Fitch affirms Fletcher Allen Health Care's revenue bonds at 'BBB+', outlook 'stable'

by Tim McQuiston Vermont Business Magazine Fitch Ratings Inc has issued a generally positive outlook for Fletcher Allen Partners. It sees the integration of its four hospitals over the last three years as adding to market share, especially with the potential in east-central New York, while incurring only a "slight" impact on operating margins. Fitch also suggests that its rating could improve if expected market share increases while margins are maintained. The one hitch could be its master facility plan, "Issuance of debt for the organization's master facility plan not supported by sufficient cash-flow would preclude an upgrade"
Fletcher Allen Health Care, right foreground, with the affiliated UVM Medical School to the left. Courtesy photo.
Fitch Ratings affirms the 'BBB+' rating on the following revenue bonds issued by the Vermont Educational and Health Buildings Financing Agency on behalf of Fletcher Allen Health Care (Fletcher Allen):
-- $54,705,000 series 2008A;
-- $55,855,000 series 2007A;
-- $146,975,000 series 2004B;
-- $35,513,000 series 2004A;
-- $2,950,000 series 1994.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a mortgage on Fletcher Allen's core hospital campus in Burlington, VT and a security interest in the gross receipts of its two Vermont hospitals. Beginning with the interim period ending May 31, 2013, Fitch's analysis is based on Fletcher Allen Partners (FAP) which includes the consolidated performance of Fletcher Allen and Central Vermont Medical Center (CVMC) in Vermont, and Champlain Valley Physicians Hospital and Elizabethtown Community Hospital in New York. The Fletcher Allen obligated group comprises 81% of total assets and 81% of total revenues of the consolidated system.
KEY RATING DRIVERS:
CONTINUED EXPANSION: While FAP's recent expansion into New York State with the acquisition of two hospitals belonging to Community Providers, Inc. (CPI), d/b/a Champlain Valley, presents a certain degree of execution risk, Fitch expects that this would be offset by benefits of increased market share and ultimately be accretive to Fletcher Allen's credit profile.
STRONG MARKET POSITION: Fletcher Allen is the dominant provider of high acuity services in a sizable geographic region that encompasses northern Vermont and adjacent counties in northeastern New York State.
POPULATION HEALTH STRATEGY: Fletcher Allen participates in the Medicare Shared Savings Program with OneCare, a statewide Accountable Care Organization (ACO) organized and operated in conjunction with Dartmouth-Hitchcock Health, consistent with national and state healthcare reform initiatives.
STABLE CORE OPERATIONS: Fletcher Allen's operating and operating EBITDA margins have been stable over the last four fiscal years, and at 2.5% and 9.3% for fiscal 2012, respectively, and 2.5% and 8% through the eight-month 2013 interim period ended May 31, 2013 (which includes CPI facilities) generally exceed Fitch's 'BBB' rating category medians.
SOLID DEBT SERVICE COVERAGE: Maximum annual debt service (MADS) of the consolidated system is $45 million and coverage by EBITDA was solid at 4.0x at the interim period, favorable to Fitch's BBB' category median of 2.8x, and MADS as percent of revenues remains at a manageable 3.2%, consistent with the 'BBB' median.
IMPROVING LIQUIDITY: Liquidity had historically been light for the rating level, but has shown improvement through fiscal 2012. Days cash on hand (DCOH) reached 162.1 days as of Sept. 30, 2012, despite the addition of CVMC, which was potentially dilutive to liquidity. For the eight-month 2013 interim period, DCOH were reported at 149.6 days, the cushion ratio rose to 16.0x, and cash equated to 109.1% of debt, all exceeding the 'BBB' category medians.
RATING SENSITIVITIES
EXPECTED BENEFITS OF EXPANSION: Positive rating pressure could be possible if the expanded system footprint produces market share gains and Fletcher Allen is able to maintain its current credit profile. Issuance of debt for the organization's master facility plan not supported by sufficient cash-flow would preclude an upgrade.
CREDIT PROFILE
Fletcher Allen is an integrated health care network, providing hospital and physician services with four hospitals located in Vermont and New York. Fletcher Allen's flagship hospital located in Burlington, VT is a full-service tertiary and quaternary academic medical center with 438 operated beds, and is the largest hospital in Vermont. The additional hospitals in the system are the 84-bed Central Vermont Medical Center in Berlin, VT, 231 acute care bed (and 90 long-term care beds) Champlain Valley Physicians Hospital in Plattsburgh, NY, and 25-bed critical access hospital Elizabethtown Community Hospital, NY. Fletcher Allen is the teaching hospital for the University of Vermont and a Level 1 Trauma Center. The Faculty Practice includes 590 employed physicians; the health system as a whole includes over 1,000 physicians. Total revenues in fiscal 2012 (Sept. 30 year end) were approximately $1.14 billion.
The affirmation of the 'BBB+' rating is supported by Fletcher Allen's stable financial profile and its dominant position as the largest healthcare provider in the state of Vermont and the leading provider of tertiary and quaternary services to an expansive area covering a 150-mile radius, which includes several counties in northeastern New York State. Fletcher Allen has very strong market share of high acuity services, with over 90% of tertiary and quaternary discharges in the northern Vermont market and 25% of tertiary and 29% of quaternary discharges in upstate New York. The 2011 addition of CVMC and the 2013 expansion into New York State is part of a strategy to create a large integrated delivery system which leverages its affiliation with the University of Vermont Medical School and its expansive physician network in order to increase its market share and translate the benefits of scale into further buttressing its low-cost provider status.
CONTINUED EXPANSION
On Jan. 1, 2013, parent Fletcher Allen Partners (FAP) incorporated into its integrated regional network the two New York-based hospitals belonging to Community Providers, Inc. (CPI): Champlain Valley Physicians Hospital (Champlain Valley) in Plattsburgh and Elizabethtown Community Hospital. The individual organizations retained their identities, boards and medical staffs, while FAP retained significant reserve powers and approval rights. Fitch does not view the CPI merger as materially dilutive to Fletcher Allen's credit profile and views the strategy of growing the system favorably. CPI remains on a Dec. 31 fiscal year end.
As a result of the merger, there has been a slight fall-off in financial performance, but the affiliation offers substantial benefits in terms of increased market position in New York State. Liquidity ratios for the interim eight-month period since the four hospitals have been consolidated are equal to or stronger than the comparable ratios for the prior year period, which included just Fletcher Allen and CVMC. Fitch evaluates the organization's overall financial position, although CPI has not been incorporated into the Obligated Group. According to management, the decision to bring these hospitals into the Obligated Group would only be made at a time when there are capital needs that need to be funded. Champlain Valley has a recently renovated plant and does not face any major capital needs in the foreseeable future.
While the opportunities for Fletcher Allen to grow market share in Vermont are limited, as it is already dominant in the northern counties and is not likely to penetrate the three southern counties, dominated by Dartmouth-Hitchcock Health (rated 'A+' by Fitch), management believes that there is still opportunity for additional volume growth through the value of the FAP integration. However, the adjacent New York state counties have historically been a source of approximately 15% of admissions to Fletcher Allen, and Champlain Valley adds a gateway to central New York. Champlain Valley has leverage with payers as the only large hospital in a sizeable service area stretching between Glens Falls and Syracuse.
PROVIDER NETWORK STRATEGY
Fletcher Allen is increasingly involved in population health management and coordination of care, which enable it to provide low-cost care and reduce utilization, consistent with national and state health care reform initiatives. The system has operated Vermont Managed Care, a wholly owned Physician Hospital Organization with over 2,700 physicians, since 1991.
Since Jan. 1, 2013, Fletcher Allen has participated in the Medicare Shared Savings Program with OneCare, a statewide ACO which it developed with and operates in conjunction with Dartmouth-Hitchcock Health. OneCare serves approximately 42,000 Medicare beneficiaries in Vermont, making it one of the larger ACOs in the nation. It includes the two academic medical centers (Fletcher Allen and Dartmouth-Hitchcock), all 14 of Vermont's hospitals, two federally qualified health centers (FQHCs), five rural health clinics and 58 private practices. OneCare focuses on leveraging its Patient-Centered Medical Home model, developed at one of Fletcher Allen's practices, with a cadre of 280 primary care physicians across the network. FAP has applied to create a similar organization in New York.
STABLE CORE OPERATIONS
Fletcher Allen's operating and operating EBITDA margins have been stable over the last four fiscal years. Operating gain of $29.1 million in fiscal 2012, equal to operating and operating EBITDA margins of 2.5% and 9.3%, respectively, was consistent with Fitch's low 'A' rating category medians although the fiscal 2012 results, which included CVMC, were down from the peaks of 3.4% and 10.4% achieved by Fletcher Allen before the CVMC hospital merger. Through the May 2013 interim period Fletcher Allen, including the New York facilities, reported operating margin of 2.5% and operating EBITDA margin of 8%.
Champlain Valley had 2012 revenues of $292.8 million, from which it generated an operating loss of $5.3 million, for an operating margin of negative 1.8%. Elizabethtown, as a small, 25-bed, critical access hospital with revenues of $18 million will remain a minor contributor, but its incorporation into FAP will be viewed as a positive as long as favorable Medicare reimbursement for critical access hospitals continues. Performance of the two New York facilities has improved since the merger, with year-to-date revenues of $131 million generating operating income of $2.6 million for the five months through May (CPI is on a calendar fiscal year).
For fiscal 2013, the flagship, Fletcher Allen, is expected to exceed its operating margin target of $40 million, or 4% (up from $36 million, or 3.6% in 2012). Additional revenue of $15 million-$16 million in Graduate Medical Education funding has been approved, offsetting the 2013 drop in revenues from the first full year without the Boston wage index. CVMC is expected to incur a small loss in 2013, a negative 0.6% operating margin, rather than its targeted 2.4% operating gain. This is attributed primarily to lower volume in some service lines, some of which is held to be permanent. A consultant was hired, and, with two new orthopedic surgeons, a reduction in premium pay and cost savings initiatives, in 2014 CVMC is budgeted for a 3% operating margin. Champlain Valley, building on the performance improvement generated by a reduction in force and outsourcing dialysis, among other actions, had anticipated achieving a targeted operating margin of $6.7 million or 2.2%. However, the hospital has recently been notified of a retroactive adjustment (back to 2009) to their Medicare sole community provider reimbursement rate, which is expected to impact the margin by $4 million-$8 million. Management remains optimistic about achieving a $45 million or 3.5% operating margin for the consolidated FAP entities through September 2013.
Management has set a 4% operating margin target for Fletcher Allen in order to be able to fund the multi-year master facility plan (MFP) at the main facility in Burlington, and to maintain the targeted 110 DCOH. The MFP includes an inpatient stay facility with three inpatient floors, with the goal of converting existing beds to a level of 90% single occupancy rooms. The MFP, not including routine capital investment, is $334 million. As currently envisioned, the construction would not start until 2014 and the MFP would require issuance of debt of $75 million, with the remaining portion to be primarily funded from internal cash flow, and $30 million targeted from philanthropy. Fitch believes that given the current operating profile, Fletcher Allen has debt capacity for the $75 million of additional debt at the current rating level.
IMPROVING LIQUIDITY
Liquidity, which had historically been light for the rating level, has shown improvement through fiscal 2012. DCOH reached 162.1 days as of Sept. 30, 2012, and were reported at 149.6 days at the end of the eight-month interim period, on par with the prior year interim period. These levels were reached despite the addition of CVMC, which carries less cash on its balance sheet than Fletcher Allen, 117 days vs. 175 days in fiscal 2012. For the eight-month 2013 interim period the cushion ratio rose to 16.0x and cash equated to 109.1% of debt, all exceeding the 'BBB' category medians.
Fletcher Allen's asset allocation policy was revised to be more conservative in December 2012 in order to anticipate future funding needs to support the multi-year MFP. Target allocations for board-designated cash and investments were adjusted to 22% for equity, 15% alternative investments, and to increase fixed income to 63% from 30%.
SOLID DEBT SERVICE COVERAGE
Coverage of MADS by EBITDA on a consolidated basis through the interim 2013 period was solid at 4.0x, and MADS as percent of revenues remains at a manageable 3.2%%, consistent with the 'BBB' median of 3.3%. Debt service coverage for the Fletcher Allen Obligated Group was 4.1x for fiscal 2012.
Fletcher Allen has two direct bank placements outstanding. In 2011, a portion of the series 2000A bond issue was refinanced with $54.175 million taxable direct bank financing from KeyBank, with $52.45 million now outstanding. This bank loan has a 12-year final maturity and fixed rate of interest of 3.49%. In March 2013, Fletcher Allen entered into a $29.5 million tax-exempt direct financing with TD Bank, with a 14-year maturity, a 10-year call, and fixed rate of interest of 2.597%, which refunded the remaining portion of the 2000A series.
Fletcher Allen has a conservative debt structure with approximately 85% of its debt at a fixed rate of interest. The variable rate debt has been converted to synthetic fixed rate under three swaps with an aggregate notional amount of $58.14 million. The swaps are insured and do not require posting of collateral, despite a mark-to-market at negative $12.44 million as of May 31, 2013.
DISCLOSURE
Fletcher Allen covenants to provide audited financial statements within 180 days of the end of the fiscal year and quarterly statements within 60 days of the end of the quarter to MSRB's EMMA system.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Rating Criteria, this action was additionally informed by information from Citi.
Applicable Criteria and Related Research:
-- 'Revenue-Supported Rating Criteria', dated June 3, 2013;
-- 'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2013.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=7...
Nonprofit Hospitals and Health Systems Rating Criteria - Effective Aug. 12, 2011 to July 23, 2012
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=6...
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=798344
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Source: NEW YORK--(BUSINESS WIRE)--Fitch Ratings, Inc. 7.31.2013