Fitch Ratings – New York – February 17, 2022: The Hospitals and Higher Education Facilities Authority of Philadelphia (the Authority) issued series 2022 revenue bonds on behalf of Temple University Health System, and Fitch Ratings granted them a ‘BBB’ rating (TUHS).
The outlook for the rating is stable.
TUHS intends to sell about $170 million in tax-exempt fixed-rate bonds. The funds, along with a $26.7 million series 2012A debt service reserve fund release, a $14.8 million TUHS equity commitment, and estimated premium bonds, will be used to refund the series 2012A bond series and cover issue expenses. The refunding is expected to result in significant net present value savings. The maximum annual debt service after refunding is planned to be $30.6 million, and the bonds are likely to be sold through negotiation the week of March 7.
SECURITY
TUHS obliged group gross receipts pledged, as well as mortgages on some committed group properties. TUHS is seeking to change certain clauses and covenants in the Loan and Trust Agreement and the Master Trust Indenture as part of the series 2022 issue, to which the purchasers of the series 2022 bonds will have consented. These measures will only take effect when 50% of bondholders agree at some point in the future. The committed group accounted for 92% of consolidated system assets and 92% of consolidated system revenues in fiscal 2021 (YE June 30).
ANALYTICAL SUMMARY
The ‘BBB’ IDR and revenue bond rating is based on TUHS’s improved profitability in the most recent two fiscal years (YE June 30) and through the second quarter of FY22, as well as a material increase in TUHS’s liquidity metrics as a result of the sale of its interest in Health Partners for approximately $300 million. The considerably improved financial profile measures in Fitch’s forward-looking scenario drove the upgrading to an investment grade rating level indicated in the Dec. 1, 2021 Fitch rating review.
While revenue defensibility is characterised by a highly restrictive payor mix and a competitive landscape, and operating risk is characterised as ‘weak,’ the recently improved liquidity and leverage metrics under Fitch’s stress case scenario, even before incorporating the positive impact on liquidity of the Health Partners Plans, Inc. (HPP) sale, which occurred after the end of FY21, support the investment grade ratio.
The Stable Outlook demonstrates Fitch’s conviction that the profitability improvement that began with the mid-2018 restructure, as well as the management team’s measures, are sustainable. Potential decreases in Medicaid reimbursement and the amount of supplementary payments from the Commonwealth are the primary risk factors that might impede TUHS’s ability to maintain and even improve its higher credit rating. Fitch observes that historically, Commonwealth funding levels have been constant to slightly improving.
Revenue Defensibility: ‘b’ KEY RATING DRIVERS
A Difficult and Competitive Service Area with a Limited Payor Mix
TUHS operates in the highly competitive health care market of southeastern Pennsylvania, with its flagship medical institution, Temple University Hospital (TUH), located in economically disadvantaged North Philadelphia. Operating issues include a significant proportion of Medicaid and self-insured patients in its major service region; Medicaid and self-pay accounted for 33.6% of total revenues, in keeping with Fitch’s assessment of ‘poor’ revenue source characteristics.
Given TUHS’s significant medical assistance population and vital community-based clinical activities, the Commonwealth of Pennsylvania provides substantial financial support in the form of supplemental payments. The financing stream has remained consistent in recent years, and management anticipates it to be somewhat higher in 2022.
‘bb’ Operating Risk
Improved Operating Performance and Controllable Capital Requirements
TUHS has maintained the major financial improvement trend that began in 2020 with operating income of $96.1 million despite pandemic-related effects and continued in fiscal 2021 with operating income of $90.5 million, resulting in operational EBITDA margins of 7.3% and 6.6%, respectively. The strong performance continued in the second quarter of FY22, with operating income of $64.6 million, corresponding to an operational EBITDA margin of 8.3%, substantially over budget.
The strong results reflect a combination of cost controls and the ability to manage the COVID-19 census in a clinically and financially sound manner even during the various coronavirus peak periods, as well as rebounding volumes in fiscal 2021, with discharges 10.9% higher than the previous year and inpatient and outpatient surgeries 2.4% and 13.7% higher, respectively.
Discharges are somewhat behind the same period last year, but outpatient procedures and outpatient visits are increasing, and transplants are up 14%. Profitability was also aided by the transition to a model of collaborative planning for all services across the entire system, as well as by bringing in new leadership and making key physician recruitments at both American Oncologic Hospital dba Fox Chase Cancer Center (Fox Chase) and TUH-Jeanes campus.
Capital Investing
Despite the high average age of plant, Fitch considers the flagship TUH facility to be suitably updated, and the expected increase in capital investment over the next five years, which includes Fox Chase redevelopment, should assist to decrease the average age of plant. Based on the recent improvement in cash, management intends to increase capital investment beginning in 2023, with an estimated $450 million over the following five years.
‘bbb’ Financial Profile
Significantly Improved Financial Profile in Line with Investment-Grade Rating
Since 2019, TUHS’s liquidity profile and leverage metrics have improved significantly; as of December 31, 2021, TUHS reported unrestricted cash and investments of $1.1 billion, excluding $83.9 million in accelerated Medicare funds and $15.1 million in deferred social security taxes, for a cash-to-adjusted debt ratio of 215.7% and a net adjusted debt to adjusted EBITDA ratio of 0.8x.
Using Fitch’s investment portfolio stress based on TUHS’s relatively mild asset allocation risk profile resulted in a modest 9% reduction in liquidity in the first year of Fitch’s forward scenario analysis. Fitch’s stress case scenario, which incorporates both a liquidity and revenue stress and includes the proceeds of the HPP sale in fiscal 2022, shows cash-to-adjusted debt at better than 200% and NADAE favourably negative throughout the entire stress case scenario, consistent with an investment grade rating. Fitch’s analytical forecast incorporates $450 million in capital investment and an operational EBITDA margin of around 6%.
Additional Risk Considerations for Asymmetry
This grade is not influenced by any asymmetric risk concerns.
SENSITIVITIES TO RATING
Factors that might lead to positive rating action/upgrade, either individually or collectively:
—Proof of a sustained operational EBITDA margin greater than 6%;
—Maintaining recently improved liquidity while investing in clinical operations and making moderate capital investments.
Factors that, separately or combined, might result in a negative rating action/downgrade:
—Persistent failure to sustain the improved operational results obtained in fiscal years 2020 and 2021, resulting in operating EBITDA margins of 5% or below;
—Notable decrease in supplementary payments;
—Decreased cash flow, capital expenditures, or borrowings that result in a weaker net leverage position with a cash-to-adjusted debt ratio of less than 120%.
SCENARIO FOR BEST/WORST CASE RATING
The best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) for Sovereigns, Public Finance, and Infrastructure issuers is three notches over a three-year rating horizon; and the worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) is three notches over three years. The whole range of best- and worst-case scenario credit ratings for all rating categories is ‘AAA’ to ‘D’. Credit ratings for best- and worst-case scenarios are based on previous performance.
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