Fitch Assigns 'BBB+' IDR to South Nassau Communities Hospital (NY) Fitch Ratings-New York-31 January 2018: Fitch Ratings has assigned a 'BBB+' rating to the expected issuance of $90 million of South Nassau Communities Hospital (NY) taxable bonds, series 2018, issued on behalf of South Nassau Communities Hospital (SNCH). In addition, Fitch downgrades the following parity debt also issued on behalf of SNCH to 'BBB+' from 'A-': --$84,235,000 Nassau County Local Economic Assistance and Financing Corporation revenue bonds (South Nassau Communities Hospital Project), series 2012. Fitch also assigns an Issuer Default Rating (IDR) of 'BBB+' to SNCH. The Rating Outlook is Stable. The debt will be issued as fixed-rate, taxable bonds. Bond proceeds are for general corporate purposes. However, Fitch expects the proceeds to pay down a $25 million line of credit, fund a variety of projects at SNCH, and pay for the cost of issuance. Maximum annual debt service (MADS) rises to $12.8 million from $7.4 million and is smoothed for a bullet maturity. SNCH's debt is frontloaded with MADS dropping to below $10 million in 2028. Bonds will sell via negotiation the week of Feb. 12. SECURITY The bonds are secured by a pledge of gross receivables of the obligated group (OG), and a mortgage on the main hospital facility. SNCH is the only member of the OG.
ANALYTICAL CONCLUSION The IDR of 'BBB+' and the downgrade of the outstanding debt to 'BBB+' reflect the increase in SNCH's leverage with the current issuance of $90 million of new debt, coupled with a trend of declining margins over the last five years. SNCH's good market position in Oceanside, NY, which is located within the competitive but demographically favorable Nassau County (IDR A), and SNCH's favorable levels of Medicaid and self-pay (under 20%) support a midrange revenue defensibility. Fitch expects SNCH's market share and payor mix to remain relatively stable through the cycle, even as SNCH manages through increased competition for outpatient services and physicians. SNCH's operating EBITDA and EBITDA margins have steadily declined over the last five years. Fitch expects operations to stabilize and improve over the next two to three years as recently employed physicians and clinical service line investments begin to support revenue growth and increased cash flow. This expected improvement, as well as SNCH's longer history of positive operating results, supports the midrange operating risk assessment. SNCH is awaiting regulatory approval to become an affiliate of the Mount Sinai Health System (MSHS), which Fitch expects will provide further lift to SNCH's operational performance. Currently none of the benefits from the affiliation are factored into Fitch's forward-looking analysis of SNCH's financial performance. After the current debt issue, SNCH's absolute levels of liquidity and leverage metrics are expected to remain stable and improve slightly through the rating cycle. SNCH is executing on a five-year, $364 million capital spending plan. Funding is coming from a variety of sources, including $27 million in equity, but the 2018 bonds are expected to be the only debt issued to fund these projects. KEY RATING DRIVERS Revenue Defensibility: 'bbb' - Good Payor Mix and Demographics Offset Competitive Market
SNCH revenue defensibility is midrange. SNCH operates within the competitive Nassau County healthcare market, which includes three solid competitors. SNCH has the lowest market share among its competitors in the larger Nassau market, but that is offset by a higher market share in Oceanside, the southeast part of the county, where SNCH is located and draws the majority of its patients. Nassau County and Oceanside have good wealth and employment indicators. SNCH's payor mix reflects the good area demographics as Medicaid and self-pay total approximately 17% of gross revenues. Fitch expects SNCH's market position to remain stable over the long term. Operating Risk: 'bbb' - Declining Margins Expected to Improve SNCH's operating risk is midrange. SNCH's margins have shown steady erosion over the last few years, driven by an uptick in Medicare, increased spending on physician acquisitions, and sector-wide downward pressure on managed care rate increases. SNCH is responding with revenue growth and efficiency initiatives, and the potential MSHS affiliation should help in these efforts. Fitch expects SNCH's margins to stabilize and slightly improve through the rating cycle. Capital spending will remain elevated during this period, with $364 million in projects expected through 2022. These will be funded through a combination of debt, including the current debt issue, FEMA grants, funds from MSHS, philanthropy, operations, and other sources. Financial Profile: 'bbb' - Stability Through the Cycle SNCH's operating performance will stabilize and improve over time as the investments in physicians and service lines, including a new Emergency Department (ED) and Southwest Tower, lead to revenue growth that outpaces expense growth. As SNCH executes on its capital plan, its unrestricted liquidity position and leverage position should remain stable. Asymmetric Additional Risk Considerations No asymmetric considerations informed this rating. RATING SENSITIVITIES STABILIZING AND IMPROVING PERFORMANCE: In order to maintain the
existing rating, South Nassau Communities Hospital (SNCH) will need to stabilize its operating performance and improve cash flow. Conversely, a return to stronger levels of performance, with EBITDA margins above 10%, coupled with liquidity growth, should lead to positive rating action. EXECUTION ON CAPITAL PLANS: SNCH has a number of projects as part of a sizable five-year capital plan that includes a new Southwest Tower, a parking structure, and a freestanding emergency room in Long Beach. Changes to the expected financing of these projects or delays or cost overruns in project execution could lead to negative rating pressure. CREDIT PROFILE South Nassau Communities Hospital (SNCH) is a 435-bed (355 operated) acute care hospital (plus a 20-bed Transitional Care Unit), located in Oceanside, on the south shore of Long Island. Its service area includes Nassau County and parts of eastern Queens County. Total operating revenue in 2016 (Dec. 31 year end) was $500 million. Revenue Defensibility SNCH has a slightly better payor mix than the typical acute care hospital, with less than 20% combined Medicaid and self-pay and just over 25% of gross revenues consisting of commercial and managed care payors. The commercial and managed care percentage of gross revenues has been steadily declining over the past few years, with Medicare showing a comparative increase. The increase in Medicare has partially contributed to SNCH's declining financial performance, as Medicare generally reimburses at lower rates than commercial and managed care payors. SNCH's inpatient market share in Nassau County has been steady at approximately 11%. The service area includes three formidable healthcare system competitors: Catholic Health Services of Long Island, Northwell Health, and NYU Winthrop Hospital. SNCH's market share strength is in Oceanside (and surrounding communities), where it maintains a larger market share, although there has been increased competition for outpatient services and physicians in Oceanside in recent years. SNCH is waiting on regulatory approval to become an affiliate of MSHS, as both boards have
approved the affiliation. Among the benefits the affiliation will bring should be the bolstering of specialty physicians (MSHS has physician practices located throughout Long Island), as well as the advancing of the tertiary service lines that SNCH will be able to offer. This will, in Fitch's opinion, strengthen SNCH's market position and be accretive to its overall operational performance. Nassau County has very favorable demographics, with most economic indicators, including employment rates, wealth, and education levels favorable to state and national averages. In 2016, for example, Oceanside's median income was 60% above the New York State average. SNHC's market position within this service area is one of its key credit strengths. There were no additional considerations. Operating Risk SNCH's margins have steadily declined since 2013, when SNCH generated a healthy 8.7% operating EBITDA margin and 10.9% EBITDA margin. Ninemonth 2017 interim results show a 4.8% operating EBITDA margin and a 7% EBITDA margin. Pressure on SNCH's margin has been driven by an uptick in Medicare, spending on physician acquisitions, and sector-wide downward pressure on managed care rate increases. Fitch believes the increase in employed physicians, which has grown by approximately 40% since 2015 and was due in part to an increase in competition for physicians in the service area, is the largest driver of the decline in performance. SNCH is budgeting for a slight improvement in performance in 2018. Longer term Fitch believes the current pressures on operations will ease as the employed physicians continue to ramp up and the recent shift to Medicare stabilizes. Revenue growth should also improve as the investments in key clinical services, such as in cardiology and surgery, begin to affect revenue growth positively. The affiliation with MSHS is expected to further improve SNCH's overall financial profile. SNCH has been in a cycle of elevated capital spending averaging 165.5% of depreciation a year over the last four audited years. Projects completed over this time include a new transitional care unit, renovation of critical care and
intensive care units, and a first phase renovation of the ED, which currently operates at more than twice its capacity with over65,000 visits per year. SNCH is undertaking $364 million in additional projects through 2022 that will include the construction of a new Southwest Tower and a central utility plant and parking structure on the Oceanside campus. A Medical Arts building will also be built in Long Beach that will house a permanent freestanding ED. The new Southwest Tower will house key revenue-producing additions including two new critical care units, the phase 2 ED expansion, and nine operating rooms. The projects will be funded through a mix of sources, including the 2018 debt issuance, approximately $120 million from MSHS, and $154 million in FEMA grants. SNCH is expected to contribute approximately $27 million of its own equity, and another $10 million will come from a capital campaign of which 70% has been raised. There were no additional considerations. Financial Profile SNCH debt service coverage, cash to adjusted debt, and net adjusted debt to adjusted EBITDA have been relatively good over the last three years in spite of the decrease in operating margins, with these figures at 4.8x, 107%, and -0.3, respectively, in 2016. After a decline in unrestricted liquidity in 2015 to approximately $152 million, SNCH's unrestricted liquidity position increased to $167 million in the nine-month interim, as good investment returns helped offset the thinner cash flow. As the proceeds from the $90 million of taxable debt begin to be spent, net adjusted debt to adjusted EBITDA will rise, but Fitch expects it to moderate as cash flow improves and SNCH's current debt continues to amortize through the five-year cycle. The higher MADS figure of $12.5 million will cause coverage to drop, but Fitch expects it to recover through the rating cycle. There were no additional considerations. Asymmetric Additional Risk Considerations No asymmetric risk considerations were identified.
After the 2018 debt issuance, SNCH will have approximately $189 million in total long-term debt and all of the debt is fixed-rate. SNCH has no swaps. SNCH does have a defined benefit plan, with a funding level of 72% at yearend 2016, and this was incorporated into Fitch's forward-looking analysis. South Nassau covenants to provide annual audited financial statements 150 days after the fiscal year-end and quarterly unaudited financial statements 60 days after the quarter-end to EMMA. Contact: Primary Analyst Gary Sokolow Director +1-212-908-9186 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Olga Beck Director +1-212-908-0772 Committee Chairperson Kevin Holloran Senior Director +1-512-813-5700 In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis. Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com
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