Fitch Rates Adventist Health (CA) Series 2016A Bonds 'A'; Outlook Stable
The Rating Outlook is Stable.
The series 2016A bonds are fixed rate and bond proceeds in addition to the release of debt service reserve funds will refund the outstanding series 1998, 2007B, 2009A, and 2007 Lodi Memorial Hospital (Lodi) bonds. Lodi will become part of the obligated group (OG) after this financing. The series 2016A bonds are expected to price the week of Aug. 22 via negotiation.
The bonds are secured by a pledge of the gross revenues of the OG. Including Lodi, the OG accounted for 98% of total assets and 93% of total revenue of the consolidated system in fiscal 2015 (Dec. 31 year end). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
REGIONAL HEALTH SYSTEM: Adventist's main credit strength is the size of its network with 19 hospitals and 275 clinics concentrated in California but geographically diversified in four regions with no one facility comprising more than 12% of system operating revenue. Management has been actively pursuing additional partnerships and acquisitions and is expected to reach its $4 billion in total revenue goal earlier than schedule in 2016. Future growth is targeted at $5.2 billion in total revenue by 2020.
SYSTEMWIDE INITIATIVES: The relatively new executive leadership team has a focus on systemwide initiatives including supply savings, employee benefit plan design, revenue cycle, physician alignment, care delivery, and productivity. Targeted goals include reaching a 4% operating margin, double digit EBITDA margins, and growing liquidity. Operating performance has improved in the last 18 months and has been the best performance in recent history.
DEBT BURDEN MODERATE: Despite issuing $165 million of additional debt in 2015 and $200 million of additional debt earlier this year (series 2016 taxable direct bank placements), Adventist's debt burden is still moderate and should facilitate liquidity growth. More frequent debt issuances are expected as a new capital planning model has been implemented and bases capital spending on a percentage of operating EBITDA and liquidity growth.
WEAK LIQUIDITY: Adventist has always had light liquidity for the rating level mainly due to robust capital spending from seismic requirements, which are essentially complete. However, liquidity metrics have improved since Fitch's last rating review in June 2015.
TRANSITION TO POPULATION HEALTH: Adventist has several strategies underway to position the organization for value based reimbursement and these include building out its network through various partnerships with other providers and payors to be able to accept risk.
SUSTAIN IMPROVED OPERATING PERFORMANCE: Fitch expects Adventist Health to sustain its improved financial performance due to its focus on operational improvement initiatives and systemness. Positive rating movement would be dependent on liquidity growth more in line for the rating level.
Adventist Health has 19 hospitals organized in four regions: Northern California, Central California, Southern California, and Northwest. Adventist's facilities have the leading market share in the majority of its markets. Total revenue in 2015 was $3.6 billion. Lodi's financials are included as of June 1, 2015 (annual revenue of approximately $175 million). Adventist provided a guarantee on Lodi's debt ($134 million Cal Mortgage insured series 2007) and after the series 2016 transaction, the Lodi debt will be refinanced and Lodi will become a member of the OG.
Financial performance has been at a new level with the implementation of various operational improvement initiatives. Operating EBITDA margin was 10.4% through the six months ended June 30, 2016, compared to 9.5% in 2015, 8.4% in 2014, and 6.8% in 2013. Management has a longer term target to reach 12.6% operating EBITDA margin.
Although the payor mix is heavily exposed to governmental payors (74.2% of gross revenue from Medicare and Medicaid through six months ended June 30, 2016), Adventist does benefit from supplemental reimbursement due to the rural location of some of its facilities. Adventist operates the largest rural health clinic network in the state.
Adventist has been a major beneficiary of the provider fee program and the net benefit is projected to be $175 million for 2016 compared to $132 million in 2015, $106 million in 2014, and $82 million in 2013. The variability in the amount generally relates to the timing of CMS approval of the various components of the program.
Adventist has been in various partnership/affiliation discussions and the most recent announcement is on a joint venture health plan with another provider to create a larger network for MediCal patients. This plan is pending state approval. This aligns with Adventist's overall focus on care transformation and other broader payor strategies are also in process.
ROBUST CAPITAL SPENDING
Adventist's capital spending has been robust and focused primarily on seismic related requirements. Future capital spending is now based on a new model, which sets spending to financial performance. Capital spending is modeled at between 75%-94% of operating EBITDA, which totals approximately $400 million-$500 million a year and facilitates liquidity growth. New debt is projected to be more routine with $120 million-$220 million of new debt a year over the next five years.
Adventist's unrestricted cash and investments totaled $1.4 billion at June 30, 2016, which equated to 142.4 days cash on hand (DCOH) and 90.9% cash to debt. Liquidity has improved since Fitch's last review in June 2015 and in line with expectations. Including the $200 million of taxable proceeds from the series 2016 direct bank placements, pro forma cash to debt and DCOH at June 30, 2016 would be 106% and 162.6, respectively. Management has a long-term target of 200 DCOH. Fitch notes that Adventist's investment portfolio is very conservative with 91% invested in cash and fixed income securities.
Adventist's total outstanding debt after the series 2016A issuance is $1.5 billion with a debt mix of 82% fixed rate and 18% variable rate. Adventist issued $200 million of series 2016 direct bank placements that closed in July 2016, which are taxable and will be used for general corporate purposes.
Uncommitted capital includes $84 million of variable rate demand bonds supported by letter of credits and $522 million of direct bank placements. The renewal dates are fairly staggered and the bank placement terms have long initial terms (at least 10 years). Certain bank loan documents include non-financial related covenants (i. e. failure to meet reporting requirements) as an event of default. Fitch views these terms negatively as it places a significant amount of control with the bank as these events of default would need to be waived by the bank to prevent an acceleration of debt. However, there is a 30 day cure period and Fitch views a non cure of financial reporting covenant violations as a remote situation.
Pro forma maximum annual debt service (MADS) increases to $92 million from $81 million after the series 2016 financings. Debt burden is still fairly moderate with MADS accounting for 2.4% of revenue through the six months ended June 30, 2016, compared to the 'A' category median of 3%. MADS coverage is good at 4.6x through the six months ended June 30, 2016 and 4x in 2015 compared to the 'A' category median of 4.2x.
MADS is calculated per the MTI treatment of balloon indebtedness (25 year amortization) for the taxable bonds.
Adventist covenants to provide quarterly disclosure within 60 days of quarter end for the first 3 quarters and annual financial disclosure within 150 days of the end of the fiscal year to EMMA.
--$183,980,000 California Statewide Communities Development Authority (CA) (Adventist Health System/West) revenue bonds series 2015A;
--$281,260,000 California Health Facilities Financing Authority (CA) (Adventist Health System/West) revenue bonds series 2013A;
--$50,000,000 Adventist Health System/West (CA) taxable bonds series 2013;
--$5,000,000 California Health Facilities Financing Authority (CA) (Adventist Health System/West) hospital revenue refunding bonds series 2009C;
--$30,000,000 California Health Facilities Financing Authority (CA) (Adventist Health System/West) variable-rate hospital revenue bonds series 2009B (LOC: U. S. Bank National Association);
--$66,535,000 Multnomah County Hospital Facilities Authority (OR) (Adventist Health System/West) revenue bonds series 2009A
--$90,000,000 California Health Facilities Financing Authority (CA) (Adventist Health System/West) health facilities revenue bonds series 2009A;
--$62,800,000 California Health Facilities Financing Authority (CA) (Adventist Health System/West) variable-rate hospital revenue bonds series 1998A & 1998B (insured: MBIA Insurance Corp.);
--$14,200,000 California Health Facilities Financing Authority (CA) (Adventist Health System/West - Sutter Health Revolving Loan Pool) variable-rate revenue bonds series 1991B;
--$14,200,000 California Health Facilities Financing Authority (CA) (Adventist Health System/West - Sutter Health Revolving Loan Pool) variable-rate revenue bonds series 1991A.