Rating Update: Moody's revises CareAlliance Health Services, SC (d/b/a Roper St. Francis Healthcare) outlook to stable; A3 affirmed

Transcription

1 Rating Update: Moody's revises CareAlliance Health Services, SC (d/b/a Roper St. Francis Healthcare) outlook to stable; A3 affirmed Global Credit Research - 21 Mar 2014 $183M debt affected SOUTH CAROLINA JOBS-ECONOMIC DEVELOPMENT AUTHORITY Hospitals & Health Service Providers SC Opinion NEW YORK, March 21, Moody's Investors Service has affirmed the A3 rating assigned to CareAlliance Health Services "CareAlliance" (d/b/a Roper St. Francis Healthcare (RSFH)) outstanding bonds (see RATED DEBT section at the end of this report) issued through South Carolina Jobs-Economic Development Authority and Charleston County. The rating outlook is revised to stable from negative. SUMMARY RATING RATIONALE The affirmation of the A3 rating reflect RSFH's good credit fundamentals with leading market position in a demographically favorable and growing Charleston market, good operating cash flow margins and an improving unrestricted liquidity position. In addition, the rating is supported by RSFH's unique ownership and management structure with three large Founding Members that have historically provided capital support, operating and management oversight to RSFH. The rating is constrained by a higher than average Medicare payer mix, a competitive marketplace for healthcare services and liquidity measures that are adequate but remain well below the A3 medians. Historically, the buildup of unrestricted liquidity has been limited in part due to large annual cash distributions to the Founding Members under the ownership structure. Earlier this year, the Founding Members entered into two new agreements including a Liquidity Replenishment Agreement that will require the Founding Members to contribute cash to RSFH in order to maintain a floor of unrestricted liquidity. In addition, an agreement was reached to amend the annual cash distributions formula, which will reduce and cap the annual distributions. Under these new agreements, RSFH will have more financial flexibility and a cash cushion to support operations, enhance its legal debt security and retain more liquidity to fund capital spending. We view this additional support by the Founding Members as a credit positive, which further supports the rating affirmation and stable outlook. The revision in outlook to stable is based on our expectation RSFH will sustain a 10% operating cash flow margin (before Founding Member distributions) and that balance sheet metrics will strengthen over time as debt continues to decline, capital spending is managed and liquidity is maintained and improves under the new liquidity agreement and reduced cash distributions to the Founding Members. STRENGTHS *RSFH has demonstrated continued stable financial performance through FY 2013 with a operating cash flow margin of 10.2%, which on par with FY 2011 and FY 2012 performance. *Unrestricted cash and investments as of FYE 2013 grew to $225 million (119 days cash on hand), up from $195 million (107 days) at FYE *RSFH has no new debt plans over the medium term. Capital spending plans are manageable at nearly one time depreciation expenses annually through FY The system operates a defined contribution pension plan which limits unexpected demands on liquidity and uncertainty with future funding requirements. *RSFH receives capital support, operating and strategic benefits from a unique three-way ownership interest and management structure formed in 1998 between three large Founding Members including The Medical Society of South Carolina (MSSC) (63% ownership), Bon-Secours Health System, Inc., MD (BSHSI) (A3 positive), (27% ownership) and Charlotte-based Carolinas HealthCare System (Aa3 stable) (10% ownership) (CHS). While MSSC

2 has majority ownership interest, the 13-member Board appointed by the Founding Members is structured so no single Founding Member has ability to control the operations of RSFH. RSFH also garners several benefits from its long-term management services agreement with CHS since A recently executed change in the annual cash distribution formula will allow RSFH to fund capital expenditures and build unrestricted liquidity over time. * RSFH has a stable, strong and proactive management team who have implemented strategies focused on growth, quality, and efficiencies that have translated into consistently favorable operating performance. *RSFH benefits from favorable demographics and a diversified economy anchored by the Port of Charleston, military, industrial and commercial development, manufacturing, higher education, healthcare, and tourism sectors. The region has favorable population growth, good wealth levels, and unemployment rates that are below state and national levels. CHALLENGES *Historically, RSFH's liquidity's measures have been weak compared to the A3 medians in large part due to large annual cash distribution paid to Founding Members. Cash-to-direct debt remains a low 67% in FY 2013 compared to the A3 median of 113%. Including indirect debt which includes debt-equivalent operating leases, cash-tocomprehensive debt is 51% compared to the A3 median of 86%. *Following the upcoming debt refinancing and restructuring plan, the debt structure will be comprised of 100% privately placed, direct purchase bank bonds with Wells Fargo Bank and TD Bank and will maintain a higher than average exposure to variable rate debt of 64% of total direct debt (before swaps). The debt structure exposes RSFH to interest rate variability, debt acceleration and renewal risk. *Although RSFH maintains leading market share, Charleston is a competitive market for healthcare services with the presence of Medical University of South Carolina, a large academic medical center and hospitals owned by for-profit health systems including Tenet-owned East Cooper Medical Center and HCA-owned Trident Health that operates two hospitals in the region. DETAILED CREDIT DISCUSSION LEGAL SECURITY: The bonds are secured by gross receivables pledge by the obligated group based on the Amended and Restated Master Trust Indenture (MTI) dated January 1, The obligated group members consist of the parent company, CareAlliance Health Services d/b/a Roper St. Francis Healthcare, Roper Hospital, Inc., Bon Secours-St. Francis Xavier Hospital, Inc., Roper St. Francis Mount Pleasant Hospital, and Roper St. Francis Physicians Network. Under the MTI, the obligated group is required to maintain financial covenants including 1.1 times (1.25 times under bank and bond insurance agreements) debt service coverage ratio (if falls below would be required to hire an independent consultant) and maximum total debt to capitalization of 65% at fiscal year end. In addition, an event of default would occur under the amended and restated MTI, if the Founding Members (collectively the Medical Society of South Carolina, Bon Secours Health System, and The Charlotte Mecklenburg Hospital Authority d/b/a the Carolinas HealthCare System) fail to make a contribution of unrestricted cash and investments to the obligated group in an amount equal to the contribution amount, which is the difference between 85 and days cash on hand reported on the testing date of June 30 and December 31, pursuant to the Liquidity Replenishment Agreement executed on January INTEREST RATE DERIVATIVES: RSFH has six interest rate swap agreements outstanding including four fixed payer swaps and two basis swaps outstanding. The four fixed rate payer swaps are in the total notional amount outstanding equal to $129 million. Three swaps are insured by Assured Guaranty (AG) and would require AG to maintain a credit rating that is A3 or higher by Moody's or A- or higher by S&P. If the AG rating falls below these levels, RSFH would be required to post collateral on net liabilities in excess of $2.0 million, which is the current threshold based on RSFH's credit rating assigned by S&P. One swap that is uninsured would require RSFH to post collateral on net liabilities in excess of $5 million. Goldman Sachs, Wells Fargo Bank, BB&T Bank are the swap counterparties. The two basis swaps are in the total notional amount outstanding equal to $97 million. Wells Fargo and JPMorgan Chase are the counterparties. RSFH would be required to post collateral if the net liability was in excess of $5 million threshold each for the basis swaps. If the credit rating of RSFH falls below Baa3, counterparties have the option to terminate the swap agreements. As of February 24, 2014 the total mark-tomarket value of the aggregate swap portfolio was a liability of approximately $21 million. RSFH has no collateral posted against the swaps at this time. All of the swaps will remain outstanding following the upcoming debt restructuring. RECENT DEVELOPMENTS/RESULTS

3 Earlier this year, RSFH's Founding Members entered into two new significant agreements that will provide RSFH with more financial flexibility and a liquidity cushion to support operations, enhance its legal debt security and retain more liquidity on its balance sheet to fund future capital expenditures. In January 2014, the Founding Members entered into a Liquidity Replenishment Agreement that would require the Founding Members to contribute cash (based on each members ownership interest in RSFH) if days cash on hand falls below 85 days pursuant to the executed agreement. In February 2014, the Founding Members also entered into an agreement to amend the annual cash distributions formula and cap distributions to $14.8 million in perpetuity. MSSC would have the right to reinstate the original distribution formula but it would revert back after three years from the time MSSC gives notice, which would provide RSFH time to plan for the change. The liquidity agreement and cap on annual cash transfers to the Founding Members are key factors in our revision of the outlook to stable from negative. Historically, RSFH's liquidity measures have been adequate but modest compared to the A3 medians due in part to the large annual cash distributions to the Founding Members. With the new agreements in place, and continued favorable operating performance, we expect balance sheet measures to improve. At FYE 2013, RSFH's absolute unrestricted liquidity grew by 15% to $224.7 million, with cash on hand improving to 119 days (A3 median is 176 days) from 107 days at FYE Cash-to-direct debt improved with growth in liquidity and decline in debt, but remains still a weak 67% (A3 median is 113%) from 55.3% at FYE FY 2013 was the third consecutive year of stable and good operating performance for RSFH. Total operating revenues grew by 3.5% while expense growth was 3.2%. RSFH reported (based on unaudited financial statements) a 2.2% operating margin and 10.2% operating cash flow margin compared to 1.9% and 10.2%, respectively, in FY The growth in operating revenues was attributed to growth in outpatient services and increased acuity of inpatient cases. Medicare CMI increased to 1.88 in 2013, while average length of stay remained stable at 4.5 days. The payer mix remained relatively stable as well. Outpatient revenues represented a higher 65% of total revenues in FY 2013 compared to 61% in FY If operating expenses were adjusted for the annual cash distributions to the Founding Members (net of the capital contributions received from the Founding Members), the operating cash flow margin would decline to 6.1% in FY 2013 and 7.8% in FY The net distributions have varied based on RSFH's operating cash flow generation, the size of discretionary capital contributions to RSFH by the Founding Members and deferment of a portion of the cash distribution in prior years by MSSC. Management is expecting operating cash flow margins to remain at 10% (before distributions to Founding Members) over the next several years. With the help of outside consultants, RSFH has identified $55-75 million in recurring revenue improvements and expenses savings and $8-11 million in nonrecurring benefits to be realized under its Mission 2020 performance improvement plan. RSFH is refinancing almost all of its outstanding public and privately held bank debt. The new debt structure will be comprised of all privately placed direct purchase bank bonds with Wells Fargo Bank and TD Bank and will remain largely variable rate (64% before swaps). The upcoming debt restructuring and refinancing plan is expected to lower annual interest expense, mitigate rollover risk with direct purchase banks agreements to have 5 or 7 year initial terms or debt that is fully amortized, and remove remarketing risk from the debt structure. However, interest rate variability, debt acceleration, and renewal risks remain elevated given the exposure to variable rate debt and bank-held debt. RSFH has sufficient headroom to all required covenants under the MTI, bank, bond insurance, and swap agreements. Future capital spending is projected to be manageable at approximately $45-50 million annually or nearly one times depreciation expense. Two of the system's largest strategic projects include the conversion of its electronic health record IT system from the McKesson Horizon platform to the Cerner platform, which is already underway. Another future project is the construction of a new 50-bed hospital in Berkeley County. No new inpatient beds will be added to the system. The IT conversion is estimated to cost about $56 million and will be funded through cash flow and remaining Series 2012 project fund of $23 million. RSFH does not anticipate any new debt issuance over medium term, allowing time for balance sheet metrics and debt capacity to improve over the next three years and before the proposed construction of the new hospital, which is estimated to cost about $75 million. However, the project has been put on hold as it remains under litigation following an appeal by HCA/Trident of the CON approvals received for both RSFH and HCA/Trident proposed facilities. In addition, there is also uncertainty regarding the status of the CON law in the state following the defunding of the program by the state in A ruling on the CON law by the state supreme court is expected in the coming months. If the CON law is repealed, this could potentially impact the plans and timing of the project.

4 OUTLOOK The revision in outlook to stable is based on our expectation RSFH will sustain a 10% operating cash flow margin given its favorable market position and area demographics. In addition, we expect the balance sheet will strengthen over time as debt continues to decline, capital spending is managed and liquidity is maintained and improves under the new liquidity agreement and reduced cash distributions to the Founding Members. WHAT COULD MAKE THE RATING GO UP A rating upgrade will be considered if there is sustainable growth in operating cash flow which contributes to absolute liquidity growth and a significant improvement in debt coverage and liquidity measures. In addition, the continued demonstration of support by the Founding Members would also be a consideration for an upgrade. WHAT COULD MAKE THE RATING GO DOWN A rating downgrade will be considered if the operating cash flow margin deteriorates, absolute liquidity declines, or there is addition of any new debt without commensurate revenue and cash flow growth. New competitive pressures that lead to a market share loss would also be a contributing factor for a downgrade. KEY INDICATORS Assumptions & Adjustments: -Based on financial statements for CareAlliance Health Services (d/b/a Roper St. Francis Healthcare) -First number reflects audit year ended December 31, Second number reflects unaudited year ended December 31, 2013 assumes upcoming debt restructuring and issuance of Series 2014 Wells Fargo direct purchase bank bonds and updated MADs -Investment returns smoothed at 6% -Comprehensive debt includes direct debt, operating leases (using multiple method), and unfunded pension liability, if applicable -Bad debt is deducted from revenues Inpatient admissions: 24,843; 23,551 Observation stays: 5,353; 5,092 Medicare % of gross revenues: 48.8%; 48.8% Medicaid % of gross revenues: 7.7%; 8.1% Total operating revenues ($): $729.8 million; $755.6 million Revenue growth rate (%) (3 year CAGR): 7.2%; 5.5% Operating margin (%): 1.9%; 2.2% Operating cash flow margin (%): 10.2%; 10.2% Debt-to-cash flow (x): 5.0x; 4.3x Days cash on hand: 107 days; 119 days Maximum annual debt service (MADS) ($) $31.9 million; $25.2 million MADS coverage with reported investment income (x): 2.5x; 3.1x Moody's-adjusted MADS Coverage with normalized investment income (x): 2.7x; 3.5x Direct debt ($):$352.6 million; $330.0 million

5 Cash-to-direct debt (%): 55.3%; 68.1% Comprehensive debt: $352.6 million; $330.0 million Cash-to-comprehensive debt (%): 42.9%; 52.0% Monthly liquidity to demand debt (%): 59.3%; 58.8% RATED DEBT (debt outstanding) -Series 1999A fixed rate bonds ($13.2 million outstanding); Assured Guaranty insured, A3 underlying rating - expected to be defeased with Series 2014 Wells Fargo direct purchase bank refunding bonds -Series 2004B-1 fixed rate bonds ($30.5 million outstanding); Assured Guaranty insured, A3 underlying rating - expected to be defeased refunded with Series 2014 Wells Fargo direct purchase bank refunding bonds -Series 2007A fixed rate bonds ($19.5 million outstanding); Assured Guaranty insured; A3 underlying rating - expected to be defeased with a 5-year initial term Series 2014 Wells Fargo direct purchase bank refunding bonds with a mandatory purchase date in April Series 2004B-2 variable rate demand bonds ($19.0 million outstanding); Assured Guaranty insured, rated Aa3/VMIG1 based on letter of credit support (expires 9/1/15) from Wells Fargo Bank; A3 underlying rating - expected to be converted to a 7-year initial term Series 2004 Wells Fargo Bank direct purchase bank bonds with a mandatory purchase date in April Series 2004B-1 variable rate Wells Fargo Bank direct purchase bank bond ($20.5 million outstanding) (expires September 2015); Assured Guaranty insured - expected to be refinanced and extended to a 7-year initial term with a mandatory purchase date in April 2021, A3 rated - Series 2007B variable rate Wells Fargo Bank direct purchase bank bonds ($80 million outstanding) (expires September 2015); Assured Guaranty insured - expected to be refinanced and extended to a 7-year initial term with a mandatory purchase date in April 2021, A3 rated UNRATED DEBT -Series 2009 variable rate BB&T bank qualified debt ($7.0 million outstanding) - expected to be paid off as part of the debt restructuring plan -Series 2010 variable rate BB&T bank qualified debt ($30 million outstanding) - expected to be refinanced with variable rate TD Bank direct purchase bank bonds -Series 2011 fixed rate Wells Fargo direct purchase bank bonds ($28.5 million outstanding) -Series 2012A fixed rate TD Bank direct purchase bank bonds ($31.9 million outstanding) -Series 2012B variable rate TD Bank direct purchase bank bonds ($47.3 million outstanding) RATING METHODOLOGY The principal methodology used in this rating was Not-for-Profit Healthcare Rating Methodology published in March Please see the Credit Policy page on for a copy of this methodology. REGULATORY DISCLOSURES For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for

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