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Fitch Upgrades Essentia Health's (MN) Revs to 'A' from 'A-'; Outlook Stable
[January 13, 2015]

Fitch Upgrades Essentia Health's (MN) Revs to 'A' from 'A-'; Outlook Stable


Fitch Ratings has upgraded the rating on the following outstanding revenue bonds, issued on behalf of Essentia Health (Essentia):

--$6.3 million Minnesota Agricultural & Economic Development Board health care facilities revenue bonds series 1999A;

--$61.1 million Cass County health care facilities revenue bonds series 2008A-1 & A-2;

--$13 million Wisconsin Health & Educational Facilities Authority health care facilities revenue bonds series 2008B-1;

--$144.8 million Minnesota Agricultural & Economic Development Board health care facilities revenue bonds series 2008C4-A & 2008C-5

--$63.7 million Cass County health care facilities revenue bonds series 2008D;

--$42.6 million Minnesota Agricultural & Economic Development Board health care facilities revenue bonds series 2008E.

The Rating Outlook is Stable.

Essentia has an additional $213 million in debt which Fitch does not rate, including $35.8 million in non-obligated group debt. The series 2008A, 2008B and 2008C bonds were reoffered as fixed rate in 2010.

SECURITY

The bonds are a joint and several obligation of the obligated group, secured by a pledge of unrestricted receivables, subject to permitted encumbrances.

KEY RATING DRIVERS

BALANCE SHEET IMPROVEMENT: The upgrade to 'A' from 'A-' is driven by healthy operating performance coupled with investment gains, which have in turn supported growth in Essentia's liquidity. Unrestricted cash and investments was $786 million at Sept. 30, 2014, and related liquidity ratios are now consistent with Fitch's 'A' rating category. At Sept. 30, 2014 Essentia had 171.5 days of cash on hand (DCOH), 133.5% cash to debt, and 17.1x pro forma cushion ratio, against Fitch's 'A' category median ratios of 199.2 DCOH, 131.2% cash to debt, and 17x cushion ratio.

SOLID OPERATING PERFORMANCE: The upgrade is further supported by Essentia's stable historical operating performance. From fiscal 2010-2014, Essentia has generated average operating and net EBITDA margins of 8.5% and 10.4% compared to respective 2014 Fitch's 'A' category medians of 9.5% and 11%. Essentia generated operating and net EBITDA margins of 8.4% and 10.7% in fiscal 2014 which is improved from the two prior years and reflect management's focus on efficiency and outcomes. Performance has improved in the three-month interim period ended Sept. 30, 2014 to a 12.8% EBITDA margin, supported by good growth in the west region and tight expense controls.

MANAGEABLE DEBT LEVEL: Essentia's leverage position is moderate, and no additional debt is anticipated over the near to intermediate term with annual capital needs near $90 million in 2015. In fiscal 2014, Essentia generated MADS coverage by EBITDA of 3.9x which consistent with 'A' category median of 3.8x. Coverage of MADS by Debt to capitalization was 38.7% at Sept. 30, consistent with Fitch's 'A' category median of 36.3%.

CLINICAL ALIGNMENT STRATEGY: Fitch believes Essentia's long-standing alignment with a large medical staff, successful deployment of its EPIC information technology platform, and ongoing efforts to grow strategically and manage core operating assets prudently should support its population health management, clinical efficiency and quality efforts, all of which are key to success under healthcare reform.

RATING SENSITIVITIES

CONSISTENT OPERATING PERFORMANCE: The upgrade reflects, in part, Essentia's steady operating profitability which is expected to be sustained going forward. Fitch expects Essentia to meet or exceed its fiscal 2015 budget of a 2% operatingmargin and 8% operating EBITDA margin. Given Essentia's manageable capital needs with no additional debt plans in the near term, liquidity metrics are expected to remain steady.



CREDIT PROFILE

Headquartered in Duluth, Minnesota, Essentia Health is an integrated health system serving patients in Minnesota, Wisconsin, North Dakota and Idaho. The obligated group includes Essentia, St. Mary's Duluth Clinic Health System, St. Joseph's Medical Center, St. Mary's Regional Health Center, St. Mary's Medical Center, SMDC Medical Center, Nat G. Polinsky Memorial Rehabilitation Center, Inc., St. Mary's Hospital of Superior, Brainerd (News - Alert) Medical Center, Brainerd Lakes Integrated Health System, St. Mary's Innovis Health, and Critical Access Group (formerly known as ECHC), The Duluth Clinic, and Innovis Health.


For the fiscal year ended June 30, 2014, the Obligated Group contributed 86.4% of the total revenue and 88.6% of the total assets of the Essentia system. Fitch analysis is based on the consolidated system, which generated $1.75 billion in total revenues in fiscal 2014.

BETTER LIQUIDITY

The upgrade to 'A' reflects steady year-over-year improvement to Essentia's balance sheet, supported via strong cash flow over time, as well as realized gains and increased asset valuations over the prior two fiscal years. Fitch also notes that Essentia's EMR implementation processes have helped support even more robust revenue cycle performance, reducing what was an elevated level of days A/R (over 50 historically) to 43.1 days at Sept. 30, 2014. This level is now more commensurate with the category peers and consistent for the industry.

STEADY PROFITABILITY

Focus on core operating performance has supported adequate profitability metrics, and Essentia has met or exceeded its operating margin budget for the past two fiscal years. Fitch notes that leadership has a history of adjusting capital spending and flexing expenses as needed to preserve profitability. Essentia is budgeting for a 2% consolidated budget for fiscal 2015, which is in line with prior year results and well below the current 4.5% margin through the three-month interim period ended Sept. 30, 2014.

OPERATING STRATEGY

Essentia continues to move very deliberately to a care management focus, following significant investment in a common electronic health record and telemedicine strategy, work with other regional providers and payors, and targeting better quality outcomes.

Going forward, Fitch believes that Essentia's well integrated physician clinic-hospital model will remain a key credit strength, leveraging its IT implementation and care modeling, solid market share capture, a strong negotiating platform with payors, and consistent utilization. This is expected to support solid market presence across Essentia's relatively wide geographic service area, preventing erosion in mature markets and providing a growth platform in high growth areas in North Dakota.

DEBT PROFILE

As of Sept. 30, 2014 Essentia had approximately $589 million in total long term debt, of which $53 million (10%) was direct placement variable rate debt with a mandatory tender. This includes $29.5 million in debt placed with BMO Harris, with a July 2024 tender date. It also includes $23.3 million in debt placed with Wells Fargo (News - Alert), which will equal $45 million when fully drawn, with a July 2019 tender date.

MADS is measured at $49.4 million, which includes both obligated and non-obligated debt, capital lease payments, and $3.8 million which assumes the full draw on direct placement debt and the line of credit per the definition of MADS in Essentia's Master Trust Indenture.

DISCLOSURE

Essentia covenants to file annual audited financial statements and operating data within 120 days of the fiscal year end to the MSRB's EMMA system. In addition, the obligated group covenants to provide quarterly unaudited consolidated financial statements to EMMA within 60 days of quarter end. Disclosure has been timely and thorough, with good access to management.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria' (May 30, 2014).

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=969155

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