Fitch Ratings assigns an 'AA-' rating to the following series of bonds expected to be issued on behalf of the UPMC Health System, PA (UPMC) by the Monroeville Finance Authority (Allegheny County, PA):
--$410,000,000 series 2012A revenue and revenue refunding bonds.
Fitch also affirms the 'AA-' rating on UPMC's outstanding parity debt (issued through the Pennsylvania Higher Educational Facilities Authority, Allegheny County Hospital Development Authority, University of Pittsburgh Medical Center and Allegheny County Industrial Development Authority).
The series 2012A and 2012B bonds are expected to be issued as fixed-rate bonds and sold via negotiation the week of July 15, 2012. Bond proceeds of the series 2012A will be used to fund various capital expenditures and proceeds of the series 2012B will be used to refund the following series of bonds: Allegheny County Hospital Development Authority series 2003 and 2004A, Pennsylvania Higher Educational Facilities Authority series 1999A and Erie County Hospital Authority 2008. The series 2012A and B bonds will have a Feb. 15, 2042 final maturity. MADS on parity indebtedness of $236.2 million was provided by the underwriters and occurs in 2015.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a revenue pledge of the Obligated Group. UPMC is in the process of standardizing its bond covenants under the 2007 Master Trust Indenture (MTI), which may be completed with this financing as the debt being refinanced by the series 2012B bonds and discussion with the remaining 1995 noteholders would bring all of their outstanding parity debt under the 2007 MTI.
KEY RATING DRIVERS
MARKET DOMINANCE IN WESTERN PENNSYLVANIA: UPMC's historical strength has been its dominant market share of the Western Pennsylvania market with an estimated 35.8% share and a 40.2% share of the 10 immediately surrounding counties, more than twice that of its main competitor.
CHANGE IN COMPETITIVE LANDSCAPE: The intent of Highmark (Blue Cross Blue Shield) to build an Integrated Delivery and Financial System (IDFS) in western Pennsylvania with a competing, financially struggling West Penn Allegheny Health System (WPAHS, rated 'B+' by Fitch) as well as a network of ambulatory malls, presents a competitive threat, but Fitch does not expect market share to shift significantly over the near term.
HIGHMARK CONTRACT EXTENDED: Bowing to political pressure from the Governor, UPMC and Highmark agreed to an extension of its contract for hospital services to December 2014 at an undisclosed increase in Highmark's reimbursement rates.
CONSISTENT PROFITABILITY: UPMC's financial metrics have historically lagged 'AA' medians, but the system has maintained a positive history of solid top line revenue growth and consistent operating profitability. Operating performance had shown improvement in fiscal 2011 (year ended June 30) and operating and operating EBITDA margins at 3.9% and 9.1% through the nine months interim period ended March 31, 2012 were close to Fitch's 'AA' medians.
MANAGEABLE DEBT: The system's debt metrics are moderate with MADS coverage by EBITDA of pro forma debt of 4.3 times (x) both in fiscal 2011 and through the interim period, and MADS remains at a moderate 2.4% of revenues. UPMC is nearing the end of its major capital investments with only a moderate level of borrowing planned over the next five years, which is not expected to materially increase long-term debt beyond the current level.
CREDIT PROFILE
UPMC has historically been the market leader, and its market share of the 10-surrounding counties increased to 40.2% through September 2011 from 37.1% in 2009 as a result of the addition of Hamot Medical Center in February of 2011 and the closure of two of WPAHS's hospitals by the end of 2010. This compares to 14.6% market share of its main competitor, WPAHS.
However, the competitive landscape is being altered as Highmark, the dominant insurer in western Pennsylvania, embarks on its plan to create its own integrated delivery system by partnering with the financially very weak WPAHS to provide hospital services, and most recently affiliating with Jefferson Regional Medical Center in Jefferson Hills, as well as creating its own network of medical malls throughout the region. Highmark has made a $475 million commitment to WPAHS in the form of loans and grants over a three-year period, of which $200 million has already been contributed. While this has the potential of shifting some market share away from UPMC, Fitch does not expect a significant impact over the near term.
The financially struggling WPAHS closed two of its facilities to acute care services as part of its urban consolidation at the end of 2010, which had a positive impact on UPMC's inpatient and emergency department volumes. Admissions increased by 5.6% in fiscal 2011 and by 9.5% through the 2012 interim period and emergency visits by 10.8% and 17% during the two respective periods. Such robust volume growth may be tempered as WPAHS is gradually reopening its West Penn Hospital to inpatient services, which is only two blocks from UPMC's Shadyside Hospital. The Highmark WPAHS affiliation has passed the federal antitrust scrutiny, but still needs approval from the Pennsylvania Department of Insurance.
UPMC and Highmark were initially unsuccessful in negotiating the renewal of a 10-year contract for hospital services, which would have expired in June of 2012 (with a one-year run-off period). Through subsequent involvement of the Pennsylvania Governor and a mediation process, the two parties agreed to an extension of the contract to December 2014 at more favorable rates to UPMC. The new rates are now reportedly closer to those UPMC obtained from the four national insurers, with which it entered into contracts last year when the contract with Highmark was expected to be cancelled. Fitch's concern with the potential impact of the Highmark contract cancellation, which would have impacted 23% of UPMC's gross revenues, has thus been at least temporarily alleviated and UPMC has two and a half years in which to adjust its course of action should the contract not be extended past that date.
UPMC's financial metrics have historically been below 'AA' category medians, with the Fitch rating based to a significant degree on the system's very strong market position, however, fiscal 2011 and the 2012 year to date performance were closer to the rating level. Revenues increased by close to 12% in 2011 and through the nine-month interim period, producing operating income of $283.5 million last year and $199.5 million for the three quarters of 2012 ended March 31, equating to operating margins of 3.1% in fiscal 2011, but a slightly lower 2.7% for the interim period, as compared to the category median of 4.3%. Management budgeted a more conservative operating margin of 1.5% for fiscal 2013.
UPMC has just opened UPMC East, a $250 million 156-bed community hospital in Monroeville. It is intended to provide more convenient access for UPMC patients in the eastern Pittsburgh suburbs and to decompress Shadyside Hospital. Projections call for only approximately half of the volume at UPMC East to be generated from new patients. WPAHS's Forbes Regional Hospital (Forbes) has a competing hospital one mile from the new site, but UPMC's presence in the market is already established with several physician groups. UPMC East is likely to draw some volume away from Forbes.
The second major project is the planned construction of the UPMC Center for Innovative Science near the Shadyside campus, a $300 million facility which is currently in the design and development stage. Construction is planned to commence in 2014 and will be funded from a combination of debt and internal sources.
Following the issuance of the series 2012A and 2012B bonds, UPMC will have approximately 80% of its debt at fixed interest rates. Management projects that the system will be issuing between $150 million and $350 million of debt annually over the next five years, roughly equivalent to its principal amortization during those years, with the target of keeping outstanding long-term debt not to exceed the current level of approximately $3.2 billion.
UPMC's debt metrics are moderate and MADS coverage by EBITDA of pro forma debt (includes $210 million of new money from the series 2012A financing), was 4.3x in both fiscal 2011 and for the 2012 interim period, as compared to the 'AA' category median of 5x, and MADS as percentage of revenues of 2.4% is consistent with the median. MADS is calculated per MTI definitions for the treatment of several balloon payments.
Unrestricted cash and investments are reported at $3.5 billion, equating to 144 days cash on hand and cash equal to 103% of pro forma debt.
Fitch's Stable Outlook for UPMC is based on the expectation that UPMC's debt metrics will remain at the current moderate level and that its strong market presence will enable it to effectively compete in this market despite the heightened competition from a Highmark supported network. Deterioration in UPMC's financial metrics or erosion of market share could introduce negative rating pressure.
UPMC's quarterly and annual disclosures to industry participants (including EMMA) have been excellent and consist of full financial statements, utilization and other information, and management's discussion and analysis of results, which Fitch views favorably.
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', dated June 12, 2012;
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Aug. 12, 2011.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015
Nonprofit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648836
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.
Contacts:
Fitch Ratings
Primary Analyst:
Eva Thein, +1-212-908-0674
Senior
Director
Fitch, Inc.
One State Street Plaza
New York, NY
10004
or
Secondary Analyst:
Emily Wong, +1-212-908-0651
Senior
Director
or
Committee Chairperson:
James LeBuhn,
+1-212-368-2059
Senior Director
or
Media Relations:
Elizabeth
Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com