Fitch Upgrades Erlanger Health System (TN) Series 2014A Revs to 'BBB+'; Outlook Stable
--$149.9 million hospital revenue and refunding bonds series 2014A.
The Rating Outlook is Stable.
The bonds are secured by a pledge of gross revenues and a first mortgage lien on certain system property.
KEY RATING DRIVERS
IMPROVING CREDIT PROFILE: The upgrade to 'BBB+' reflects the further improvement in operating performance in fiscal 2015 (year-end June 30) which has exceeded Fitch's expectation, reversing several years of operating losses. Under the leadership of the new CEO who came on board in 2013, EHS has seen increased volumes and a sharp improvement in operating results with margins and debt service coverage that exceed Fitch's 'BBB' category medians.
SOLID FISCAL 2015 RESULTS: EHS ended fiscal 2015 with operating income of $36.2 million, producing a solid 5.1% operating and 10.4% operating EBITDA margin and is exceeding budget for the first quarter of fiscal 2016 (1Q16) ended Sept. 30, 2015. The strong 2015 results were driven by robust volumes reflected in 15.3% revenues growth, successful physician recruitment, as well as the benefit of supplemental payments for which EHS qualified for the past two fiscal years.
REGIONAL SERVICE PLATFORM: EHS serves the tri-state region as the only academic medical center, and the only provider of Level 1 trauma, Level IV NICU and other tertiary referral services. EHS has cemented its position as a safety-net provider, garnering local and state legislative support for its position as the area's public hospital, which brings additional reimbursement through 2016 and potentially beyond.
MANAGEABLE DEBT BURDEN: EHS generated strong coverage of maximum annual debt service coverage (MADS) by EBITDA of 5x in fiscal 2015, exceeding Fitch's 'BBB' category median of 2.7x. MADS is a moderate 2.1% of revenues. A current expansion project at Erlanger East, funded with a portion of the series 2014A bonds, is proceeding on budget and is expected to be completed by 2016 calendar year end. However, due to capacity constraints at the main campus, EHS may need to invest in facility expansion in the medium term.
MIXED LIQUIDITY INDICATORS: EHS reported $205.5 million of cash and unrestricted investments at June 30, 2015, translating to 115 days cash on hand (DCOH), cushion ratio of 13.7% and cash equal to 93% of debt, which are at median levels with the exception of DCOH. However, Fitch notes that although unrestricted cash and investments have grown by close to 50% since fiscal year end (FYE) 2013, the improvement in liquidity metrics has been muted by strong revenue growth and the additional debt issued in 2014 to fund facility expansion plans. Fitch does not expect a meaningful improvement in liquidity metrics over the medium term as EHS's capital needs are expected to remain elevated over the next several years.
SUSTAINED CASH FLOW: Fitch believes that Erlanger Health System can sustain the higher levels of operating cash flow achieved over the last two years resulting in coverage better than 'BBB' category medians, mitigating Erlanger Health System's 's light liquidity metrics and elevated capital spending requirements. However, a return to weak operating margin could pressure the rating.
Founded as the Baroness Erlanger Hospital in 1889, Erlanger Health System (EHS) operates 576 staffed inpatient beds at five principal campuses; the University Hospital at the Erlanger Baroness Campus, Children's Hospital at the Erlanger Baroness Campus, Erlanger North Hospital, Erlanger East Hospital, and Erlanger Bledsoe Hospital, located in Pikeville, Tenn. EHS provides Level 1 trauma services, Level IV NICU services, and is affiliated with the University of Tennessee College of Medicine as the region's only academic teaching hospital. EHS is based in Chattanooga, and serves the tri-state region of eastern Tennessee, northeastern Alabama and northwestern Georgia. Total revenues were $715 million in fiscal 2015 (year-ended June 30).
Improving Credit Profile
The upgrade to 'BBB'+ is based on the continued strong financial results with margins and coverage of MADS well exceeding Fitch's 'BBB' medians. Leveraging its role as the region's academic medical center and implementing several strategic initiatives which included increasing its primary care platform, establishing affiliations with two local physician groups, and growing its presence centered on Erlanger East, which has a well-insured population, has resulted in robust growth in clinical volumes. As a result the system's revenues increased by 8% in fiscal 2014 and 15.3% in fiscal 2015.
Inpatient admissions increased by 9.5% last year and are 6.9% ahead of the prior year period through 1Q16 ended Sept. 30, 2015. ED visits were up by 14.3% and inpatient surgeries grew by 7.2%. The system is in the process of adding six operating rooms at the main campus, which are expected to further increase surgery capacity, now very constrained. EHS has maintained and slightly improved its leading market share to 32.2% within its primary and secondary service areas, against the 29% held by Memorial Health Care (part of Catholic Health Initiatives, rated 'A+' by Fitch) and 17.2% share by Parkridge (part of HCA Inc, rated 'BB'). Fitch notes that EHS's share is significantly higher for certain specialties such as neonatology, high-risk obstetrics, trauma, and neurology, and now 100% for neurosurgery, after employment of a neurosurgery group which practices solely at Erlanger Medical Center.
While Fitch notes that there is some concern regarding the recent problems with Volkswagen, which has a large manufacturing plant near Erlander East, so far there has been no indication that this would have a material impact on EHS. Fitch will continue to monitor the situation.
Continued Operating Improvement
Implementation of the key strategic initiatives helped generate operating income of $36.2 million in 2015, equal to a 5.1% operating and 10.4% operating EBITDA margin, which well exceeded the 'BBB' category medians of 0.6% and 7.7%, respectively. The strong results were also driven by productivity improvements, as evidenced by the reduction of FTEs per adjusted occupied bed to 4.8 from 5.4 in 2013, despite the volume pressures. EHS also benefits from being included in the Tennessee Public Hospital Supplemental Pool, from which EHS is receiving close to $19 million annually through 2016. Financial performance has been maintained through 1Q16, with operating income of $3.8 million, ahead of budgeted $1.6 million. EHS is highly reliant on governmental sources of revenue, with combined Medicare and Medicaid accounting for 52.6% of gross revenues, but EHS did see a benefit from patients participating in the Tennessee Health Insurance Exchange, which reduced self-pay to 8.1% last year from over 10% in the prior years.
The interim results are understated by the quarterly portion of DSH payment expected at $8.5 million for the current year, which is expected to be received at FYE. Similarly, the 2016 operating income budget of $18.2 million does not include the DSH payment and management expects to exceed the budget based on year-to-date results. The completion of the expanded Erlanger East Hospital by calendar year-end 2016 is projected to add $22 million to system net income over the next five years.
EHS reported cash and unrestricted investments of $205.5 million at June 30, 2015, a material increase from $153.7 million in 2014. Still, the system's liquidity metrics are relatively light, though cash-to-debt at 93% was in line with the category median of 90%, but DCOH at 114.9 days lags the median of 161.5 DCOH. As a governmental entity the system is subject to certain investment limitations and as such has a very conservative investment allocation with over 80% invested in fixed income. Given the capital needed over the medium term to address capacity constraints at the main campus, liquidity growth may be hampered despite solid cash flows.
Conservative Debt Profile
EHS has approximately $202 million of long-term debt outstanding, which is 92% fixed rate. In addition to the fixed-rate series 2014A, the system has $40.1 million currently outstanding 2004 series (fixed rate and not rated by Fitch) and a $12 million 2014B taxable variable-rate note, due in 2021, also not rated by Fitch. The 2014 transaction reduced MADS to $15 million from close to $19 million and MADS coverage by EBITDA was a strong 5x in fiscal 2015, favorable to Fitch's 'BBB' category median of 2.7x. The system's leverage is moderate, with MADS representing 2.1% of system revenues, as compared to the 3.6% median. EHS terminated all swaps in December 2014 paying termination fees of $3.2 million using a portion of the proceeds of the taxable 2014B debt.
EHS has covenanted to provide annual disclosure within 150 days of FYE (June 30) and quarterly disclosure within 60 days of the end of the first three quarters of the fiscal year to the Municipal Securities Rulemaking Board's EMMA system. Disclosure will include financial statements, utilization, payor mix, and management discussion and analysis.