SAN FRANCISCO/--(BUSINESS WIRE)--Fitch Ratings has assigned a 'A+' rating to the approximately $185,120,000 Salem Hospital Facility Authority, OR revenue refunding bonds series 2016A issued on behalf of Salem Health (Salem). In addition, Fitch has affirmed the 'A+' rating on Salem's outstanding debt, which is listed at the end of this release.
The Rating Outlook is Stable.
The series 2016A bonds will be fixed rate and bond proceeds will refund Salem's outstanding series 2006A, 2008A, and 2013A&B bonds. The final maturity is being extended to 2046 since there is additional average life remaining. The extension on the final maturity as well as interest rate savings significantly reduces MADS to $15.9 million from $22.1 million. In addition, the sources of funds include the release of the series 2008A debt service reserve fund. The bonds are expected to price on Oct. 25.
SECURITY
The bonds are secured by a gross receivables pledge of the obligated group (OG). There is an amended and restated master trust indenture dated Nov. 1, 2016, which will be effective at closing of the series 2016A bonds.
KEY RATING DRIVERS
SUSTAINED STRONG PERFORMANCE: Since Fitch's last rating review in February 2016 when Salem's rating was upgraded to 'A+' from 'A', Salem's financial performance continues to be very strong and mainly driven by benefits from its lean management system. The refinancing provides further financial cushion with a significant reduction in debt service. Operating EBITDA margin was 13.4% in fiscal 2016 (June 30 year-end) and operating EBITDA margins are expected to be sustained around 12%.
AFFILIATION WITH OHSU: Effective November 2015, Salem affiliated with Oregon Health and Science University (OHSU; rated 'AA-'/Outlook Stable) under a Joint Management Agreement. While Salem and OHSU will remain separately obligated on their debt, the clinical enterprises are operated as a single entity with a common management team and shared bottom line (operating income).
DOMINANT MARKET SHARE: Salem maintains a dominant market share position of almost 80% in its primary service area, which includes the cities of Salem (the state capital) and Keizer. Volume growth has been strong and driven by Medicaid expansion as well as an aging population.
SOLID LIQUIDITY POSITION: Liquidity metrics have consistently grown and compare favorably to Fitch's A category medians. At June 30, 2016, Salem had 296 days cash on hand and 178.7% cash to debt compared to the 'A' category medians of 215.5 and 148.6% cash to debt, respectively.
ADDITIONAL DEBT CAPACITY: With the refinancing, Salem has created additional debt capacity at its current rating level for future growth plans. No additional debt is expected in the next two years, but there is longer-term planning underway for potential additional bed capacity.
RATING SENSITIVITIES
FLEXIBILITY AT CURRENT RATING LEVEL: Salem Health's current financial performance provides flexibility as it manages strong demand. The maintenance of current operating performance and further growth in liquidity could lead to upward rating movement over the medium term depending on the size and scope of any large scale capital plans.
CREDIT PROFILE
Salem Health Hospitals and Clinics includes Salem Health (fka Salem Hospital), a 413-staffed bed hospital located in Salem, OR, approximately 45 miles south of Portland, as well as other healthcare related entities. Salem Health is the only member of the OG and accounted for 98% of total assets and 96% of total revenue of the consolidated entity in fiscal 2016 (June 30 year-end). Fitch's analysis is based on the consolidated entity.
Salem had $741 million in annualized total operating revenue for fiscal 2016. Salem changed its fiscal year end to June 30 from Sept. 30 in 2016, and the audited period for fiscal 2016 is for a nine-month period.
Strong Operating Performance
Salem has been using the lean management system since 2010, which aligns the whole organization in reducing waste. There are visual management tools for the six main strategies (financial performance, quality, patient experience, employee engagement, physician engagement, and population health), which cascade down to the department level.
The lean management tools and good volume growth has led to very good operating performance with a 13.4% operating EBITDA margin in fiscal 2016 compared to 15.4% in fiscal 2015, 12.2% in fiscal 2014 and 12.9% in fiscal 2013. Salem has also implemented a rolling forecast (versus budgeting), which allows the ability for more timely responses to any issues that arise. Salem has a target of maintaining at least 12% operating EBITDA margin.
For the annualized fiscal 2016 period, emergency room visits are up 6% while surgeries are flat at 0.3% and admissions are slightly down at negative 0.7% compared to the prior year period. Salem maintains one of the busiest emergency rooms in Oregon (over 125k for fiscal 2016), and volume growth has been accommodated by improved throughput.
OHSU Affiliation
OHSU is based in Portland, Oregon and is the state's only health science university and major academic health center. In addition to the Schools of Medicine, Nursing, and Dentistry, OHSU operates 564 beds in its two hospitals (OHSU Hospital and OHSU Doernbecher Children's Hospital) and provides highly complex tertiary and quaternary care with a case mix index over 2.0. OHSU has trained over a third of the physicians in the state, which provides a good foundation for the physician integration expected with the affiliation.
OHSU and Salem entered into a 40-year joint management agreement in November 2015, which states that the clinical enterprise will be jointly managed by a common management team (OHSU Partners). The academic and research missions of OHSU are excluded from this. OHSU Partners' executive management team includes individuals from both OHSU and Salem and the hospitals of both entities will be managed on a combined basis with integrated financial and capital planning. The OHSU Partners budgets have to be approved by both the OSHU board and Salem board. The profitability (operating income) of the combined entity is split based on each entity's historical share of financial performance (Salem 19%, OHSU 81%). The expectation is that growth will be greater as a combined entity as the entities leverage each other's resources, capacity, and capabilities. For fiscal 2016, the operating margin split resulted in Salem recording an expense of $8.26 million.
Fitch views this relationship favorably as it allows Salem to be part of a larger system while maintaining local control. However, effective implementation and consensus on a shared strategic vision can be challenging achieve. Initial work is still underway, and over the lab, pharmacy and supply chain are expected to be standardized over the next 18 months. There are two potential hospitals that will be joining OHSU Partners.
Solid Liquidity
Salem's liquidity metrics are solid for the rating level, and unrestricted cash and investments have steadily increased year over year since fiscal 2012. Unrestricted cash and investments totaled $530.3 million at June 30, 2016, which equated to 296 days cash on hand and 178.7% cash-to-debt from 255.1 and 114.6%, respectively at fiscal year-end 2012.
Capital Spending
Capital spending totaled $51.3 million for fiscal 2016 (1.6x depreciation expense) and strategic capital included investing in a new outpatient rehabilitation building as well as the build out of 40 additional beds in shelled space. These beds will open in October 2017; however, two more floors need to be renovated so the additional capacity will not be on line until the end of 2018. The fiscal 2017 capital allocation model results in $69 million of total spend with $39 million of strategic capital planned. A master facility plan is underway with the potential long-term need for additional bed capacity being assessed.
Additional Debt Capacity
Fitch believes Salem has created additional debt capacity at its current rating level due to the refinancing. MADS drops from $22.4 million to $15.9 million. MADS as a percentage of revenue declines to 2.1% from 3% in fiscal 2016 and compared to A category median of 2.7%. MADS coverage is strong at 6x in fiscal 2016 and 5.6x in fiscal 2015, which improves to 8.5x and 7.9x, respectively on the pro forma MADS. The aggregate debt service schedule is level.
As of June 30, 2016, Salem had $296.7 million of debt outstanding. With the refinancing, Salem is removing the bank renewal risk as the series 2013A&B direct bank loans are being refinanced. Post series 2016 financing, the debt mix will be 72% fixed rate and 28% variable rate. Salem's variable rate exposure totals $75 million (series 2008C) and the variable rate demand bonds are supported by a letter of credit (LOC) from US Bank that expires April 2018. There is an 18-month term-out period under the reimbursement agreement if there is a draw on the LOC.
Including Salem's fixed payor swap, Salem has 100% fixed-rate debt. The swap is with UBS and the collateral posting threshold is $20 million. Currently, no collateral posting is required.
Disclosure
Salem Health covenants to provide annual disclosure within 180 days of fiscal year end and quarterly disclosure within 60 days of quarter end for the first three quarters to the Municipal Securities Rule Making Board's EMMA system.
Outstanding debt:
--$75,000,000 Salem Hospital Facility Authority (OR) (Salem Hospital Project) variable rate revenue bonds series 2008B (LOC: U.S. Bank National Association);
--$36,490,000 Salem Hospital Facility Authority (OR) (Salem Hospital Project) revenue bonds series 2008A;
--$110,075,000 Salem Hospital Facility Authority (OR) (Salem Hospital Project) revenue bonds series 2006.
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
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https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013019
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013019
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https://www.fitchratings.com/regulatory
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