Fitch Ratings has assigned an 'AA' rating to the following bonds expected to be issued by the North Carolina Medical Care Commission (the authority) on behalf of Duke University Health System (DUHS):
--$300 million series 2012A health care facilities revenue bonds.
In addition, Fitch affirms the 'AA' rating on the following bonds issued by the authority on behalf of DUHS:
--$26.1 million series 1985B hospital revenue bonds;
--$28.7 million series 1993A hospital revenue bonds;
--$214.8 million series 2005B-C health care facilities revenue refunding bonds;
--$180.0 million series 2009A health care facilities revenue bonds;
--$120 million series 2010A health care facilities revenue bonds.
Fitch Ratings has withdrawn the long- and short-term ratings on the following bonds which are currently directly held by banks and no longer require ratings.
--$107.4 million series 2005A health care facilities revenue refunding bonds;
The Rating Outlook is Stable.
The 2012 bonds are expected to be issued as fixed rate bonds. Bond proceeds will be used to fund a portion of the construction of the Duke Medicine Pavilion (DMP) and to pay costs of issuance. The bonds are expected to price the week of June 11 via negotiation.
SECURITY
Debt payments are unsecured, general obligations of the obligated group.
KEY RATING DRIVERS
ROBUST OPERATING PROFITABILITY: DUHS has maintained consistently strong operations with operating margins ranging between 7.7% and 9.7% since fiscal 2009, well in excess of Fitch's 'AA' category median of 4.3%.
MANAGEABLE DEBT BURDEN: Including the series 2012A bond issuance, DUHS's pro forma debt burden remains manageable with maximum annual debt service (MADS) equal to 3.1% of total revenues and MADS coverage of 4.6 times (x) EBITDA through the 9 month interim period ended April 1, 2012.
STRONG LIQUIDITY POSITION: At April 1, 2012 DUHS's $1.9 billion of unrestricted cash and investments equated to 321.5 days cash on hand, a 23.6x cushion ratio (based on pro-forma MADS) and 153% of long term debt including the series 2012A bonds.
LEADING CLINICAL REPUTATION: DUHS benefits from a strong national clinical reputation and its academic affiliation with Duke University School of Medicine.
CREDIT PROFILE
The 'AA' rating is supported by DUHS's robust operating profitability, strong balance sheet, an excellent clinical reputation and academic affiliation with a leading medical school.
Operating profitability has been consistently strong, with operating and operating EBITDA margins averaging 8.5% and 14.1%, respectively, since fiscal 2009. Operating profitability remains strong with operating margin equal to 8.1% in fiscal 2011 and 9.7% in the nine-month interim period ended April 1, 2012, easily exceeding Fitch's 'AA' category median of 4.3%.
The consistently strong operations is a function of solid surgical volumes, particularly in high acuity cases, growth in outpatient volumes and management's continued focus on margin improvement initiatives. Margin improvement initiatives resulted in an additional $13 million of operating income in fiscal 2011 and were primarily focused on labor management, supply chain initiatives and revenue cycle management. The increased profitability in the interim period is primarily due to an amended disproportionate share program in North Carolina which resulted in increased funding in fiscal 2012.
Strong profitability and a manageable pro forma debt burden result in solid historical coverage of pro forma debt service. Pro forma maximum annual debt service (MADS) of approximately $81 million is a manageable 3.1% of annualized 2012 total revenues. Pro forma MADS coverage is solid at 4.6x EBITDA and 4.7x operating EBITDA in the nine month interim period ended April 1, 2012 relative to Fitch's 'AA' category medians of 5.0x and 4.1x, respectively. Including transfers of $31.5 million in in the interim period to Duke University School of Medicine and DUHS's parent, Duke University, MADS coverage remains solid at 4.1x EBITDA in the interim period.
DUHS's unrestricted cash and investment position is viewed as a strong resource for timely payment of principal and interest. Unrestricted cash and investments have increased 29% since fiscal 2010 to $1.9 billion at April 1, 2012. Days cash on hand remains strong at 321.5 days relative to 'AA' median of 240 days while pro forma cushion ratio and cash to debt ratios of 23.6x and 152.9% are consistent with the respective 'AA' category medians of 22.4x and 159%.
Post issuance, DUHS will have approximately $1.2 billion of long-term debt outstanding. Leverage will increase with debt to capitalization rising to 37.2% from 31%, but remains reasonable for the rating category. The pro forma debt mix will be 53% fixed rate debt with the remaining 47% swapped to fixed rate.
DUHS is in the process of restructuring its variable rate exposure to reduce risks related to conditional capital. DUHS converted its series 2005A and 2006A-C bonds from variable rate demand bonds to direct bank placements. Fitch no longer rates these bonds. Terms of the direct purchase agreements are consistent with the terms of the previous standby bond purchase agreements. Management intends to convert the remaining variable rate demand bonds to direct bank placements by the end of summer 2012, thereby significantly decreasing or eliminating renewal risk, put risk and remarketing risk. Fitch views the decreased risk profile of the debt portfolio positively.
DUHS's strong clinical reputation and academic affiliation with a top medical school are credit positives. Duke University Hospital (DUH), DUHS's flagship facility, has been consistently ranked as one of the top hospitals in the nation for over a decade. The strong clinical reputation is supported by the high acuity of services provided at DUH, evidenced by a high Medicare case mix index of 2.28, and is bolstered by DUHS's solid 21.5% market share in its primary service area. Additionally, DUH is the principal teaching affiliate of Duke University School of Medicine, which is consistently recognized as one of the nation's top medical schools. The strong clinical reputation and academic affiliation are viewed as credit strengths due to their positive impacts on patient demand as well as physician recruiting and alignment initiatives.
The Stable Outlook reflects Fitch's belief that DUHS will maintain its robust operating performance. Upon the opening of DMP, the additional capacity should allow DUHS to improve volumes, enhance its competitive position in a favorable service area and further leverage its strong clinical reputation.
Based in Durham, NC, DUHS is a large integrated delivery system with three hospitals, several operating subsidiaries and total operating revenues of $2.4 billion in fiscal 2011. The three hospitals consist of: Duke University Hospital, with 957 licensed acute care and specialty beds located in Durham, N.C.; Durham Regional Hospital, 369 licensed beds located in Durham; and Duke Raleigh Hospital, 186 licensed beds located in Raleigh. DUHS covenants to provide annual and quarterly financial disclosure within 180 days and 60 days, respectively, through the MSRB's EMMA system.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 20, 2011);
--'Nonprofit Hospitals and Health Systems Rating Criteria'
(Aug. 12, 2011).
Applicable Criteria and Related Research:
Nonprofit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648836
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130
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