TEXT - Fitch affirms Children's National Medical Center, D.C.
Dec 17 - Fitch Ratings has affirmed the underlying 'A-' rating Children's National Medical Center's (CNMC) outstanding debt listed below: --$145,250,000 District of Columbia (DC) (Children's Hospital Obligated Group Issue) hospital revenue bonds series 2005; --$250,000,000 District of Columbia (DC) (Children's Hospital Obligated Group Issue) hospital revenue bonds series 2008. The Rating Outlook is Positive. KEY RATING DRIVERS IMPROVED 2012 PERFORMANCE: The Outlook remains Positive due to CNMC's solid fiscal 2012 performance, which is reflected by strong revenue growth from increased collaborations with various adult providers in the service area. Fitch believes solid operating cash flow should be sustained because of opportunities with other partnerships that are being developed, managed care contracting, and physician practice management. SOLID LIQUIDITY: Once a credit concern, CNMC's liquidity has markedly improved over the last five years. Management plans on issuing $75 million of taxable debt to further bolster the balance sheet. Fitch believes CNMC has the additional debt capacity for this financing if the proceeds are maintained on the balance sheet and operating cash flow continues to meet projected targets. STRONG MARKET POSITION: CNMC maintains a leading and growing market position in its service area for pediatric services. CNMC's strong physician alignment, increased capacity, and enhanced relationships with other providers in the area should result in continued market share growth. MODEST CAPITAL NEEDS: CNMC's master facility plan resulted in a significant renovation and expansion of its facility that included the construction of a new patient tower, which is all complete. Projected capital spending is manageable between $50 million-$60 million a year; however, management is currently evaluating future long-term needs due to potential capacity constraints from its growing collaborations with adult providers. HIGH EXPOSURE TO MEDICAID: Not unlike other children's hospitals, CNMC is vulnerable to reductions in governmental funding with approximately 56% of its gross revenues from Medicaid. CNMC is exposed to three different programs given its location and the funding has been either flat or reduced for the current year. WHAT COULD TRIGGER A RATING ACTION SUSTAINED SOLID OPERATING CASH FLOW: Sustained improved operating EBITDA margins and debt service coverage ratios similar to fiscal 2012 levels could result in upward rating movement. SECURITY The bonds are secured by a pledge of gross receipts and a mortgage pledge. CREDIT PROFILE Improving Profitability CNMC's profitability has historically been weak, but improved in fiscal 2012 with an operating EBITDA margin of 8% compared to 5.9% in fiscal 2011. Revenue growth was strong at 8.4% in fiscal 2012 and driven by increased volume from its new partnerships with adult hospitals. Through the four months ended Oct. 31, 2012, operating EBITDA margin declined to 5.6% as a result of to a system conversion, which resulted in higher one-time expenses. However, the interim period was ahead of budget and management expects to meet or exceed its budgeted target of 8.7% operating EBITDA margin in fiscal 2013. Management projects operating EBITDA margins to remain at this level for the next several years. Medicaid Funding an Ongoing Concern Not unlike other children's hospitals, CNMC has a high exposure to reductions in Medicaid funding. Given its location, CNMC has to manage three Medicaid programs (DC, MD and VA). The DC program has reduced the amount of disproportionate share funding to CNMC, while funding from the Maryland program could result in additional revenue from a provider fee program. The reimbursement for the Virginia program has been flat. Strong Market Position CNMC is a freestanding pediatric teaching facility that maintains a strong market position as the leading pediatric provider in its service area. Its market share was 38.7% in fiscal 2011 from 36.0% in fiscal 2008. The competitors are adult facilities that provide pediatric services. The majority of its competitors have lost market share and the second leading provider is Inova-Fairfax with 15.7% market share in fiscal 2011 compared to 16.6% in fiscal 2008. CNMC's strategies include building hospital partnerships with the adult providers in the service area to increase tertiary referrals to its facility while keeping primary pediatric care local as well as providing pediatric subspecialty coverage and management of certain high-acuity service lines, such as neonatal intensive care. Relationships have been developed with Virginia Hospital Center, Mary Washington Hospital, and Peninsula Regional. There are two other partnerships in development that should also yield significant growth opportunity. Fully Aligned Medical Staff A key part of its growth strategy relies on CNMC's strong breadth of physician subspecialists on staff, all of which are employed. The medical staff has been growing and there were over 500 faculty physicians in fiscal 2012. CNMC's medical staff serves as the Department of Pediatrics for George Washington University. Fitch views the alignment with the medical staff positively as it should further assist CNMC in redesigning patient care that could lead to lower costs and improved quality. However, the physician group generates large operating losses, which has been growing due to the increased number of physicians. Fitch believes that there is opportunity for profitability improvement through better physician practice management. Expected Growth in Philanthropic Support In addition to its clinical activities, CNMC maintains a strong presence in education and research, which generates philanthropic activity. CNMC trains approximately 100 residents a year and has over 150 pediatric subspecialty fellows. The organization received its largest gift in its history in 2009, which was a $150 million gift from the United Arab Emirates. The gift funded the construction of the Sheikh Zayed Institute for Pediatric Surgical Innovation and $20.5 million of the gift remains to be received. CNMC just completed a $500 million capital campaign and expects to launch a $1 billion capital campaign in the next few years with a targeted goal of raising approximately $50 million-$100 million a year. Manageable Capital Needs in the Near Term CNMC's master facility plan is complete and was constructed on time and within budget. The plan included a new east patient tower that opened in November 2007. Other parts of the plan included a new 54-bed neonatology unit and a new 26-bed pediatric intensive care unit. The last main project was the expansion of surgical space with five additional operating rooms that opened in July 2012. Capital spending has averaged over 2x depreciation expense in fiscal 2008-2012 or approximately $92 million. Projected capital spending is more manageable at $50 million-$60 million a year for fiscal 2013-2015 and is predominately for information technology and other routine needs. Management indicated that projects outside of the capital plan will be funded by philanthropy. Due to strong volume growth and growing relationships with other providers in the area, CNMC may face capacity constraints in the longer term. CNMC is evaluating its longer term plan but believes additional capacity can be created without any major building needs. Growing Liquidity Total unrestricted cash was $445.8 million as of Oct. 31, 2012 and has markedly improved since fiscal 2008. Days cash on hand was 168 and cash-to-debt was 114% compared to 134 and 56%, respectively, at fiscal year end 2008 (June 30). However, unrestricted cash is down from the prior year due to an increase in receivables of approximately $20 million. CNMC's investment portfolio is conservative and very liquid with approximately 60% cash and fixed-income and 40% equities. Anticipated Debt Issuance CNMC is pursuing an additional taxable debt issuance of $75 million, which will be used to build liquidity. Management stated that these funds will remain in a board-designated fund and will not be spent. Although Fitch does not believe this financing is necessary as liquidity is sufficient for the rating level, the additional debt issuance would not impact the current rating or Outlook. CNMC expects to issue this debt on a variable-rate basis through a direct loan with a bank and has issued a request for proposal. Conservative Debt Profile Total outstanding debt was $418 million as of October 2012 and is 100% fixed rate. However, CNMC has orphan floating- to fixed-rate swaps outstanding, which currently do not require collateral posting at its current rating level. The current mark-to-market valuation as of Oct. 31, 2012 was negative $41 million. CNMC would be required to post collateral if its rating was downgraded to 'BBB+' or below. Fitch used a pro forma maximum annual debt service (MADS) of $31 million in its analysis, which incorporates the $75 million taxable issuance. Existing MADS is $27.7 million. With the additional debt, MADS coverage by operating EBITDA was adequate at 2.5x for fiscal 2012 as a result of improved cash flow compared to 1.7x the prior year. Positive Outlook The Positive Outlook reflects Fitch's expectation that CNMC will sustain the improved operating performance exhibited in fiscal 2012, which should lead to improved debt service coverage and liquidity levels due to manageable capital needs. The inability to meet budgeted goals would likely lead to a revision in the Outlook to Stable. About the Organization Located in Washington, DC, CNMC is a nationally recognized full-service tertiary and quaternary pediatric hospital with 303 licensed beds. Total operating revenue in fiscal 2012 was $977 million. CNMC covenants to provide audited annual financial statements within 150 days of fiscal year end and quarterly disclosure within 75 days of the quarter end for the first three quarters to the Municipal Securities Rulemaking Board's EMMA system.
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