Fitch Upgrades Hackensack University Med Center, NJ's Revs to 'A'; Outlook Revised to Positive
--$221.2 New Jersey Health Care Facilities Financing Authority, series 2008;
--$68.3 million New Jersey Health Care Facilities Financing Authority, series 2010A;
--$100.3 million New Jersey Health Care Facilities Financing Authority, series 2010B;
--$52.8 million New Jersey Economic Development Authority, series 1997.
The Rating Outlook is revised to Positive from Stable.
The bonds are secured by a mortgage lien on Hackensack's principal facilities and its gross receipts.
KEY RATING DRIVERS
CREDIT PROFILE IMPROVEMENT AND MERGER WITH MERIDIAN HEALTH : The upgrade to 'A' and the Outlook revision to Positive is based on Hackensack University Medical Center's (Hackensack) improving credit profile and the anticipated benefits from the recent merger between Hackensack University Health Network, the parent of Hackensack, and Meridian Health (Meridian; 'A+'/Stable Outlook). Fitch views the merger with Meridian as a significant credit positive. The two systems' markets do not overlap and the newly formed Hackensack Meridian Health Network (Hackensack Meridian) has a full continuum of care with 11 acute care hospitals, a comprehensive ambulatory facility network and post-acute services, providing the new system with significant scale and geographic coverage and an improved platform for population health management.
STEADY PROFITABILITY: Hackensack's operating profitability has been solid and slightly improving over the last four years with operating margin and operating EBITDA margins increasing to 5.5% and 10.9%, respectively, for the fiscal year ended Dec. 31, 2015. Through the six-month interim period ended June 30, 2016, the respective metrics are slightly lower at 4.6% and 10%, but still consistent with Fitch 'A' category medians.
SOLID MARKET POSITION: Hackensack has a stable, leading market share of 28.6% of its Bergen County primary service area (PSA) and is the health system of choice for certain specialized services in northern New Jersey. Its market position has been further enhanced by the March 2016 merger with Palisades Medical Center ('BBB+'). The market share of the combined Hackensack Meridian Health in Hackensack's PSA increases to 32.5% as a result of the merger. Similarly, the combined system holds a leading market share of 40.5% of Meridian's traditional service area of Monmouth and Ocean counties.
MODERATING LEVERAGE AND ADEQUATE LIQUIDITY: Hackensack's elevated debt position, the result of a $175 million 2013 pension funding borrowing intended to reduce the volatility of Hackensack's defined benefit pension expense, which has a short seven-year final maturity, is slowly moderating. Maximum annual debt service (MADS) coverage through the 2016 interim period was 2.4x and MADS as percent of revenues has declined to 4.4% from a high 5.4% at fiscal 2013 year-end. Hackensack's absolute liquidity has grown over the last several years; at June 30, 2016 Hackensack reported $720 million of unrestricted cash and investments, equal to 166 days cash on hand (DCOH), cushion ratio of 9.5x, and cash equal to 113.5% of outstanding long-term debt.
ANTICIPATED BENEFITS OF THE MERGER WITH MERIDIAN HEALTH: Fitch expects the increased scale, geographic coverage and the resulting synergies from the merger between Hackensack University Health Network and Meridian Health, combined with the plan to create a common obligated group within the next two years, to result in potential further upward rating pressure.
Hackensack is a university-affiliated (Rutgers New Jersey Medical School) teaching hospital, with 775 beds in service, located in Hackensack, in northern New Jersey. This regional referral center provides an array of tertiary and quaternary-level services in its primary service area of Bergen County and in a secondary service area of Hudson and Passaic Counties. In FY 2015, Hackensack had $1.64 billion in total revenues. Hackensack is also a joint-venture part owner with a for-profit of two other hospitals - Hackensack at Pascack Valley (128 beds) and Hackensack Mountainside (350 beds). In March 2016, Hackensack University Health Network, the parent of Hackensack, became the sole corporate member of Palisades Medical Center in North Bergen (202 beds; rated 'BBB+'). Palisades is not a member of the Hackensack obligated group.
Effective July 1, 2016 Hackensack merged with Meridian Health, an integrated health care system with locations throughout Middlesex, Monmouth and Ocean counties. Meridian has licenses to operate 2,236 licensed beds and 774 skilled nursing beds. The eight hospitals that comprise the system are Jersey Shore University Medical Center and The K. Hovnanian Children's Hospital with academic affiliation with Rutgers University - Robert Wood Johnson Medical School; Ocean Medical Center; Riverview Medical Center; Southern Ocean Medical Center; and Bayshore Community Hospital and the recently added Raritan Bay Medical Center Old Bridge and Perth Amboy). Meridian had total revenues of $1.86 billion in fiscal 2015 (year-end Dec. 31).
For additional information on Meridian Health refer to Fitch's press release 'Fitch Upgrades Meridian Health System's (NJ) Revs to 'A+'; Outlook Stable', dated April 15, 2015. Fitch will update Meridian's rating no later than April 2017.
The merger approval took 18 months and management used the time to start the integration process, with the assistance of McKinsey Consulting - there are currently 16 integration teams in place. The merged system including Palisades and Raritan Bay has over 3,700 beds, 6,000 physicians on staff and 2015 revenues of $3.49 billion. The two systems' debt remains separately secured at this time, but the intention is to bring indebtedness under a common security structure in the next 12-18 months in connection with future debt issuance. The governance structure of the new system has a board made up of 24 individuals, half from each legacy system, and the management team is led by the two former CEOs, acting as Co-CEOs. A consolidated audit will be issued for fiscal 2016 for the six months ended Dec. 31.
MERGER RATIONALE AND STRATEGIC PRIORITIES
While the merger will significantly increase the scale and geographic coverage of the new entity, a significant aspect of the combination of two organizations is the opportunity to create an integrated system that leverages the strengths of both partners. With the coming together of the two systems, Hackensack Meridian Health will have a full continuum of care, bringing the 11 hospitals and two children's hospitals, the extensive Meridian ambulatory network with approximately 140 separate locations planned to be extended north, Meridian's post-acute care components and Hackensack's strong presence and clinical reputation in the North Jersey market together to form one of New Jersey's largest, fully integrated networks with a strong platform for executing population health strategies. The merged system's facilities are within 15 miles of 70% of New Jersey population and are located in areas with the most concentrated populations. The two recent additions to the network - Palisades and Raritan Bay, serve to bridge the two systems' service areas.
Further differentiating the new system in the competitive New Jersey landscape is the development of a School of Medicine affiliation with Seton Hall University, which is planning to enroll the first class in 2018 on a leased campus in Nutley. Only approximately $15 million of the $75 million capital cost to renovate and develop the site will be borne by Hackensack Meridian, with the remaining portion funded by the developer and various other sources.
The combined system has identified $2.3 billion of strategic capital investments over the next five years, including current levels of capital spending for the two systems at their existing facilities. The assumed capital spending anticipates a potential issuance of new debt over the next two years in support of the capital plan. Also contemplated is a possible refinancing of a portion of both systems' existing indebtedness of over $500 million for savings. The new money and the refunding would be issued under a joint security structure. None of the projected debt is assumed in the current rating action.
STEADY HACKENSACK PROFITABILITY AND SOLID JOINT OPERATING PROFILE
Hackensack's profitability has improved over the last two fiscal years producing operating income of $74.9 million in 2014 and $89.7 million in 2015, translating to operating and operating EBITDA margins of 4.8% and 10.5% in 2014, respectively, increasing to 5.5% and 10.9% in fiscal 2015, better than Fitch's 'A' category medians of 3.6% and 10.3%. Profitability was maintained through the six-month interim period ended June 30, 2016 with operating and operating EBITDA margins of 4.6% and 10%.
The operating results of the two systems on a pro forma combined basis are consistent with the 'A' category metrics before any realized benefits of the merger. The combined operating income in fiscal 2015 (both organizations have Dec. 31 year-end) was $247 million, equal to operating margin of 7.1%, up from 4.6% on pro forma basis in fiscal 2013. Operating margin through the five months ended May 31, 2016 was 4.5% and operating EBITDA margin 9.9%; both are solidly in line with Fitch's 'A' medians. The savings potential from the merger are estimated at $300 million, portions of which will be incorporated into the 2017 budget. Both organizations have worked at expense management and each reported reducing expenses by $125 million.
MODERATING LEVERAGE AND ADEQUATE LIQUIDITY
Facing the uncertainly and volatility related to the funding of the defined benefit pension plan, and the projections showing that the plan would be only 62% funded by the end of fiscal 2012, Hackensack raised $175 million in March 2013 via two taxable private placement loans to prefund a portion of their pension liability, resulting in the plan being overfunded in that year. The $175 million, seven-year loan increased leverage, but despite the unfavorable discount rates since then, the transaction created $32 million in cash flow savings, though the now frozen plan was only 76% funded as of 2015 year-end. Between Hackensack and Meridian, the system has five defined benefit pension plans, all frozen and or soft-frozen.
In 2015 Hackensack executed two private placement loans - $84 million tax-exempt and $36 million taxable with fixed rate blended at 2.63% and an $85.6 million balloon payment due in 2025 to purchase a medical office building and a garage on the main campus that had previously been leased at a higher expense. In July 2016 Hackensack took out a 10-year taxable bank loan in the amount of $20.3 million to refinance its non-recourse debt.
While Hackensack's leverage metrics are elevated compared to Fitch's 'A' category medians, they have shown slight improvement over time, despite the additional debt in 2015 and 2016 with the $76.1 million MADS coverage (excluding the 2015 balloon payment) increasing to 2.7x at 2015 year-end and 2.4x through the June 2016 interim period, and MADS as percent of revenues at 4.4%, down from 5.4% in 2013. All of Hackensack's debt is fixed rate and the institution has no swaps. Additionally, Hackensack has a significantly front-loaded debt service schedule with MADS declining to $57 million in 2020 and then to $17 million in 2026.
Liquidity measures have historically been moderate, but have improved, and Fitch views the $720 million of unrestricted cash and investments, with a conservative asset allocation, all fixed-rate debt and absence of swaps, as adequate for the rating category.
Hackensack covenants to disclose annual and quarterly information to the Municipal Securities Rulemaking Board's EMMA system.