Fitch Affirms Nanticoke Health Services, DE at 'BBB-'; Outlook Revised to Stable
OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB-' rating on the following bonds issued by the Delaware Health Facilities Authority on behalf of Nanticoke Health Services (Nanticoke):
--$44.125 million revenue bonds, series 2013.
The Rating Outlook is revised to Stable from Positive.
The bonds are secured by the obligated group's gross revenues, a mortgage on Nanticoke's main hospital facility and a debt service reserve fund.
KEY RATING DRIVERS
WEAKENED FINANCIAL PERFORMANCE: The revision of the Rating Outlook to Stable from Positive is primarily based on weakened financial performance. After posting very good operating margins of 8.1% and 7.3%, respectively, in fiscal 2014 and 2015 (June 30 year-end), performance suffered through the first eight months of fiscal 2016. Primarily due to heightened employee benefit costs and increased staffing levels to prepare for population health initiatives, the operating margin decreased to a negative 1.7% for the eight-month period ending Feb. 29, 2016.
HEIGHTENED CAPITAL SPENDING: The Outlook revision to Stable from Positive also reflects increased capital spending that has reduced liquidity levels. Nanticoke spent a significant $22.8 million on capital projects during fiscal 2015 and the first eight months of fiscal 2016. Projects include a new medical office building, substantial renovations to patient rooms, new medical equipment and urgent care clinic investments. Unrestricted cash and investments declined to $49.2 million or 128.1 days cash on hand as of Feb. 29, 2016, from $61.4 million or 185.6 days cash on hand at the end of fiscal 2014. Regardless, liquidity metrics remain adequate for the rating category and Nanticoke plans to reimburse themselves from proceeds of a $7.5 million loan.
SOLID VOLUME TRENDS: As a result of physician practice investments and expansion of ambulatory care programs, outpatient volumes over the last several years have increased. However, while inpatient admissions have been relatively stable, total hospital stays (admissions plus observation cases plus) dropped over the past few years.
MODEST OPERATING PROFILE: Nanticoke's relatively small operating profile with $146 million of revenue leaves it susceptible to reimbursement modifications and changes in the delivery of healthcare. Additionally, Nanticoke's high exposure to governmental payors (71% of gross revenue from Medicare and Medicaid) limits operational and financial flexibility.
FINANCIAL IMPROVEMENT EXPECTED: Fitch expects Nanticoke Health System's financial performance to rebound with the return of its supplemental Medicare funding and benefits from physician clinic and programmatic investments. If the system's earnings and debt service coverage do not improve if there are further liquidity reductions, negative rating pressure could result.
Located in Seaford, Delaware, Nanticoke operates 99 acute care beds at its main affiliate, Nanticoke Memorial Hospital. The system also owns and operates a network of employed physicians that are located in multiple sites throughout the service area. The system generated $146.3 million of total operating revenue during fiscal 2015. Nanticoke Memorial Hospital is the only obligated group member and represents about 90.3% of system revenues and 93% of system assets. Fitch's analysis is based on the results of the consolidated system and those figures are sighted in this press release.
Nanticoke is the only hospital in the primary service area and reported an increase in inpatient market share to 54.3% in 2014 from 47.2% in 2012. Its nearest competitor is a tertiary care provider located about 23 miles south in Salisbury, Maryland. However, additional competition is derived from Delaware health systems located 25 miles north in Milford and 35 miles east in Lewes.
Nanticoke has made substantial investments in its physician network and ambulatory care strategy, which now includes 37 employed doctors, six primary care clinics and three urgent care sites. The subsidy to the physician network ($4.3 million in fiscal 2015 and $3.2 million through the first eight months of fiscal 2016) continues to be large, but the benefit of the strategy is reflected in growing outpatient volumes and relatively stable admissions. Business has also been supported by several affiliations, such as a joint cancer program with Beebe Medical Center based in Lewes, Delaware and a pediatric partnership with Nemours Alfred I. DuPont Hospital for Children based in Wilmington, Delaware. Furthermore, Nanticoke participates in an accountable care organization (ACO) with Dover-based Bayhealth Medical Center ('AA-'/Outlook Stable) and Wilmington-based Christiana Care Health System and recently joined Ebright Health Alliance with the same two organizations as well as Beebe Medical Center. Ebright Health Alliance is a limited liability company with the goal of developing shared services such as group purchasing, human resources programs and managed care risk contracts.
After posting strong operating profitability during fiscal 2014 and 2015, performance suffered through the first eight months of fiscal 2016. While management's fiscal 2016 budget anticipated reduced operating earnings, interim results are about $2.3 million below plan. As a result of increased employee benefit costs and additional staffing levels to prepare for population health initiatives, the operating margin decreased to a negative 1.7% for the eight-month period ending Feb. 29, 2016.
Additionally, effective Dec. 31, 2014, Nanticoke lost its Medicare Dependent Hospital (MDH) reimbursement status due to the Center for Medicare and Medicaid Services (CMS) geographic reclassification of Sussex County to urban from rural. The MDH designation brought an additional $4.5 million of revenue in fiscal 2014 and $1.9 million of monies in fiscal 2015. Nanticoke received a temporary two-year administrative reinstatement of its MDH funding status beginning Jan. 1, 2016, and is expecting about $2-3 million of revenue for the remainder of fiscal 2016. For January and February of 2016, Nanticoke received about $465,000 of MDH funding. Management is working with consultants and advisors on a permanent resolution through the federal legislative process, and a permanent reinstatement of its MDH status could result in $7 million of annual supplemental payments.
Nanticoke increased capital spending over the past few years which has resulted in reduced liquidity levels. Nanticoke spent a significant $22.8 million on capital projects during fiscal 2015 and the first eight months of fiscal 2016. Projects include a new medical office building, substantial renovations to patient rooms, new medical equipment and urgent care clinic investments. As a result, unrestricted cash and investments declined to $49.2 million or 128.1 days cash on hand as of Feb. 29, 2016, from $61.4 million or 185.6 days cash on hand at the end of fiscal 2014. Capital spending plans are expected to moderate for the remainder of fiscal 2016 and fiscal 2017. In addition, Nanticoke plans to reimburse themselves for the medical office building project with proceeds of a $7.5 million loan. This increases pro forma cash levels to nearly $57 million or 147.6 days cash on hand and 96% of pro forma debt. These liquidity ratios compare adequately to Fitch's 'BBB' category median of 161.5 days cash on hand and 89.5% cash to debt.
The system's debt position is manageable with pro forma MADS ($5.75 million) at 3.9% of fiscal 2015 revenues. Fitch notes that debt service is front-loaded with MADS declining to about $4 million after fiscal 2020. Coverage of MADS by EBITDA was strong at 3.8x in fiscal 2015 but dropped to a weak 1.4x during the eight-month interim period of fiscal 2016 due to the operating losses. The system's long-term debt is all fixed rate, and there are no swaps.