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Fitch Upgrades Scripps Health's Rev Bonds to 'AA'; Outlook StableFitch Ratings has upgraded the long-term rating on Scripps Health's outstanding debt to 'AA' from 'AA-'. In addition, Fitch has affirmed the 'F1+' short-term rating on Scripps Health's series 2012B&C bonds based on self-liquidity. Scripps Health's outstanding debt is listed at the end of the press release. The Rating Outlook is Stable. SECURITY The bonds are secured by a gross revenue pledge of the obligated group (OG). The OG accounted for 99% of total assets and 96% of total revenue of the consolidated entity in fiscal 2014 (Sept. 30 year-end). Fitch's analysis is based on the consolidated entity. KEY RATING DRIVERS CONSISTENTLY STRONG FINANCIAL PROFILE: The upgrade to 'AA' from 'AA-' reflects Scripps Health's consistently strong financial profile that is characterized by improved liquidity, strong profitability, very good debt service coverage and low debt burden. Fitch believes the maintenance of its strong financial profile in a competitive market reflects its excellent management practices, and the higher rating level is supported despite ongoing industry challenges given the management team's ability to execute on its strategic initiatives. STRONG PROFITABILITY AND LOW DEBT BURDEN: Scripps Health's operating performance has been consistently solid even without the impact of the provider fee, which has fluctuated operating results. Operating margin and operating EBITDA margins were 6.2% and 10.8% in fiscal 2014 (Sept. 30 year end), respectively, compared to 7.3% and 11.7% the prior year (performance includes provider fee impact) and the 'AA' category median of 3.9% and 11%. Strong profitability combined with a low debt burden produced very strong debt service coverage of 10.2x in fiscal 2014 and 8.7x the prior year. Scripps Health's debt burden is low with maximum annual debt service (MADS) accounting for only 1.8% of total revenue in fiscal 2014. There are no additional debt plans despite continued capital spending. IMPROVED LIQUIDITY DESPITE HEALTHY CAPITAL SPENDING: Unrestricted cash and investments at fiscal year end (FYE) 2014 has grown to $2.2 billion (347.9 days cash on hand and 252.5% cash to debt) from $1.4 billion at FYE 2011 (241.4 days cash on hand and 229.5% cash to debt) despite healthy capital investment funded from operating cash flow. Scripps Health's capital spending has been robust and one of the organization's largest capital projects, the $404 million Scripps Prebys Cardiovascular Institute (Prebys) opened in March 2015 on time and under budget. Other near-term major capital projects are focused on ambulatory growth and a replacement EMR. Scripps Health's six-year capital plan is still healthy at $1.7 billion. However, capital spending is always balanced against financial performance and available cash flow. EXCELLENT MANAGEMENT PRACTICES: Fitch believes Scripps Health's history of consistently good financial performance is a reflection of strong management practices that include enhancing productivity, investing in infrastructure, expanding operations, and maintaining control on costs. Scripps Health has also been proactive in changing the care design model and expects a greater percentage of its revenue to be at risk in fiscal 2015. The organization is focused on improving quality, reducing costs, minimizing variation, eliminating waste, and improving access. GOOD MARKET FOOTPRINT: In addition to its four hospitals in San Diego County, Scripps Health has an extensive ambulatory network, an aligned physician base, as well as a growing health plan division. Fitch views this favorably especially due to the competitive service area. Key competitors include Sharp (News - Alert) HealthCare, Kaiser, and University of California San Diego Medical Center. The missing component in its delivery system is an integrated electronic medical record (EMR), which is expected to be in place by 2018. AMPLE CUSHION RELATED TO SELF-LIQUIDITY: The 'F1+' rating on the series 2012B&C variable-rate demand bonds (VRDBs) is based on self-liquidity, and reflects Scripps Health's long-term credit quality, as well as its strong position of liquid cash and investments to fund any potential unremarketed puts. RATING SENSITIVITIES SUSTAINED FINANCIAL PERFORMANCE: Fitch believes that Scripps Health will continue to maintain its current level of operating cash flow even as it transitions to a more risk-based revenue model given the organization's track record to date. The organization has consistently exceeded its targets of performance improvement initiatives needed to maintain solid cash flow in a reduced reimbursement environment. CREDIT PROFILE Scripps Health is a regional health system located in San Diego County, CA (News - Alert). The system is comprised of four hospitals on five campuses (1,369 licensed beds: Scripps Memorial Hospital La Jolla, Scripps Green Hospital, Scripps Memorial Hospital Encinitas, Scripps Mercy Hospital Chula Vista, Scripps Mercy Hospital San Diego), the medical foundation with various medical groups that have almost 700 physicians including Scripps Clinic Medical Group, an extensive ambulatory network, as well as a health plan. Total operating revenue in fiscal 2014 was $2.6 billion. Strong Liquidity Growth Scripps Health's liquidity has grown significantly over the last three years and has been driven by strong cash flow, and good investment returns despite healthy capital spending. Unrestricted cash and investments totaled $2.195 billion at FYE 2014 compared to $2.062 billion at FYE 2013, $1.76 billion at FYE 2012 and $1.415 billion at FYE 2011. At Sept. 30, 2014, Scripps Health had 347.9 days cash on hand, 47.7x cushion ratio and 252.5% cash to debt, compared to Fitch's respective 'AA' category medians of 277.1 days, 26.5x, and 178.5%. Scripps Health targets maintaining at least 250 days cash on hand and the balance sheet forecast includes establishing a $500 million hospital replacement fund to plan for seismic compliance related to Mercy Hospital's replacement tower and La Jolla's second patient tower post 2030. Consistently Strong Operating Performance Scripps Health reported $159.5 million in operating income for fiscal 2014 or 6.2% operating margin, and 10.8% operating EBITDA margin and performance exceeded budget. Scripps Health consistently budgets for a targeted level of performance improvement initiatives needed to maintain a 10% operating EBITDA margin. The areas of focus have been in labor productivity, suplies expense, and coding and documentation initiatives. The performance improvement initiatives figure also includes the receipt of meaningful use funds. Other initiatives that are expected to reduce costs are 'lean' initiatives or value by design, which are designed to reengineer core processes and enhance standardization. California enacted a hospital provider fee in 2010 to draw down additional federal funds for Medi-Cal services and Scripps Health has benefited from the provider fee program. However, given the varying program lengths and timing of approvals, the net benefit skews Scripps Health's financial performance. The net benefit of the provider fee was $22.6 million in fiscal 2011, $43.2 million in fiscal 2012, $8.7 million in fiscal 2013 and $6.3 million in fiscal 2014. Without the provider fee, operating EBITDA margin was 12.9%, 12.1%, 11.8% and 10.7% from fiscal 2011-2014. The current provider fee program is for the period Jan. 1, 2014 - Dec. 31, 2016, which is expected to result in a total of $55 million of net benefit to Scripps Health. The fiscal 2015 budget is for a 4.2% operating margin and 9.6% operating EBITDA margin (does not include any net benefit from provider fee program), which Fitch believes Scripps Health will surpass given its performance year to date and its history of exceeding budgeted targets. Good Market Footprint Fitch views Scripps Health's market footprint favorably especially given the competitive service area. Scripps Health has continued to make investments in physician groups and ambulatory clinics in its service area. The most recent acquisition was a network of eight ambulatory radiology centers. Scripps Health maintains the second leading market share in the service area (24.5%) and competes against Sharp HealthCare (28.8% market share), Kaiser Permanente (9.3% market share; rated 'A+'), University of California San Diego Medical Center (10.2% market share), Palomar Health (10% market share; rated 'BB+'), and several other independent community hospitals. Scripps Health maintains a higher market share in cardiac surgery and the organization has an exclusive agreement to provide cardiac services to Kaiser members. The most recent agreement expires in 2020; however, the relationship has been in place for over 30 years. Kaiser is building a new hospital in the service area, but a shift in cardiac business is not expected. Also, with the recent completion of Prebys, Scripps Health should realize enhanced efficiencies as it combines cardiovascular programs from two hospitals (La Jolla and Green Hospital) onto one site. Transitioning to Risk-Based Revenue The organization is in the process of transitioning its commercial HMO contracts from fee for service to risk adjusted capitation and currently has approximately 53,000 lives on the risk-based arrangement. In addition to its Medicare Advantage business and an additional commercial HMO contract that will convert later in 2015, total lives attributable to Scripps Health will be 93,200, slightly lower than the original expectation of 96,000. Fitch views management's actions to date positively as it aligns the reimbursement with the organization's goals to bend the cost curve, standardize care and medical management, improve quality outcomes, and manage population health. Healthy Capital Plan Scripps Health has had a healthy level of capital spending at 2.6x of depreciation expense in fiscal 2014, 3.4x in fiscal 2013, and 2.9x in fiscal 2012, which have all primarily been funded from operating cash flow or philanthropy. Philanthropy has been a consistent funding source with $28 million raised in fiscal 2014 and $38 million in fiscal 2013. One of Scripps Health's largest projects to date, Prebys, opened on time in March 2015 and under budget at $404 million ($97 million funded by philanthropy). With the project savings, a new emergency department is expected to be built in shelled first floor space and open in October 2016. The other major project on the La Jolla campus is a medical office building attached to Prebys that will open in April 2016. Scripps Health's fiscal 2015-2020 capital plan totals $1.7 billion (only $731 million is committed) and includes the replacement EMR, which is expected to be installed in 2017-2018. Although a replacement EMR is of concern, it is necessary especially for the care model that is envisioned. Projected capital spending by year is $379 million in fiscal 2015, $327 million in fiscal 2016, $250 million in fiscal 2017, and $250 million a year in fiscal 2018-2020. Management reiterated that capital spending will be flexed according to available funding sources. There are no additional debt plans. Low Debt Burden Scripps Health's debt burden is low. Debt service is level and MADS is approximately $46 million. MADS comprised only 1.8% of total revenue in fiscal 2014 compared to Fitch's 'AA' category median of 2.6%. MADS coverage is very strong at 10.2x in fiscal 2014 and 8.7x in fiscal 2013 and was 12.7x through the three months ended Dec. 31, 2014 (OG only). Scripps Health has $832 million in outstanding revenue bonds and the capital structure remains somewhat aggressive with 54% ($450 million) in underlying VRDBs. Of the VRDBs, $350 million are supported by letters of credit (LOC), which exposes Scripps Health to renewal, remarketing and put risks. However, the LOC banks are diversified and the expiration dates are staggered. In addition, Fitch believes Scripps Health's liquidity position mitigates some of the capital structure risk. Including its fixed payer swaps, Scripps Health's debt mix is 63% fixed rate and 37% variable rate. The collateral posting threshold is $60 million and the current negative mark-to-market valuation was $24.3 million as of Dec. 31, 2014. Short-Term Rating based on Self-Liquidity The affirmation of the 'F1+' short-term rating is supported by the adequacy of Scripps Health's highly liquid resources available to fund any unremarketed puts on the $100 million series 2012B&C weekly VRDBs. Based on Fitch's rating criteria related to self-liquidity, Scripps Health's position of eligible cash and investments available for same-day settlement easily exceeds Fitch's 1.25x requirement to cover the maximum tender exposure on any given date. Disclosure Scripps Health has covenanted to provide annual and quarterly disclosure through the Municipal Rule Making Board's EMMA system. Outstanding Debt: --$40,000,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2012C; --$60,000,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2012B; --$175,000,000 California Health Facilities Financing Authority hospital revenue bonds series 2012A; -- California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2010C (Bank Bonds); --$40,000,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2010C (LOC: Northern Trust Company (The)); --$60,000,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2010B (LOC: JPMorgan Chase Bank, N.A.)'; --$114,575,000 California Health Facilities Financing Authority hospital revenue bonds series 2010A; --$19,625,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008G (LOC: Wells Fargo (News - Alert) Bank, N.A.); --$33,840,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008F (LOC: Northern Trust Company (The)); --$33,670,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008E (LOC: Union Bank, N.A.); --$33,645,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008D (LOC: Bank of America, N.A.); --$33,670,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008C (LOC: Union Bank, N.A.); --$33,670,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2008B (LOC: Wells Fargo Bank, N.A.); --$92,930,000 California Health Facilities Financing Authority hospital revenue bonds series 2008A; --$11,100,000 California Health Facilities Financing Authority hospital revenue variable-rate bonds series 2001A (LOC: JPMorgan Chase Bank, N.A.). Additional information is available on www.fitchratings.com. Applicable Criteria and Related Research: --'Revenue Supported Rating Criteria', dated June 16, 2014 --'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', dated May 30, 2014; --'Rating US Public Finance Short Term Debt', dated Dec. 19, 2013. Applicable Criteria and Related Research: Rating U.S. Public Finance Short-Term Debt http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=846969 U.S. Nonprofit Hospitals and Health Systems Rating Criteria http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860 Revenue-Supported Rating Criteria http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012 Additional Disclosure Solicitation Status http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982344 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 (News - Alert) 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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. |
