Fitch Ratings has affirmed its underlying rating on the following series of bonds issued by the Health, Educational and Housing Facility Board of the County of Knox for the benefit of Covenant Health (TN) at 'A':
--Hospital revenue refunding and improvement bonds (Fort Sanders Alliance), series 1993;
--Hospital revenue refunding and improvement bonds, series 2002 A and D;
--Hospital revenue refunding and improvement bonds, series 2006 A and B.
The Rating Outlook remains Positive.
RATING RATIONALE:
--Covenant Health has the leading market share for the Knoxville health care market, as well as strong and improved liquidity, offsetting the somewhat light profitability metrics.
--Covenant increased its already leading market share position by 5.7% in what is now a more consolidated and less over-bedded three-system market after the 2008 merger of Baptist and St. Mary's and the subsequent closure of Baptist Hospital of East Tennessee.
--The October 2008 sale of Cariten-PHP health plan had a positive impact on liquidity by reducing the expense base, offsetting the liquidity deterioration caused by investment market losses, and also enabled Covenant to reduce potential liabilities related to ownership of a health plan at a time of increased competition for managed care lives and reduced reimbursement levels.
--Debt burden has historically been higher than the Fitch 'A' category and continues to be so due to system expansion and investment in facilities, but is mitigated by the solid market position and liquidity metrics as of the end of fiscal 2009 (unaudited) with 335 days cash on hand, 22.3x cushion ratio and 113% cash to debt.
--Operating performance metrics are at the lower end of the 'A' medians and are expected to remain so while Covenant completes its construction projects and further invests in system facilities focused on strengthening of its regional presence.
WHAT COULD TRIGGER AN UPGRADE:
--Increasing profitability metrics closer to the rating category medians while maintaining solid liquidity.
--Continuing to maintain the leading market share of the service area while focusing on growing a regional system.
SECURITY:
Debt payments are secured by a pledge of the gross revenues of the obligated group. There is also a springing mortgage on Fort Sanders Regional Medical Center and Parkwest Medical Center if debt service coverage is below 1.35 times (x) or days cash on hand are less than 90 days while the series 2002 bonds are outstanding.
CREDIT SUMMARY:
The 'A' rating affirmation with a Positive Outlook reflects Fitch's recognition of Covenant's leading position in the Knoxville market. Covenant's market presence stems from a well-thought-out business strategy focusing on forming a regional system with a network of community hospitals in the 16-county service area which feed referrals to the three tertiary/quaternary facilities in Knoxville and Oakridge owned by the system. Covenant benefited from the closure of the downtown Baptist East Tennessee Hospital by the Mercy Health System to a greater degree than its competitors. As contemplated in the revision of Fitch's outlook to Positive in September 2008, Covenant was successful in completing the sale of its Cariten-PHP health plan to Humana for approximately $250 million. The sale both significantly improved liquidity as reflected in the improvement in days cash relative to expenses to 335 days as of the fiscal year ended Dec. 31, 2009 (unaudited) from 227 days in fiscal 2007, and also reduced the potential liabilities resulting from owning a sizeable health plan with exposure to risk contracts for TennCare and Medicare populations in a down economic environment.
An upgrade to 'A+' is predicated on the system improving its profitability ratios closer to the category medians. Fitch is maintaining the Outlook at Positive based on the expectation that the system will be able to leverage its improved market position by translating this into stronger profitability metrics.
Utilization continues its consistent positive trend. Admissions in fiscal 2009 increased by a solid 5.8%, inpatient surgeries increased by 6%, and outpatient growth was equally strong with outpatient surgeries up by 4.7% and outpatient visits by 12.2%. In addition to benefiting from the closure of Mercy's Baptist East Tennessee facility, Covenant's utilization was also driven by the increasing usage of their Knoxville facilities by the local physicians, who in the past typically split their admissions between Covenant and Mercy (University Health System has a closed medical staff). Through various partnering relationships with physicians, including involvement in system strategies, active participation in clinical service line management, including the establishment of several centers of excellence (e.g. orthopedics, stroke treatment), Covenant was able to increase physician activity at its hospitals while at the same time benefiting from better control of expenses through the use of standardization and common protocols.
At year end 2009, the system had $760.4 million in unrestricted cash and investments equal to 335 days cash on hand, 22.3x cushion ratio, both significantly above Fitch's 'A' medians of 171 days and 15.4x, respectively. Investment allocation is conservative with 50% invested in fixed income and 28% in equities, with less than 10% in alternative investments. Cash-to-debt ratio of 113% is at par with the Fitch 'A' median and management has no plans to issue debt in the near future. The system's major project, a replacement hospital at its Fort Sanders Sevier Hospital, is expected to be completed on schedule and below budget this month.
Credit concerns have historically included a relatively high debt burden and slim operating margins. Covenant's debt burden with MADS coverage of 3.1x, MADS as a percentage of revenues of 3.6% and debt-to-capitalization ratio of 49.9% in fiscal 2009, are moderately unfavorable to Fitch's 'A' medians of 3.5x, 3.1% and 40.3%, respectively. Operating margins have historically been light. For fiscal 2008, the $20 million operating loss (2.3% negative operating margin) was partially the result of the accounting treatment of the sale of the health plan, which was reported as $40 million income of discontinued operation and $18.8 million gain on the sale in non-operating income (despite being part of the system's operations for 10 months of that year), higher interest costs associated with the system's auction-rate securities, and a generally conservative receivables reserving policy.
For fiscal 2009, Covenant reported an essentially breakeven performance (a negative 0.1% operating margin), well below the 'A' category median of 2.7%, but the operating EBITDA margin was a more robust 8.9%, though still slightly behind the category median of 9.2%. Management projects operating margin to remain relatively modest for fiscal 2010. However, the system is focused on maintaining a strong liquidity position, with management targeting days cash relative to expenses to remain at the 300-day level. Any concern stemming from Covenant's $224 million of series 2002 auction-rate securities is offset by the system's ample liquidity. Covenant has no swaps outstanding.
Covenant consists of six hospitals with 1,383 licensed beds located throughout 16 counties that make up the Knoxville metropolitan service area, and several other health care related organizations. Covenant had total operating revenues of $1 billion in 2009. Through a continuing disclosure agreement Covenant agrees to provide annual audited and quarterly financial statements to the MSRB's EMMA system.
Applicable criteria available on Fitch's website at 'www.fitchratings.com' include:
--'Nonprofit Hospitals and Health Systems Rating Criteria' (Dec. 29, 2009);
--'Revenue-Supported Rating Criteria' (Dec. 29, 2009).
Additional information is available at 'www.fitchratings.com'.
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or
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