[October 21, 2016]

Fitch Affirms Anne Arundel Health System (MD) at 'A-'; Outlook Stable

Fitch Ratings has affirmed the ratings on the following series of bonds issued by the Maryland Health and Higher Educational Facilities Authority (MHHEFA) on behalf of Anne Arundel Health System (AAHS) at 'A-'.

-- $122,580,000 series 2014 fixed -rate bonds

-- $67,380,000 series 2012 fixed-rate bonds;

-- $76,430,000 series 2010 fixed-rate bonds;

-- $60,000,000 series 2009B variable-rate demand bonds (letter of credit: Bank of America).

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group and a mortgage on certain property.

KEY RATING DRIVERS

SOLID PROFITABILITY: The maintenance of the 'A-' rating is based on AAHS's solid and stable profitability over the last three years, moderating debt burden and substantial market share in a market with favorable demographic characteristics. The solid operating profile is partially due to the benefit of AAHS's participation in Maryland's Global Budget Revenue (GBR) program starting with July 1, 2013, which provides a regulated revenue stream and results in a certain level of financial predictability and stability.

MODERATING DEBT BURDEN: Debt burden is still slightly higher than the median, but is slowly moderating. Maximum annual debt service (MADS) coverage by EBITDA was adequate at 3.6x in fiscal 2016 and MADS as percent of revenues is manageable at 3.6%. Management does not expect a material increase in debt from the planned construction of a freestanding mental health hospital, based on the expectation that it would require only a relatively small debt issuance.

ADEQUATE BUT VARIABLE LIQUIDITY LEVELS: Liquidity levels are generally below Fitch's 'A' category medians and exhibit variability related to AAHS's significant collateral posting requirements under its swap. Unrestricted cash and investments totaled $328.3 million at June 30, 2016 (net of the $69.3 million of collateral posting) representing 197.3 days cash on hand (DCOH), 13.6 cushion ratio and 79.5% cash-to-debt.

JOHNS HOPKINS AFFILIATION: AAHS's ongoing strategic alliance with Johns Hopkins Health System (revenue bonds rated 'AA-'/Stable) is an additional positive credit factor which yields benefits related to physician recruitment, development of clinical programs, and cost containment initiatives. A CON for an open-heart program in collaboration with Johns Hopkins is expected to be ruled on before the calendar year-end.

SOLID MARKET SHARE IN FAVORABLE SERVICE AREA: Market share is solid, most recently reported at 67.4% in the primary service area of Anne Arundel County (rated 'AA+') with strong underlying demographic characteristics. The hospital is experiencing capacity issues and just opened a 30-bed inpatient unit in a shelled in space, for which it had a CON approval. The strong volumes are considered a market shift under GBR, and AAHS will be compensated for the increase in volumes under GBR.

RATING SENSITIVITIES

FURTHER IMPROVEMENT IN FINANCIAL PROFILE: Anne Arundel Health System's continued improvement in balance sheet, resulting in moderating leverage and strengthening cushion and cash-to-debt metrics to levels more consistent with the 'A' category medians, would lead to upward rating movement.

CREDIT PROFILE

Anne Arundel Health System, headquartered in Annapolis, MD, operates a 384-licensed bed acute care general hospital and several outpatient facilities in its primary service area of Anne Arundel County. The system generated total operating income of $635.7 million in fiscal 2016, a 13% increase since 2014 year-end.

AAHS is the leading provider in a favorable service area, with a steady inpatient market share. Management has been successfully implementing its strategic expansion plans via growing select service lines and physician base.

Solid Profitability

AAHS has been operating under the Maryland GBR program since fiscal 2014. Currently in a five-year pilot period, the GBR program offers participants a fixed revenue stream designed to reimburse hospitals for avoiding unnecessary admissions and managing care in the most appropriate cost setting. The amount of hospital revenue is known before the start of the fiscal year, providing a level of predictability, and is adjusted annually. For fiscal 2016, the hospital's gross regulated revenue totaled $576 million (before contractual adjustments), equal to 86% of its total revenue for that year. Regulated revenues are projected at $592 million in 2017.

Operating performance since the implementation of GBR has been solid and stable. The 2015 and 2014 fiscal years (year-end June 30) ended with operating income of $25 million and $25.4 million, respectively. Operating income for 2016 equated to operating and operating EBITDA margins of 3.8% and 11%, both consistent with Fitch's respective category medians of 3.8% and 10.3%. Although continued enhancements to rate adjustment methodology are expected, Fitch believes GBR provides AAHS with increased stability during the transition to value-based care. Management is budgeting operating income of $24.6 million (3.5% operating margin) for fiscal 2017, which Fitch believes is achievable.

Liquidity Growth Limited

At June 30, 2016, unrestricted cash and investments totaled $328.3 million, which equated to 197.3 days cash on hand, 13.6 cushion ratio and cash equal to 79.5% of debt, all lower than Fitch's respective 'A' medians of 215.5 days, 19.4x and 148.6%. Absolute liquidity has remained flat with 2014 and DCOH were lower due to increased expense base of the growing enterprise and investment losses. Additionally, capital spending was higher in 2015 compared to historical levels. AAHS has a low swap-posting threshold and was posting $69.3 million at June 30, 2016, which continues to pressure liquidity metrics. The swap is long-dated with a final maturity of 2048.

Moderating Debt Burden

At fiscal year-end 2016, AAHS had $412.8 million in total debt outstanding, of which $326.4 million is revenue bonds and the remainder non-obligaed group, nonrecourse bank loans. Of the bonds; $60 million is in variable-rate demand bonds supported by a letter of credit that expires July 2020. Approximately 82% of AAHS's debt is in fixed-rate mode. Fitch uses maximum annual debt service (MADS) of $24.2 million, which incorporates the fixed swap rate on the variable-rate debt and the bank loans.

AAHS's debt burden has been moderating but is still below category medians, with MADS as a percentage of revenues at 3.6%, down from 4.5% in 2014 and debt-to-EBITDA at 4.7%, compared with the respective 'A' medians of 2.7%% and 2.9x. As a result, MADS coverage has improved to 3.6x at fiscal 2016 year-end, as compared to 4.5x for the category median. AAHS has applied for a CON to construct a 16-bed mental health hospital adjacent to its Pathways substance abuse facility. The cost is estimated at approximately $25 million, but it will be offset by philanthropy, as well as par and coupon savings that might be realized from refunding of existing debt. While it will likely require some issuance of debt, management does not anticipate a material increase in their debt level. Construction would not start before fall of 2017.

AAHS has a fixed payor swap with notional par of $180 million, which was novated in April 2016 with Wells Fargo (News - Alert) assuming the first five years with no collateral posting and Citi remaining on the swap to maturity. The swap restructuring resulted in reduction of collateral posting by $29.2 million. At Aug. 31, 2016, the swaps had a marked-to-market value of negative $79.6 million.

Disclosure

AAHS discloses annual financial statements within 120 days and quarterly unaudited financial statements within 45 days after the end of the first three quarters and no later than 60 days after the end of the fourth fiscal quarter through the MSRB EMMA website. Financial statements include an income statement, balance sheet, flow of funds, utilization data and management discussion and analysis.

Additional information is available at www.fitchratings.com.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)

https://www.fitchratings.com/site/re/866807

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013553

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013553

Endorsement Policy

https://www.fitchratings.com/regulatory

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEB SITE AT 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.

Copyright (c) 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.

The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.

For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.

View source version on businesswire.com: http://www.businesswire.com/news/home/20161021005960/en/

[ Back To TMCnet.com's Homepage ]