<0> Fitch Rates Dignity Health (CA) Series 2014A Bonds 'A'; Outlook Stable </0>
Fitch RatingsEmily Wong, +1-415-732-5620Senior DirectorFitch Ratings, Inc.650 California St.San Francisco, CA 94108orSecondary AnalystJames LeBuhn, +1-312-368-2059Senior DirectororCommittee ChairpersonCharles Giordano, +1-212-908-0607Senior DirectororMedia Relations, New YorkElizabeth Fogerty, +1-212-908-0526
Fitch Ratings has assigned an 'A' rating to the approximately $718 million Dignity Health, CA taxable bonds series 2014A. The par amount may increase to $888 million depending on market conditions. Fitch has also affirmed the 'A' rating on Dignity Health's (Dignity) outstanding debt, which is listed at the end of the press release.
The Rating Outlook is Stable.
The series 2014A bonds in conjunction with proceeds from direct bank loans (not rated by Fitch) will be used to provide new money to fund capital investments ($430 to $600 million), refund outstanding debt and draws on working capital lines ($773 million) and pay costs of issuance. The series 2014A bonds are expected to be fixed rate and is expected to price on Oct. 7.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group. The obligated group accounted for 97% of total revenue and 99% of total unrestricted net assets of the consolidated entity in fiscal 2014 (June 30 year-end). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
LARGE AND DIVERSE HEALTH SYSTEM: Dignity's key credit strength is the size and diversity of its operating profile with a focus on integrating and consolidating its acute care business in each respective market while diversifying its growth in certain business verticals to support population health. Dignity's total revenue base was $10.4 billion in fiscal 2014 and acute care operations are concentrated in California, Arizona, and Nevada.
TRANSFORMATIVE GROWTH STRATEGY UNDERWAY: Dignity has strategic initiatives underway to reposition the organization for a value based reimbursement environment with a focus on integration, growth, and diversification. These strategies are in the areas of brand development, employee engagement, quality and patient experience, aligned economics, physician integration, technology and building capabilities.
BELOW AVERAGE PROFITABILITY AND DEBT METRICS: Including the 2014 financing, Dignity's historical coverage of pro forma maximum annual debt service (MADS) by EBITDA is light at 3.0 times (x) in fiscal 2013 and 2.8x in fiscal 2014, respectively, relative to the 'A' category median of 3.8x. Dignity's light coverage metrics reflect modest operating profitability and elevated leverage position. Fitch notes that profitability was negatively impacted by a drop in provider fees received in fiscal 2014 which should be realized in fiscal 2015.
GOOD BALANCE SHEET: Liquidity metrics are in line with the 'A' category medians with $5.3 billion in unrestricted cash and investments at June 30, 2014 that translated to 192.7 days cash on hand and 104.3% cash to debt.
RATING SENSITIVITIES
MAINTAIN CONSISTENT CASH FLOW: Fitch expects Dignity's operating profitability to rebound in fiscal 2015 as its transformational strategies mature and the system benefits from higher provider fee payments and expanded Medicaid coverage. An inability to improve operating profitability from fiscal 2014 levels would likely result in negative rating pressure.
LIMITED DEBT CAPACITY: Given the system's elevated leverage metrics, Fitch believes Dignity's debt capacity is limited at the current rating level without a commensurate improvement in cash flow and cash position.
CREDIT PROFILE
Dignity Health is a not-for-profit health system with 39 hospitals, 33 of which are located in California, four in Arizona, and three in Nevada. Dignity has over 9,000 affiliated physicians and 530,000 attributable members in its system. In fiscal 2014, unrestricted revenue by service area was 10% for Bay Area, 20% for Greater Sacramento, 5% for North State, 13% for Central California, 8% for Central Coast, 15% for Southern California, 16% for Arizona, 5% for Nevada, 4% for U.S. HealthWorks, and 4% for corporate entities and other. On Aug. 10, 2012, Dignity Health acquired U.S. HealthWorks - a multi-state for-profit operator of occupational health and urgent care centers with 3.5 million visits annually spanning 20 states.
Large and Diverse Health System
Dignity Health's acute care markets are in competitive service areas and the organization has been focused on exiting markets that are underperforming while investing and integrating within its eight existing regions. Dignity divested of St. Mary's in Reno, NV in June 2012 and the organization was also planning on exiting the Southern California market. However, management is recommitted to this region due to its mission and there are several strategies underway to improve the performance of this region, which has been challenged in the past. Dignity's best performing region continues to be Arizona due to its network in the service area and continued payor mix and rates better than expectations.
On Aug. 10, 2012, Dignity Health acquired U.S. HealthWorks, a multi-state for-profit operator of occupational health and urgent care centers. This business line remains a standalone strategy and has been profitable with very strong cash flow. Dignity is focused on increasing its investments in other various healthcare related entities that further diversify its revenue and profitability while supporting population health.
Although still a small percentage of its overall revenue, Dignity has been active in value based contracting and the majority of its agreements only have upside risk. Dignity expects these new payor arrangements to grow in the future with growth expected in direct contracting and patient centered medical homes. A key to the success of this strategy is Dignity's physician alignment and there are various models in place across its regions with a current total of 892 employed providers.
Below Average Profitability
In fiscal 2014, Dignity's operating margin dropped to negative 0.2% from 1.9% the prior year. Part of the decline was due to a lack of provider fee funding in the last half of the fiscal year as well as continued revenue pressure from lower patient volumes. Adjusted patient days increased .5% in fiscal 2014 from the prior year. Provider fee funds have been a key contributor to operating income and management expects these funds to be a permanent funding source. The provider fee was extended for the Jan. 1, 2014-Dec. 31, 2016 period, however, the program is still awaiting approval from the Centers for Medicare and Medicaid Services (CMS) so Dignity was not able to recognize or book an expected $181.5 million of net benefit in fiscal 2014. Including these funds, Dignity would have had a 1.6% operating margin. The net provider fee income booked in fiscal 2014 was $86.8 million compared to $230.2 million in fiscal 2013 and $233.7 million in fiscal 2012 and is expected to total $400 million in fiscal 2015.
Dignity has been able to generate solid and consistent EBITDA margins through strong investment returns. In fiscal 2013 and 2014, Dignity posted EBITDA margins of 11.1% and 10%, respectively which compare favorably with the 'A' category median of 10%. However, due to the system's elevated debt burden, historical coverage of pro forma MADS by EBITDA is light at 3.0x and 2.8x in fiscal 2013 and 2014, respectively compared to the 'A' category median of 3.8x. Fitch used pro forma MADS of $393 million (as provided by management) in its analysis which equates to an elevated 3.8% of fiscal 2014 total revenue.
Good Liquidity
Dignity's balance sheet is solid and growth has been driven by favorable investment returns. Total unrestricted cash and investments was $5.26 billion at June 30, 2014, up from $4.77 billion at FYE 2013 and $4.55 billion at FYE 2012. The investment portfolio is well diversified and liquid with 65% available within one month. Investment strategies are in place to reduce overall volatility.
Debt Profile
Total pro forma outstanding debt is $5.23 billion and is 80% fixed rate and 20% floating rate including its swaps. Dignity has $776.4 million of variable rate demand bonds that are supported by letters of credit that expire between October 2015 and June 2017. Unrestricted cash and investments to demand debt is strong at 6.8x.
Dignity's debt burden is above average. Pro forma MADS increases to $381 million from prior MADS of $339 based on issuance of $430 million of new money borrowing. However, Dignity may issue up to $600 million of new money, which would increase MADS to $393 million. Fitch believes the impact on Dignity's debt ratios between $430 million and $600 million new money is negligible and used the higher MADS figure in its analysis.
Dignity Health has 16 floating to fixed-rate swaps and four fixed-to-floating risk participation agreements. Dignity Health is prohibited from posting collateral on derivative instruments under its Master Trust Indenture.
Manageable Capital Plan
Dignity has been spending almost 1.5x of depreciation expense on capital investments mainly related to seismic requirements as well as its electronic health record. Capital spending totaled $684 million in fiscal 2014 compared to $658 in fiscal 2013 and $671 million in fiscal 2012 and is projected to total $786 million in fiscal 2015 and $650 million in fiscal 2016. Fitch expects capital spending to reduce over the midterm as seismic related projects are near completion.
Disclosure
Dignity covenants to disclose audited annual financial statements and unaudited quarterly results to bondholders. Quarterly condensed financial statements include a consolidated income statement, balance sheet, cash flow statement, and management discussion and analysis. In addition, management hosts quarterly investor calls and posts all financial information on its website at ''.
Outstanding debt:
$75,000,000 Arizona Health Facilities Authority (AZ) (Dignity Health) revenue bonds series 2012A
$140,000,000 California Health Facilities Financing Authority (CA) (Dignity Health) revenue bonds series 2012A
$600,000,000 Dignity Health (CA) taxable bonds series 2012
$75,000,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) variable-rate health facility revenue bonds series 2011C (LOC: Bank of Montreal) & bank bonds
$60,000,000 Arizona Health Facilities Authority (AZ) (Catholic Healthcare West) revenue bonds series 2011B-2
$68,260,000 Arizona Health Facilities Authority (AZ) (Catholic Healthcare West) revenue bonds series 2011B-1
$75,000,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) variable-rate health facility revenue bonds series 2011B (LOC: Bank of Montreal) & bank bonds
$335,895,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) revenue bonds series 2011A
$90,000,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) variable-rate revenue bonds series 2009H
$76,000,000 Arizona Health Facilities Authority (AZ) (Catholic Healthcare West Loan Program) variable-rate bonds series 2009F
$101,255,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) revenue bonds series 2009E
$36,450,000 Arizona Health Facilities Authority (AZ) (Catholic Healthcare West) revenue bonds series 2009D**
$38,410,000 Maricopa County Industrial Development Authority (AZ) (Catholic Healthcare West) health facility revenue bonds series 2009A
$314,115,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2009A**
$20,475,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008L*
$24,850,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008K*
$67,700,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008J*
$19,450,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008I*
$19,325,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008H*
$29,675,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008G
$35,950,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008E
$53,825,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008D
$40,000,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008C
$31,175,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008B
$46,825,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2008A
$36,000,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2007L (insured: Assured Guaranty Corp.)
$54,000,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2007K (insured: Assured Guaranty Corp.)
$80,000,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2007F (insured: Assured Guaranty Municipal Corp.)
$80,000,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2007E (insured: Assured Guaranty Municipal Corp.)
$80,000,000 California Statewide Communities Development Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 2007D (insured: Assured Guaranty Municipal Corp.)
$134,660,000 Henderson (NV) (Catholic Healthcare West) health facility revenue bonds series 2007B
$51,945,000 Reno (NV) (Catholic Healthcare West) health facility revenue bonds series 2007A
$169,585,000 Maricopa County Industrial Development Authority (AZ) (Catholic Healthcare West) health facility revenue bonds series 2007A
$59,600,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) variable-rate demand revenue bonds series 2005I
$140,400,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) variable-rate demand revenue bonds series 2005H
$34,000,000 Arizona Health Facilities Authority (AZ) (Catholic Healthcare West Loan Program) hospital revenue bonds series 2005B
$60,000,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) variable-rate demand revenue bonds series 2004K
$28,805,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health care facilities revenue refunding bonds series 2004G*
$85,335,000 Maricopa County Industrial Development Authority (AZ) (Catholic Healthcare West) health facility revenue bonds series 2004A*
$40,910,000 Henderson (NV) (Catholic Healthcare West) health facility revenue bonds series 2004A*
$22,400,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) health facility revenue bonds series 1997C (insured: MBIA Insurance Corp.)
$30,500,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) auction-rate hospital revenue bonds series 1996G
$20,700,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) auction-rate hospital revenue bonds series 1996D
$37,800,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) variable-rate demand revenue bonds series 1988C
$14,600,000 California Health Facilities Financing Authority (CA) (Catholic Healthcare West) variable-rate demand revenue bonds series 1988B
*bonds to be refunded
**partial refunding
Additional information is available at ''.
Applicable Criteria and Related Research:
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2014
Applicable Criteria and Related Research:
Not-for-Profit Hospitals and Health Systems Rating Criteria
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