Allina Health System, MN

Transcription

1 CREDIT OPINION Allina Health System, MN Update - Moody's Affirms Allina Health System's (MN) Aa3; Outlook Stable Update Summary Rating Rationale Moody's Investors Service has affirmed the Aa3 ratings on Allina Health System's (Allina) approximately $837 million of outstanding revenue bonds. The outlook is stable. Contacts Eva Bogaty VP-Senior Analyst eva.bogaty@moodys.com Lisa Goldstein Associate Managing Director lisa.goldstein@moodys.com Brad Spielman VP-Sr Credit Officer brad.spielman@moodys.com The Aa3 rating reflects Allina's large size and scope of operations with favorable balance sheet metrics, good coverage of a low leverage and stable operating performance across the past five years. The rating also benefits from Allina's leading market position as the largest provider in the economically and demographically strong Twin Cities' service area. However, the Twin Cities market is highly competitive with other large tertiary systems and three large payors. A prolonged strike by the nursing union at Allina (settled in mid-october) also underscores the challenging operating environment. Management is proactively making strategic investments to position Allina for healthcare reform and population health management. Such investments, however, have lead to operating cash flow margins that are unfavorable to Aa3 medians and are expected to continue over the near term. Exhibit 1 Steady Revenue Growth Helps Allina Maintain Favorable Debt Coverage Source: Moody's Investors Service Credit Strengths Largest hospital system in the Twin Cities with growing operating revenue of $3.8 billion in FY 2015, and leading market share in its service area Manageable leverage given low debt burden with 223% cash to debt, 2.0 times debt-tocash flow and 23% debt to operating revenue in FY 2015, favorable to Aa3 medians

2 Strong fiscal management demonstrated history of expense containment, clearly articulated strategic initiatives and a focus on maintaining positive operating performance Economically vibrant service area with low unemployment and strong economic diversity in the Twin Cities Credit Challenges Pressure on inpatient revenue and continued strategic investments continue to drive lower operating cash flow margins relative to peers and medians Competitive Twin Cities Market with multiple nearby hospitals Growing benefit costs and pension liabilities add longer term pressure Recent strike cost over $100 million, resulting in decline in days cash on hand to an expected 190 days for FY 2016 from 204 days in FY 2015 Rating Outlook The stable outlook reflects expectations of stable operating cash flow providing strong MADS coverage and sufficient surplus to rebuild liquidity. Factors that Could Lead to an Upgrade Material and durable improvement in operating cash flow Material growth of cash and investments relative to debt and operations Factors that Could Lead to a Downgrade Deterioration of liquidity Decline in financial performance below current levels that represents a new, lower level of performance for the system going forward Decline in debt service coverage from financial weakening or material increase in debt This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. 2

3 Key Indicators Exhibit 2 Operating Revenue excludes rural floor settlements of approximately $39 million in FYs Investment returns normalized at 6% prior to 2015 and 5% in 2015 and beyond. Source: Moody's Investors Service Recent Developments On Thursday, October 13, Allina finalized negotiations with the Minnesota Nurses Association. Nurses returned to work on October 16, ending a work stoppage that began with a one-week strike in June and a six-week strike through mid October. As of September 30, 2016, the financial impact to Allina was $104 million in replacement nurses and associated costs. While the total impact is not yet finalized, management indicates that the expense will grow from the $104 million to reflect that the nurses did not return to work until October 16. Strike costs will be reported as an extraordinary, non-operating expenses. Allina used reserves and cash flow to pay these one-time expenses, and days cash on hand will decline to approximately 190 days for FY Overall, the new contract will provide the system approximately $10 million annually in healthcare benefit savings. Management reports that utilization remained generally strong throughout the strike, with some small impact to specific areas where procedures are difficult to schedule, such as labor and delivery. The new MNA contract expires at midnight on May 31, Detailed Rating Considerations Market Position: Leading Market Share in Very Competitive Twin Cities Headquartered in the Twin Cities, Allina Health System maintains a very strong market position in the demographically and economically vibrant greater Minneapolis/St. Paul service area. The Twin Cities Market is fairly consolidated and Allina is the largest system with management-reported 31% market share, with the next competitor almost 10 percentage points behind. The system has grown a geographically diverse integrated network beyond its comprehensive offerings in the metropolitan area. The network includes 13 hospitals (5 in the metro area), 86 clinics and ambulatory care centers, over 1,350 employed physicians and specialists, and 4,650 associated physicians, with clinical lines extending across central eastern Minnesota and into Wisconsin. Management has positioned Allina well for the evolving healthcare delivery and reimbursement environment, particularly for population health. Over the last several years, Allina has invested in information technology and data management systems to help lower the cost of care, and also to transition to outcomes based payment models. Allina will to continue to increase the amount of primary care physicians within its network to align itself better with its population health strategy. Operating Performance, Balance Sheet and Capital Plans: Strong Expense Management Yields Positive Operations and Consistent Cash Flow We expect Allina's careful fiscal management and data analysis, strong market position and geographic breadth to yield continued positive financial performance, with operating margins in the 3-4% range and operating cash flow margins in the 8-9% range. However, operating cash flow margins over the past five years (including expected FY 2016 results) are lower than the Aa3 median of 10.3% due to continued strategic investments. Performance through third quarter of FY 2016 is consistent with FY 2015 (excluding expenses associated with the strike). Management is budgeting a 3% operating margin in FY

4 Overall revenue growth will continue in the 4-5% range, primarily driven by outpatient volume. Inpatient admissions continue to decline in line with general trends for the Minneapolis area, and that trend will continue to suppress revenue growth. Allina continues to make significant investments in its primary care model redesign in preparation for a migration to more risk-based payment arrangements that reimburse for outcomes versus volumes. Outpatient revenues and volumes continue to grow, and Allina is well positioned to continue that trajectory with its wide network of services, and continuous expansion of clinics and physicians networks. Management is focused on rebuilding its balance sheet after the impact of the MNA nurses strike, and as such will reduce its capital spending budget to $175 million in FY 2017, down from previous years of $ million annually. This level of spending will be easily managed through cash flow. IT and strategic alignment spending will consume just under a third of the budget. Capital spending over the last five years has averaged a healthy 1.4 times. LIQUIDITY Growing liquidity through solid cash flow has been an important credit factor for Allina providing strong financial flexibility to balance weaker operating cash flow margins. We expect Allina to resume liquidity growth in FY 2017, after a projected dip to 190 days for FY 2016 due to expenses related with the MNA nurses strike. Cash-to-debt will remain strong relative to medians at about 219% as of September 30, 2016, compared to FY 2015 Aa3 medians of 201% Investments are very liquid with 88% of the total portfolio available in one month or less. The investment allocation of Allina Health's cash and investments includes 20% cash, 46% fixed income, 20% equities, and 12% in hedge funds, private equity and commodities. Debt Structure and Legal Covenants: Some Variable Rate Demand Debt; Strong Headroom on Covenants Allina's relatively modest debt load and low leverage are key credit strengths at the Aa3 rating. Debt to operating revenue of 22% is lower than Aa3 peers (median of 30%). Maximum annual debt service coverage of 5.6 times is strong, in part due to a low cost of borrowing and low leverage position, and allows the system sufficient cash flow to continue to invest in strategic initiatives and capital. DEBT STRUCTURE Allina's debt structure presents manageable rollover and counterparty risk with approximately 37% variable rate demand debt backed by three different letters of credit from Wells Fargo (Series 2007C and 2009C) and JP Morgan (Series 2009B) that expire in January Debt service is relatively stable between $50-60 million through 2034, with five larger serial payments in FYs The system has more than ample headroom on its covenants. The financial covenant under the Master Trust Indenture is a 1.1 times historical annual debt service coverage ratio requirement, with a consultant call upon any breach of the covenant. In addition, the covenants under the reimbursement agreements include a minimum days cash on hand of 55 days, and a debt to capital ratio of no more than 60%. Management reports that the extraordinary expenses associated with the strike will not be included in the covenant calculations. DEBT-RELATED DERIVATIVES Allina is party to five fixed payer swap arrangements with a $350 million of notional outstanding as of June 30, Counterparties for the swaps are Goldman Sachs, US Bank, Wells Fargo, and JP Morgan. As of September 30, 2016, Allina had a fair value liability of $116.5 million on its swap portfolio. Three of the swaps have collateral posting thresholds at this rating: Series 2007C with US Bank ($40 million threshold), Series 2009B&C, Wells Fargo ($20 million) and JP Morgan ($30 million). As of September 30, 2016, Allina had posted $18.2 million in swap collateral. PENSIONS AND OPEB Allina takes part in several multi-employer pension plans including the Twin City Hospital's Minnesota Nurses Association Pension Plan (MNA Plan) for its unionized nurses and at December 31, 2016 Allina's share of the unfunded obligation as $129.6 million. The new MNA contract did not change any pension benefits, only healthcare benefits. Employer contributions have been rising over the last several years, with $39 million expended in FY 2016, and $35 million in Allina Health terminated its defined benefit pension plan for non-union employees effective December 31,

5 Management and Governance: Good Fiscal Management; Strong Execution of Strategy Allina's senior management team consists of highly experienced individuals. The long-standing chief financial officer is retiring in December A new CFO was named earlier this year and has been working with the current CFO to effect a smooth transition. The new CFO worked at Allina several years ago. The 17 member Board of Allina Health consists of seasoned leaders in the community. Legal Security The bonds are secured by a security interest in Pledged Revenues of the Obligated Group Members which consists primarily of Allina Health's 12 wholly-owned hospitals, representing approximately 99% of net system revenues and over 96% of unrestricted net assets. Moody's analysis incorporates all health system entities. Use of Proceeds Not applicable. Obligor Profile Allina Health System, doing business as Allina Health, is a Minnesota nonprofit corporation which, together with its subsidiaries, delivers health care services to patients in Minnesota and western Wisconsin. Allina Health owns and operates twelve hospitals and jointly owns and operates one other hospital. These include urban tertiary care, suburban community and rural hospitals. As of September 30, 2016, Allina Health hospitals had licensed bed capacity of 2,451 acute care beds, 1,716 of which were staffed for inpatient services. Methodology The principal methodology used in this rating was Not-For-Profit Healthcare Rating Methodology published in November Please see the Rating Methodologies page on for a copy of this methodology. 5

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7 Contacts 7 CLIENT SERVICES Eva Bogaty VP-Senior Analyst eva.bogaty@moodys.com Lisa Goldstein Associate Managing Director lisa.goldstein@moodys.com Brad Spielman VP-Sr Credit Officer brad.spielman@moodys.com Americas Asia Pacific Japan EMEA