Fitch Ratings has affirmed the 'BBB+' rating on the $208.2 million Health, Educational and Housing Facility Board of the County of Knox (TN) (University Health System, Inc.) series 2007 revenue bonds.
The Rating Outlook is Stable.
SECURITY
Debt payments are secured by a pledge of the gross revenues of the obligated group.
KEY RATING DRIVERS
STRONG MARKET PRESENCE: University Health System (UHS) is the area's only academic medical center with a regional draw providing tertiary and quaternary services, some of which are unique to UHS. UHS's market share has increased every year in the last five years, and the utilization trend has been strong, to a large degree owing to its significant clinical integration with its large medical staff.
HISTORICALLY WEAK OPERATING PERFORMANCE: UHS exceeded its break-even operating budget in fiscal 2013 (year end Dec. 31) with operating margin of 0.8%, but operating results historically fall below Fitch's 'BBB' rating median. Based on the third quarter ended Sept. 30, 2014 (the interim period), management projects to end fiscal 2014 with a slightly higher operating margin of 1.4%.
ADEQUATE COVERAGE AND MODERATE CAPITAL NEEDS: Coverage of maximum annual debt service (MADS) by EBITDA was 2.3x through the third quarter interim period, consistent with the category median. UHS's balance sheet metrics are weaker than Fitch's 'BBB' medians, but UHS completed a major facility update and has no plans for debt issuance in the next three years, which should enable the organization to improve its balance sheet.
RATING SENSITIVITIES
NEED TO MAINTAIN OPERATING PERFORMANCE: Moderate capital spending going forward should enable the organization to produce a stronger level of operating performance, which should ultimately lead to a stronger balance sheet, more consistent with the rating category. Deterioration in operating performance resulting in lower coverage could lead to downward rating pressure.
CREDIT PROFILE
UHS is a 581-staffed-bed academic teaching facility affiliated with, but separate from, the University of Tennessee, which provides a diverse array of clinical services to 21 counties in eastern Tennessee. UHS had revenues of $631.4 million in fiscal 2013, an increase of 9.9% over the prior year.
Market Dynamics
UHS operates in a competitive market. - Its major competitors are the multi-facility systems Covenant Health (rated 'A' by Fitch) and Tennova, which was recently acquired by Community Health System (CHS). UHS was able to increase its market share in each of the last five years and its 15.2% market share (2013 data) was the highest of any individual hospital in the Knoxville market. The entry of CHS has not had a negative impact on UHS volumes. UHS provides a broad array of services, some of which are unique in the market, and has a closely aligned medical staff of approximately 600 physicians located on the UHS campus.
Inpatient admissions increased by 4.4% in fiscal 2013 and a further 0.9% increase was registered through the third quarter of fiscal 2014, despite a sharp increase in observation cases during the interim period. Outpatient volumes also grew year over year in 2013 and through the nine-month interim period. In preparation for managing population health, the organization has put major focus on quality, efficiency and standardization of processes, with approximately 70% of all care processes now under standardized pathways. UHS has opened its first diagnostic outpatient center outside its campus near one of Covenant's hospitals. UHS is planning to add two additional sites as a way to grow market share without increasing its inpatient footprint.
Historically Thin Operating Performance
UHS's operating performance has historically been weaker than the category median, as management invested in programs, clinical integration and facility expansion. For fiscal 2013, UHS recorded operating margin of 0.8% ($5 million operating income) and operating EBITDA margin of 6.8%, ahead of budgeted breakeven performance, but slightly below Fitch's respective 'BBB' medians of 1.1% and 7.9%. Driven by solid volumes and higher Medicare case mix index of 1.99, operating gain through the third quarter of 2014 was $5.2 million, more than double the prior year period. Management projects to end fiscal 2014 with operating income of at least $9.9 million (1.4% operating margin) based on management's estimates of a strong fourth quarter. Budgets have historically been conservative and management has budgeted operating income of $3.5 million for 2015.
Manageable Debt Load
UHS's MADS coverage by EBITDA and operating EBITDA of 2.3x and 2.1x, respectively, through the nine-month interim period are adequate, and only slightly below the respective category medians of 2.6x and 2.3x. MADS as a percentage of revenues, which has been elevated, has been moderating and, at 3.2%, is now lower than the 'BBB' median (3.6%). The $217.5 million of unrestricted cash and investments at Sept. 30, 2014 translates to 120 days cash on hand (DCOH), 9.7x cushion ratio and 77.3% cash-to-debt. While holdings are slightly below the 2013 fiscal year end of $235.9 million, management expects to end 2014 with an additional $15 million-$20 million of cash reserves, which would make liquidity metrics consistent with the 'BBB' category medians. Fitch notes UHS's conservative asset allocation, with approximately 70% of investments in fixed income.
UHS has completed a major update of its facility and faces no significant capital needs over the near term. A CON was filed to add an additional 44 beds, which would increase licensed bed complement to 625. Capital expenditures are projected to range between $30 million-$33 million over the next three years, slightly above depreciation expense, and will not require debt issuance over the near term. The capital budget does not include the investment for the outpatient facilities, which are expected to be self-supporting assuming the inclusion of the capital expenditures.
Debt Profile
UHS has a relatively conservative debt structure with 80% fixed-rate debt. The organization has two bank qualified (SunTrust) bond issues with an interest rate at one-month LIBOR plus 80 basis points which require UHS to have MADS coverage of 1.2x, DCOH of 60 days minimum and a rating of 'BBB-'. UHS has one fixed-to-variable-rate swap ($176 million notional par) with a positive mark-to-market of $0.9 million as of the end of December 2014 and no required collateral posting ($10 million threshold).
Disclosure
UHS covenants to provide bondholders with annual and quarterly financial disclosure through the Municipal Securities Rulemaking Board EMMA system. UHS also provides management discussion and analysis and utilization statistics with their quarterly financials.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria' (May 30, 2014)
--'Revenue-Supported Rating Criteria' (June 16, 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Nonprofit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=977875
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