Fitch Affirms MedStar Health (MD) Revs at ‘A’; Outlook Stable

The following is from Fitch Ratings on July 11:

Fitch Ratings has affirmed the 'A' rating on approximately $1.1 billion in revenue bonds issued by Maryland Health and Higher Educational Facilities Authority and District of Columbia on behalf of MedStar Health (MedStar).

The Rating Outlook is Stable.

SECURITY

The bonds are secured by pledges of gross revenues of the system hospitals and by mortgages on the system hospitals and parking facilities.

KEY RATING DRIVERS

SIGNIFICANT MARKET PRESENCE: The system has a strong market presence in the Baltimore - Washington D.C. corridor, which includes a large ambulatory network, a significant and increasing level of physician alignment and a reputation for clinical excellence, garnering MedStar a stable 21.6 percent market share.

CONSISTENT PROFITABILITY: MedStar's operating metrics have historically been lower than the 'A' category medians, but the system has maintained a consistent level of profitability, with operating margins of around 2 percent and operating EBITDA margins of 7 percent, generating a robust cash flow from operations averaging $241 million annually over the last four fiscal years. The system should also benefit from several of its hospitals participating in Maryland's Global Budget Revenue (GBR) Program, which provides a predictable revenue stream.

MODEST LIQUIDITY METRICS: At March 31, Medstar's$1.4 billion of unrestricted cash and investments equated to 120.5 days cash on hand (DCOH) and 125.7 percent of cash to debt, lighter than the category medians. However, liquidity growth has been limited by the substantial investment in system growth, which has largely been funded from operating cash flow.

MANAGEABLE DEBT LOAD: The system's coverage of maximum annual debt service (MADS) at 4.1x at fiscal year-end (FYE) 2013 (June 30) and 5x through the third quarter of 2014 (3Q'14)was better than the 'A' category median of 3.8x, MADS is a light 1.7 percent of revenues, and the system has a conservative debt structure with close to 90 percent of its long-term debt in fixed-rate mode.

WELL-POSITIONED FOR HEALTH CARE REFORM: MedStar's geographic coverage of its market, its robust and growing ambulatory network and 3,400 active physicians, and close alignment with 1,400 employed and 1,000 contracted physicians provide a solid base for participating in population-based health management programs.

RATING SENSITIVITIES

STABLE PROFITABILITY EXPECTED: The Stable Outlook and maintenance of the 'A' rating depends on MedStar's ability to maintain profitability at the current level in order to generate sufficient cash flow from operations to support the planned ongoing investments in system facilities and programs.

CREDIT PROFILE

MedStar is a large, integrated health care system composed of 10 hospitals (nine acute care and one rehabilitation hospital) with a total of 3,398 licensed beds and several other health care-related organizations. MedStar had total operating revenues of $4.2 billion FYE 2013.

Significant Market Presence

MedStar maintains a leading 21.6 percent market share (2013 data) of its primary service area, which encompasses the cities of Baltimore and Washington D.C. and the 11 surrounding Maryland counties. The system has the leading market position in several high- end specialty areas including cancer (21 percent), cardiac services (28.9 percent), neurology (21.7 percent), and orthopedics (22.9 percent), services for which it competes with University of Maryland Medical System (rated 'A' by Fitch) and Johns Hopkins Health System (rated 'AA-'). Its market share is supported by a large employed physician component with 1,400 physician full-time employees (FTEs), as well as a comprehensive and still growing ambulatory network which includes a number of urgent care centers, ambulatory surgery centers and freestanding oncology site. The ambulatory footprint will be further bolstered by a planned addition of eight multispecialty centers, part of MedStar's continuous investment in the system's distributive care network.

Consistent Profitability

MedStar has generated a modest but steady level of profitability over the last four years, with operating margin averaging 2 percent and operating EBITDA margin averaging 7 percent. In fiscal 2013 MedStar reported operating income of $73.9 million, equal to a 1.8 percent operating margin and 6.8 percent operating EBITDA margin, lower than Fitch 'A' category medians of 3.3 percent and 10.7 percent, respectively. Through the nine months ended March 31, MedStar's income from operation was reported at $75.6 million, ahead of the budgeted $53.7 million, for operating margin of 2.2 percent and operating EBITDA margin of 7.2 percent, and the system is projected to end the 2014 fiscal year with operating income of $100 million. Management credits the solid year-to-date results to expense control, focus on bad debt management and favorable rates, partially arising from five of their hospitals under Maryland's GBR program starting with January 2014, which accounts for approximately one third of the system's total revenues. Under GBR, which is designed to align incentives with a population-based health care delivery model, the participating providers are paid a predetermined level of revenues regardless of volumes based on their market position and demographic profile of the populations they serve.

MedStar's operating metrics have historically been lower than Fitch's 'A' category medians, partially due to the system focus on physician recruitment and expansion of the ambulatory network, and the reimbursement constraints imposed by the Maryland all-payor system. Management is projecting to maintain a 1.9 percent operating margin through the 2015-2018 period, while continuing to fund a portion of their capital needs from operating cash flow.

Manageable Debt Load

MedStar's debt burden remains light with coverage of MADS by EBITDA of 4.1x in 2013 and 5x through 3Q'14, better than the 'A' category median of 3.8x. MADS as a percent of revenues at 1.7 percent is significantly lower than the 3.1 percent category median. Management has planned additional debt issuance in 2015 and 2016 totaling approximately $275 million to fund portions of their capital investment plan. Fitch considers the rating stable even when assuming the potential additional debt issuance, provided profitability is maintained at the projected level.

MedStar has a $250 million line of credit, with $129.8 million drawn as of March 31, (deducted from available unrestricted cash for purposes of Fitch liquidity metrics calculation). The three letters of credit backing the series 1998A, B and C bonds have May 2015 and March and May 2017 expiration dates with repayment terms over five years. The mark-to-market of its one swap with notional par of $103.4 million was a negative $14.4 million at March 31.

Modest Liquidity

Fitch views MedStar's liquidity to be modest relative to the 'A' category medians. The lower liquidity levels, however, need to be seen in the context of the investment in system growth that was accomplished to a large degree from internally generated cash flow. MedStar's debt increased by only approximately $232 million over the last four years, which included the acquisition of Southern Maryland Hospital Center in 2012, funded with $180 million of debt. Unrestricted cash and investments of $1.4 billion at March 31, translate to 120.5 DCOH, 17.8x cushion ratio and 125.7 percent cash- to-debt, with DCOH lower than the respective 'A' category median of 196 days, but cushion ratio and cash-to-debt are consistent with the medians of 15.6x and 129.2 percent, respectively. MedStar's lower liquidity metrics are partially mitigated by a modest debt load, the system's considerable geographic diversification, and advanced level of system integration. Fitch does not anticipate liquidity to increase significantly over the next several years based on the capital needs of the system.

DISCLOSURE

MedStar covenants to provide annual disclosure to bondholders within six months of year-end and quarterly disclosure within 75 days of quarter-end. Quarterly disclosure is very good and includes a balance sheet, income statement, cash flow statement, utilization, and management discussion and analysis.

More information:

fitchratings.com

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