A1 RATING APPLIES TO $519.8 MILLION OF OUTSTANDING DEBT
North Carolina Medical Care Commission
Health Care-Hospital
NC
Opinion
NEW YORK, Jun 24, 2011 -- Moody's Investors Service has affirmed the A1 underlying rating assigned to
University Health Systems of Eastern Carolina's (UHSEC) $519.8 million of
outstanding bonds, which were issued by the North Carolina Medical Care
Commission. The outlook remains stable. Our review is in conjunction with an
upcoming private placement issue that will add $50 million of new debt to the
system.
SUMMARY RATING RATIONALE
The A1 rating is based on the continuation of UHSEC's trend of
favorable operating performance; growing cash levels and increasing
distance from the minimum days cash on hand covenant required in UHSEC's
Letters of Credit (LOC); and UHSEC's leading market share position, strong
reputation, and expanding presence in eastern North Carolina. These favorable
attributes are offset by UHSEC's exposure to put risk associated with several
liquidity facilities and long mode put bonds. The stable outlook reflects our
expectation that sound operating margins will continue to be driven by favorable
operations at the flagship Pitt County Memorial Hospital (PCMH), which should
offset weaker performance at the system's smaller hospitals.
STRENGTHS
*Strong brand name recognition and reputation in eastern North Carolina, as
evidenced by a dominant market share in the primary service area (79.6% in
2010), as well as a strong market share in the broader 29 county service area
(29.6% in 2010); UHSEC serves as the academic medical center for East Carolina
University's (rated Aa2/stable outlook) Brody School of Medicine
*Slight improvement in financial performance in fiscal year (FY) 2010 as the
operating cash flow margin grew from 9.8% in FY 2009 to 10.3% in FY 2010.
Through the first six months of FY 2011 (the period ending March 31, 2011), the
operating cash flow margin held steady at 10.5%, largely due to additional bed
capacity at PCMH's new bed tower and the success of initiatives to control
salary and benefit costs
*Satisfactory debt coverage ratios, including 3.6 times maximum annual debt
service (MADS) coverage in FY 2010 (an improvement from 3.2 times in FY 2009)
and debt to cash flow of 4.9 times in FY 2010 (also an improvement from 5.8
times in FY 2009)
*Continued growth in liquidity, with $431.8 million in unrestricted cash at
fiscal year end (FYE) 2010 (an increase from $366.8 million at FYE 2009)
equating to 131 days cash on hand (an increase from 116 days cash at FYE 2009);
management expects to end FY 2011 (September 30, 2011) with $471 million in cash
*Very liquid asset allocation with 100% of investments available within a month;
defined benefit pension plan was frozen effective January 2010, which should
help limit impairment to the balance sheet
CHALLENGES
*Relatively reliant on Medicaid (19% of gross revenues in FY 2010 compared to a
FY 2009 median of 11% for all rated hospitals) reflecting the academic role of
UHSEC and its location in eastern North Carolina; PCMH is one of only two
hospitals in the state that receives cost based Medicaid reimbursement, which we
view favorably
*Economic downturn in some of the rural areas of the 29 county service area
resulted in weaker financial performance at UHSEC's smaller hospitals, creating
greater pressure on the flagship (PCMH) to compensate in order to maintain the
long track record of stable performance. Management notes that volumes at the
smaller hospitals increased slightly (0.9%) in the first six months of FY 2011,
which partially reflects the addition of a new hospital (Duplin General
Hospital, described below) in October 2010
*$50 million direct loan with Bank of America (rated Aa3/rating under review for
possible downgrade) will increase UHSEC's debt levels and exposure to put risk
(the Series 2011 bonds have a 7-year put date) and interest rate risk associated
with variable rate debt (UHSEC will pay 65% of one month LIBOR plus 85 basis
points to Bank of America)
*UHSEC will need to address two long-dated put bonds due in December 2013 and
December 2014 (both were issued in 2008 and total $78 million); likewise, the
LOC from Bank of America that supports the tender feature of the Series 2008A-1
and A-2 bonds expires in December 2013 (which represents an extension from its
original expiration date of December 2011), and the LOC from Branch Banking
& Trust (rated A1/stable outlook) that supports the tender feature of the
Series 2008B-1 and B-2 bonds expires in December 2015
CREDIT DISCUSSION
LEGAL SECURITY: Security interest in its Accounts and all proceeds thereof of
the Obligated Group (UHSEC and PCMH). There is also a "lock box"
provision requiring all "Gross Receipts" to be deposited with the
Master Trustee upon its request upon the occurrence and continuation of an Event
of Default under the Master Trust Indenture. There is no mortgage pledge.
INTEREST RATE DERIVATIVES: UHSEC has one outstanding floating to fixed rate swap
with a notional amount of $223.5 million. UHSEC pays a fixed rate of 3.542% to
the counterparty (Citigroup, rated A3/rating under review for possible
downgrade) in exchange for variable rate payments equal to 62% of one month
LIBOR plus 30 basis points. As of May 31, 2011, the mark to market valuation was
- $22.1 million (negative to UHSEC). Approximately $7 million of collateral was
posted ($15 million threshold); swap collateral is excluded from the days cash
on hand computation.
RECENT DEVELOPMENTS/RESULTS
Since our last review, UHSEC has expanded its presence in its service area in
eastern North Carolina. In October 2010, UHSEC entered into a lease-based
affiliation with Duplin General Hospital, bringing the total number of UHSEC
facilities to 7 (the flagship PCMH and 6 small rural hospitals, including Duplin
General). UHSEC also plans to enter into a lease-based affiliation with
Beaufort County Hospital, a 142 bed facility located in eastern North
Carolina. To finance this lease, UHSEC will issue $50 million of bonds to be
directly purchased by Bank of America in June 2011. The new borrowing will
slightly increase debt levels and slightly decrease debt service coverage. FY
2010 net revenues provided 3.59 times maximum annual debt service (MADS)
coverage, but factoring in the additional debt, FY 2010 net revenues would
provide a lower but still sound MADS coverage of 3.37 times. We expect
debt levels to remain manageable as no additional borrowing is planned in
the near term.
The affirmation of the A1 rating and the maintenance of the stable
outlook reflects continued growth in liquidity and the distance from the 75
days cash covenant required under the two LOC agreements and the Series
2011 bonds. At the time of our last review, UHSEC had 113 days cash on hand
(measured on June 30, 2010), which was 38 days (or $125 million) above the
covenant. By FYE 2010 (September 30, 2010), days cash grew to 131 days, which
was 56 days above the covenant. Days cash has since declined to 119 days (as of
March 31, 2011) but management expects days cash to increase to 128 days by FYE
2011. Cash to puttable debt (which includes the Series 2008A-1, A-2, B-1,
and B-2 variable rate issues, as well as the Series 2008E-1 and E-2 long mode
put bonds) grew from 118% at FYE 2009, to 138% at FYE 2010, to 140% on March 31,
2011. Factoring in the current $50 million borrowing, cash to puttable debt
would equal a lower, but still satisfactory, 120% based on the cash position at
March 31, 2011.
Financial performance improved in FY 2010 with a 10.3% operating cash flow
margin, an increase from 9.8% in FY 2009. Through the first six months of FY
2011 (ending March 31, 2011), performance remained stable with a 10.5% operating
cash flow margin. Strengthened performance in recent years reflects volume
increases at PCMH (largely due to the increase in bed capacity following the
January 2009 opening of the newly constructed tower), reductions in the length
of stay, and cost cutting initiatives, particularly those related to salaries
and benefits. We expect performance to remain stable over the near term, as past
performance has demonstrated, due in part to the lack of formidable
competition in the expansive service area.
Outlook
The stable outlook reflects UHSEC's stable financial operations and
improved liquidity. We expect these trends to continue despite the
additional $50 million borrowing and depressed margins at the system's
smaller hospitals in the more economically stressed areas of eastern North
Carolina.
What would change the rating - UP
Material improvement in liquidity; stable financial performance; no erosion of
market share
What could change the rating - DOWN
Material decline from current cash balances; substantial weakening of operating
cash flow; any immediate liquidity payment triggered by an event of default on
the bank letters of credit
KEY INDICATORS
Based on audited financial statements for University Health Systems of East
Carolina
-First number reflects audit year ended September 30, 2009
-Second number reflects audit year ended September 30, 2010
-Investment returns normalized at 6%
-Bad debt expense is reclassified as an operating expense
Inpatient admissions: 54,560; 56,622
Total operating revenue: $1.245 billion; $1.311 billion
Net revenues available for debt service: $122.1 million; $138.0 million
Days cash on hand: 116.0; 130.7
Debt to cash flow: 5.8 times; 4.9 times
Maximum annual debt service (MADS): $38.4 million; $38.4 million
Moody's adjusted MADS coverage: 3.2 times; 3.6 times
MADS coverage based on reported investment returns: 2.2 times; 3.4 times
Total debt outstanding: $545 million; $532 million
Operating cash flow margin: 9.8%; 10.3%
Operating margin: 2.2%; 2.5%
RATED DEBT (issued through the North Carolina Medical Care Commission) (amounts
outstanding as of September 30, 2010)
-Series 1998A (fixed rate), $8.1 million outstanding, A1 underlying rating
-Series 1998A (fixed rate), $4.9 million outstanding, A1 underlying rating
-Series 2008A-1 and A-2 (variable rate demand bond), $112.1 million outstanding,
Aa1/VMIG1 enhanced rating (based on LOC with Bank of America that expires
December 10, 2013), A1 underlying rating
-Series 2008B-1 and B-2 (variable rate demand bond), $123.1 million outstanding,
Aa2/VMIG1 enhanced rating (based on LOC with BB&T that expires December 1,
2015), A1 underlying rating
-Series 2008C (fixed rate), $74.2 million outstanding, A1 underlying rating
-Series 2008D (fixed rate), $119.7 million outstanding, A1 underlying rating
-Series 2008E-1 (5 year term bond expires December 1, 2013), $22.4 million
outstanding, A1 underlying rating
-Series 2008E-2 (6 year term bond expires December 1, 2014), $55.3 million
outstanding, A1 underlying rating
CONTACTS
Issuer: Jack Holsten, Chief Financial Officer, UHSEC, (252) 847-4582
PRINCIPAL METHODOLOGY
The principal methodology used in this rating was Not-For-Profit Hospitals and
Health Systems, published in January 2008.
REGULATORY DISCLOSURES
Information sources used to prepare the credit rating are the following: parties
involved in the ratings, parties not involved in the ratings, public
information, confidential and proprietary Moody's Investors Service information,
and confidential and proprietary Moody's Analytics information.
Moody's Investors Service considers the quality of information available on the
credit satisfactory for the purposes of maintaining a credit rating.
Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.
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Analysts
Rachel Cortez
Analyst
Public Finance Group
Moody's Investors Service
Lisa Goldstein
Backup Analyst
Public Finance Group
Moody's Investors Service
Contacts
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New York, NY 10007
USA
MOODY'S AFFIRMS A1 UNDERLYING RATING ON UNIVERSITY HEALTH SYSTEMS OF EASTERN CAROLINA'S (NC) OUTSTANDING BONDS; OUTLOOK REMAINS STABLE
