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TMCNet:  Fitch Upgrades Stanford Hospital & Clinics, CA's Revs to 'AA'; Outlook Revised to Stable

[July 21, 2014]

Fitch Upgrades Stanford Hospital & Clinics, CA's Revs to 'AA'; Outlook Revised to Stable

CHICAGO --(Business Wire)--

Fitch Ratings has upgraded to 'AA' from 'AA-' and to 'AA/F1+' from 'AA-/F1+' the ratings on the respective California Health Facilities Financing Authority's revenue bonds issued on behalf of Stanford Hospital & Clinics (SHC), which are listed at the end of this press release.

The Rating Outlook is revised to Stable from Positive.

SECURITY

Debt payments are secured by a gross revenue pledge of the obligated group.

KEY RATING DRIVERS

CONSISTENT FINANCIAL STRENGTHENING: The upgrade to 'AA' from 'AA-' reflects SHC's improving operating profitability, robust debt service coverage, growing liquidity and strong philanthropic support on their hospital replacement project. Operating margin of 10.3% at Feb. 28, 2014 (six month interim), is more than double the 'AA' category median of 4.2% and operating EBITDA of 15.5% during the same time period is also significantly above the category median of 11.8%. Fitch believes the reduction in development risk associated with its hospital replacement project in conjunction with a stronger financial profile and exceptional qualitative attributes warrants the upward rating movement.

RELATIONSHIP WITH STANFORD UNIVERSITY: Fitch views SHC's close and collaborative relationship with Stanford University (rated 'AAA'; Stable Outlook) and Lucile Packard Children's Hospital (rated 'AA'; Stable Outlook) as a positive credit factor. Stanford University is the sole corporate member of SHC and Lucile Packard Children's Hospital. Although the entities have separate boards and leadership teams, the coordination between the organizations in research, fundraising and clinical and educational activities are accretive to SHC's credit profile.

EXCELLENT CLINICAL AND RESEARCH REPUTATION: SHC's strong reputation and brand recognition for excellent tertiary and quaternary care and state of the art clinical research conducted by faculty physicians is a key credit strength as it increases its geographic footprint in the Bay Area and beyond. SHC is leveraging its information technology resources to partner with nine major Silicon Valley corporations, providing on-site and near-site clinics and telemedicine for employees around the world.

GROWTH STRATEGY: SHC is investing in near-term growth in certain strategic clinical services in which it has demonstrated distinction. The strategic plan also calls for strengthening local market presence and promoting growth in higher acuity inpatient and outpatient procedures. SHC signed a letter of intent to affiliate with ValleyCare Medical Center, which Fitch views positively as it will expand SHC's outreach to the Tri-Valley service area. Fitch believes this strategy should serve SHC well in the large and highly competitive San Francisco Bay Area and in attracting patients both nationally and internationally.

CONSTRUCTION PROGRESS: SHC's $2.5 billion master facility plan is underway and on schedule. The new facility is expected to open in 2018 and Fitch anticipates construction to continue on time and within budget.

RATING SENSITIVITIES

CONTINUED SOLID FINANCIAL PERFORMANCE: SHC's overall financial profile is strong and financial performance is expected to remain in line with 'AA' category medians. Fitch notes that there may be near term softening of certain liquidity metrics due to the remaining funding of its master facility plan however, the impact of this is expected to be temporary.

CREDIT PROFILE

Stanford Hospital and Clinics (SHC) is a principal teaching affiliate of the Stanford University's School of Medicine. SHC, together with Lucile Salter Packard Children's Hospital at Stanford operates clinical settings through which the School of Medicine educates medical and graduate students, trains residents and clinical fellows, supports faculty and community clinicians and conducts medical and biological sciences research. SHC's close relationship with Stanford University and its School of Medicine generates certain reputational and clinical benefits that are unique in the service area and are important for recruitment. SHC operates a 613 licensed bed tertiary, quaternary and specialty hospital, and the primary, specialty and sub-specialty clinics in which the medical faculty of the School of Medicine provide clinical services. The hospital and a majority of the clinics are located on the campus of Stanford University adjacent to the School of Medicine in Palo Alto, California.

SHC has embarked on a six-year, $2.5 billion capital plan to replace, expand, and renovate major portions of the main hospital campus in order to address California's seismic mandates. The remaining spend totals $2.3 billion and is expected to be funded from debt, operating cash flow, investment income and philanthropy. Total debt contemplated for the project is $600 million, $500 million has been issued and $100 million is being contemplated in 2016, which Fitch believes SHC can absorb at the current rating level. Construction of the new hospital began in 2012 and is scheduled to be completed in 2017, with transition to the new hospital anticipated to occur through 2018. Currently, construction is on time and on budget. Fitch believes the development risk has been mitigated by a signed guaranteed maximum price contract ($807.6 million) an SHC's experienced construction team. Upon completion of the project, SHC's bed capacity, including both the new hospital and the renovated portions of the existing hospital, will be approximately 600 patient beds. In fiscal year 2013, SHC had $2.7 billion in total operating revenue.

SOLID FINANCIAL PROFILE

The upgrade to 'AA' from 'AA-' is supported by continued robust operating performance, growing liquidity position and very healthy debt service coverage metrics.

Due to standardization, and adherence to LEAN methodology, operating profitability metrics all well exceed the 'AA' category medians. Operating EBITDA of about $393.7 million (14.5% operating EBITDA margin) and income from operations of $252.8 million (9.3% operating margin) in fiscal 2013 compare favorably to the respective 'AA' category medians of 11.8% and 4.2%. Strong performance continued through the six months ended Feb. 28, 2014, with 15.5% operating EBITDA and 10.3% operating margin. Continued growth in high acuity outpatient and inpatient volumes combined with coordinated-care efforts and attention to process improvements has generated improved profitability, which resulted in a strengthening of cash reserves.

SHC's strong revenue growth and robust cash flow generation resulted in strong debt service coverage. Maximum annual debt service (MADS) of $73.9 million is a moderate 2.7% of total fiscal 2013 operating revenue as compared to Fitch's 'AA' median of 2.6%. Coverage of MADS by EBITDA in 2013 was a very strong 5.5x compared to 5.3x in fiscal 2012 and 4.4x in fiscal 2011. Coverage improved further through February 28, 2014 (six month interim) at 6.3x, well exceeding the 'AA' category median of 4.8x. Including the potential $100 million of additional debt in 2016, MADS is projected to increase to $82.4 million.

As of Aug. 31, 2013, total debt (including $100 million series 2012D direct placement not rated by Fitch) was approximately $1.27 billion and includes $228.2 million or about 18% in variable-rate bonds backed by SHC's self-liquidity. In recent years, SHC undertook several financing actions to restructure its debt profile and lower its variable-rate bond put risk, which Fitch views favorably. In February 2014, SHC terminated two swaps, leaving four swaps outstanding and decreasing the notional amount to $577.2 million from about $745 million. The counterparties on the swaps are diversified but certain aggregate collateral thresholds do exist.

Liquidity remains somewhat mixed but has grown year-over-year for the last five years. Unrestricted cash and investments equaled $1.81 billion in fiscal 2013, a 13% improvement from the prior year and nearly double SHC's unrestricted cash position of $894.1 million at fiscal 2009 year-end. At Feb. 28, 2013 (six month interim), unrestricted cash and investments equaled $1.86 billion, translating to 273.8 days cash on hand, 142.8% cash to debt and 25.2x cushion ratio compared to the 'AA' respective category medians of 254.3 days, 173.6% and 23.4x.

STRATEGIC GROWTH

Fitch believes SHC's strategic plan is a strong base for sustained profitability and market share growth over the long term. The strategy builds on SHC's strength and excellence in five strategic clinical service lines: cardiac, cancer, transplantation, orthopedics, and neurosciences. The plan's goals are to strengthen SHC's outpatient subspecialty presence in selected local markets and to simultaneously increase its share of patient care volume and revenue derived from higher-complexity tertiary and quaternary cases in regional, state, and national markets. SHC continues to focus on providing the premier patient experience, developing virtual care and providing an innovative and service-oriented approach to care. In January 2011, and in support of regional growth strategy, SHC and Stanford University, acting on behalf of its School of Medicine, formed United Healthcare Alliance (UHA) to operate clinics staffed by a network of community-based physicians complementing the faculty practice clinics operated by SHC and staffed by members of the faculty of the School of Medicine. UHA continues to expand its membership of community physicians throughout the Bay Area.

SHC and ValleyCare Health System signed a non-binding letter of intent to affiliate in May 2014. If the transaction moves forward as anticipated, ValleyCare Health System and its hospitals in Pleasanton and Livermore would become a subsidiary of SHC and ValleyCare would retain its medical staff and its physician organization would be integrated with Stanford's University Healthcare Alliance. Fitch views this affiliation positively as it would increase SHC footprint in the east Bay/ Tri-Valley service area.

SELF-LIQUIDITY

The assignment and affirmation of the 'F1+' short-term ratings are supported by the adequacy of SHC's highly liquid resources available to fund any un-remarketed puts on the $228.2 million series 2012C, 2008B1, and 2008B-2 VRDBs. Based on Fitch's rating criteria related to self-liquidity, SHC'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. SHC has liquidation procedures in place detailing the process by which internal funds would be liquidated to meet the tender obligations.

DISCLOSURE

SHC covenants to provide annual audited financial and utilization data within 150 days of each fiscal year-end, quarterly un-audited financial and utilization data within 60 days of each fiscal quarter-end and monthly liquidity disclosure by the 15th of each month. Quarterly disclosure includes balance sheet, income statement, and statement of cash flows.

Fitch affirms the following California Health Facilities Financing Authority outstanding debt:

--$69,485,000 refunding revenue bonds, series 2008A-1, upgraded to 'AA' from 'AA-';

--$102,775,000 C refunding revenue bonds, series 2008A-2, upgraded to 'AA' from 'AA-';

--$83,065,000 refunding revenue bonds, series 2008A-3, upgraded to 'AA' from 'AA-';

--$140,200,000 refunding revenue bonds, series 2010A, upgraded to 'AA' from 'AA-';

--$146,710,000 refunding revenue bonds, series 2010B, upgraded to 'AA' from 'AA-';

--$84,100,000 variable rate refunding revenue bonds, series 2008B-1, upgraded to 'AA/F1+' from 'AA-/F1+';

--$84,100,000 variable rate refunding revenue bonds, series 2008B-2, upgraded to 'AA/F1+' from 'AA-/F1+';

--$340,000,000 revenue bonds, series 2012A upgraded to 'AA' from 'AA-';

--$63,550,000 variable rate revenue bonds, series 2012B,upgraded to 'AA/'F1+' from 'AA-'/F1+';

--$60,000,000 variable rate revenue bonds, series 2012C, upgraded to 'AA/'F1+' from 'AA-'/F1+'.

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

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 30, 2014;

--'Revenue-Supported Rating Criteria', dated June 16, 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

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=840758

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.


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