SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A+' rating on PeaceHealth's outstanding debt, which is listed at the end of the press release.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group (OG). The OG accounted for 99% of total assets and 100% of total revenue of the consolidated entity in fiscal 2016 (June 30 year end). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
GOOD MARKET POSITIONS: PeaceHealth's primary credit strength continues to be its geographic diversity and good market positions in its major service areas. The Northwest Network's (Bellingham, WA and Alaska) largest facility is St. Joseph Medical Center in Bellingham, WA, which has maintained over 80% market share the last four years. The Oregon West Network's (Eugene/Springfield/Florence, OR) flagship facility is Sacred Heart Riverbend and market share dropped to 67% from 70% the prior year due to physician and labor issues, which have been resolved and a rebound in market share is expected. The Columbia Network (Longview/Vancouver, WA) is the most challenging and competitive market with 49% market share.
GOOD LIQUIDITY: The rating affirmation also reflects PeaceHealth's solid balance sheet with total unrestricted cash and investments of $1.5 billion at Sept. 30, 2016, which equated to 242 days cash on hand and 146.7% cash to debt compared to the 'A' category medians of 215.5 days and 148.6% cash to debt.
PRESSURED PROFITABILITY: PeaceHealth has successfully implemented Epic (electronic health record), across its inpatient facilities (ambulatory was already complete) in all three networks which negatively impacted profitability especially in fiscal 2016. Operating EBITDA margin in fiscal 2016 fell to 7% from 13.5% in fiscal 2015 and 9.1% in fiscal 2014. However, Fitch notes that excluding Epic expenses operating EBITDA margin would have been 10.3% in fiscal 2016.
EXPECTED INCREASE IN CAPITAL SPENDING: Capital spending has been constrained but is expected to increase starting in fiscal 2018. The five year capital plan totals $1.5 billion (approximately 1.8x depreciation expense/year) which includes master facility needs, routine capital expenditures ($117 million a year), as well as strategic acute and ambulatory growth.
LIGHT DEBT SERVICE COVERAGE: Coverage of MADS weakened in fiscal 2016 to a light 2.5x from 4.0x and 3.5x in fiscal 2015 and 2014, respectively. Coverage was negatively impacted by Epic expenses and PeaceHealth's front loaded debt structure. The fiscal 2017 budget includes a 9.2% operating EBITDA margin (including Epic expenses) resulting in MADS coverage of 3.2x.
RATING SENSITIVITIES
FINANCIAL IMPROVEMENT EXPECTED: The rating affirmation reflects Fitch's expectation that operating cash flow will improve as a new management team implements its long range financial plan and realizes benefits of its favorable markets. The failure to meet the fiscal 2017 budget and ongoing operating EBITDA margin targets of around 10+% could trigger negative rating action.
ADDITIONAL DEBT PLANS: PeaceHealth has additional debt plans to fund a portion of its large capital plan within the next three years. Improved operating cash flow will be necessary to absorb additional debt at the current rating level.
CREDIT PROFILE
PeaceHealth is a multi-state health care system with 10 acute care hospitals (1,653 licensed beds) in Washington, Oregon, and Alaska with total revenue of $2.4 billion in fiscal 2016. PeaceHealth sold its interest in Columbia United Providers (Medicaid managed care lives) to Molina Health Care of Washington effective Dec. 31, 2015. The figures cited in this report are for the consolidated entity for the audited periods and obligated group for the interim financials.
At the time of the Fitch's last review in April 2015, the CEO and CFO positions were vacant and have been filled effective November 2015 and June 2016, respectively. In addition, governance was restructured from a traditional hospital board to a parent system board structure and half of the board members are new. There are ongoing management changes (COO role vacant) as well as personnel changes throughout the organization with a new culture focused on accountability.
GOOD MARKET POSITIONS
PeaceHealth's main credit strength is the system's geographic diversity and good market position in most of its service areas in Washington, Oregon and Alaska. Fitch views the revenue diversity favorably with the Oregon West Network accounting for 34.1% of consolidated revenue in fiscal 2016, Columbia Network with 28.9% and Northwest Network with 23.8%.
There was a disruption in the Oregon West Network in fiscal 2016 due to issues with the hospitalist group as well as labor pressures that resulted in diversions and impacted volume. These issues have been resolved and a rebound in volume is expected.
The Columbia Network continues to be the most challenging with two facilities in diverse markets and also the most competitive as it competes with the Portland metropolitan area. Issues have arisen in this Network since a Kaiser contract termination in October 2013. Fitch expects a longer-term strategy related to this Network by Fitch's next review since an evaluation of these strategies has been underway for some time with no marked progress, but likely slowed due to management changes.
PRESSURED PROFITABILITY
After several years of weaker operating performance, profitability rebounded in fiscal 2015 aided by one time items, and a trend of improved profitability would have been sustained without Epic implementation costs. The total cost of the inpatient electronic health record was budgeted at $293 million with $157 million expensed and $136 million capitalized. Operating expenses related to Epic totaled $126.4 million through Sept. 30, 2016 with the remainder to be spent by the second quarter of fiscal 2017. The implementation was successful with go live dates of May 1, 2016 for the Northwest Network, Aug. 1, 2016 for the Columbia Network, and Oct. 1, 2016 for the Oregon West Network.
Without the Epic costs, operating EBITDA margins have been over 10% compared to Fitch's 'A' category median of 10.3%. The fiscal 2017 budget is for a 9.2% operating EBITDA margin due to the remainder of the Epic costs (10.8% operating EBITDA margin without Epic). Fitch expects PeaceHealth to maintain close to or above 10% operating EBITDA margins.
The organization continues to invest in physician alignment and the employed physician group (PeaceHealth Medical Group) is at almost 700 FTEs. The losses at the Medical Group are fairly sizeable but the loss per provider has been declining.
INCREASE IN CAPITAL SPENDING
Capital spending is expected to increase significantly beginning in fiscal 2018. Capital expenditures are expected to total $302 million in fiscal 2018, $372 million in fiscal 2019, $337 million in fiscal 2020, $277 million in fiscal 2021, and $227 million in fiscal 2022.
There are growth and expansion plans included in the projections and the increased capital spending will need to be commensurate with improved, consistent financial performance.
DEBT PROFILE
Total master note debt is $990.2 million as of Sept. 30, 2016, which is 64% underlying fixed rate and 36% underlying variable rate. PeaceHealth's debt profile includes $502 million direct placements or bank loans and $146 million variable rate demand bonds. The direct placements and variable rate demand bonds have a three-year term out provision and the expiration dates and counterparty exposure are staggered and diversified, which is viewed favorably. Including the impact of its swaps, PeaceHealth's debt profile is 98% fixed rate. PeaceHealth is not posting any collateral related to its swaps.
MADS equals $88.5 million and occurs in fiscal 2017. The debt service schedule includes a smoothing of PeaceHealth's bullet maturities ($80.65 million in fiscal 2019 for series 2008A, $50 million in fiscal 2021 for US Bank loan and $130 million in fiscal 2024 for BofA loan) as permitted under the master trust indenture. Aggregate debt service is not level and MADS drops to $80.3 million in fiscal 2018 then $79.8 million post fiscal 2018.
PeaceHealth has a frozen defined benefit pension plan (legacy Southwest Medical Center plan) and the funded status dropped to 61% in fiscal 2016 from 74% the prior year due to a decline in the discount rate. Pension plan funding could pressure liquidity growth.
DISCLOSURE
PeaceHealth has covenanted to provide annual audited financial statements to Electronic Municipal Market Access within 150 days of each fiscal year end and unaudited quarterly financial statements (including a consolidated balance sheet, income statement, statement of cash flows, and utilization statistics) within 60 days of each fiscal quarter end.
Outstanding Debt:
--$66,060,000 Oregon Facilities Authority refunding revenue bonds (PeaceHealth Project), 2014 series A;
--$36,620,000 Washington Healthcare Facilities Authority refunding revenue bonds, series 2014A (PeaceHealth);
--$86,310,000 Oregon Facilities Authority (OR) (PeaceHealth) revenue bonds series 2009A;
--$72,410,000 Washington Health Care Facilities Authority (WA) (PeaceHealth) revenue bonds series 2009;
--$145,975,000 Oregon Facilities Authority (OR) (PeaceHealth) revenue bonds series 2008A&B (LOC: U.S. Bank National Association);
--$80,650,000 Washington Health Care Facilities Authority (WA) (PeaceHealth) revenue bonds series 2008A
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=1016332
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1016332
Endorsement Policy
https://www.fitchratings.com/regulatory
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