Fitch Rates Deaconess Health System (IN) Revs 'AA-'; Outlook Stable
--$95,115,000 revenue bonds, series 2016A.
The bonds are being issued to finance the costs of capital projects, to fund a portion of interest during construction, and to pay certain costs of issuance. The bonds are expected to price the week of Sept. 12 via negotiated sale.
In addition, Fitch affirms the following IFA bonds:
--$48,270,000 refunding revenue bonds, series 2015A at 'AA-';
--$66,300,000 hospital revenue bonds, series 2013A at 'AA-';
--$15,835,000 hospital revenue bonds, series 2011A at 'AA-'.
Finally, Fitch also withdraws the 'AA-' rating on the following IFA bonds due to prerefunding activity:
--Revenue bonds, series 2009A.
The Rating Outlook is Stable.
Debt payments are secured by a pledge of the gross revenues of the obligated group.
KEY RATING DRIVERS
MANAGEABLE PRO FORMA DEBT: Despite the estimated $150 million in total additional debt being issued in 2016, Deaconess maintains a pro forma financial profile that is adequate for the 'AA-' rating. Pro forma coverage of maximum annual debt service (MADS) was a healthy 7.3 times (x) at June 30, 2016, and pro forma MADS was 2.4% of total revenue, both consistent with 'AA' category medians of 5.7x and 2.4%, respectively. Notably, at June 30, 2016 pro forma debt to EBITDA remains very low at 2.3x versus the 'AA' category median of 2.4x.
ROBUST PROFITABILITY: Healthy revenue growth combined with ongoing expense management efforts produced very strong operating and operating EBITDA margins of 14.3% and 20.2%, respectively, in the fiscal year ended (FYE) Sept. 30, 2015, which was well ahead of budget. Though softened through the nine-month interim period ended June 30, 2016, operating and operating EBITDA margins remain very healthy at 9.9% and 15.8%, respectively.
BALANCE SHEET GROWTH: Supported by strong cash flows, unrestricted cash and investments grew to $623.3 million at June 30, 2016 which is an 11.3% year-over-year increase. While pro forma cash to debt will fall below the 'AA' category median level post-issuance, Deaconess maintains a healthy 300.1 days of cash on hand and 29.3x pro forma cushion ratio.
LEADING MARKET POSITION: Deaconess continues to lead the primary market with an inpatient market share of 63.6% versus the next competitor at 31.2% (1Q-3Q'15). Its share for certain specialties - like Women's, Pediatrics, and Cardiac - is higher. Deaconess' integrated clinical network, highly aligned physician base, mature EPIC platform, and sophisticated approach to care management are viewed positively, and should position it well for delivering value based care.
PROJECT EXECUTION: Fitch expects Deaconess Health System to sustain its operating cash flow and balance sheet strength through a period of heightened capital spending over the next 12-18 months. Further, successful navigation of project and construction risks will also be necessary to maintain the 'AA-' rating.
Headquartered in Evansville, IN, Deaconess is an acute care provider serving a 26-county, tri-state area in southwestern Indiana. Deaconess operates a total of 711 beds across its four campuses, which includes Main, Gateway (including Heart & Women's), Cross Pointe, and HealthSouth. Fitch analyzed the financial performance of Deaconess Health System. The obligated group comprised 81.5% of total operating revenue and 96.8% of total assets of the system for fiscal 2015 (Sept. 30 year-end). Total operating revenue was $866.1 million in fiscal 2015.
The approximately $150 million in total debt proceeds in 2016 will be used to finance several key projects at Gateway, including a six-story orthopedic and neuroscience hospital tower, a five-story medical office building, a five-story parking deck, and expansion of the energy center. An additional medical office building in Vanderburgh County is also part of project spending.
The Gateway project should all be largely completed by mid-2018, and Deaconess will have capitalized interest through Sept. 1, 2018. The project will enable Deaconess to capitalize on its well-integrated medical staff and skill in managing risk and bundled payments, which is expected to mean incremental market presence for the orthopedic and neuroscience service lines. Opportunity exists for Deaconess to stem unnecessary outmigration, further solidify its referral networks across the region, and support its steady move toward population health.
SOLID OPERATING PERFORMANCE
Deaconess maintained very healthy operating performance ahead of budget in 2015, driven by good volume trends, favorable shifts away from bad debt and self-pay, and incremental market share growth. In addition, Deaconess continued its efforts on better clinical documentation, revenue cycle improvements, productivity and staffing improvements, and contract management.
While the six month interim period illustrated some softening in cash flow, Deaconess expects to maintain operating margins ahead of 7% going forward which would generate sufficient coverage of pro forma MADS at the 'AA-' rating level. Key to Deaconess' strategic success will be continued focus on sustaining and growing its referral network and solidifying its primary care footprint within the region.
The $95.5 million in series 2016A bonds, together with $53 million in private bank debt, will bring Deaconess' total debt to approximately $350 million. Deaconess maintains a largely fixed rate structure with only 17% in variable rate private bank loans which have a 2023 initial term. Pro forma MADS is estimated at $21.3 million, and debt service is level.
Deaconess is party to a fixed payor swap related to the series 2013B bonds, with a notional value of $19.4 million and negative $969,960 mark-to-market at fiscal 2015. Deaconess also has a frozen defined benefit pension plan, which had a total $278.6 million liability funded at 71% at fiscal 2015. Contributions of approximately $8 million annually were a manageable 4.2% of fiscal 2015 EBITDA.
Deaconess covenants to provide continuing disclosure, with the submission of audited financial statements within 120 days of fiscal year end. Quarterly statements will be provided within 45 days of quarter end for the first three quarters and within 60 days of the last quarter end.