NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB' rating on the following New Jersey Health Care Facilities Financing Authority bonds issued on behalf of University Hospital (UH):
--$254,975,000 revenue and refunding bonds University Hospital Issue series 2015A.
The Rating Outlook is Stable.
SECURITY
General revenues of UH, a lockbox on unrestricted state appropriations, and a debt service reserve fund. There is no mortgage.
KEY RATING DRIVERS
SERVICE ESSENTIALITY: The 'BBB' rating incorporates the essentiality of and state statutory directives for the services that UH provides. These include UH's objective to operate as the safety net hospital for Newark, the Level I trauma center for Northern New Jersey, and the teaching hospital for the Rutgers School of Biomedical and Health Sciences' Newark-based schools. Fitch believes that this positions UH to receive annual appropriations from the State of New Jersey (GO bonds rated 'A'/Stable Outlook) necessary to offset operating losses.
STATE APPROPRIATIONS: UH receives individual supplemental state appropriations above its regular state supplemental distributions. The additional appropriations relate to a 2012 state act (the Restructuring Act)that restructured the University of Medicine and Dentistry of New Jersey (UMDNJ) and provided, among other things, that state funds should be sufficient to maintain UH's core services.
THIN FINANCIAL PROFILE: UH's financial profile is characterized by annual operating losses, weak liquidity, and a challenging payor mix, with nearly 60% of UH's gross revenues composed of Medicaid and self-pay. UH continues to implement a performance improvement plan, which has yielded efficiencies, savings and additional revenue). However, Fitch believes the structural challenges of UH's payor mix make the individual supplemental state appropriations necessary over the medium to long term.
INSTRUMENTALITY OF THE STATE: UH was established as an instrumentality of the State of New Jersey; three of its 11 board members are appointed by the governor, with advice and consent from the state senate (including the board chair), and the state is a signatory on the lockbox agreement. Fitch views these governmental ties as a credit positive.
LOCKBOX STRUCTURE: Unrestricted state appropriations will flow through a lockbox held by a trustee. Funds in the lockbox will pay debt service prior to being released to UH for operations, providing bondholders with an additional layer of security. In September 2016, the funds flowing through the lockbox covered debt service at a solid 7.3x.
RATING SENSITIVITIES
STATE SUPPORT: A material decline in unrestricted state appropriations to University Hospital (UH) would likely lead to a downgrade. Movement in New Jersey's GO rating could also impact UH's rating.
OPERATIONAL PERFORMANCE: A material decline in University Hospital's operating performance that would require increased state support could also lead to negative rating pressure.
CREDIT PROFILE
UH is a component unit and instrumentality of the State of New Jersey, operating a medical center in downtown Newark on a 63 acre campus that it shares with Rutgers New Jersey Medical School and the Rutgers School of Dental Medicine. UH has 519 licensed beds, an active medical staff of more than 500 physicians, and more than 3,100 employees. Total operating revenues in FY16 were $513.1 million (excluding the state appropriations).
Overview
In 2013, UH became a standalone hospital, as part of the 2012 Restructuring Act that restructured UMDNJ. UH had served the local Newark community for over 100 years prior to joining with UMDNJ and evolved over time to become a Level I Trauma Center and teaching hospital for the region and the state.
UH currently has one of the highest all payor case mix index in the state at 1.64, and the high acuity services that it provides, in addition to the trauma services, include a Level III neonatal intensive care unit, the largest liver transplant program in the state, and a stroke center that was awarded the Certificate of Distinction for Advanced Certification in Comprehensive Stroke Center by The Joint Commission.
Language in the Restructuring Act law specifies that state funding be provided to enable UH to continue the provision of community services to the local Newark population and that UH be maintained as a level 1 trauma center and teaching hospital. The Restructuring Act also provides for a five-year period in which any substantive changes to UH's essential health care services be subject to review by a community board established in the act, which is composed of local community members and is separate from UH's governance board, with approval by the New Jersey Department of Health. UH is in the third year of that five year period.
Underlying Operating Performance
UH's operations have been challenged by its central role as the safety net provider for the city of Newark, which has a weak economy and an unemployment rate of approximately 9.5%. In its first three years as a standalone hospital, UH has incurred operating losses and the additional individual supplemental state appropriations have helped bring its performance to breakeven.
The individual supplemental appropriations totaled $23.7 million in FY14 and $43.8 million in FY15 and FY16. The state has appropriated $43.8 million for FY17.
UH management has worked to reduce costs and improve efficiencies, and Barnabas Health System has provided technical assistance in this effort under a consultancy engagement. Revenue was up in FY16 due to growth in most utilization statistics, with inpatient acute care adult admissions up 4.3% and inpatient surgeries up 11%.
The growth in utilization was driven by Medicaid expansion, which brought more patients through local clinics with which UH has relationships. The increased Medicaid volume also helped to reduce bad debt, which further contributed to the good revenue growth. However, Fitch believes the operating and reimbursement environment for UH will remain challenging and operating losses are expected to persist.
State Appropriations
UH received total unrestricted appropriations from the state of $153.6 million in FY14, $149.9 million in FY15, and $128.2 million in FY16. The drop in FY16 is due largely to the recalculation of state charity pools due to Medicaid expansion and the associated drop in charity care across the state. UH expects this to fall further in FY17, with total state appropriations budgeted at $123.1 million.
In spite of the reduction in the appropriation totals, there remains more than adequate levels of funds flowing through the lockbox to cover debt service.
The individual supplemental appropriations, which are included in the total yearly appropriations noted above, are critical in closing UH's operating losses and enabling UH to achieve a positive bottom line performance and cover debt service. This figure was $43.8 million in FY15 and FY16 and will be $43.8 million in FY2017.
UH's reliance on annual state appropriations to sustain balanced operations will continue to expose UH to the state's budget challenges, in Fitch's view. However, this concern is offset by the essentiality of UH's services, the ability of the current management team to keep the operational losses manageable, and UH's status as an instrumentality of the state.
Lockbox Provisions
A lockbox as an additional security feature was established with the 2015 debt issuance. All unrestricted state appropriations flow through the lockbox and debt service payments are set aside, with any excess funds released to UH for operations only after the lockbox provision have been satisfied.
Under the lockbox provisions, the debt service payments accrue over the first three months of each six month period (with a third of the semi-annual interest and a sixth of the yearly principal held each of these first three months). This allows for enough funds to be set aside for debt service payments and provides needed cash flow to UH for operations.
Every six months a sufficiency certification is issued attesting that debt payments have been received by the Trustee. Should there be a payment failure, a draw on the debt service reserve fund, or should the yearly coverage by the lockbox fall to below 2x, 100% of the unrestricted state appropriations will be intercepted until the deficiency is remedied.
The lockbox does not improve UH's financial ability to pay debt service but does provide an extra layer of protection for bondholders, especially given the six-month sufficiency certifications. The state payment of annual appropriations, which occurs generally on a monthly basis, remains very steady.
Debt Profile
The 2015 fixed rate bonds represent the vast majority of UH's long-term debt. Fitch views UH's conservative debt structure as a credit positive helping to offset UH's thin balance sheet and operating profile. MADS is $17.3 million, and the issue is structured to amortize interest only for the first five years, when debt service will be approximately $12.1 million, and then rise to MADS, staying fairly level for the rest of the life of the bonds. Fitch views the interest only payments as a credit neutral, but in the near term it will provide UH with more financial flexibility.
Disclosure
UH covenants to provide annual and quarterly financial disclosure within 150 days and 45 days. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA system.
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=1015271
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