Fitch Affirms Palmetto Health (SC) Rev Bonds 'BBB+'; Outlook Stable

The following is from Fitch Ratings on June 25:

Fitch Ratings has affirmed its 'BBB+' rating on Palmetto Health's outstanding debt, as listed at the end of the press release.

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues and a leasehold mortgage.

KEY RATING DRIVERS

LEADING MARKET SHARE IN VERY COMPETITIVE SERVICE AREA: Palmetto maintains a leading market position in a very competitive market that drives the need for constant focus on physician relationships. One of Palmetto's main competitors, Sisters of Providence Charity Hospitals' (SPCH, rated 'A', Stable Outlook), sponsor wants to exit the market and the facilities are for sale. Fitch believes this creates additional physician recruitment opportunities, as SPCH specialized in cardiac procedures.

GOOD LIQUIDITY: Palmetto's liquidity metrics are good with 230.7 days cash on hand and 100.8 percent cash to debt at March 31, compared to the 'BBB' category medians of 145 and 93.6 percent, respectively.

PRESSURED PROFITABILITY: Fiscal 2014's operating loss was driven by start-up losses at its new hospital, Palmetto Health Baptist Parkridge (Parkridge), as well as rising labor costs due to the competitive market. Through the six months ended March 30, profitability has rebounded; however, there were some one-time items in fiscal 2015. Labor pressure is expected to continue, especially as outpatient volume, particularly emergency room, has increased significantly mainly due to the impact of the Affordable Care Act (ACA) with an increased amount of insured through the exchange as well as the increase in volume at Parkridge.

HIGH DEBT BURDEN: Maximum annual debt service (MADS) was a high 4.7 percent of fiscal 2014 revenue compared to the 'BBB' category median of 3.6 percent. Fitch uses MADS of $54 million, which includes the full drawdown on the series 2010A-D bank loans ($20 million remaining) that Palmetto issued to fund Parkridge and ongoing capital expenditures. MADS coverage is adequate at 1.9x in fiscal 2014 but improved to 2.7x through the six months ended March 31.

FAVORABLE IMPACT WITH EXCHANGE: Palmetto's payor mix has improved with a reduction in self-pay and increase in commercial insurance as more people are obtaining insurance through the exchange. This has also been aided by the opening of Parkridge, which is in a desirable area with a good payor mix. Palmetto has entered into various narrow network arrangements that should also continue to steer volume.

RATING SENSITIVITIES

MAINTAIN LIQUIDITY POSITION AND OPERATING CASH FLOW: Palmetto Health will need to maintain its good liquidity position and operating cash flow to offset its high debt burden and the failure to do so could cause negative rating pressure.

MARKET DEVELOPMENTS: Palmetto Health has been actively engaged in affiliation/partnership discussions with other providers and Fitch will monitor the impact of these developments on Palmetto Health's credit profile if and when they finalize.

CREDIT PROFILE

Palmetto is a three-hospital system, consisting of Palmetto Richland Memorial Hospital (640 staffed beds), Palmetto Health Baptist Medical Center (358 staffed beds) located in Columbia, SC and Palmetto Health Baptist Parkridge Hospital (76 staffed beds), located in the Irmo-Chapin area (opened in March 2014). Total revenue for fiscal 2014 (Sept. 30 fiscal year end) was $1.1 billion.

MARKET DEVELOPMENTS

A key credit strength continues to be Palmetto's leading market share position in a very competitive service area. In the 10-county service area, Palmetto had a 39 percent market share in fiscal 2014 compared to its two main competitors - Lexington Medical Center (Lexington; rated 'AA-', Outlook Stable), with 21 percent and SPCH with 8 percent. Lexington's market share has slightly increased due to the opening of an open-heart surgery program in 2012, while SPCH's market share has declined since 2012.

The Palmetto Health Baptist Parkridge Hospital opened on March 19, 2014 and the hospital is located in a favorable service area in the Irmo Chapin area and is approximately 11 miles north of downtown Columbia. There were some unanticipated challenges with opening the hospital, which partially caused the decline in operating performance in fiscal 2014; however, the facility is now in line with expectations and volume growth has been strong, especially in outpatient visits.

Palmetto is in negotiations with Tuomey Health System located in Sumter, SC (approximately 45 miles east of Columbia, SC; 301 licensed beds) and Tuomey could potentially join Palmetto depending on the outcome of a settlement with the federal government regarding violations with Stark laws and the False Claims Act. Tuomey is facing a $237 million fine; however, this is being appealed. Fitch will monitor the outcome of the negotiation, but expects that the deal will not be finalized unless the fine is significantly reduced.

EMPLOYED PHYSICIAN STRATEGY

In the service area, most physicians are employed either by Palmetto, SCPH, Lexington or University of South Carolina School of Medicine (USCoM). Physician recruitment is competitive and Fitch will monitor the shifting alliances of the various physician groups. Palmetto is planning to merge its employed physician group with the USCoM faculty physician group and details are still unavailable. However, the governance of the new entity is expected to be 50/50 with Palmetto operating the clinical functions and USCoM leading education and research.

GOOD LIQUIDITY

Palmetto's liquidity position is a main credit strength with $722.8 million in unrestricted cash and investments at March 31, which resulted in 230.7 days cash on hand and 100.8 percent cash to debt. Liquidity metrics have dropped slightly due to increased swap collateral posting, higher operating expenses and increased debt, but are still solid for the rating category. Capital needs are expected to be moderate and the fiscal 2015 capital budget is $40 million (less than depreciation expense).

REBOUND IN OPERATING PERFORMANCE

Fiscal 2014 operating performance was weak due to start-up expenses at Parkridge as well as continued pressure on labor expense. Operating margin and operating EBITDA margin were negative 1.4 percent and 6.3 percent compared to 1.4 percent and 9.2 percent, respectively, in fiscal 2013. Operating performance has rebounded through the six months ended March 31, with a 1.5 percent operating margin and 9.1 percent operating EBITDA margin. However, there were some one-time items which totaled approximately $7.7 million.

Fitch believes the operating cash flow will need to be sustained at the current levels due to Palmetto's high debt burden. Management continues to focus on operational efficiencies particularly in the current tight labor environment and the targeted amount of cost reductions/revenue enhancements is $49 million. Management expects to end fiscal 2015 ahead of budget (breakeven operating performance).

Given Palmetto's payor mix, Palmetto receives a notable amount of supplemental funding, which totaled $62 million in fiscal 2014 and $52 million in fiscal 2013. Palmetto has benefited from an increased amount of insured through the exchanges with a shift in payor mix to managed care from self-pay. For the six months ended March 31, Palmetto had 27.3 percent of gross revenues from managed care and 8.6 percent from self-pay compared to fiscal 2014 with 25.9 percent and 10 percent, respectively. Volume growth has been very strong with discharges and emergency room visits up 9 percent and 23 percent, respectively, through the six months ended March 31, compared to the prior year period.

HIGH DEBT BURDEN

Total outstanding debt at March 31, was approximately $710 million with 71 percent fixed rate and 29 percent variable rate. All of the variable rate exposure is indexed floating with the direct bank loans. The direct bank loans include the series 2014 and series 2010A-D, and the series 2010A-D bonds were structured as a drawdown loan with $20 million remaining. Palmetto expects to use this to fund equipment. The series 2014 bonds have a mandatory tender on Dec. 1, 2020 and the series 2010A-D bonds have a mandatory tender on Aug. 3, 2020.

Fitch used MADS of $54 million, which includes the full drawdown on the series 2010A-D bonds. MADS coverage is adequate at 2.7x through the six months ended March 31, compared to 1.9x in fiscal 2014, 2.5x in fiscal 2013, and the 'BBB' category median of 2.6x. There are no additional debt plans.

Palmetto has five swaps outstanding with a total notional amount of $321.5 million, which required collateral posting of $43 million as of March 31, up from $22 million at fiscal year end 2014. In April 2013 Palmetto suspended all its fixed-payer swap cash flows until April 2016.

CONTINUING DISCLOSURE

Palmetto covenants to provide annual and quarterly disclosure to bondholders and posts on EMMA. Quarterly disclosure consists of a consolidated balance sheet, income statement, cash flow statement, footnotes to the quarterly report, management discussion and analysis, utilization statistics and payor mix information.

Fitch has affirmed the following outstanding debt:

--$129,845,000 South Carolina Jobs-Economic Development Authority, fixed rate revenue refunding bonds, Series 2013A;

--$83,720,000 South Carolina Jobs-Economic Development Authority, hospital refunding and improvement revenue bonds, series 2011A;

--$94,855,000 South Carolina Jobs-Economic Development Authority, series 2009;

--$194,400,000 South Carolina Jobs-Economic Development Authority, series 2005A.

Additional information is available at 'fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)

https://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=866807

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://fitchratings.com/creditdesk/press_releases/content/ ridf_frame.cfm?pr_id=986990

Solicitation Status

https://fitchratings.com/gws/en/disclosure/ solicitation?pr_id=986990

Endorsement Policy

https://fitchratings.com/jsp/creditdesk/ PolicyRegulation.faces?context=2&detail=31

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