Fitch Rates Northwell Health, NY 2016 Revs 'A'; Outlook Stable
Additionally, Fitch affirms the 'A' rating on outstanding debt issued by NSLIJ and by the Dormitory Authority of the State of New York on behalf of NSLIJ.
The Rating Outlook is Stable.
The series 2016 bonds are expected to be issued as taxable fixed rate. Proceeds will be used for general corporate purposes of Northwell including future capital expenditures. The bonds are expected to price the week of September 19 via negotiation. The series 2016 bonds will be structured as a balloon maturity in November 2046, which is the typical structure for taxable debt. Maximum annual debt service (MADS) of $209.9 million on all debt assumes the smoothing of balloon debt as per the Master Trust Indenture (MTI) and was provided by the underwriters.
Effective Jan. 1, 2016 North Shore Long Island Jewish Health System changed its name to Northwell Health, reflecting its expanding role outside its traditional market.
Bonds are secured by revenue pledge of the Northwell obligated group (OG) and by mortgages on primary hospital facilities of the OG. The OG represented 92.8% of system assets and 86.8% of system revenues in 2015. Fitch reports on the performance of the Northwell consolidated system.
KEY RATING DRIVERS
EXPANDING FOOTPRINT: The affirmation of the 'A' rating is based on the system's significant and growing footprint in the New York metropolitan service area, its manageable debt burden and operating stability as the system continues to make major investments in system growth and diversification.
LARGE INTEGRATED SYSTEM: Northwell has a large clinical footprint that covers most of Long Island, expanded with the recent addition of Peconic Bay Medical Center in Riverhead, and large portions of New York City and portions of Westchester County. The system has a large employed physician faculty component, more than 450 ambulatory and physician practice locations and continues to grow its insurance division.
MANAGEABLE DEBT BURDEN: Northwell has a still moderate debt burden with coverage of pro forma MADS, which includes the addition of approximately $500 million of new money in the current issuance, of 3.0x in fiscal 2015 (year-end Dec. 31), and 3.2x through the six-month interim period ended June 30, 2016. MADS as percent of revenues continues to be moderate at 2.2% and favorable compared to the category median. The low debt burden is a key credit strength, helping to offset the lower-than-median operating results and liquidity metrics.
COMPRESSED OPERATING MARGIN: The system operating margin has been compressed due to expenses related to investment in system growth and diversification, including the subsidy to its insurance company, which was launched in 2013. Management expects operating margin to remain modest in the 1%-1.25% range over the next two years based on further investment in ambulatory growth and continued subsidy to the insurance division, which has faced unanticipated losses related to the federal risk adjustment program under ACA.
MODEST BUT STABLE LIQUIDITY: Cash and unrestricted investments were reported at $2.46 billion through the June 30, 2016 interim period, reflecting strong cash flows, though historically, liquidity metrics have been lower than Fitch's 'A' category medians. The liquidity level translates to days cash on hand (DCOH) of 98.6 days and cash-to-debt of 101.2%. The new money in the 2016 transaction will provide a portion of the funds for continued capital investments, estimated at $1.7 billion for 2016 and 2017, allowing for the substantial cash flow from operations to maintain cash-to-debt at the mid - 90% level.
CREDIT STABILITY: Fitch views the system's expanding geographic coverage, significant level of integration, and leading market share as key strengths which provide a high degree of credit stability to the system. Fitch expects the system to maintain stable operating results while financing its sizeable capital plan, without materially affecting its balance sheet metrics.
With corporate headquarters in New Hyde Park, NY, Northwell is an integrated health care delivery system comprised of 18 hospitals, three long-term care facilities, three certified home healthcare agencies, five trauma centers, a hospice network, over 450 ambulatory and physician practice locations, and CareConnect - one of the only provider-owned insurance companies in its market. CareConnect's total premium revenue was only $125 million in 2015 and $175 million through the June 30, 2016 interim period, but is expected to increase significantly due to the recent enrollment growth. The system reported revenues of $8.72 billion in fiscal 2015 (year-end Dec. 31).
Large Integrated System
Northwell operates in the highly fragmented and competitive New York metropolitan market, but its large and expanding footprint and leading market share in its six-county PSA are viewed as key credit strengths. Northwell has been slowly increasing its market share in its PSA, reported at 27.4% in 2015, an increase from 26.2% in 2010, and plays a large role in its core Long Island market, which was further supported by the January 2016 acquisition of the 200-bed Peconic Bay Medical Center. Effective January 2015 Northwell expanded into Westchester County by adding two hospitals, the 238-bed Phelps Memorial Hospital and 245-bed Northern Westchester Hospital.
In February 2015, Northwell signed a memorandum of understanding with Maimonides Medical Center, a large tertiary hospital in Brooklyn. Maimonides is already one of the providers in the CareConnect network and the move into Brooklyn serves to further solidify the system's market position in New York City. While this is only an affiliation at this time, Northwell has made a $125 million loan commitment to Maimonides, of which close to $78 million has already been drawn. A major portion of the funds are intended for expansion of ambulatory services which should improve Maimonides's payor mix and reduce outmigration for care to Manhattan.
CareConnect Projected Loss
CareConnect, the system's commercial insurance arm, which was launched in January 2014, is slowly building up enrollment with current enrollment at close to 100,000 full-risk members (63,000 small-group) as of July 2016. The recent significant increase occurred after enrolling 40,000 small-group commercial members following the demise of a local exchange cooperative. CareConnect has a growing network of providers - 2,000 physician providers, including several large groups and a number of hospital providers in the tri-state area - in addition to the Northwell hospitals and a focus on positive consumer experience.
CareConnect had a net loss of $27.2 million in 2014 and $31.8 million in 2015 million and an $18 million loss budgeted for 2016. However, the financial performance was negatively affected by the federal risk adjustment program adopted by the New York state regulators, which is designed to redistribute premium revenue among insurers to eliminate the effects of adverse selection in the small - and individual-group markets, where a particular insurer may have an enrollee population that is less healthy. As a result of the risk adjustment, CareConnect is now projecting a loss of approximately $110 million for 2016, which is much larger than anticipated.
CareConnect, as a relatively new insurer in the market, has members who have not necessarily seen a physician and therefore do not have an assigned risk score, and as such are viewed by the federal system as 'healthy', resulting in CareConnect's risk profile that is not consistent with the actual health profile of its enrollment. In reality, the New York risk scores for small groups are on the higher side. This contrasts with established insurers who have long and accurate diagnostic profiles of their members and therefore benefit from the risk redistribution program.
The state and federal regulators are aware of this flawed model and there are several initiatives to address this including an approved rate increase for CareConnect's small-group premium, as well as potential modification to the risk adjustment methodology. While compressing system operating profitability in the near term, Fitch views CareConnect as an investment that should benefit the system's operations over the longer term.
The system reported income from operations of $89.7 million in fiscal 2015, closely tracking the prior year, on revenues of $8.72 billion in fiscal 2015, equal to an operating margin of 1.0% and operating EBITDA margin of 6.6%. Operating income through the six-month interim period ended June 30, 2016 was $66.5 million, and management has budgeted to end the 2016 fiscal year with operating income of $93 million, mirroring the fiscal 2015 1.0% operating margin. Despite strong volumes, which are causing capacity issues at some of the system's tertiary facilities, the thin profitability is driven by the ambulatory and physician network growth and the ramp-up of CareConnect, continuing implementation of the electronic health record and increased depreciation expenses related to completion of several recent projects.
The system has a $1.7 billion capital plan for 2016 and 2017 with approximately 45% funded from operating cash flow and the remaining 55% from the current transaction, $360 million available from prior issuance and over $80 million from philanthropy. The system has raised between $60 million-$70 million annually from philanthropy over the last three years. Several of the projects in the capital plan include upgrading areas at North Shore University Hospital, Long Island Jewish Medical Center and Southside Hospital, where the system is experiencing capacity issues, as well as completing the renovation of the O'Toole Building in Greenwich Village to accommodate medical offices (Northwell has been operating a free-standing ED at that location already for two years), as well as continued investments in IT and joint ventures. Management is committed to monitoring and reevaluating capital plans in order to maintain its balance sheet.
Following the issuance of the proposed debt, Northwell will have approximately 95% of its long-term debt effectively in fixed rate. The current transaction is structured with a balloon payment in 2046 and using smoothing as permitted by the MTI allows for a relatively level debt service, with debt service gradually declining after 2030. The system's several swaps had a negative $11.4 million mark-to-market at June 30, 2016, and no collateral posting was required. Northwell had 3.0x coverage of pro forma MADS of $209.9 million in fiscal 2015 and 3.2x through the 2016 interim period, as compared to Fitch's 'A' category median of 4.2x. MADS as percent of revenues at 2.4% in fiscal 2015 and 2.2% at the interim period are favorable to Fitch's median of 2.8%.
Modest But Stable Liquidity
Northwell's absolute liquidity has more than doubled since 2013, supported by solid cash flow from operations which averaged over $600 million in the last three years, but liquidity metrics have historically lagged the rating category. Cash and unrestricted investments at June 30, 2016 were reported at $2.46 billion, equal to 98.6 DCOH, cushion ratio of 11.7x and 101.2% of cash-to-debt, all of which are weaker than Fitch's 'A' category medians of 205.3 DCOH, 18.5x cushion and 143.7% cash-to-debt. Reducing the available cash by the $110.2 million of draws on a line of credit would reduce cash-to-debt to 96.7% at June 30, 2016. Northwell uses the lines of credit to fund construction costs of projects for which it will eventually issue debt and to bridge the receipt of capital pledges. Maintaining liquidity will remain crucial as the system continues to execute its capital plan which requires significant cash-flow to be generated from operations. The issuance of the 2016 transaction, supported by cash flow from operations, will allow Northwell to maintain cash-to-pro forma debt in the mid-90% range while funding its capital plan.
The OG covenants to provide bondholders with annual and quarterly financial disclosure as well as operating statistics. Current financial disclosure for the OG is excellent and includes a balance sheet, income statement, utilization statistics, cash flow statement and management discussion and analysis.