Fitch Rates Harris County Hospital District (TX)'s 2016 Sr Lien Refunding Revs 'AA'; Outlook Stable
The following bonds issued by HCHD are also rated 'AA':
--$62.8 million certificates of obligation (COs), series 2016;
--$93.9 million senior lien refunding bonds, series 2010;
--$181.3 million senior lien refunding and revenue bonds, series 2007A;
HCHD's Issuer Default Rating (IDR) is 'AA'.
The Rating Outlook is Stable.
The series 2016 refunding revenue bonds will be issued as fixed-rate debt, with debt service secured by a pledge of gross revenues excluding ad valorem taxes. The bonds are expected to price September 28, and will be used to refinance the series 2007A bonds, fund a debt service reserve, and pay costs of issuance.
The series 2016 revenue refunding bonds, series 2010 bonds, and series 2007A bonds are secured by a lien on the pledged revenues of HCHD (excluding ad valorem tax revenues) and a debt service reserve fund. The series 2016 COs are secured by an annual property tax levy limited to $0.75 per $100 assessed valuation (AV).
KEY RATING DRIVERS
TAXING MARGIN SUPPORTS REVENUE BASE: The 'AA' IDR and revenue bond ratings reflect the strength of the HCHD's expansive tax base, significant taxing margin to support operations and debt service, as well as the operating security of its position as the safety net provider for Harris County. Tax revenues in fiscal 2015 represent a high 30% of operating revenues (which Fitch adjusts to include premium, tax, and net patient revenues). However, ample room in the tax margin could support up to a 340% increase in tax revenues, which provides a significant amount of revenue flexibility that is atypical for the sector.
MANAGEABLE DEBT BURDEN: Post-issuance, HCHD's total leverage remains manageable. Pro forma debt to capitalization was a low 36.3% and pro forma maximum annual debt service (MADS) was a low 1% of fiscal 2016 revenues (excluding the benefit of the limited tax levy for the COs). Further, capital needs are diminishing (to near 110% of annual depreciation) and are expected to be funded via cash flow and philanthropy rather than debt over the medium term.
DEDICATED TAX PLEDGE: The 'AA' rating on the series 2016 COs reflects ample room under the dedicated ad valorem tax pledge to support the additional $4.7 million in annual debt service. This rating is capped by the IDR given the security's exposure to the operating risk of HCHD.
STRONG SERVICE AREA FUNDAMENTALS: HCHD is coterminous with Harris County, for which Fitch maintains a 'AAA' IDR/Stable Outlook. While diversification into biomedical research, aerospace, and international trade via the Port of Houston is evident, energy, and petrochemical manufacturing remain major determinants of employment and tax base growth.
STEADY LIQUIDITY: Despite several years of significant expenditures, HCHD's balance sheet has maintained solid liquidity metrics and reflects its manageable debt burden. As per consolidated financials for the fiscal year ended Feb. 29, 2016, HCHD had 156 days of cash on hand (DCOH), a 42x pro forma cushion ratio, and will have over 270% cash to pro forma debt.
PAYOR MIX CHALLENGES: Over 60% of HCHD's volume is uninsured or indigent care, and the system will likely see a decline in supplemental Medicaid reimbursement beyond 2017 absent the renewal of Texas' 1115 waiver program or without Medicaid expansion in the state. HCHD received $254 million in net supplemental Medicaid funding benefit for federal fiscal year 2015, and expects level funding for the current fiscal year before the waiver program expires in December 2017.
SUSTAINED FINANCIAL PROFILE: The 'AA' rating is supported by an expectation that Harris County Hospital District (HCHD) will preserve its balance sheet strength and coverage levels. With expected revenue pressure from reductions in Medicaid supplemental funding, HCHD will need to continue its work on operating efficiency and perhaps increase its tax revenues in order to maintain its financial profile. Unexpected erosion in HCHD's financial profile could pressure the rating.
HCHD is the fifth largest metropolitan health system in the country, and consists of three hospitals: Ben Taub General Hospital (492 operated beds), Lyndon B. Johnson Hospital (235 operated beds), Quentin Mease Hospital (49 operated beds), 18 community care centers, six school-based clinics, and other ambulatory sites. Other component units of the HCHD system include a foundation and a Medicaid Health Maintenance Organization known as Community Health Choice (CHC).
Fitch's analysis is based on HCHD and its component units. In fiscal 2016 (February 29 year-end), HCHD generated $2.2 billion of revenues, including $361.5 million in net patient service revenue, $891 million of premium revenue, $180.6 million of DSH and Uncompensated Care (UC) funding, and $635.4 million of ad valorem tax revenue and $73.8 million in delivery system reform incentive payment (DSRIP) revenue (both classified as non-operating revenue in the audited financials).
NEW ISSUE DEBT
HCHD is issuing $157.8 million in series 2016 refunding revenue bonds, which will be used to refund its existing series 2007A revenue bonds. Post issuance, HCHD will have approximately $315 million in total long term bonds outstanding, of which $62.8 million in series 2016 COs are supported by tax revenue. Aggregate debt service is estimated at $21.8 million including all bonds; however the covenant calculation (2.0x coverage requirement) and debt service reserve fund will be based on $17.1 million in debt service associated with its revenue bonds. Through fiscal 2015, coverage of aggregate MADS was a healthy 3.5x by EBITDA at fiscal 2015, and coverage of the required $17.1 million in revenue debt service was 4.4x. HCHD's debt mix will be approximately 70% fixed rate post issuance.
HCHD covenants to provide only annual disclosure to bondholders, via the Municipal Securities Rulemaking Board's EMMA system. Fitch views the lack of a provision for quarterly disclosure as negative.
VARIATION FROM PUBLISHED CRITERIA
The analysis supporting the 'AA' IDR on HCHD includes a variation from the U. S. Nonprofit Hospitals and Health Systems Rating Criteria. Enhanced analysis under the variation relates to the evaluation of the strength of the tax revenues available to support operations. This evaluation is supported by Fitch's new U. S. Tax-Supported Rating Criteria dated April 18, 2016 that includes refinements to the analysis of both tax revenue volatility, through the new Fitch Analytical Sensitivity Tool (FAST), and the value of taxing capacity relative to the issuer's potential revenue stress in a downturn.