Fitch Rates UMass Memorial Health Care Series 2016I Revs 'A-'; Outlook Stable
--$177,000,000 Massachusetts Development Finance Agency (MDFA) revenue bonds, 2016I
The Rating Outlook is Stable.
The series 2016I will be issued as fixed-rate bonds with final maturity in 2040. Proceeds will be used to refund UMMHC's series 2005D and 1998A bonds and provide $60.7 million of new money as partial funding of the system's Master Facility Plan, and pay for related costs of issuance. The bonds will sell via negotiation the week of Jan. 18, 2016.
Security
The bonds are a joint and several obligation of the obligated group members and are secured by their gross receipts as well as a mortgage lien on certain property of UMMHC (the Memorial Campus in Worcester).
Key Rating Drivers
Unique Market Position: The system enjoys a unique position both due to its close connection to the University of Massachusetts Medical School (Medical School), for which its flagship UMass Memorial Medical Center (UMMC) serves as the primary teaching facility, and as a result of the leading 43% inpatient market share of the Central Massachusetts service area The importance of the system is further demonstrated by the significant amount of Medicaid Supplemental Funding (MSF) from the Commonwealth.
Improved Operating Results: Following a large operating loss in 2013 the system put a new leadership in place headed by a physician CEO , and the new management team has successfully implemented a financial recovery plan starting with fiscal 2014 (fiscal year-end September 30). The improvement has continued and the 2015 fiscal year ended with operating income of $43.6 million (2% operating and 7.3% operating EBITDA margins), well exceeding budgeted performance. The system's ability to receive substantial MSF funding is important to financial stability and, historically, the Commonwealth has been supportive, including annual appropriations for up to a maximum $240 million for MSF funding in the last three Commonwealth budgets, but receipt of the funds is typically delayed well past the relevant period. UMMHC relies on MSF, in part, to meet its obligations to the Medical School.
Adequate Liquidity: The system's liquidity remained stable even during years of poor operating performance. At fiscal year-end 2015 the system had $599.2 million of cash and unrestricted investments, equal to 105 days cash on hand (DCOH) and cash equal to 140% of debt. As of Nov. 30, 2015, UMMHC reported cash and unrestricted investments at $719.2 million, reflecting the receipt of retroactive 2014 MSF funding ($183 million). However, there still remains an amount due to the Medical School that is approximately $100 million higher than in a typical period. As of Nov. 30, 2015, UMMHC had received only $28 million of the expected MSF funding for 2015.
Moderate Leverage: The system is lightly leveraged, which helps mitigate the system's historically thin operating performance. Coverage of pro forma maximum annual debt service (MADS) of $39.1 million was a solid 4.1x in fiscal 2014 and 5x in fiscal 2015, consistent with Fitch's 'A' category median, and pro forma MADS represents a manageable 1.8% of 2015 revenues.
Capacity for Planned Future Issuance: The system's capital plans, which include an EPIC Electronic Health Record install, would add $175 million of new debt over the next two years, in addition to the $60.7 million in the 2016I series. While the system is expected to have operating profit compression over the next 24 months, Fitch believes that the planned investments are accretive over the longer term and, in Fitch's opinion, the additional debt can be absorbed at the 'A-' rating.
RATING SENSITIVITIES
Need to Maintain Improved Operations: UMass Memorial Health Care needs to continue to execute its long-term performance improvement plan, which includes investment in various joint ventures and expansion of ambulatory coverage, in order to help generate volumes and further solidify market share, leading to continued solid debt service coverage.
Exposure to Supplemental Funding Risk: UMass Memorial Health Care is vulnerable to risks related to the level and timeliness of the Commonwealth Medicaid Supplemental Funding. A significant change in the funding, not offset by corresponding increase in system productivity, resulting in erosion of liquidity or coverage, could lead to negative rating pressure.
System Overview
The UMMHC System was formed in 1998 as a result of the joining of the clinical component of the University of Massachusetts and Memorial Health Care, whose principal component is UMMC. UMMC's 779 acute care beds are located on three of its four campuses and operated under a single license in Worcester, in central Massachusetts. In addition to UMMC, the system includes three community hospitals: Health Alliance (122 beds) at two locations in Leominster and Fitchburg, Marlborough Hospital (79 beds) in Marlborough, and Clinton Hospital (41 beds) in Clinton. UMMC provides a full range of services, including high-end specialty services, is the designated Level I trauma center, and serves as the primary teaching facility for the Medical School. It is the largest component of the system, generating 67% of the system revenues in 2015.
The consolidated system had revenues of $2.12 billion in fiscal 2015 (year-end Sept. 30). The Parent - UMass Memorial Health Care, Inc., UMMC, UMass Health Ventures and Health Alliance Hospital, are the only members of the obligated group. The obligated group accounted for 83% of system total assets and 77% of the consolidated system revenues in fiscal 2015. Fitch bases its analysis on the consolidated UMass Health Memorial Health Care, Inc. and Affiliates.
Evidence of Sustained Operating Improvement
Following several years of declining operating results, the organization appointed Dr. Eric Dickson as President and CEO of the parent in spring 2013. His prior position was as President of the UMass Medical Group. Under his leadership the new management team formed a short-term financial recovery plan and began implementing a long-term strategic plan, which has had the effect of returning the organization to a stable operating platform. Following a large $66 million operating loss in fiscal 2013 (year-end Sept. 30), operating profitability returned in 2014 with operating income of $11.2 million, producing a $77 million turnaround which included significant expenses related to a reduction in labor force. The recovery continued into 2015, which ended with operating income of $43.6 million, and a 2% operating and 7.3% operating EBITDA margin. The system is budgeting to generate slimmer operating margins for the next couple of years partially due to the expenses related to the EPIC implementation. The budget for 2016 is for operating income of $14.5 million (0.6% operating margin) and projections call for improved but still lower operating margin of 1.2% by 2018.
The strategic initiatives included solidifying market presence by affiliating with several local hospitals to generate referrals, forming joint ventures for urgent and outpatient care to increase service area coverage, formulating a common vision with the Medical School and focusing investments on service lines with the highest potential growth. UMMHC is developing a collaborative relationship with certain key partners.
Supplemental Funding Exposure
Due to its high Medicaid load (24% of gross revenues) the organization is highly dependent on Commonwealth MSF, with MSF funding representing close to 10% of system revenues. The funding level has increased over the last 10 years and was approved up to a maximum of $240 million in each of the last three Commonwealth budgets (the actual funding was $210 million in 2014 and a similar level is expected for 2015). However, while much of the funding can be recorded as income in a typical year, the actual receipt of the funds is often delayed and may be reduced slightly going forward based on recent federal rulings which require the funding to be calculated based on actual Medicaid activity.
UMMHC relies on MSF funding in part to fund its obligations to the Medical School in support of medical education and for payment for clinical services. After offsetting these obligations to the Medical School, the remaining benefit to UMMHC is typically in the range of $50 million annually. UMass has included $188 million in its 2016 budget for MSF. While there is uncertainty regarding future funding levels, the strategic initiatives being implemented by UMMHC management are intended to offset potential reductions in funding with strengthened revenue generation.
Sufficient Debt Capacity
The system capital plan includes various projects at the two UMMC campuses in Worcester including reconfiguration and upgrading of facility components, as well as a $251 million investment in EPIC installment throughout the entire system. The capital plan funding consists of the $60.7 million in the series 2016I and the system is planning to issue an additional $175 million over 2017 and 2018.
The system had solid coverage of the pro forma MADS of 5x in fiscal 2015, and MADS at 1.8% of consolidated 2015 system revenues, is moderate and both metrics compare favorably to Fitch's 'A' category medians of 4.2x and 2.8%, respectively. Based on management's budget for fiscal 2016, the system would have 3.8x coverage of the pro forma series 2016I MADS. Fitch believes that the system has adequate debt capacity at the rating level even for the planned additional $175 million - the system would cover the higher 2017 pro forma $44.6 million MADS 4.4x based on 2015 EBITDA.
Post-2016I issuance, the system will have approximately $486 million of long-term indebtedness, which will be 85% fixed and 15% variable. The system does not have any swaps.
Disclosure
The issuer will file audited statements on behalf of the Obligated Group not later than 120 days following the end of each fiscal year and the quarterly statements will be filed not later than 60 days after each of the first three fiscal quarters and not later than 90 days after the end of the fourth fiscal quarter.
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