Fitch Rates Banner Health, AZ's Commercial Paper 'F1+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has assigned an 'F1+' rating to Banner Health, AZ's (Banner) approximately $100 million taxable commercial paper notes
series 2015 based on self-liquidity.
In addition, Fitch has assigned an underlying 'AA-' rating to the approximately $100.63 million series 2015B and $100.63 million series 2015C weekly rate securities, an 'AA-' bank bond rating to the series 2015B and C bonds, and affirmed the 'AA-' rating on Banner's debt, which is listed at the end of the press release.
The Rating Outlook is Stable.
The series 2015 financing will total approximately $600 million and effectively pay down a portion of the draw on a bank loan that was used for the acquisition of University of Arizona Health Network (UAHN; $500 million) and refinance a portion of the series 2007A bonds.
The series 2015 plan of finance includes $94.8 million series 2015A tax exempt fixed rate bonds, $100.63 million tax exempt variable rate demand bonds (VRDBs) supported by a letter of credit (LOC) from Bank of Tokyo (series 2015B), $100.63 million tax exempt VRDBs with LOC from Bank of America (series 2015C), $100.3 million tax exempt direct placement with JP Morgan Chase (series 2015D), $100.6 million taxable direct placement with Northern Trust and $100 million of taxable commercial paper supported by self-liquidity.
Fitch will be assigning a rating to the series 2015B and C bonds based on the support of the LOC at a later date and the series 2015A bonds were rated 'AA-' on Oct. 9, 2015. The variable rate bonds are expected to price the week of Nov. 2 via negotiation.
The bonds are secured by a gross revenue pledge of the obligated group. The obligated group accounted for 76% of total revenue and 94% of total assets of the consolidated entity in fiscal 2014 (Dec. 31 year-end).
KEY RATING DRIVERS
STRATEGIC BENEFITS OF UAHN ACQUISTION: Fitch believes the strategic benefits of the UAHN acquisition outweigh the near-term impacts of the cost of the transaction ($733 million) and the weak financial performance of UAHN on Banner's financial profile. Banner has a long track record of integrating acquired assets and improving financial performance. The integration is underway, and performance is ahead of budgeted targets but still expected to generate an operating loss for fiscal 2015.
EXPANDED GEOGRAPHIC FOOTPRINT: Historically, Banner's operations have been primarily concentrated in the Phoenix, AZ metropolitan area. The acquisition of UAHN expands Banner's presence into the Tucson metropolitan market and has turned Banner into a statewide network with 82% of Arizona's population having access to Banner providers.
SOLID FINANCIAL PROFILE: Banner's historical performance has been very strong, and while the UAHN acquisition is dilutive to Banner's financial profile, projected performance is expected to remain in line with Fitch's 'AA' category medians.
ELEVATED CAPITAL SPENDING: Banner has consistently invested in its plant, and the UAHN acquisition includes a $500 million capital commitment in the Tucson facilities. In addition, there may be other capital projects that would be driven by market/volume growth demands. Fitch believes that additional debt capacity will be dependent on Banner's ability to generate improved cash flow at UAHN and maintain debt metrics in line for the rating level.
GROWING HEALTH PLAN OPERATIONS: Banner has been proactive in the move to risk based contracts and plans to significantly grow its health plan operations. The Banner Health Network (BHN) was created to enter into various risk based reimbursement contracting including a Pioneer ACO and senior risk plans. In addition, the UAHN acquisition included three health plans. Health plan performance has been volatile as management is gaining competencies in utilization management and health plan operations are unprofitable year to date.
SELF-LIQUIDITY PROCEDURES IN PLACE: The 'F1+' rating on the commercial paper reflects management's plans to handle any potential failed remarketing of the commercial paper notes, Banner's long-term credit quality, as well as the solid position of liquid assets to fund any potential unremarketed notes.
SUCCESSFUL INTEGRATION OF UAHN: Although Fitch views the University of Arizona Health Network transaction favorably and believes that management will successfully integrate the two systems, there is less flexibility at the current rating level now for negative variance relative to its plan. A sustained deterioration in financial performance, although not expected, could lead to negative rating pressure.
Banner Health is a large, integrated health care provider headquartered in Phoenix, AZ with operations in seven states that include 28 hospitals, over 1,000 employed physicians (Banner Medical Group), outpatient and post-acute facilities and insurance products. In 2014, Banner generated $5.4 billion in total revenue. The majority of Banner's operations are located in the Phoenix metropolitan area, which accounted for over 60% of total revenue in 2014. In fiscal 2014 (June 30 year end), UAHN generated $1.4 billion of total revenues and had $963.5 million of total assets and $363.3 million of debt outstanding. Fitch's analysis is based on consolidated financial results of Banner that include various non-obligated entities.
Self Liquidity Rating
The assignment of the 'F1+' short-term rating is supported by the adequacy of Banner Health's highly liquid resources available to fund any unremarketed notes on the approximately $100 million commercial paper. Banner expects to have a maximum of $25 million of commercial paper maturing at one time and Banner's cash flow management plans include maintaining at least that amount in cash on the commercial paper rollover dates. The average cash balance is approximately $50 million.
As of Feb. 28, 2015, Banner acquired two medical centers in Tucson, the faculty practice plan of University of Arizona Colleges of Medicine, and three health plans. Banner and the University of Arizona, Colleges of Medicine have a 30-year Academic Affiliation Agreement in place with two 15-year terms. Banner already had a relationship with the Colleges of Medicine as Good Samaritan Medical Center was the teaching facility for the University of Arizona College of Medicine - Phoenix. The acquisition has solidified Banner's role in academic medicine and leveraging the academic brand in Phoenix/Tucson is a component of the strategy. Banner has created a new division, Banner - University Medicine, and all the entities have been rebranded and include Banner - University Medical Center - Phoenix (BUMCP; fka Good Samaritan Medical Center) and Banner - University Medical Center - Tucson (BUMCT; fka University of Arizona Medical Center - University Campus).
The total cost of the transaction was $733 million, which included $300 million for the establishment of an Academic Enhancement Fund (AEF) and $433 million to defease UAHN's debt and purchase a ground lease. In addition, Banner made a $500 million capital commitment to the Tucson facilities. The AEF is at the University of Arizona and is an endowment to support clinical and translational research, in addition to providing operating support for the academic enterprise. Banner funded the acquisition primarily through a $694 million draw on a bank loan, which will be converted to permanent financing with the series 2015 issuance ($500 million). The remaining amount of the bank loan may remain outstanding until the maturity date (Feb. 25, 2016) when it could be paid down with cash or extended.
Fitch believes Banner will accrue strategic benefits from the acquisition including a broader geographic network, greater scale and efficiency, and the creation of an academic brand. Prior to the acquisition, UAHN's financial performance was on a significant downward trajectory and the losses have been stabilized since Banner's management team has been in place.
Longer-term challenges of the acquired assets include the highly competitive Tucson service area, which is evenly split among four providers, and sizable capital needs that include plans for a new patient tower, operating rooms and entrance to BUMCT, which is projected to be completed by 2018.
Management is committed to achieving synergies in a short timeframe and expects UAHN to end 2015 ahead of budget, although still with an operating loss. The integration plans include reducing overhead costs, converting UAHN to Banner's Cerner IT platform, expanding payer relationships in the Tucson market, improving revenue cycle, supply chain and productivity, and reducing length of stay and increasing throughput. There is also significant opportunity related to market share growth.
Fitch believes the main mitigating factor to the challenges related to the turnaround/integration of UAHN is the strength of Banner's management team, which is experienced in acquiring provider assets and has a solid track record in generating operational improvement to plan due to its performance based culture.
Participation in Risk Based Contracts
As part of its overall strategic plan, Banner has been very proactive in readying the organization for payment reform, coordinated delivery of care, and population health management. With the acquisition of UAHN, Banner's service area covers approximately 82% of the State of Arizona's population. Banner created BHN to enter into various value based contracts (both full risk and shared risk) with Medicare and commercial payors. With the addition of the UAHN health plans, which has a solid presence in Medicaid products, total premium revenue is expected to increase and was $468 million in fiscal 2014.
Over the long term, management is projecting significant growth in health plan premium revenue and membership which presents added operating risk as health plan performance over the last few years has been volatile and year to date performance is unprofitable. Challenges include reimbursement under the Medicare Advantage plan and higher pharmacy utilization. There are various opportunities and focus areas regarding utilization management that the organization is addressing, and Fitch will monitor the impact on Banner's overall financial profile.
Solid Financial Profile
Banner's historical performance has been solid with consistently strong operating performance. Banner had a 4.9% operating margin ($263 million operating income) in 2014 compared to 5% operating margin in 2013 and the 'AA' category median of 3.9%. Through the six months ended June 30, 2015, Banner had a 3.2% operating margin (four months of UAHN), and management budgeted a 2.2% operating margin for full year 2015, which Fitch expects to be met.
Liquidity metrics have dropped with the UAHN acquisition with 263 days cash on hand and 135% cash to debt at June 30, 2015 compared to 298 days cash on hand and 155% cash to debt at fiscal year end 2014. Days cash on hand is projected to be around 250 and cash to debt is projected to be around 160-170% over the next few years, which is consistent with the 'AA-' rating.
Elevated Capital Spending
Banner has consistently invested in its facilities and its clinical IT system. Twenty-one of Banner's hospitals have achieved HIMSS stage 7 designation compared to a total of 204 hospitals nationwide. Capital spending is projected to total $615 million in 2016, $656 million in 2017, and $377 million in 2018. While much higher than the plan provided during Fitch's last review, this includes several strategic projects that are not yet board approved.
Current major capital projects include a new emergency room at BUMCP and a new patient tower at BUMCT. The project at BUMCP includes a new and expanded emergency room, a 40-bed observation unit, and four additional operating rooms at a cost of $180 million that should be complete by mid-2017. The project at BUMCT includes an 11-story patient tower with 300 private rooms, new operating rooms, and new lobby and entrance at a cost of $400 million that should be complete by end of 2018.
Banner's total debt outstanding after the series 2015 financing will be approximately $2.95 billion composed of 52% fixed rate debt and 48% variable rate debt. Including its swaps, the debt profile is 97% fixed rate. The bank exposure and renewal risk related to its variable rate debt is diversified and staggered.
Pro forma MADS increases to $188 million with the series 2015 financing from the current $166 million. Through the six months ended June 30, 2015, MADS accounted for 2.8% of annualized 2015 total revenues. MADS coverage was 4.6x for the six months ended June 30, 2015 compared to 4.2x in fiscal 2014 and 2013. Furthermore, historical pro forma coverage is understated as UAHN's earnings are not included.
Banner novated its fixed payer swaps in May 2015 and increased the number of counterparties, which spread the collateral threshold among six counterparties from four and reduced the amount of collateral posting required. Banner is currently posting approximately $89 million in collateral compared to $221 million prior to the novation.
Banner covenants to provide audits within 150 days of fiscal year end and quarterly disclosure within 60 days of quarter end for the first three quarters. Banner's financial reporting is excellent. Disclosure is timely and complete. Interim financial statements are presented in an audit format and include a management discussion and analysis. Furthermore, Banner hosts quarterly investor calls.
Fitch has affirmed the following Arizona Health Facilities Authority (Banner Health) debt at 'AA-':
--$94,800,000 revenue bonds, series 2015A;
--$200,600,000 revenue bonds series 2014A;
--$67,840,000 revenue bonds series 2012B (taxable);
--$179,090,000 revenue bonds series 2012A;
--$67,905,000 variable-rate demand revenue bonds series 2008H (LOC: Northern Trust Company (The)) & bank bonds;
--$86,900,000 variable-rate demand revenue bonds series 2008G (LOC: Wells Fargo Bank, N.A.) & bank bonds;
--$92,090,000 variable-rate demand revenue bonds series 2008F (LOC: JPMorgan Chase Bank, N.A.) & bank bonds;
--$112,310,000 variable-rate demand revenue bonds series 2008E (LOC: Bank of America, N.A.) & bank bonds;
--$754,195,000 revenue bonds series 2008D;
--$209,675,000 revenue bonds series 2008A;
--$400,000,000 revenue bonds series 2007B;
--$135,350,000 revenue bonds series 2007A