Fitch Affirms Einstein Healthcare Network, PA at 'BBB'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB' rating on the following bonds issued by the Montgomery County Industrial Development Authority on behalf of Einstein Healthcare Network, PA (EHN):
--$478.8 million health system revenue bonds, series 2015A.
The Rating Outlook is Stable.
The bonds are secured by a granted mortgage lien on and security interest in certain real property through separate open-ended mortgage and security agreements.
KEY RATING DRIVERS
MODEST FINANCIAL PERFORMANCE: While operating earnings are slightly improved over the past 18 months, profitability levels are soft partially as a result of a restrictive payor mix and the challenging operating environment in Philadelphia. After a negative 2% operating margin during fiscal 2014, EHN produced nearly break-even results in fiscal 2015 and a negative 1.1% operating margin through the first six months of fiscal 2016 (June 30 year-end).
MANAGEABLE DEBT BURDEN AND STRONG COVERAGE: The series 2015A bond refunding substantially reduced EHN's debt service costs and resulted in a lower debt burden and strong maximum annual debt service (MADS) coverage. Current MADS of $32.2 million is over $14 million lower than prior levels and represented a very manageable 2.9% of fiscal 2015 total revenues. As a result, MADS coverage was a healthy 4.0x in fiscal 2015. MADS coverage for the six month period ending Dec. 31, 2015 dropped to 2.7x due to lower operating earnings and reduced investment income.
CHALLENGING OPERATING ENVIRONMENT: EHN operates in the highly competitive southeastern Pennsylvania healthcare market, with its main acute care hospital located in the economically challenged north Philadelphia area. Additionally, EHN's payor mix is restrictive, with governmental payors accounting for a high 68.4% of net revenues during the first six months of fiscal 2016. However, Fitch notes EHN's positive volume trends, successful growth strategy and increasing market position, especially in the more demographically favorable Montgomery County area.
SOFT LIQUIDITY METRICS: At Dec. 31, 2015, EHN's nearly $325 million of unrestricted cash and investments amounted to 108 days operating expenses, 10.1x cushion ratio and 68% of debt. These metrics are down from 139 days operating expenses, 13.5x cushion ratio and 85.5% of debt at the end of fiscal 2013 as a result of heightened capital expenses, lower earnings trends and unrealized investment losses.
FINANCIAL STABILITY EXPECTED: Despite the challenging operating environment, Fitch expects Einstein Healthcare Network's profitability to remain at or around fiscal 2015 levels. Any earnings erosion that results in reduced MADS coverage or lower liquidity balances could result in negative rating pressure.
EHN operates Einstein Medical Center Philadelphia (EMCP), a 489-bed tertiary and quaternary teaching hospital in northern section of the city of Philadelphia; Einstein Medical Center Montgomery (EMCM), a 171-bed facility in East Norriton Township; Elkins Park Hospital, a 66-bed general hospital; and Moss Rehab, a nationally recognized inpatient rehabilitation hospital located in Elkins Park. EHN also operates several other ambulatory and specialized facilities located throughout its service area. Additionally, EHN includes a large medical education component with over 400 fellow and residents and 24 residency programs. On July 1, 2015, EHN sold the assets of Belmont Center for Comprehensive Treatment, a behavioral health provider. In fiscal 2015, EHN had total revenues of $1.1 billion and the obligated group represented 99.7% of network revenues and 92.8% of network assets.
EHN operates in the highly competitive southeastern Pennsylvania healthcare market, with its main acute care hospital located in the economically challenged north Philadelphia area. In 2013, EHN successfully opened its new 171-bed acute care hospital in the northwest section of its service area in Montgomery County, and produced an impressive reduction in outmigration of tertiary services over the past several years. EHN has also been very effective at expanding its ambulatory and primary care programs and facilities throughout its entire service area.
As a result of this growth strategy and strong physician relations, patient volumes, particularly at EMCM have been healthy. From fiscal 2012-2015, inpatient utilization (admissions plus observation stays) increased at a healthy compound annual growth rate of 2.6%. Over the same three year period, outpatient visits jumped at a 5.6% compound annual growth rate. These volume trends are notable given the greater Philadelphia area's inpatient hospital use rate reductions. This has led to a strengthened market position, with EMCP's inpatient market share in its primary service area growing slightly to 18% in fiscal 2015, from 17% in 2013. For EMCM, inpatient market share jumped to 24% in fiscal 2015 from 17% in the first year after opening.
Despite EHN's improving business position, the southeastern Pennsylvania healthcare market is highly competitive, experiencing consolidation activity, and dominated by few commercial health insurers. Influential competitors with relatively large market profiles include Main Line Health System, University of Pennsylvania Health System, and Temple University Health System. Additionally, Thomas Jefferson University Hospitals is growing rapidly given its consolidation with Abington Health, Aria Health and pending transaction with Cherry Hill, New Jersey based Kennedy Health System. Moreover, new entrants to the Philadelphia area, such as Community Health Systems, Prime Healthcare Foundation, and Prospect Medical Holdings create another dynamic in the environment.
The southeastern Pennsylvania health insurance market is dominated by Independence Blue Cross and Aetna health plans. This concentration limits EHN's pricing flexibility, especially in light of the competitive nature of the provider market. However, narrow network products have not been popular in the Philadelphia region and EHN is positioned well for a transition to more value-based contracts given its cost structure and quality indicators. Furthermore, EHN's partial ownership interest in a not-for-profit HMO, Health Partners of Philadelphia provides strategic and increasing financial benefits, especially in the Medicaid HMO market given the expansion of benefits under the program.
EHN's economically challenged service area surrounding the EMCP campus produces some operating challenges with the indigent population and high governmental payor exposure. Medicare (38.8%) and Medicaid (29.6%) represent a very high percentage of net revenues and supplemental funding (disproportionate share and upper payment limit) has been slowly declining over the last several years. However, Medicaid expansion has resulted in a 30% enrollment increase which has reduced bad debt and charity care costs and is providing a financial boost from EHN's joint venture HMO investment.
FINANCIAL PERFORMANCE AND POSITION
While operating earnings are slightly improved over the past 1.5 years, profitability levels are soft partially as a result of the restrictive payor mix, medical education costs, and volatile professional liability expenses. After a negative 2% operating margin during fiscal 2014, EHN produced nearly break-even results in fiscal 2015 and a negative 1.1% operating margin through the six months interim period of fiscal 2016. Operating EBITDA margins are also modest at 7.6% in fiscal 2015 and 6.5% for the first six months of fiscal 2016, but in line with Fitch's 'BBB' category median of 7.7%. Current year financial performance through six months is slightly ahead of the prior year period when EHN produced a negative 1.9% operating margin and 6.2% operating EBITDA margin.
Despite the increasing volumes, EHN has more effectively controlled staffing expenses by reducing full time equivalent (FTE) employees by about 400 positions over the past few years. As a result, FTEs per adjusted occupied bed fell to 5.37 at Dec. 31, 2015, from 5.73 at the end of fiscal 2014.
EHN's balance sheet is characterized by modest liquidity and moderately high leverage position. At Dec. 31, 2015, EHN's nearly $325 million of unrestricted cash and investments amounted to 108 days operating expenses, 10.1x cushion ratio and 68% of debt. These metrics do not compare well to Fitch's 'BBB' category medians of 161.5 days operating expenses, 11.1x cushion ratio or 89.5% of debt. EHN's net asset position is also negatively affected by an accrued pension deficit ($169.8 million as of June 30, 2015) and accrued professional liability claims that are in excess of internally designated reserves and available reinsurance recoveries ($84 million as of June 30, 2015). As a result, debt to capital is a high 61.7% at the end of fiscal 2015.