Fitch Ratings assigns an 'A-' to Norton Healthcare's $75 million variable rate revenue bonds, series 2011A and 2011B, to be issued by the Louisville-Jefferson County Metro Government, KY. The bonds are expected to price the week of Aug. 8th via negotiation.
The 'A-' is an underlying rating. The bonds are expected to be supported by irrevocable, direct-pay letters of credit from JP Morgan Chase. Fitch will assign ratings based on liquidity support nearer to the sale date.
Fitch also affirms its 'A-' rating on the following parity issues:
--$45.4 million Jefferson County health system revenue bonds, series 1997;
--$446.1 million Kentucky Economic Development Finance Authority health system revenue bonds, series 2000;
--$302.4 million Louisville-Jefferson County Metro Government health system revenue bonds, series 2006.
The Rating Outlook is Stable.
RATING RATIONALE:
--With the series 2011 variable rate debt issuance, Norton will add interest rate, put and liquidity facility renewal risk to a significantly leveraged debt profile. These risks are offset somewhat by adequate liquidity metrics against the pro forma level of demand debt.
--Norton's stable and leading market position improved in 2010 to 45.5%, and was supported by the completion of the Kosair Children's Medical Center-Brownsboro in 2010 and Norton Brownsboro Hospital in 2009, and by Kentucky's strong certificate of need (CON) program providing additional market stability.
--Of some concern, the Louisville and Jefferson County service area remains highly competitive and dynamic, as illustrated by the anticipated merger between Catholic Health Initiatives and the University of Louisville Hospital.
--Norton's profitability is light for the 'A' rating category but adequate against debt service requirements and cash flow needs. Norton produced maximum annual debt service (MADS) coverage by EBITDA of 2.8 times (x) in 2010 and 3.3x in the nine-month interim ended March 31, 2011.
--Norton's debt load is elevated for the rating level, driven primarily by significant investment in new facilities and information technology. Pro forma debt to operating EBITDA was a high 5.2% through March 31, 2011, against Fitch's 'A' category median of 4%.
KEY RATING DRIVERS:
--Moderate capital needs through 2016 should allow for balance sheet growth and allow Norton to continue to grow into its sizeable debt burden.
--Maintenance of a leading market position will be integral to continued operating stability and healthy top line revenue growth.
SECURITY:
The series 2011 bonds and all outstanding bonds are secured by a pledge of gross revenues of the obligated group. The series 1997 and series 2000 bonds are further secured by a debt service reserve fund and a mortgage on principal hospital facilities.
CREDIT SUMMARY:
The series 2011 issuance will increase Norton's exposure to both interest rate and put risk, as the pro forma debt structure will have approximately $150 million in variable rate debt, of which $75 million are variable rate demand bonds (VRDB's). An approximate $75 million in 2011C and 2011D bonds are being issued as variable rate direct bank purchase bonds, which Fitch will not rate, but were included in its analysis. The direct bank purchase bonds will have a fully-amortized 10-year term, with no put risk. Following the series 2011 issuance, Norton will have approximately $755 million in total long term debt with an 80% fixed /20% variable rate mix. Aggregate MADS is level through 2034 and estimated at $53.7 million as provided by the underwriter. Norton also has four basis swaps for a notional value of $540 million, with a $25 million collateral posting threshold and Citigroup as counterparty. The mark-to-market was -$7.9 million as of March 31, 2011, and Norton has no collateral posted.
Norton remains significantly leveraged and its balance sheet provides only minimal flexibility against the heavy debt burden. Capital risks are mitigated somewhat by adequate liquidity against puttable debt, as demonstrated by Norton's pro forma cash to demand debt of 824.9% as of March 31, 2011. The 2011 financing will reimburse Norton for approximately $75 million in prior capital expenditures. Still, Norton's pro forma cash position remains light for the rating level. Pro forma unrestricted cash at March 31, 2011 is estimated at $614 million equating to 160 days of cash on hand (DCOH), an 11.4x cushion ratio, and 81.4% cash to debt. While improved, Norton's liquidity metrics compare unfavorably to Fitch's 'A' category medians of 183.8 DCOH, 14.4x cushion ratio, and 105.5% cash to debt.
While Norton's leading market share improved by 4% to 45.5% in 2010, the competitive landscape within the greater Louisville service area is a negative credit factor. In Nov. 2010 Catholic Health Initiatives (revenue bonds rated 'AA' by Fitch; jointly owns Jewish Hospital and Sts. Mary and Elizabeth Hospital) announced an intent to merge with the University of Louisville Hospital, which would give that group a combined 2010 market share of 33%. Though Norton and the University of Kentucky have also announced plans to formalize their long-standing partnership, material changes to the competitive landscape could present credit risk going forward. This risk is slightly offset by Kentucky's stringent certificate of need (CON) law which limits certain competitive activities via restrictions on inpatient beds and capital expenditures above $2.6 million.
Operating performance has improved marginally, driven in part by the successful ramp up of the Norton Brownsboro Hospital and completion of the Kosair Children's Medical Center-Brownsboro, both in Louisville. Management reported that Norton Brownsboro is now contributive to the positive bottom line, and Kosair Children's Medical Center-Brownsboro has had a positive impact on existing Norton pediatric volumes. Through March 31, 2011 acute discharges were up 7.9%, newborn births were up 0.5% and emergency room visits were up 22.7% over the prior year's comparable period. As a result, Norton's operating and operating EBITDA margins improved to 2.4% and 9.1% through March 31, 2011, respectively, ahead of 1.4% and 8.9% in 2010. Further, healthy investment income of $21.8 million in 2010 boosted Norton's excess and EBITDA margins to 2.7% and 10.1%, respectively, in 2010.
While improved operating cash flow has resulted in better coverage metrics, Norton continues to demonstrate significant leverage. Coverage of pro forma MADS by EBITDA was 3.3x through March 31, 2011 ahead of 2.8x in 2010 and in line with Fitch's 'A' category median of 3.3x. Still, pro forma MADS as a percent of revenue was slightly high at 3.4% and pro forma debt to capitalization was high at 55.4% through March 31, against Fitch's 'A' rated category medians of 3% and 42.1%, respectively. Norton has completed its major capital projects for the near term, and expects to fund future annual capital expenditures of $75 million through 2016 via operating cash flow. With average annual operating EBITDA exceeding $100 million since 2005, Fitch expects that Norton should have little difficulty generating cash flow in excess of capital needs, and enabling balance sheet improvement over the near to medium term.
The Stable Outlook is based on the expectation that Norton will continue to generate healthy operating cash flow in excess of capital expenditures, enabling modest balance sheet growth. The Outlook is further supported by Fitch's expectation that Norton will retain a leading market position, which should facilitate its physician integration and accountable care strategies over the next 12-24 months.
Norton Healthcare is a multi-hospital health care system headquartered in Louisville, Kentucky. It operates five hospitals with 1,136 staffed beds (1,857 licensed beds), serves a population base of about 1.5 million, and is the region's largest health care network. Total revenues in fiscal 2010 were approximately $1.47 billion. Norton covenants to provide audited annual financial statements and quarterly disclosure to bondholders via the Municipal Securities Rulemaking Board's (MSRB) EMMA system. Quarterly disclosure consists of a management discussion and analysis, balance sheet, income statement, cash flow statement, and utilization statistics.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Citigroup Global Markets as Underwriter and Ponder & Co as Financial Advisor.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', dated Oct. 8, 2010;
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Dec. 29, 2009.
For information on Build America Bonds, visit www.fitchratings.com/BABs.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130
Nonprofit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493186
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