SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A' rating on HonorHealth's (HH) outstanding debt, which is listed at the end of this press release. HH is the new name (effective date March 2015) of the merged entity - Scottsdale Healthcare Hospitals (SHH) and John C. Lincoln Health Network and affiliates (JCL). SHH and JCL affiliated in October 2013 and merged in January 2015. The series 2014 financing consolidated the debt under one obligated group.
The Rating Outlook is Stable.
SECURITY
Debt payments are secured by a pledge of the gross revenues of the obligated group, which includes SHH and JCL. The obligated group accounted for 83% of total assets and 90% of total revenue of the consolidated entity through the nine months ended Sept. 30, 2016. Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
INITIAL INTEGRATION BENEFITS ACHIEVED: HH has accomplished the initial integration goals since the affiliation in October 2013 and cost savings outlined at that time have been achieved. These benefits have been offset by market challenges including declining volume and an erosion in payor mix as well as continued strategic investments in information technology and ambulatory expansion. The organization is well positioned to leverage the next level of opportunities of the new branded entity especially with a common IT platform complete.
MAJOR INVESTMENTS MADE: HH completed the implementation of Epic and the entire organization is on a common IT platform effective October 2016. The cost of the implementation was under budget and is expected to result in further improvement in revenue cycle management.
ADEQUATE FINANCIAL PERFORMANCE: Although certain metrics lag the 'A' category medians, HH's financial profile is consistent with the rating level. Operating performance is expected to improve over the medium term as further benefits of the integration are realized. Balance sheet metrics also remain satisfactory despite the higher level of capital spending.
GOOD GEOGRAPHIC FOOTPRINT: HH has facilities in the desirable service area in northern Phoenix and this footprint makes HH an attractive partner in contracting strategies and HH continues to pursue increasing exposure to risk based contracts.
RATING SENSITIVITIES
FURTHER IMPROVEMENT IN PERFORMANCE: Fitch expects HonorHealth's financial performance to improve as it continues to leverage its greater scale and realize further benefits from the integration, especially as service line reconfiguration will be a focus in the near term. An improvement in operating cash flow and balance sheet metrics would likely lead to upward rating movement.
EXPANSION PLANS: HonorHealth has bed expansion plans that could be funded from an additional debt issuance. Fitch will assess the impact of these plans on HH's rating when plans are finalized.
CREDIT PROFILE
HH includes five hospitals, one free standing emergency department, eight outpatient clinics, 43 primary care locations, five immediate care locations and 304 employed physicians located in the northern Phoenix/Scottsdale market. Total revenue in fiscal 2015 (December 31 year end) was $1.6 billion.
BENEFITS OF INTEGRATION
On Oct. 1, 2013, SHH and JCL entered into an affiliation agreement and the entities merged as of January 2015. The organization was renamed HH in March 2015. The integration has been successful with cost savings targeted at an annual benefit of $200 million achieved. Integration activities include common governance and management, standardization of support functions and contracting, and leveraging economies of scale. The debt was also consolidated under one master trust indenture with the series 2014 financing.
In addition to integration activities, significant investments have been made in information technology as well as the ambulatory network to continue to position the organization for population health management. These investments in addition to market headwinds have offset the cost savings achieved with the integration.
Fitch expects HH to improve its operating performance over the medium term as additional benefits from the next level of integration opportunities are executed. These include service line reconfiguration as well as leveraging its common IT platform.
HH's market position is desirable in the northern Phoenix market, which makes the organization an attractive partner as it pursues more risk based contracting. HH has participated in a narrow network strategy with Banner Health (rated 'AA-'/ Stable) for a Medicare Advantage plan and HH will now be at risk for the performance of this product.
ADEQUATE FINANCIAL PROFILE
HH's performance has been stable in 2014 and 2015 with a compression in operating performance through the nine months ended Sept. 30, 2016. Operating margin was 1.9% through the nine months ended Sept. 30, 2016 compared to 2.6% in 2015 and 2.7% in 2014 and the A category median of 3.8%. Market headwinds include softening volume and a slight erosion in payor mix.
The balance sheet has remained relatively stable despite elevated capital spending; however, HH did draw $30 million on a line of credit in 2016 to fund a land acquisition. Unrestricted cash and investments totaled $779.5 million at Sept. 30, 2016, which equated to 187.9 days cash on hand and 110.4% cash to debt. HH has a fairly significant amount of restricted funds raised by the foundation solely for the benefit of HH. HH maintained $148 million of endowment and donor restricted funds in 2015.
The debt burden is slightly above average and MADS of $40.1 million accounted for 3.5% of total revenue in 2015. Debt service coverage is good at 4.8x through the nine months ended Sept, 30, 2016, 4.8x in 2015 and 5.3x in 2014.
CAPITAL SPENDING
Total capital spending has been elevated the last few years due to the implementation of Epic at SHC. Future capital spending is manageable and includes a bed expansion strategy as well as additional outpatient facilities, including oncology. Capital spending is projected to total $189 million in 2016, $97.8 million in 2017, $102.5 million in 2018, and $104 million in 2019 as compared to annual depreciation expense of about $89 million.
HH may issue additional debt in the next year to fund a portion of its capital plan. Fitch will assess the impact on the rating when plans are finalized.
DEBT PROFILE
Total outstanding debt at Dec. 31, 2015 was $667 million with a debt mix of 74% fixed rate and 26% variable rate. HH has several direct bank loans (2014 taxable note, series 2015A&B bonds) that are subject to renewal risk. Fitch believes HH's access to capital mitigates this risk. The covenants under the direct bank loan are more restrictive than those in the amended and restated MTI, which will be in effect when the insured bonds are paid off (series 2006C and 2006F).
DISCLOSURE
HH covenants to provide quarterly disclosure within 60 days of quarter end for the first three quarters and annual financial disclosure within 150 days of the end of the fiscal year to EMMA.
Outstanding debt:
--$336,810,000 Arizona Health Facilities Authority (AZ) (Scottsdale Lincoln Hospitals Project) revenue bonds series 2014A;
--$52,406,000 Scottsdale Industrial Development Authority (AZ) (Scottsdale Healthcare) hospital revenue refunding bonds series 2008A;
--$89,327,000 Scottsdale Industrial Development Authority (AZ) (Scottsdale Healthcare) hospital revenue bonds series 2006F (insured: Assured Guaranty Municipal Corp.);
--$58,174,000 Scottsdale Industrial Development Authority (AZ) (Scottsdale Healthcare) hospital revenue refunding bonds series 2006C (insured: Assured Guaranty Municipal Corp.).
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=1015788
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1015788
Endorsement Policy
https://www.fitchratings.com/regulatory
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.
Copyright © 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.
The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.