Fitch Affirms South Nassau Communities Hospital's (NY) Rating at 'A-'; Outlook Negative
The Rating Outlook is revised to Negative from Stable.
The bonds are secured by a pledge of gross receivables of the obligated group, and a mortgage on the main hospital facility. South Nassau is the only member of the obligated group.
KEY RATING DRIVERS
MODERATE LEVERAGE METRICS: The rating affirmation is primarily supported by South Nassau's manageable debt burden. Maximum annual debt service (MADS) coverage was 5.4x in fiscal 2015 and 4.4x through the six months of fiscal 2016 ended June 30. MADS represents a low 1.5% of revenues for the six months of fiscal 2016.
INCREASING CAPITAL EXPENDITURES: The revision of the Outlook to Negative from Stable reflects an increased capital and programmatic investment agenda that has diluted South Nassau's cash position. Some of the upcoming capital projects may be funded by a new financing in the second half of fiscal 2017, which, when combined with the lower cash position, result in a more constrained balance sheet position in the near future.
DECLINING and LOW LIQUIDITY CUSHION: Unrestricted cash and investments have declined significantly since the prior rating review primarily due to weak cash flow generation and increased capital and strategic investments. Unrestricted cash balances fell to $134.3 million in fiscal 2015, equating to 110 days cash on hand (DCOH) from $158.7 million in fiscal 2014 (143.4 DCOH). Liquidity of 105.6 days cash as of June 30, 2016 is significantly below the 215.5-day median for the 'A' rating category.
WEAKER BREAK-EVEN OPERATING RESULTS: Profitability has decreased in fiscal 2015 and year-to-date fiscal 2016, yielding break-even operations and low operating EBITDA margins of 6.5% and 6.9%, respectively. These results compare unfavorably to the 10.3% median for this rating category. Financial results have been compressed by high medical claims in South Nassau's self-insured program, a low flu season in 2016 and increased competition for orthopedic volume.
FEMA FUNDING EXPECTED FOR STRATEGIC IMPROVEMENTS: South Nassau is expected to receive approximately $171 million in FEMA funding as a result of having acquired the assets of Long Beach Medical Center (LBMC), which closed after incurring significant damage from superstorm Sandy. South Nassau proposes to expand its ambulatory campus in Long Beach (approximately $40 million) and use the remaining funds (approximately $130 million) for major upgrades at its main Oceanside campus, which also serves the Long Beach and other communities in the south shore of Long Island.
CONTINUED MARGIN COMPRESSION: South Nassau Communities Hospital's (South Nassau) profitability will need to improve in order to generate increased cash flow to cover the elevated level of strategic investments. The increased spending, without a commensurate growth in cash flow, may result in negative rating pressure.
BALANCE SHEET METRICS: The 'A-' rating may also be pressured if liquidity decreases further from the current position and/or if South Nassau incurs a significant amount of debt to fund the expected capital projects.
South Nassau Communities Hospital (SN) is a 435-bed (358 operated) acute care hospital (plus a 20-bed Transitional Care Unit), located in Oceanside, on the south shore of Long Island. Its service area includes Nassau County and parts of eastern Queens County. Total operating revenue in fiscal 2015 (Dec. 31 year end) was $472.8 million.
South Nassau operates in a service area that is competitive and fragmented, with two dozen hospitals, many of which are owned by two larger competitors: Catholic Health Services of Long Island (CHS) (rated 'BBB+'/Stable Outlook) and Northwell Health (rated 'A'/Stable Outlook). To remain competitive in its service area and to prepare for changes in the healthcare industry, South Nassau has been increasingly investing in its physicians, Trauma II designation, residency programs, capital projects, and population health initiatives.
Over the past couple of years, South Nassau opened a new Transitional Care Unit and renovated the Critical Care and Intensive Care Units at its Oceanside campus. It also began the first phase of a renovation and eventual expansion of its Emergency Department (ED), which operates at almost twice its capacity (over 60,000 visits per year). Aside from doubling the ED, future capital plans at Oceanside include adding and renovating the surgical suites and the addition of critical care beds.
Some of these projects will be funded from operations as well as a possible debt financing in the second half of fiscal 2017, while another portion (approximately $130 million) of projects at Oceanside are expected to be funded from FEMA funds. FEMA funding would be provided to South Nassau under a permitted alternate use plan at Oceanside. South Nassau purchased LBMC's assets during a bankruptcy proceeding in 2014, making South Nassau the designated recipient of these funds. LBMC was not rebuilt as an inpatient hospital, but South Nassau opened a new freestanding ED at that location in 2015. The Long Beach community is served by South Nassau's Oceanside campus, and therefore South Nassau expects approval from FEMA for the alternate use of funds for regional services.
If awarded, the FEMA grant would be approximately $171 million and it would fund 90% of the FEMA-related projects, which include the $130 million in capital updates at Oceanside and $40 million for a Long Beach medical pavilion that expands the ambulatory presence and offerings at the current ED site in Long Beach. South Nassau is required to fund the other 10% of the FEMA funded projects. The FEMA-funded projects will not commence unless South Nassau receives final approval from FEMA.
In addition, South Nassau is projecting to spend approximately $90 million in other capital expenditures between 2016 and 2019. To that end, the hospital may consider a financing in the second half of 2017. The amount, or timing, is uncertain but it may be up to $60 million.
The incremental debt combined with the lower cash position may stress the balance sheet in the short - to intermediate-term. South Nassau's moderate debt burden is evidenced in strong MADS coverage of 5.4x in fiscal 2015 and cash-to-debt of 153.1%. With $87.7 million in long-term debt at fiscal year-end 2015 and $20 million outstanding on a line of credit, South Nassau's current debt burden is manageable. Depending on the final amount, additional debt of up to $60 million may result in balance sheet indicators that are no longer in line with the 'A-' rating category.
WEAKER OPERATING RESULTS
The elevated capital and programmatic spending in 2015 and 2016 coincided with a period of compressed margins at South Nassau. Fiscal 2015 was affected by high medical expense claims in its employee self-insured program. The hospital incurred an additional cost of over $500,000 in 2016 to purchase stop-loss insurance, but the claim experience has not been as high in 2016. The hospital also increased its clinical staff in 2015 in response to a high flu season and increasing acuity at the hospital. However, the volume did not materialize as expected in 2016 and patient visits are below budget.
South Nassau's profitability has also been affected by the increase in ambulatory competition from other hospital providers as well as private physician practices. Overall, South Nassau has incurred higher expenses related to physician recruitment and start-up costs, as growing the number of employed and aligned physicians is a key objective for management. The hospital has also formed an Independent Physician Association, New York Medical Partners (NYMP), to align its employed and voluntary staff. NYMP applied to Medicare to become an ACO in 2017.
Given the competition and mature service area, Fitch expects that cash flow will continue to be tepid in the coming years, precluding any significant growth in liquidity, especially since cash flow is required to fund the elevated capital needs over the next three years.
South Nassau covenants to provide annual audited financial statements 150 days after the fiscal year-end and quarterly unaudited financial statements 60 days after the quarter-end to EMMA.