Henry Mayo Newhall Memorial Hospital, California; Hospital

Transcription

1 Henry Mayo Newhall Memorial Hospital, California; Hospital Primary Credit Analyst: Kenneth T Gacka, San Francisco (1) ; kenneth.gacka@standardandpoors.com Secondary Contact: Karl Propst, Dallas (1) ; karl.propst@standardandpoors.com Table Of Contents Rationale Outlook Enterprise Profile Financial Profile Related Criteria And Research JANUARY 7,

2 Henry Mayo Newhall Memorial Hospital, California; Hospital Credit Profile Henry Mayo Newhall Mem Hosp Hospital Revenue Bonds ser 2014 due 10/01/2043 Long Term Rating BBB-/Stable Rating Assigned Rationale Standard & Poor's Ratings Services assigned its 'BBB-' rating to the California Statewide Communities Development Authority's $70.0 million series 2014 revenue bonds issued on behalf of Henry Mayo Newhall Memorial Hospital (Henry Mayo). The outlook is stable. The rating assignment reflects our view of Henry Mayo's strong cash flow and its good overall enterprise profile highlighted by a healthy market share and a solid payor mix. Based on the hospital's position in the market and recent service line enhancements, we anticipate that Henry Mayo will at least maintain or perhaps increase its market share. The business position combined with management's demonstrated focus on expense management will likely position Henry Mayo to continue to generate strong cash flow in the two-year outlook period, despite mounting sectorwide challenges associated with health care reform. In our opinion, continued cash flow strength will be an important credit factor because of the hospital's pro forma debt burden, which we consider high. In addition, while we consider Henry Mayo's balance sheet appropriate for the 'BBB-' rating, key metrics are lower than rating medians and the organization has plans for a sizable facilities plan including a new patient tower in Consequently, we believe continued growth in financial metrics will be imperative during the next few years as the organization prepares for a period of heightened capital spending. More specifically, the rating and outlook reflect our view of Henry Mayo's: Very strong cash flow for the rating in the past two audited fiscal years driving healthy pro forma maximum annual debt service (MADS) coverage equal to 3.4x and 2.5x in fiscal years 2013 and 2012, respectively; Good operating margins with no reliance on programs such as California's provider fee program -- because of the hospital's low Medi-Cal exposure, it breaks even on the provider fee program; Good business position, with a 41% market share in its primary service area (PSA); and Increased liquidity in recent years, including fiscal 2013's 104 days' cash on hand, which is sufficient, but lower than rating medians. Credit risks that partially temper the preceding strengths include our opinion of: Henry Mayo's high pro forma debt load, resulting in elevated pro forma leverage of 59.6% and limited pro forma unrestricted reserves to debt equal to 38%; The organization's master facility plan, which currently calls for $140 million of capital spending, including a new tower project, which is expected to commence in 2016; The pro forma debt profile, which includes roughly 53% contingent liability debt ($89.6 million), which exceeds total JANUARY 7,

3 unrestricted reserves; and Henry Mayo's high pro forma debt burden equal to 5.3% of fiscal 2013's revenues. On a pro forma basis, Henry Mayo has $168.6 million of long-term debt, including the series 2014 bonds ($70 million), three series of fixed-rate bonds (series 2013A for $25 million, series 2013B for $35 million, and series 2013C for $29.6 million) directly placed with three separate institutions in December 2013, and capital leases. Prior to the issuance of the 2013 direct placement bonds and the proposed series 2014 bonds, all of Henry Mayo's revenue bonds (approximately $110 million) were insured through California's Health Facilities Construction Loan Insurance Program (Cal-Mortgage). Henry Mayo used the proceeds from the 2013 financing to current refund all of the series 2001A and a portion of the series 2007A Cal-Mortgage insured bonds. Proceeds from the series 2014 bonds will be used to refund the remaining series 2007A and 2007B Cal-Mortgage insured bonds. Collectively, the 2013 and 2014 financings provide roughly $46 million of new money, which Henry Mayo will use for several capital projects. The pro forma debt portfolio consists of 53% contingent liability debt, which includes the $89.6 million of direct placement debt. Standard & Poor's has reviewed the terms of the direct placements. Certain terms of the governing documents, if violated, could constitute a default. If an event of default were to occur and continue, the holder of the direct placement bonds could accelerate payment and declare all principal and accrued interest immediately due. This does present risk in the event of a potential liquidity event, and we think this is amplified by the fact that Henry Mayo's unrestricted reserves are less than its contingent liability debt. However, the direct placements have lengthy terms each with different holders. Also, the principal of the 2013A and 2013B bonds are scheduled to be fully paid over the term of the commitments leaving only a portion of the 2013C bonds ($21.6 million) scheduled to be left outstanding at the close of the direct placement terms, so renewal risk is lessened. The terms of the direct placements range from 11 to 15 years and the financial covenants are the same as those of the series 2014 bonds including financial covenants of 60 days' cash on hand, 70% debt to capitalization and 1.25x MADS coverage. The series 2014 bonds and the series 2013 direct placement bonds (not rated) are secured pursuant to the terms of a new master trust indenture (MTI) that was established in December The new MTI is initially subordinate to the Cal-Mortgage financing documents; however, at closing when the remaining Cal-Mortgage bonds are retired, the new MTI's position on the gross revenue pledge and the deed of trust become senior. The 2014 bonds and the three series of direct placement bonds will be on parity and become the only bonds issued under the MTI. Henry Mayo is the only member of the obligated group. The 'BBB-' rating is based on our view of Henry Mayo's group credit profile and the obligated group's "core" status. Accordingly, the series 2014 bonds are rated at the same level as the group credit profile. Management anticipates that the 2014 bonds will carry bond insurance from Assured Guaranty. Henry Mayo is a 238-bed acute care hospital that provides a broad range of services and is located in the community of Valencia in the City of Santa Clarita, about 35 miles northwest of Los Angeles. Outlook The stable outlook reflects our anticipation that Henry Mayo is positioned to continue to generate strong cash flow despite industry challenges because of its good market position, healthy payor mix, and management's attention to enhancing service lines and controlling costs. The outlook also reflects our expectation that leadership will manage JANUARY 7,

4 future capital spending associated with the master facility plan in line with available resources to ensure that the financial profile remains consistent with management's projections. Because Henry Mayo has a high pro forma debt load and also has a large capital project ($140 million) beyond the outlook period that will likely involve additional debt, we think that it is important that cash flow remains strong and in line with recent history, resulting in strengthened balance sheet metrics as projected by management to absorb this debt issuance and the potential financing in the future. Given the currently high pro forma debt load and the project on the horizon, a higher rating is extremely unlikely within the two-year outlook period. However, a negative outlook or a lower rating would be considered if operations falter for any reason, resulting in MADS coverage below 2.2x. Similarly, if the balance sheet erodes such that unrestricted reserves decline to less than 80 days' cash or 30% of long-term debt, we would consider a negative rating or outlook action. Enterprise Profile Market position Henry Mayo, located in the community of Valencia, is the only hospital located in the Santa Clarita Valley. The 238-bed acute care hospital defines its PSA as the Santa Clarita Valley, which has a population of approximately 277,000 and accounts for roughly 80% of Henry Mayo's admissions. Santa Clarita is located 35 miles northwest of Los Angeles in an area that has experienced population growth during the past several years. Projections provided by management show continued growth in the PSA population. Generally speaking, population growth is viewed favorably from a market position standpoint, as it offers the hospital a broader pool of potential patients. Henry Mayo's payor mix consists of 62% commercial payors and only 4% Medi-Cal (based on net revenues). We consider the hospital's payor mix to be a strength currently. With the roll-out of health care reform, it is uncertain how the mix will evolve over time, though we don't anticipate a material impact in the near term. Because the hospital's exposure to Med-Cal is low, its contributions and receipts from the California provider fee program have netted to zero since the advent of the program in April This is anticipated to continue to be the case through the program's planned extension through Although this program has certainly had a favorable impact on other providers in the state that are net beneficiaries of the program, we view Henry Mayo's lack of reliance on such a program and profitable operations favorably -- though the program has developed a track record of being renewed, we still consider there to be some longer-term uncertainty with such programs. Henry Mayo's market position in its PSA is good, but not dominant, in our opinion. It has a 41% market share (based on the latest available information from the state, dated 2011), indicating that there is a fair amount of outmigration to other providers in the service area, but this is not inconsistent with the dynamics of the broadly fragmented market in Southern California. The balance of the rest of the share of the PSA is split across several hospitals that are members of larger systems, including Kaiser Permanente's facility in Panorama City, which has an 11% share, and Providence Health & Services' facility in Mission Hills, which has a 10% share. Management has strategies to bolster its share in the market, including targeted growth in its cardiovascular service line. In June 2012, Henry Mayo expanded its cardiac service line from solely performing diagnostic cases to also doing interventional cases and open-heart surgeries. Henry Mayo also became a STEMI (ST-Elevation Myocardial Infarction) designated center effective JANUARY 7,

5 December These strategies surrounding this nascent service line provide growth potential for Henry Mayo during the coming years, in our opinion. Utilization Henry Mayo's utilization was generally good in fiscal 2013, which contributed to strong operating performance. Inpatient admissions (excluding newborns, psych, and rehab) rose by 7.2% to 11,073 from 10,329 between fiscal year 2013 and fiscal year We consider this increase solid, particularly at a time when inpatient volumes are fairly soft in many markets nationally. The hospital has experienced an increase in observation visits, consistent with national trends, with a steady increase in observation cases, including 12% growth in fiscal 2013 to 2,407 from 2,140 in the prior year. This followed observation cases of 1,415 and 425 in fiscal year 2011 and fiscal year 2010, respectively. Henry Mayo's total surgeries were flat in fiscal 2013 with 5,157 cases in fiscal 2013 compared with 5,130 in the prior year. Management Henry Mayo's CEO (Roger Seaver) and CFO (C.R. Hudson) have been with the hospital since The CEO was brought in to turn the organization around when the hospital filed for bankruptcy in September We understand that the bankruptcy occurred because of mismanaged capitation contracts under prior management and strain from short-term financing incurred to pay for facility repairs needed due to earthquake damage. Mr. Seaver hired Mr. Hudson as CFO in 2001 to join the executive team that ultimately led Henry Mayo out of bankruptcy in 2003 (18 months from filing). After emerging from bankruptcy, the management team steadily improved Henry Mayo's financial strength, demonstrated by a stronger balance sheet and solid operations. Recent areas of management's strategic focus include the 2013 and 2014 financings in addition to efforts designed to continue to enhance operations and prepare the organization for reform. Over the years, management has focused on productivity, service line profitability, and physician performance, and it continues to do so in order to strengthen the bottom line. Also during the past two to three years, management has focused on reducing its Medicare losses and set a goal of a 50% reduction in Medicare losses this year, and management feels it is on track for success in this initiative. Other areas of focus include service line expansion, including the previously mentioned expansion of Henry Mayo's cardiac service line, as well as the addition of a neonatal intensive care unit. Management expects that these new service lines, particularly cardiovascular, will provide opportunities for revenue and market share growth. In our opinion, management's past efforts have driven a notable improvement in the financial profile. Also, despite industrywide hurdles anticipated in the coming years, we anticipate that management's strategic initiatives paired with Henry Mayo's recent performance will position the hospital to continue to generate good cash flow. Financial Profile Change in accounting for bad debt In accordance with the publication of our article, "New Bad Debt Accounting Rules Will Alter Some U.S. Not-for-Profit Health Care Ratios But Won't Affect Ratings," published Jan. 19, 2012, on RatingsDirect, we recorded Henry Mayo's JANUARY 7,

6 fiscal 2012 audit and all subsequent financial statements incorporating the adoption of Financial Accounting Standards Board , but not in prior periods. The new accounting treatment means that Henry Mayo's fiscal 2012 and subsequent financial statistics are not directly comparable to the results for fiscal 2011 and prior years. For an explanation of how each financial measure is affected by the change in accounting for bad debt, including the direction and size of the change, please see the above article. Income statement Henry Mayo's operating income surged in fiscal year 2013 due to healthy revenue growth due in part to the increase in admissions during the fiscal year. During this time, expenses were managed well and the organization posted a 9.0% operating margin (8.5% under old bad-debt accounting rules), which we consider very strong compared with comparably rated hospitals. These results include zero net impact from the provider fee program and a modest $370,000 of revenues related to meaningful use, so the results are driven by core operations. In the previous four fiscal years, operations were not as strong as fiscal 2013, but in three of the four years were very good, in our opinion, with margins ranging from 3.7% to 4.1% (under old bad-debt accounting). Fiscal 2011's operating results were much weaker, in our opinion, at under 1.0%, which management attributed to the spike in observation cases in that year. Henry Mayo's investment portfolio is very conservative, with 100% invested in cash and cash equivalents. As a result, it has consistently returned realized investment income, and though income has been fairly minimal in some years, it has added to bottom-line profitability. The organization's cash flow has been very strong for the rating, most recently with 18.0% and 14.6% EBIDA margins (17.0% and 13.7% under old bad-debt accounting) in fiscal year 2013 and fiscal year 2012, respectively. The strong cash flow drives good pro forma MADS coverage of 3.4x and 2.5x based on these respective cash flows. This comes despite a debt burden greater than 5%, which we consider high. Management's projections call for continued cash flow strength including EBIDA margins of at least 18% moving forward. In our opinion, continued cash flow in line with recent history will be important so that Henry Mayo continues to generate MADS coverage appropriate for the 'BBB-' rating and to add to balance sheet indicators. Balance sheet and capital plan Overall, we consider Henry Mayo's balance sheet indicators adequate for the rating, though key metrics are weaker than rating medians. The organization's strong cash flow has contributed to good improvement in metrics during the past few years, though. Specifically, days' cash on hand improved to 104 days (97 days under old bad-debt accounting) at the close of fiscal 2013 from 59 days in fiscal 2011 (according to prior bad-debt treatment). Similarly, during the same three-year period, unrestricted reserves to debt doubled to 53% from 26% and leverage declined to 51% from 63%, indicating Henry Mayo's ability to make material improvements to the balance sheet in a relatively short period of time. With the additional debt since December 2013, pro forma leverage and unrestricted reserves to debt weakened to nearly 60% leverage and 38% unrestricted reserves to debt. While these metrics are somewhat weak, in our opinion, Henry Mayo's recent cash flows and management's projections of continued cash flow strength should position the organization well to absorb the debt and strengthen these metrics in the coming years. Continued strength in cash flow and increases in key balance sheet metrics as projected by management will be important factors in maintaining the rating, in our view, particularly as Henry Mayo prepares for a major capital JANUARY 7,

7 project at the end of fiscal 2015, which is expected to require additional debt. Henry Mayo's master facility plan includes the construction of a new five-story tower to be built on the campus that will add 120 beds. Management anticipates the $142 million project will begin in late fiscal 2015 or early 2016 and will be completed in fiscal Management expects to finance between $110 million and $120 million of the project and fund the rest through cash flow and philanthropy. In our opinion, the project places some medium-term risk to the balance sheet. Project details and timing are preliminary and are subject to change, so we will continue to evaluate the details as they are finalized and will determine the rating impact, if any. Management views the project as strategically important to address the needs of its growing service area, allow for volume growth as it pursues market share, and allow for a move to private rooms. All of Henry Mayo's required seismic related spending is complete through 2030, according to management. Larger projects that are expected to be funded with the proceeds of the 2013 and 2014 financings include pre-development costs associated with the new tower ($12.5 million), a parking expansion ($9.4 million), and tenant improvements in a new medical office building in which Henry Mayo is leasing space ($9.7 million). Henry Mayo does not have a defined benefit pension plan, which is a conservative aspect of its balance sheet, in our opinion. Henry Mayo Newhall Memorial Hospital Fiscal Year Ended Sept. 30, Selected Medians 2013* 2012* 2011 Stand-alone hospital BBB Stand-alone hospital Speculative Grade 2012 Financial performance Net patient revenue ($000s) 251, , , , ,459 Total operating revenue ($000s) 262, , ,778 MNR MNR Total operating expenses ($000s) 238, , ,677 MNR MNR Operating income ($000s) 23,691 10,329 2,101 MNR MNR Operating margin (%) Net nonoperating income ($000s) 1,222 1, MNR MNR Excess income ($000s) 24,913 11,407 2,920 MNR MNR Excess margin (%) Operating EBIDA margin (%) EBIDA margin (%) Net available for debt service ($000s) 47,494 34,462 24,322 17,688 7,916 Pro forma maximum annual debt service ($000s) Pro forma maximum annual debt service coverage (x) Pro forma operating lease-adjusted coverage (x) Liquidity and financial flexibility 14,029 14,029 14,029 MNR MNR Unrestricted reserves ($000s) 63,770 40,833 33,024 50,341 22,198 Unrestricted days' cash on hand Unrestricted reserves/total long-term debt (%) JANUARY 7,

8 Average age of plant (years) Capital expenditures/depreciation and amortization (%) Debt and liabilities Total long-term debt ($000s) 119, , ,647 MNR MNR Long-term debt/capitalization (%) Contingent liabilities ($000s) MNR MNR Contingent liabilities/total long-term debt (%) MNR MNR Pro forma debt burden (%) Defined benefit plan funded status (%) N/A N/A N/A Pro forma balance sheet ratios Unrestricted days' cash on hand Unrestricted reserves/total long-term debt (%) Long-term debt/capitalization (%) N/A: Not applicable. MNR: Median not reported. *Fiscal 2012 and 2013 results stated by Standard & Poor's incorporating FASB ASU related to bad debt medians reflect FASB accounting for bad debt. Assumes $168.6 million of long-term debt including the 2014 and 2013 financings. Related Criteria And Research Related Criteria USPF Criteria: Not-For-Profit Health Care, June 14, 2007 USPF Criteria: Contingent Liquidity Risks, March 5, 2012 General Criteria: Group Rating Methodology, Nov. 19, 2013 Related Research Glossary: Not-For-Profit Health Care Ratios, Oct. 26, 2011 The Outlook For U.S. Not-For-Profit Health Care Providers Is Negative From Increasing Pressures, Dec. 10, 2013 U.S. Not-For-Profit Health Care Stand-Alone Ratios: Operating Pressures Led To Mixed Results In 2012, Aug. 8, 2013 Health Care Providers And Insurers Pursue Value Initiatives Despite Reform Uncertainties, May 9, 2013 U.S. Not-For-Profit Health Care Providers Hone Their Strategies To Manage Transition Risk, May 16, 2012 U.S. Not-For-Profit Health Care Providers Hone Their Strategies For Reform, May 16, JANUARY 7,

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