AFFIRMATIONS AFFECT TOTAL OF $301 MILLION OF RATED DEBT OUTSTANDING
Regents of the University of Michigan
Health Care-Hospital
MI
Opinion
NEW YORK, Oct 20, 2010 -- Moody's Investors Service has affirmed the Aa2 and Aa2/VMIG1 ratings assigned to
The University of Michigan Hospitals' (UM Hospitals) $301 million of outstanding
debt issued by the Regents of the University of Michigan (see RATED DEBT section
below). The outlook remains stable.
RATING RATIONALE
LEGAL SECURITY: The bonds are secured by the Hospital Gross Revenues, as defined
in the bond documents. Rate covenant and additional bonds test are in place. UM
Hospitals' obligations under the swap agreements (discussed below) are secured
by the Hospital Gross Revenues on parity with the outstanding bonds.
INTEREST RATE DERIVATIVES: UM Hospitals has two swap agreements outstanding. In
conjunction with the issuance of the Series 2005 bonds, UM Hospitals entered
into an $81 million notional amount interest rate swap with The Bank of New York
Mellon as counterparty, currently outstanding at $68.7 million. The swap is a
fixed to one-month LIBOR base swap with UM Hospitals paying a fixed interest
rate. The swap matures on December 1, 2025. UM Hospitals has the option to
terminate the swap with five days written notice. Given the expected terms of
the swap, the credit rating of The Bank of New York and the issuer's credit
profile, we believe the swap transaction does not detract from the current
bond rating. In addition, UM Hospitals maintains another interest rate swap with
a notional amount of $44.7 million with Morgan Guaranty Trust Company of New
York, now J.P. Morgan Chase Bank, N.A., as counterparty and that was issued to
hedge the interest cost on the Series 1998A-2 bonds. This is a fixed to variable
rate swap with UM Hospitals paying a fixed rate. The swap matures in 2024, the
final maturity date of the underlying bonds. The counterparty has the option of
terminating the swap if the daily weighted average of the variable rate in the
preceding 180 day period is more than 7%. We believe the swap transaction does
not detract from the current bond rating. As of September 30, 2010 the swaps
mark-to-market combined value was a liability of $22.2 million.
STRENGTHS
*Preeminent reputation for this quaternary academic medical center with a wide
draw of patients from across the state and out-of-state
*Consolidated unit of The University of Michigan (rated Aaa), with strong
relational ties through inter-university transfers, commingled investments, and
loans to the hospitals from The University to support sizable capital projects
and refund outstanding variable rate debt
*A well developed interrelationship with the Medical School and faculty practice
plan to create a focused strategic direction for the university health system as
a whole
*Good liquidity of 205 days cash on hand and modest 135% cash-to-debt in FY
2010, including loans from The University
*Operational improvement, both before and after transfers to The University, in
FY 2010 to generate operating cash flow of 9.9% before transfers; management
projects tighter but favorable operating performance in the near-term due to
escalated costs associated with opening the new Children's and Women's hospitals
as well as other expanded healthcare facilities
CHALLENGES
*Sizeable transfers to The University Medical School to support
strategic operating needs and capital plans by UM Hospitals that weakens
operating and debt measures, with operating cash flow margin of 6.8% after
transfers
*Significant capital investment and expansion of facilities resulting in
increased total debt outstanding, risks associated with start-up, need to expand
personnel in a tight nursing and medical staff market, and increased costs
(staffing, depreciation, interest, etc.) that will pressure operating
performance
*Current budget constraints by the State resulted in a 4% Medicaid rate
reduction in FY 2010 and potential pressure on future rates of
reimbursement possible with proposed health care reform and changes in
governmental reimbursement structures
RECENT DEVELOPMENTS/RESULTS
Operating revenues increased $138 million (7.5%) in FY 2010, with continued
growth in volume metrics. With UM Hospitals diversified draw of patients across
a wide service area along with its provision of high end specialty services, the
hospital is partly immune from volume pressures related to any particular
geographic location and election to defer elective procedures. FY 2010
admissions grew 3.4% to 44,665, with an additional 12.3% growth in observation
cases. Outpatient visits increased 3.6% and total surgeries increased 1.7% in FY
2010. Management also continued to focus on cost control initiatives, including
limited or deferred annual salary increases. As a result, operating income
before transfers to The University (but after deducting interest expense and
capitalized interest) improved to $44.1 million (2.2% margin) from $5.2 million
(0.3% margin) in FY 2009. Correspondingly, operating cash flow margin improved
to 9.9% in FY 2010 from 7.9% in FY 2009.
Ongoing standard net transfers from the hospital to the University were $61.9
million in FY 2010 and $65.7 million in FY 2009. For FY 2010, this excludes a
$38.7 million non-cash forgiveness of a prior year working capital advance to
the Medical School and for FY 2009 this excludes a $15.4 million transfer to
support an asset acquisition, $13.0 million of M-Care sale proceeds, and $8.9
million in insurance dividend. When we include transfers as an
operating expense, as is our analytical practice, UM Hospitals has an operating
deficit of 0.9% in FY 2010, an improvement over the 3.3% deficit in FY 2009, and
operating cash flow margins of 6.8% and 4.3% in fiscal years 2010 and 2009,
respectively. As a result of the improvement in operating performance,
Moody's-adjusted MADS coverage improved to 3.6 times from 2.5 times the prior
year. Management projects tightened operating performance beginning in FY
2012 due to escalated costs associated with the opening of the new
Children's and Women's hospitals and other facility expansions.
Unrestricted cash and investments was flat at FYE 2010 compared to FYE 2009 at
$1.0 billion. Despite the improvement in operations in FY 2010, liquidity growth
was stymied due to increased capital spending and a $56 million payment to
defease outstanding Series 1992A bonds. Capital spending increased to $321
million in 2010 compared to $287 million in 2009, as construction on major
capital projects continued. Cash on hand declined to 205 days (with expenses
including transfers and bond interest paid) from 215 days at FYE 2009. The
hospitals liquidity is commingled and managed with that of The University,
enabling a broader asset allocation for investment than might otherwise be
undertaken. Moody's evaluates investments for self liquidity purposes on a
university wide basis.
Despite $141 million in new projects funds in 2010 from loans from The
University, the outstanding debt load increased only $57 million with the
refunding and defeasance of existing bonds and scheduled principal payments.
Across the past two years The University has reduced its exposure to variable
rate demand bonds, also reducing UM Hospitals exposure to puttable bonds. Debt
supported by self liquidity for UM Hospitals declined to $253 million at FYE
2010 from $492 million at FYE 2009. As a result, the current portfolio is 66%
fixed rate and 34% variable rate. A large portion of the restructuring was
accomplished through a refinancing of UM Hospitals issued variable rate revenue
bonds with fixed rate general obligation bonds issued by the University, and
subsequently loans to UM Hospitals from The University with fixed rate interest.
With the slight increase in debt load in FY 2010 and flat liquidity, the
cash-to-debt ratio declined slightly to 135% from 146% the prior year,
substantially below historical levels and the Aa2 median of 202%. Without The
University loans, cash-to-debt on revenue bonds is a healthier 346% and
cash-to-puttable debt is a very comfortable 411%.
Major capital projects continue. The $132 million Kellogg Eye Center project is
virtually complete and opened in 2010. The $754 million children's and women's
hospital projects are on time and on budget and are expected to open in 2012.
These projects will increase capacity. At this time, The University is
issuing $220 million of Series 2010D and 2010E bonds, $162,4 million of which
will finance healthcare facilities, including the children's and women's
hospitals. These funds will be loaned to UM Hospitals and become
"intercompany" debt. As a result, intercompany debt will increase to
$631 million for UM Hospitals. While not obligated to bondholders on the general
obligation bonds, the University fully expects UM Hospitals to meet its annual
intercompany debt payments, which will be used to support payments on the
outstanding general obligation bonds. Beyond The University's current
borrowing, there is an additional $152 million in debt issuance expected
over the next three years to support capital investment in the healthcare
system. The remainder of the $960 million of projected capital costs over the
next three years are expected to be supported from fund raising and internal
cash flow.
Moody's continues to be cautious on the impact current budget constraints by the
State could have on hospital revenues. The Medicaid program recently experienced
rate reductions, and we are mindful of levels of State funding to support the
University. Medicaid represented 13% of gross patient revenue in FY 2010.
According to management, the health system is well-positioned for the
implementation of healthcare reform as it has piloted Medicare programs which
were included in the recent legislation, including that for accountable care
organizations. The organizational structure of the health system has a
long-standing integration of the clinical systems with the medical staff and the
Medical School to provide common strategic direction for research and the
provision of services. UM Hospitals continues to pilot health programs for the
improvement in healthcare delivery.
For additional information on The University's credit profile
including information on liquidity of The University that forms the basis for
the short-term ratings on UM Hospitals, please see our report issued concurrent
with this report.
Outlook
The stable outlook reflects our belief that UM Hospitals will continue to
generate good cash flow to support its debt load, while maintaining a good
liquidity position. New construction projects will add additional capacity to
meet growth in volumes and to provide additional revenues and cash flow.
What could change the rating--UP
Very unlikely chance of rating increase; driving factors would include increased
diversity of cash flow, improvement in margins and debt service coverage after
transfers; material decline in debt load
What could change the rating--DOWN
Increase in debt load without commensurate increase in cash flow; material
declines in market share, operating performance or liquidity; deterioration of
The University's credit strength
KEY INDICATORS
Assumptions & Adjustments:
-Based on financial statements for The University of Michigan Hospitals and
Health Centers
-First number reflects audit year ended June 30, 2009
-Second number reflects audit year ended June 30, 2010
-Transfers to other University units (net) were reclassified to operating
expenses to correspond with Moody's analytical methodology ($65.7 million and
$61.9 million recurring in FY 2009 and FY 2010, respectively)
-Interest expense reclassified to operating expenses and increased by
capitalized interest of $1.4 million and $3.6 million in FY 2009 and FY 2010,
respectively
-Restricted assets estimated at restricted net asset balance less pledges
receivable and deducted from unrestricted liquidity
-Investment returns normalized at 6%
*Inpatient discharges: 43,186; 44,665
*Total operating revenues: $1.84 billion; $1.97 billion
*Moody's-adjusted net revenue available for debt service before transfers: $209
million; $267 million
*Moody's-adjusted net revenue available for debt service after transfers: $144
million; $206 million
*Total debt outstanding: $712 million; $769 million
*Maximum annual debt service (MADS): $57.0 million; $57.0 million (includes debt
service on loans from The University)
*MADS Coverage with realized reported investment income, after transfers: 2.29
times; 3.35 times
*Moody's-adjusted MADS Coverage with normalized investment income, after
transfers: 2.52 times; 3.60 times
*Debt-to-cash flow, after transfers: 5.36 times; 4.05 times
*Days cash on hand after transfers: 215 days; 205 days
*Cash-to-debt: 146%; 135%
*Operating margin, before transfers: 0.3%; 2.2%
*Operating margin, after transfers: -3.3%; -0.9%
*Operating cash flow margin, before transfers: 7.9%; 9.9%
*Operating cash flow margin, after transfers: 4.3%; 6.8%
RATED DEBT (debt outstanding as of June 30, 2010)
-Series 1998A-2 variable rate bonds ($44.7 million outstanding), rated Aa2/VMIG
1 with liquidity for tendered variable rate bonds supported by internal
liquidity
-Series 2002A fixed rate bonds ($47.6 million outstanding), rated Aa2
-Series 2005A and B variable rate bonds ($138.0 million outstanding), rated
Aa2/VMIG 1 with liquidity for tendered variable rate bonds supported by internal
liquidity
-Series 2007A and B variable rate bonds ($70.5 million outstanding), rated
Aa2/VMIG 1 with liquidity for tendered variable rate bonds supported by internal
liquidity
CONTACT
Obligor: Milagros C. Dougan, Assistant Treasurer, The University of Michigan
(734) 647-8297
The last action taken with respect to UM Hospitals' revenue bond rating was on
December 23, 2009, at which time Moody's affirmed the municipal-finance-scale
ratings of Aa2 and Aa2/VMIG 1 on UM Hospitals outstanding revenue bonds. The
outlook was stable. Ratings were subsequently recalibrated to the global-scale
on May 7, 2010, and were assigned global scale ratings of Aa2 and Aa2/VMIG 1.
METHODOLOGY
The principal methodology used in rating UM Hospitals was Moody's
Not-For-Profit Hospitals and Health Systems Methodology, published in
January, 2008 and available on www.moodys.com in the Rating
Methodologies sub-directory under the Research & Ratings tab.
Other methodologies and factors that may have been considered in this
process can also be found in the Rating Methodologies sub-directory on Moody's
website.
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.
Analysts
Kay Sifferman
Analyst
Public Finance Group
Moody's Investors Service
Karen Kedem
Backup Analyst
Public Finance Group
Moody's Investors Service
Contacts
Journalists: (212) 553-0376
Research Clients: (212) 553-1653
Moody's Investors Service
250 Greenwich Street
New York, NY 10007
USA
MOODY'S AFFIRMS THE UNIVERSITY OF MICHIGAN HOSPITALS' (MI) Aa2 AND Aa2/VMIG 1 DEBT RATINGS; OUTLOOK REMAINS STABLE
