption losses and roughly $2 million of property loss (insurance reimbursement is expected in 2017); and start-up costs associated with ThedaCare's new regional cancer center.
ThedaCare is implementing a number of improvement efforts to generate better operating margins. Key improvements include: staff reduction through attrition (ThedaCare's headcount reduced from 6,939 in May 2016 to 6,766 in October 2016); reduction of contract labor; improved flexing of staff levels to match fluctuating volumes; and improved billing practices of cancer services. Long-term, ThedaCare expects to maintain an operating margin of 4% to 6% (before the system's "success sharing" program), including 4% initially targeted for fiscal 2017.
Operating margins for full-year fiscal 2016 are expected to be better than interim fiscal 2016 and in-line with results in fiscal 2015, as ThedaCare benefits from initial improvements as well as typical year-end adjustments that are not included in interim results (e.g., cost report reconciliations).
FAVORABLE LIQUIDITY RATIOS
ThedaCare's liquidity remains a credit strength. At fiscal year-end 2015 (December 31 year-end), cash on hand measured 254 days ('AA' median is 277 days), cash-to-debt 182% ('AA' median is 198%), and cushion ratio 24% ('AA' median is 30%). Liquidity strength was generally sustained at unaudited Sept. 30, 2016, with 240 days cash on hand and 180% cash-to-debt.
ThedaCare's investment portfolio is somewhat aggressive. Fixed income and related investments account for approximately 27% of ThedaCare's portfolio (not including current cash), domestic and international equities 45%, and hedge funds, private equity and other alternatives 28%. Management notes that approximately 70% of ThedaCare's investments can be liquidated in a manner of days.
LEADING MARKET SHARE
Favorably, ThedaCare maintains the leading market share of its quality service area. Of a core service area around Outagamie and Winnebago counties, ThedaCare maintains approximately 43% to 44% inpatient market share. Affinity Health (a member of 'AA+' rated Ascension Health Alliance) captures the number two market position of the service area with roughly 31% share. Affinity has two hospitals in the area: St. Elizabeth Hospital in Appleton and Mercy Medical Center in Oshkosh. ThedaCare also faces some degree of competition in the broader service area from Aurora Health Care (rated 'A'). Fitch notes that inpatient market share does not represent a complete picture of ThedaCare's competitive position since inpatient services represented less than 29% of gross revenue in fiscal 2015.
Competition between ThedaCare and Aurora is mitigated to some extent as both systems are founding members of AboutHealth. AboutHealth is a collaboration among eight health systems in Wisconsin that also includes Bellin Health Systems (whose flagship facility is located 30 miles northeast of Appleton in Green Bay), Aspirus, Gundersen Health System, Marshfield Clinic Health System, ProHealth Care, and UW Health. Moreover, ThedaCare and Bellin have additional partnerships, including Bellin-ThedaCare Healthcare Partners ACO, which has been one of the most successful participants in the CMS Pioneer ACO program in terms of generating and maintaining low costs per Medicare beneficiary.
Demographic characteristics are generally favorable in ThedaCare's core service area. Outagamie and Winnebago counties are experiencing population growth (particularly Outagamie), the median household income level is above average in Outagamie and average in Winnebago, poverty rates are average to below average, and the Appleton MSA has one of the lowest unemployment rates in the U.S. (U.S. Census Bureau and U.S. Bureau of Labor Statistics data).
CONSERVATIVE DEBT STRUCTURE, BUT MODEST COVERAGE FOR RATING CATEGORY
ThedaCare's debt structure is quite conservative, with approximately 97% fixed rate debt and only 3% variable rate. The series 2012 and series 2014 bonds are private placements, with initial fixed rate terms to 2022.
ThedaCare's debt coverage ratios are somewhat thin for a 'AA-' rated health system, with modest operating results in fiscal 2015 and interim fiscal 2016. While MADS burden is only somewhat elevated at 2.8% of total fiscal 2015 revenue, MADS coverage from EBITDA measured 3.8x in fiscal 2015 and 3.3x based on nine-months fiscal 2016 ('AA' median is 6.0x). Debt-to-EBITDA and debt-to-capitalization are more palatable, as debt-to-EBITDA measured 3.4x in fiscal 2015 and 3.8x in interim fiscal 2016 ('AA' median is 2.5x) and debt-to-capitalization measured 31% and 30%, respectively ('AA' median is 28%).
ThedaCare's financial covenants include a minimum rate covenant of 1.25x, minimum cash on hand of 65 days, and maximum debt-to-capitalization of 65%.
ThedaCare has a frozen defined benefit pension plan. The plan was 74% funded at fiscal year-end 2015 (relative to a projected benefit obligation of $260 million). The system made a $10 million contribution to the defined benefit pension in September 2016 and plans to make similar annual contributions in the coming years. ThedaCare also has operating leases in place, with a lease expense of nearly $24 million in fiscal 2015.
ThedaCare's near-term capital spending plans are manageable. The system has nearly $110 million of capital identified in fiscal 2017 and fiscal 2018. This translates to capital expenditures-to-depreciation of roughly 115% ('AA' median is 122%). ThedaCare's average age of plant measured 11.8 years at fiscal year-end 2015 ('AA' median is 10.0 years). Highlighted projects include OR upgrades, information technology, and clinic investments. While ThedaCare does not have near-term new money debt plans, the system will consider debt options as long-term capital plans evolve.
ThedaCare's CEO, Dr. Dean Gruner, is planning to retire in 2017. Dr. Gruner has been with ThedaCare since 1983. After taking the CEO position in 2009, a succession planning process was implemented. The board has initiated a search for a new CEO. Internal and national candidates will be considered, and the system hopes to have a final candidate identified by spring 2017.
Disclosure
ThedaCare covenants to post its annual and quarterly statements on EMMA by no later than 150 days after the end of the fiscal year and 45 days after the end of each quarter.
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=1014888
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014888
Endorsement Policy
https://www.fitchratings.com/regulatory
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