APPROXIMATELY $230 MILLION OF RATED BONDS OUTSTANDING
Michigan State Hospital Finance Authority
NEW YORK, Jul 12, 2011 -- Moody's Investors Service has affirmed Sparrow Obligated Group's (Sparrow) A1
bond rating affecting approximately $230 million of rated bonds outstanding
issued through the Michigan State Hospital Finance Authority (see Rated Debt
section at the end of this report). The rating outlook remains stable.
Sparrow is a member of Sparrow Health System (System) and includes 539 staffed
bed Edward W. Sparrow Hospital Association (Sparrow Hospital, located in
Lansing, MI), 25 staffed bed critical access hospital Sparrow Clinton Hospital
(Clinton, located in St. John's, MI), and 25 staffed bed critical access
hospital Sparrow Ionia Hospital (Ionia located in Ionia, MI). Ionia was acquired
by the Sparrow System effective January 2010. Other members of the System
include: (a) Physicians Health Plan of Mid-Michigan (PHPMM), the system's health
maintenance organization (HMO) with approximately 68,000 covered lives
(including approximately 18,000 Medicaid covered lives); (b) Sparrow
Development, Inc. (SDI); (c) Sparrow Specialty Hospital, which provides
long-term acute care hospital services; (d) Home Health Care of Sparrow, Inc.;
and (e) the Sparrow Foundation. The System also has a management arrangement
with 99 licensed bed Carson City Hospital in Carson City, MI, which is 35% owned
by the System.
SUMMARY RATING RATIONALE: The affirmation of the A1 rating and stable rating
outlook reflect Sparrow's continued good operating performance in fiscal year
(FY) 2010, maintenance of strong debt ratios, and improved liquidity ratios.
*The Sparrow System is a sizeable, integrated healthcare system with three
hospital facilities (anchored by the Sparrow Hospital tertiary flagship), an
HMO, and approximately 170 employed physicians.
*According to the Michigan Inpatient Database (provided by management), Sparrow
maintains a distinct market share lead, capturing approximately 57% of the three
county primary service area (PSA) and 42% of the broad eight county total
service area (TSA). Ingham Regional Medical Center (IRMC, a member of Aa3 rated
McLaren Health Care) represents the only material competition and captures
approximately 29% of the PSA and 19% of the TSA.
*Adequate operating margins in FY 2010 (3.7% operating margin and 9.7% operating
cash flow margin) after strong FY 2009 (4.2% operating margin and 10.9%
operating cash flow margin). We note that the operating cash flow margin for
health systems with sizeable health plans tends to be suppressed.
*Good debt coverage ratios with 23% debt-to-total operating revenue, 2.1 times
debt-to-cash flow, 6.1 times maximum annual debt service coverage, and
186% cash-to-debt at fiscal year end (FYE) 2010.
*Continued improved liquidity as cash on hand increased to 173 days at FYE 2010
from 156 days at FYE 2009 and 116 days at FYE 2008.
*Conservative balance sheet with all debt in fixed rate mode, no swaps, and
nearly 60% of unrestricted liquidity allocated to cash and fixed income
*The Lansing area economy is stronger and more stable than much of the rest of
Michigan as the area benefits from being the state capital and home to Michigan
State University, although we note that population trends are stagnant.
*The Sparrow System's frozen defined benefit pension plan is underfunded. As of
FYE 2010 the plan had a pension funded ratio of 70% compared to a projected
benefit obligation of $490 million. We note that the plan was frozen to new
hires starting in 2007 and that Sparrow management has restructured the plan,
which has resulted in reduced pension expense starting May 2011 and balance
sheet savings of approximately $60 million. Management expects to contribute
approximately $44 million to the plan in FY 2011 and approximately
$22-$25 million per year starting in FY 2012.
*While Sparrow maintains a distinct market share lead, IRMC represents material
competition in the area.
*The state economy and associate budget challenges are a concern to Sparrow
given that Medicaid represented 15.8% of System gross revenues in FY 2010 (the
A1 median is 10.9%).
*Large organized labor presence, as management reports that approximately 68% of
System staff is unionized.
DETAILED CREDIT DISCUSSION
LEGAL SECURITY: The bonds are a joint and several general obligation and are
secured by a security interest in the accounts receivable and general
intangibles of the Sparrow Obligated Group. The Sparrow Obligated Group consists
of the Sparrow Hospital flagship and Clinton Memorial Hospital and represents
approximately 83% of System assets and 78% of System operating revenues.
INTEREST RATE DERIVATIVES: None.
The Sparrow System maintains the distinct market share lead in a two
hospital service area. The only other hospital in Lansing is IRMC (a member of
Aa3 rated McLaren Health Care). According to the Michigan Inpatient Database
(provided by Sparrow management), Sparrow captured 57.1% of the three county PSA
in 2010 (up from 55.7% in 2009, 54.9% in 2008, and 52.7% in 2007) and 41.7% of
the broad eight county TSA (up from 38.0% since 2007). IRMC captures
approximately 29% of the PSA and 19% of the TSA. Sparrow is somewhat shielded
from other health systems in communities such as Ann Arbor, Flint, Detroit, and
Grand Rapids, all of which are at least 55 miles from Lansing. Management
attributes Sparrow's increased market share capture in recent years to the
opening of the new patient tower on the Sparrow Hospital flagship campus in 2008
(including new emergency department, operating rooms, and cardiac services) and
recent physician recruits.
The Sparrow System continued to generate good operating results in FY 2010,
although performance dipped from peak performance in FY 2009. In audited FY
2010, the System recorded adjusted operating income of $39.3 million (3.7%
operating margin, adjusted to reclassify capitalized interest as an operating
expense) and operating cash flow of $103.8 million (9.7% operating cash flow
margin). In FY 2009, the System recorded adjusted operating income of $41.7
million (4.2% margin) and operating cash flow of $107.7 million (10.9% margin).
In FY 2008, the System recorded an adjusted operating margin of 0.04% and
operating cash flow margin of 6.9%. The A1 median operating cash flow margin is
Management reports that FY 2010 benefited from the following: (a) a 1.4%
increase in inpatient admissions (3.4% factoring observation stays) and 0.3%
rise in total surgeries, which contributed to Sparrow's aforementioned market
share growth; (b) productivity improvements as management continues to focus on
reducing full-time equivalents per adjusted occupied bed; (c) increased acuity
as the Medicare case mix index increased from 1.44 in FY 2008 to 1.50 in FY 2009
to 1.62 in FY 2010; (d) continued efforts to improve the System's quality
scores; and (e) the Lansing area received a wage area reclassification from
Medicare that is helping to offset the industry-wide 0.4% net rate cut
from Medicare for inpatient services in federal fiscal year 2011. Factors in FY
2010 offsetting these favorable trends include: (a) a 5.0% increase in combined
charity care and bad debt in FY 2010 (following a 17.8% increase in FY 2009);
and (b) the average length of stay (ALOS) increased from 4.80 days in FY 2009 to
4.99 days in FY 2010.
Looking forward, management projects the Sparrow System to achieve a 3.9%
operating margin and 9.8% operating cash flow margin in FY 2011. According to
management, through five months FY 2011, the System recorded an adjusted
operating margin of 3.3% and operating cash flow margin of 9.2%, compared to
3.7% and 9.8%, respectively, for the same period FY 2010. Management notes that
the System's hospital operations continue to perform well in interim FY
2011, but PHPMM is off budget as demonstrated by premium revenue through
five months FY 2011 is 1.4% above same period FY 2010 but 11.5% below plan
(management notes that PHPMM tends to perform better in the second half of the
year). According to management, improvement efforts in FY 2011 include: (a)
continued focus on reducing ALOS (through five months FY 2011 ALOS is down from
4.89 days to 4.78 days); (b) the System's 2011 pension expense is expected to be
reduced from a budget of $27 million to approximately $17 million due to
aforementioned pension plan changes (starting May 2011); and (c) a Medicaid
rebasing in the state is expected to provide an additional $3.5 million annual
net to the System (starting July 2011).
Due to cash flow generation, investment returns, and lower accounts receivable
days, the Sparrow System's absolute unrestricted cash and investments increased
to $460 million at FYE 2010 from $381 million at FYE 2009 and $277 million at
FYE 2008. As a result, cash on hand improved to a more adequate 173 days at FYE
2010 from 156 days at FYE 2009 and 116 days at FYE 2008 (A1 median is 182 days).
According to management, at FYE 2010, approximately 60% of the System's
unrestricted cash and investments were allocated to cash and fixed income
securities, 35% to equities, and 5.5% to hedge funds, and approximately 95% of
unrestricted cash and investments could be liquidated within one month. Despite
making the bulk of pension contributions in the first five months of FY 2011,
according to management, the System's unrestricted cash and investments
increased further to $490 million at May 31, 2011, resulting in further growth
in cash on hand to 183 days.
Due to adequate cash flow and low debt load, the Sparrow System's Moody's
adjusted debt coverage ratios are good at the A1 rating level. Based on audited
FY 2010 results, the System's adjusted debt-to-cash flow measures a favorably
low 2.1 times (A1 median is 3.2 times), adjusted maximum annual debt service
(MADS) coverage measures a good 6.1 times (A1 median is 5.1 times),
debt-to-total operating revenue measures a low 23% (A1 median is 39%), and
cash-to-debt measures a strong 186% (A1 median is 130%).
The Sparrow System has approximately $73 million of capital spending budgeted
for FY 2011. While management is in the process of updating the System's five
year capital plans, highlighted current and expected projects include continued
installation of an electronic medical record system, build-out of the remaining
four floors of shelled space at the new patient tower (for which the System has
applied for state certificate of need approval), and consolidation of operating
rooms. Management is considering debt options to support a portion of these
The stable rating outlook reflects Sparrow's continued good
operating performance in FY 2010, maintenance of strong debt ratios, and
improved liquidity ratios.
WHAT COULD MAKE THE RATING GO UP
Maintenance of distinct market share lead; sustained elevated cash flow
generation and operating margins leading to maintenance of strong debt ratios;
continued increase in liquidity ratios
WHAT COULD MAKE THE RATING GO DOWN
Significant market share decline; reversion to weaker operating margins as
recorded in FY 2008 and commensurately weaker debt ratios; material weakening of
liquidity ratios; material increase in debt without commensurate increase in
cash flow and cash
Assumptions & Adjustments:
-Based on Sparrow Health System consolidated financial statements
-First number reflects audited FY 2009 for the year ended December 31, 2009
-Second number reflects audited FY 2010 for the year ended December 31, 2010
-Capitalized interest reclassified as an operating expense
-Investment returns normalized at 6%
*Inpatient admissions: 33,554; 34,013
*Total operating revenues: $989 million; $1.06 billion
*Moody's-adjusted net revenues available for debt service: $130.6 million;
*Total debt outstanding: $258 million; $248 million
*Maximum annual debt service (MADS): $22.0 million; $22.0 million
*MADS Coverage with reported investment income: 4.05 times; 5.88 times
*Moody's-adjusted MADS Coverage with normalized investment income: 5.94 times;
*Debt-to-cash flow: 2.20 times; 2.06 times
*Days cash on hand: 156 days; 173 days
*Cash-to-debt: 148%; 186%
*Operating margin: 4.2%; 3.7%
*Operating cash flow margin: 10.9%; 9.7%
Issued through Michigan State Hospital Finance Authority (debt outstanding as of
December 31, 2010):
-Series 2007 Fixed Rate Hospital Revenue Bonds ($138.9 million outstanding),
-Series 2005 Fixed Rate Hospital Revenue Bonds ($87.3 million outstanding),
insured by MBIA, unenhanced rating of A1
-Series 2001 Fixed Rate Hospital Revenue Bonds ($4.8 million outstanding), rated
Obligor: Paula Reichle, CFO, (517) 364-5405; Gary Reetz, Controller, (517)
Underwriter: Kathleen Costine, RBC Capital Markets, (212) 618-5598
PRINCIPAL METHODOLOGY USED
The principal methodology used in this rating was Not-for-Profit Hospitals and
Health Systems published in January 2008.
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.
Please see ratings tab on the issuer/entity page on Moodys.com for the last
rating action and the rating history.
The date on which some Credit Ratings were first released goes back to a time
before Moody's Investors Service's Credit Ratings were fully digitized and
accurate data may not be available. Consequently, Moody's Investors Service
provides a date that it believes is the most reliable and accurate based on the
information that is available to it. Please see the ratings disclosure page on
our website www.moodys.com for further information.
Please see the Credit Policy page on Moodys.com for the methodologies used in
determining ratings, further information on the meaning of each rating category
and the definition of default and recovery.
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.
Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.
The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.
Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.
Public Finance Group
Moody's Investors Service
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Moody's Investors Service
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MOODY'S AFFIRMS SPARROW OBLIGATED GROUP'S (MI) A1 BOND RATING; OUTLOOK REMAINS STABLE
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