NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A' rating to the following revenue bonds issued by the Maryland Health and Higher Educational Facilities Authority on behalf of University of Maryland Medical System (UMMS).
--$151,050,000 series 2017B (Tax-Exempt);
--$122,365,000 series 2017C (Taxable).
In addition, Fitch affirms the rating on UMMS's $1.2 billion outstanding debt including the series 2005 and 2010 bonds to be refunded; Fitch does not rate the series 1991B bonds.
The Rating Outlook is revised to Negative from Stable.
SECURITY
Debt payments are secured by a pledge of the gross revenues of the obligated group.
KEY RATING DRIVERS
POTENTIAL ACQUISITION OF DIMENSIONS HEALTHCARE SYSTEM: UMMS, Prince George County (County) and Dimensions Healthcare System (Dimensions) entered in a revised MOU in August 2016 that paves the way for UMMS to become the sole corporate member of the Dimensions. The proposed transformation project includes construction of a replacement hospital for the Dimensions Cheverly campus and scaling back of inpatient care at one other Dimensions facilities at a total cost of $645.5 million. The proposed project will receive significant capital commitments from both the State of Maryland and the County and will require UMMS to make a capital commitment for the project.
REVISION OF THE OUTLOOK TO NEGATIVE: The Negative Outlook reflects the expected execution of a Definitive Agreement and acquisition of Dimensions by UMMS, as well as the potential impact on UMMS financial profile. The timing, size and security structure of any potential UMMS debt issuance in support of the Dimensions transformation has not been finalized at this time and as such cannot be fully incorporated into Fitch's analysis.
GROWING REGIONAL FOOTPRINT: UMMS has been strengthening its regional presence through affiliations with community hospitals and driving tertiary business to its flagship facility, University of Maryland Medical Center (UMMC). UMMS maintains the leading market position within the state of Maryland with a market share of 25.5% in the PSA, compared to 19.9% for Johns Hopkins and 14.9% for MedStar.
FACING MARGIN PRESSURE: Operating performance has been relatively stable over the last three years despite challenges related to integrating new hospitals into the system. UMMS generated operating income of $87.2 million in fiscal 206 (year-end June 30), ahead of budget, translating to operating and operating EBITDA margins of 2.4% and 9.4%, respectively. The first quarter of fiscal 2017 ended with a small operating loss of $0.6 million, which includes a one-time expense related to a termination of a defined benefit pension plan at one of the facilities. Excluding the one-time expense operating income was $20.1 million, equal to an operating margin of 2.1%. The attainment of projected margins averaging 2% over the next five years will require implementation of a performance improvement plan totaling $1 billion during this period.
WEAK LIQUIDITY: While liquidity is weak for the rating category and is not expected to improve materially given the system's future capital needs, metrics have remained. Absolute liquidity has been slowly improving over the last several years but liquidity metrics improvement is limited by increase in system expenses as the organization expanded - consolidated system revenues increased by 21% since 2014. Unrestricted cash and investments at Sept. 30, 2016 of $1.2 billion translating to 122.2 days cash on hand (DCOH), 12.5x cushion ratio and 68.6% cash-to-debt, all trail the respective 'A' category medians of 125 DCOH, 19.4x and 148.6%. UMMS liquidity is also negatively impacted by a large swap portfolio, requiring collateral posting of $170.9 million at Sept. 30, 2016. Given capital plans on the horizon, liquidity is likely to remain stressed, but expected to remain fairly close to historical levels.
ELEVATED DEBT BURDEN AND ROBUST CAPITAL NEEDS: UMMS debt burden is still elevated but has moderated over time. Historical coverage of pro-forma maximum annual debt service (MADS) by EBITDA was 3.4x in fiscal 2016, lower than Fitch's 'A' category median of 4.5x, but MADS as percent of revenues has declined to 2.7%, consistent with the category median. However, the system has significant capital needs over the next five years, requiring debt issuance of approximately $286 million in fiscal 2018, not including any potential debt issuance in support of Dimensions, which may be as early as summer 2017.
RATING SENSITIVITIES
NEED TO IMPLEMENT A $1 BILLION PERFORMANCE IMPROVEMENT: Fitch expects University of Maryland Medical System to execute its goal of generating operating margins averaging 2% over the medium term needed to support its capital and programmatic investments. Failure to generate adequate cash-flow to maintain positive margins in absence of moderating its capital spending would produce downward rating pressure.
RISKS IN ACQUISITION OF DIMENSIONS HEALTH: While the impact of the potential acquisition and funding of the Dimensions Health transformation strategy is not fully reflected in the rating, the increased risk associated with the acquisition, operation and execution of a replacement hospital for Dimensions is likely to result in negative action. Fitch will evaluate the impact of the acquisition once the Definitive Agreement is signed and debt plans are solidified.
NEW ISSUE DETAILS
The series 2017B fixed-rate tax exempt bonds and the series 2017C fixed-rate taxable bonds are expected to be sold via negotiation the week of Jan. 16, 2017. The transaction will refinance or refund the outstanding series 1991B (not rated by Fitch) and series 2005 and 2010 bond series. Sources of funds include release of all or portion of the debt service reserve funds (DSRF) of the series 1991B and the series 2010 bonds. DSRF's will not be funded in connection with the 2017 series. Final maturity of the bonds is in July 2039 and MADS, provided by the underwriters of $100.7 million occurs in 2021. Net present value savings are currently estimated at $8.2 million. Additionally, the transaction will enable the elimination of a 63% debt to capitalization covenant.
CREDIT PROFILE
UMMS is comprised of the flagship facility, University of Maryland Medical Center (UMMC) located in Baltimore, Maryland, and several community and specialty hospitals. UMMS leverages its strong relationship with the state and University of Maryland's School of Medicine (SOM), which is a key differentiating factor compared to UMMS's competitors. The state continues to provide UMMS operating as well as capital support and UMMS is aligned with the SOM, which trains 50%-60% of the physicians in the state. Fitch reviews the consolidated system, which generated total operating revenues of $3.67 billion in fiscal 2016. The obligated group accounted for 95.3% of consolidated system assets and 90% of consolidated system revenues in fiscal 2016.
Essential Provider in Maryland
Once a state-owned institution, UMMS continues to benefit from its close ties to the State of Maryland (general obligation bonds rated 'AAA') as an essential provider of certain high-end services, including the state's largest trauma center. UMMS has been receiving ongoing operating support of approximately $3 million annually for the Shock Trauma Center as well as $32.2 million for certain capital projects over the last four years. For fiscal 2017, the state will provide capital support of $25.3 million, with $20 million specifically dedicated for upgrading of UMMS's NICU and labor and delivery areas.
UMMS' strong relationship with the University of Maryland's (rated 'AA+') SOM enhances its ability to reduce costs and increase revenue as the faculty at SOM (approximately 1,200 physicians) is the medical staff at UMMC. Further, UMMC's ability to provide high end services is evidenced by a Medicare case mix index of 2.34 that results in a large volume of referrals throughout the state.
Maryland Global Budget Revenue Program
Effective Jan. 1, 2014, UMMS signed onto the Maryland GBR program, which now accounts for majority of total system revenues. Currently under a five-year pilot period, the GBR program offers participants a fixed revenue stream designed to incentivize hospitals to avoid unnecessary care and provide care in the most appropriate cost setting. The amount of hospital revenue is known before the start of the fiscal year and is adjusted annually. The per capita growth rate of total GBR payments is capped at 3.58% annually for the first three years. With continued implementation, less complex services are expected to migrate to more cost effective outpatient settings from the main campus. Strategies are under development to improve physician alignment, which will be one of the key drivers of success in managing populations. Additionally, as part of its population health management strategy, UMMS acquired Riverside Health Plan, which has 35,000 Medicaid managed care enrollees.
Need to Maintain Profitability
UMMS revenue base continues to diversify and grow, with operating revenues totaling over $3.7 billion in fiscal 2016 compared to $2.4 billion in fiscal 2012. The system reported two fiscal years with solid operating income - $117.7 million in 2015 and $87.2 million in 2016, generating operating margin so 3.5% and 2.4%, respectively. Fitch notes particularly the success of reversing the large operating losses at St. Joseph Medical Center following its acquisition in 2012, which initially pressured UMMS's profitability. The small operating loss reported for the first quarter of 2017 is the result of a $20.7 million one-time expense from the termination of a frozen defined benefit pension plan at Upper Chesapeake Medical Center and a higher than budgeted medical loss ratio at the Riverside Health Plan. UMMS has budgeted 2017 operating income of $69.8 million (1.8% operating margin). The ability to generate the projected margins will require performance improvement of $1 billion over the next five years, with the biggest lift in the current fiscal year. Failure to execute these financial improvement plan targets would necessitate the need to delay or alter the capital plans.
Update on Dimensions Health System
UMMS, together with the University of Maryland and the State and Prince George's County, has been a partner in the effort to address the inadequate facilities operated by Dimensions. The current plan to which both the County and State have committed themselves via legislation, contemplates the construction of a replacement 231-bed hospital - Regional Medical Center (RMC) at a more favorable new location outside of the 495 beltway, as well as the transformation of the other two campuses more focused on outpatient care. As conceived, RMC would become more of a tertiary regional medical center. UMMS already operates several programs at Dimensions, such as Level II Trauma and cardio-thoracic surgery. The State and the County have each committed $208 million of capital support for the project and $15 million each for operating support in the initial years. A Definite Agreement is expected to be signed in December 2016 and the County and State funding is contingent on UMMS becoming the sole corporate member of Dimensions, responsible for its governance and operations. Construction of the RMC may start as early as summer of 2017.
Weak but Stable Liquidity
At Sept. 30, 2016, unrestricted cash and investments totaled $1.2 billion, equal to 122 DCOH, 12.2x cushion ratio, and 68.6% cash to debt, weaker against the 'A' medians of 215 days, 19.4x and 148.8%, respectively. Fitch notes that unrestricted cash and investments have grown steadily over time, but the ability to grow liquidity is partly limited within Maryland's rate setting system. Balance sheet weakness is somewhat offset by the relative revenue stability and predictability under the GBR model.
Robust Capital Plans
Management has projected $760 million of capital expenditures for next five years roughly split between routine capital and IT needs and approximately $780 million for strategic investments and projects. The current projections envision issuance of close to $300 million in 2018. This does not include any debt that UMMS may need to issue in support of the Dimensions replacement hospital. While issuance of additional debt could pressure the rating, management is committed to flex capital expenditures based on debt capacity. Fitch would evaluate the impact of any issuance against UMMS's financial profile once plans are solidified.
Elevated Debt Burden
MADS coverage by EBITDA of the pro forma MADS was 3.4x in fiscals 2016, lower than Fitch's 'A' category median of 4.5x, but MADS as percent of revenues has moderated to 2.7%, in line with the category median. Debt to capitalization remains elevated at 55.5% compared to the 36% median. The metrics do not include any assumption of the potential Dimensions debt.
Debt Profile
At Sept. 30, 2016, UMMS's outstanding total debt including short term debt, leases and draws on line of credit totaled approximately $1.8 billion, of which approximately 54% was fixed rate and the remaining variable (swapped to fixed). Debt service is level until 2024 and then declines slightly. Pro forma MADS of $100.7 million occurs in 2021.
Given market conditions, swap collateral posting requirements have been sizeable and volatile. As of Sept. 30, 2016, UMMS was counter-party to 11 swap contracts with a total notional value of $776 million. The aggregate market value of UMMS' swap portfolio was negative $268.7 million which required collateral posting of $170.9 million. UMMS draws on its line of credit for these requirements, which Fitch includes in total debt.
Disclosure
UMMS discloses annual financial statements within 120 days and quarter unaudited financial statements within 45 days for the first three quarters and within 90 days for the last quarter through the MSRB EMMA website.
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=1015707
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