Fitch Affirms Memorial Health Services, CA's Revs at 'AA-/F1+'; Outlook Stable
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group (OG). The OG includes the parent corporation, Long Beach Memorial Medical Center, Orange Coast Memorial Medical Center, and Saddleback Memorial Medical Center. The OG accounted for 87% of total assets and 80% of total revenue of the consolidated entity in fiscal 2014 (June 30 year end; audited). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
SOLID FINANCIAL PROFILE: MemorialCare's overall financial profile is solid for its rating level with strong liquidity, good profitability and moderate debt burden. Profitability has been aided by the net benefit from the state provider fee. The timing of the receipt of the provider fee funding is volatile as various components of the different phases of the program obtain approval at different times, which has created variability in profitability. However, excluding the impact of the provider fee, operating profitability has declined over the four-year period mainly due to strategic investments in its integrated delivery strategy including physician alignment, ambulatory growth, and development of a health plan.
EXCELLENT MANAGEMENT PRACTICES: Fitch believes the organization has conservative budgeting and financial planning, which does not rely on the state provider fee funds. In addition, Fitch views MemorialCare's business strategy favorably as it continues to diversify from acute care, which should position the organization well especially in its highly competitive environment.
SYSTEM GROWTH AND INTEGRATION: MemorialCare has grown its system through strategic physician acquisitions and affiliations and also acquired a health plan license (Seaside Health Plan) that started operations in September 2013. Membership and revenue from the health plan still remains fairly small but is expected to grow over time.
COMPETITIVE MARKET: MemorialCare operates in the highly competitive Los Angeles and Orange County market with a number of health systems as well as independent providers as competitors. MemorialCare is one of seven hospitals in the Los Angeles area that is part of Vivity - a joint venture with Anthem Blue Cross, which will offer a health maintenance organization plan intended to align care delivery and in which the providers and the insurer will share financial risk and gain.
RATING SENSITIVITIES
FINANCIAL CUSHION AT RATING LEVEL: Fitch believes MemorialCare has cushion at its current rating level as it continues to invest in its strategic initiatives, which has been partially afforded by the benefit from the provider fee.
Credit Profile
MemorialCare is comprised of five hospitals with a total of 1,586 licensed beds, an extensive ambulatory network, a medical foundation, a health plan as well as other related entities. The organization has grown into an integrated delivery system with a geographic reach that covers southern Los Angeles County and Orange County. Total revenue in fiscal 2014 (June 30 fiscal year end) was \$2 billion. Interim financials are for the OG only.
Strong Liquidity
Liquidity is one of MemorialCare's main credit strengths. Liquidity growth has been driven by manageable capital needs, the provider fee, as well as good investment returns. Total unrestricted cash and investments was \$1.44 billion at Dec. 31, 2014 (OG only), which resulted in 343.2 days cash on hand, 36.4x cushion ratio, and 250.1% cash to debt, compared to Fitch's respective 'AA' category medians of 277.1 days, 26.5x, and 178.5%. Unrestricted cash and investments have grown from \$1.33 billion (OG only) at Dec. 31, 2013.
Variability in Profitability
California enacted a hospital provider fee in 2010 to draw down additional federal funds for Medi-Cal services and MemorialCare has benefited from the provider fee program. MemorialCare's profitability has fluctuated over the last four years, mainly driven by the timing of the receipt of these funds. However, excluding the benefit of the provider fee funds, MemorialCare's operating margin has declined over the last four years due to its strategic investments in physician alignment, ambulatory care, and the development of a health plan. Operating margin without the provider fee was 0.4% in fiscal 2014 compared to 5.7% in fiscal 2011.
Fitch believes the funds from the provider fee program have given MemorialCare more flexibility to invest in its strategic initiatives. The net benefit was \$76.7 million in fiscal 2011, \$11.4 million in fiscal 2012, \$86.4 million in fiscal 2013 and \$6.2 million in fiscal 2014. Fiscal 2014 operating and operating EBITDA margin was 0.7 and 6.3%, respectively compared to the AA category median of 3.9% and 11% and prior year's performance with 6% operating margin and 10.9% operating EBITDA margin. Fiscal 2014 performance was impacted by the timing of the approval of the most recent phase of the program (Phase 4), which covers the period Jan. 1, 2014-Dec. 31, 2016. A portion of this program (fee for service component) was just approved in December 2014 and should result in a net benefit of \$40 million (to be booked in fiscal 2015). Phase 4 is expected to generate a net benefit of \$220 million over the three year period once all the approvals are received.
System Growth and Integration
Fitch views management's business strategy favorably as MemorialCare has invested heavily on strategic physician acquisitions, building its electronic medical record, growing its ambulatory network and adding additional capabilities including owning a health plan. MemorialCare has been proactive in managing the wellness of its employees and plans to extend this program to other employers in the area. Other areas of focus include continued clinical integration within its system across service lines.
Having made significant investments in its physician alignment strategy, MemorialCare has a strong base of affiliated physicians, which should allow it to better coordinate care and deliver care in the most cost effective setting. Fitch believes that MemorialCare's strategic moves to date should allow MemorialCare to perform well in a lower and pressured reimbursement environment.
Competitive Service Area
MemorialCare operates five acute-care hospitals in the densely populated Los Angeles and Orange counties. Overall, the organization continues to experience softening inpatient volume and lower elective procedures while outpatient volume and emergency room volume increase. One of MemorialCare's competitors, Hoag, merged with St. Joseph Health System rated 'AA-' in March 2013. To date, there has not been any major market shifts due to the consolidation activity and Fitch will continue to monitor market developments. MemorialCare is planning to transition its Saddleback Memorial -San Clemente campus to an ambulatory campus, which Fitch would view favorably as it should further enhance efficiency in the system.
A recently announced partnership between Anthem Blue Cross and seven area hospital systems, including Memorial Care, Cedars Sinai Medical Center (rated AA-; Stable), and UCLA Health is an effort to provide a lower cost insurance product while providing high quality care and should foster collaboration between the hospitals.
Manageable Capital Plan
MemorialCare's 10-year capital plan is manageable and totals \$1.1 billion and includes several expansion projects at MemorialCare's various campuses, IT needs, seismic compliance projects, and routine maintenance. Seismic requirements are minimal and total only approximately \$35 million.
Moderate Debt Burden
Total debt outstanding was \$590 million as of June 30, 2014 with 63% underlying fixed rate and 37% underlying variable rate. MemorialCare's debt structure has three bullet maturities (\$65 million series 1991 variable rate demand bonds (VRDBs) in fiscal 2017, \$100 million direct bank loan in fiscal 2019 and \$100 million taxable bonds in fiscal 2022). Fitch believes MemorialCare has good market access and sufficient liquidity to handle the bullet maturities.
Memorial has a fixed payor swap for a notional amount of \$100 million and three basis swaps with a notional amount of \$190 million outstanding. There are no collateral posting requirements under the swaps.
Debt ratios are moderate with MADS accounting for 2% of total revenue compared to Fitch's 'AA' category median of 2.6%. Fitch used MADS of \$39.6 million, which was calculated according to the master trust indenture definition for the treatment of bullet maturities (amortized over 20 years) and assumes variable rate at 2.2%. MADS coverage has also fluctuated due to the provider fee funding - but was 4.7x in fiscal 2014, 7.4x in fiscal 2013 and 4.4x in fiscal 2012. Debt service coverage (OG only) through the six months ended Dec. 31, 2014 was very strong at 7.4x due to higher than normal realized gains on investments.
Self-Liquidity
The 'F1+' short-term rating is supported by the adequacy of MemorialCare's highly liquid resources available to fund any unremarketed puts on the \$171.1 million series 1991, series 1994, and series 2013A weekly VRDBs. MemorialCare also has \$50 million of series 2013B bonds in a windows mode. The windows mode provides a longer time frame to handle any unremarketed puts (180 days after 30 day notice). Based on Fitch's rating criteria related to self-liquidity, MemorialCare's access to highly liquid resources to handle any potential unremarketed puts easily exceeds Fitch's 1.25x requirement. MemorialCare has liquidation procedures in place detailing the process by which internal funds would be liquidated to meet the tender obligations.
Disclosure
MemorialCare covenants to provide annual and quarterly financial statements through EMMA.
Outstanding debt affirmed at 'AA-':
--\$167,700,000 California Health Facilities Financing Authority (CA) (Memorial Health Services) revenue bonds series 2012A;
--\$100,000,000 Memorial Health Services (CA) taxable bonds series 2012.
Outstanding debt affirmed at 'AA-/F1+':
--\$100,000,000 California Health Facilities Financing Authority variable rate revenue bonds (Memorial Health Services) series 2013A&B
--\$56,100,000 California Health Facilities Financing Authority (CA) (Memorial Health Services) variable-rate health facilities revenue refunding bonds series 1994;
--\$65,000,000 Long Beach (CA) (Memorial Health Services) variable-rate health facilities revenue bonds series 1991.
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