TEXT-fitch affirms Dartmouth-Hitchcock Obligated Group, N.H. revs at 'A+'
Feb 7 - Fitch Ratings affirms the 'A+' rating on approximately $207 million of Dartmouth-Hitchcock Obligated Group's (DHOG) outstanding debt issued through the New Hampshire Health & Education Facilities Authority and Massachusetts Health & Educational Facilities Authority. DHOG has approximately $616 million of total debt outstanding of which $409 million are non-rated direct bank loans. The Rating Outlook is Stable. SECURITY Debt payments are secured by a pledge of the gross revenues of the obligated group (OG). DHOG is comprised of Dartmouth Hitchcock (DH; Mary Hitchcock Memorial Hospital and Dartmouth Hitchcock Clinic) and Cooley Dickinson Hospital (CDH). CDH is expected to withdraw from the OG sometime in 2013. Fitch does not view this as a credit negative as it comprised approximately 11% of the OG's revenue base. KEY RATING DRIVERS INTEGRATED DELIVERY PLATFORM: DH provides high acuity care to an extensive geographic area through its flagship academic medical center (Mary Hitchcock Memorial Hospital) and its physician clinic (Dartmouth Hitchcock Clinic). DH has a close relationship with the Geisel School of Medicine at Dartmouth College (Fitch rated 'AAA'; Stable Outlook) to further its mission in education and research. Under new consolidated leadership at DH, the organization is focused on providing value through lowering cost, increasing efficiency and improving value. DH has consistently been ranked as one of the lowest cost providers in the nation. IMPROVED OPERATING PERFORMANCE: Under new leadership, DH's financial discipline and improved profitability has been a mandate with maintaining an operating margin target of 4% beginning in fiscal 2013. Fiscal 2012 performance exceeded budget with a 1.5% operating margin despite the elimination of disproportionate share funding (DSH). Through the five months ended Nov. 30, 2012, improved operating performance was sustained with a 2.6% operating margin, although behind the fiscal 2013 operating margin budget. LIMITED DEBT CAPACITY: DH issued $150 million of taxable debt (direct bank loan) and the proceeds were used to fund its defined benefit pension plan. This issuance limits DH's future debt capacity; however, DH does not have any major capital needs in the near to medium term. Fitch is concerned about DH's debt profile, which has put dates in 2018, 2019 and 2022. TACKLING PENSION OBLIGATION: DH's projected benefit obligation totals approximately $927 million and with the pension financing, the plan is now approximately 82% funded on a GAAP basis. Management's objective with the pension financing was to increase the funded status and to lower the volatility associated with pension requirements, which includes settling approximately $320 million of its pension liabilities over the next seven years, which Fitch views favorably. RATING SENSITIVITIES FAILURE TO SUSTAIN IMPROVED PERFORMANCE: Given DH's pressured financial profile with the additional debt and pension obligation, it is necessary for DH to sustain its operating performance trend to improve debt service coverage and build liquidity. The failure to sustain improved performance could result in negative rating pressure. CREDIT PROFILE Transforming Healthcare Delivery In November 2011, the dual-presidency leadership structure of DH was consolidated into a chief executive officer (CEO) position. The current CEO was previously President of the Dartmouth-Hitchcock Clinic and Director of the Dartmouth Institute for Health Policy and Clinical Practice, home of the Dartmouth Atlas of Healthcare. Fitch believes the directives under the new leadership have leveraged DH's integrated platform model, which should continue to drive down costs and provide care more efficiently. These initiatives include streamlining governance and management of DH, focusing on population health, and collaborating with national providers, all in an effort to deliver the best quality outcomes at the lowest cost possible. DH has demonstrated lower utilization rates in imaging and surgeries compared to national averages and have been ranked highly by UHC regarding efficiency, which focuses on per case cost performance and length of stay. A newly created Chief Clinical Officer and Executive Vice President for Population Health role is expected to further DH's initiatives in creating a high value network in its expansive geographic region. DH is the state's only academic medical center and has various outpatient facilities throughout NH and VT. DH is collaborating with other providers and has a goal of serving one million lives over the next three to five years. Improved Operating Performance DH's operating performance has improved despite the elimination of DSH funding from the state. Historically, the state funded its DSH program through a Medicaid Enhancement tax (MET) on providers. As of July 1, 2011, the state continued to collect the MET with no offsetting revenue and the annual impact to DH was approximately $40 million. Fitch views positively management's quick response to the loss in revenue. Cost reduction initiatives included a voluntary early retirement option ($16 million expense in fiscal 2011) and a further reduction in force in early fiscal 2012. DH exceeded its fiscal 2012 budget with a 1.5% operating margin. If the DSH funding was still in place, DH would have ended fiscal 2012 with a 5.8% operating margin. Through the five months ended Nov. 30, 2012, DH had an operating margin of 2.6%, which is behind its 4% operating margin budget for the full year. Management has identified several clinical improvement initiatives to reach its 4% operating margin target by year end, which Fitch believes are achievable. In addition, Fitch believes there are benefits to be realized from DH's continued transformation of healthcare delivery and full implementation of its EMR. Pension Plan Liability As of June 30, 2012, DH's projected benefit obligation was $927 million and with the proceeds from the pension financing, the pension plan is now approximately 82% funded on a GAAP basis (based on 4.9% discount rate, which is the same discount rate as of June 30, 2012). Under IRS guidelines and incorporating the pension law changes in MAP-21 (allows use of 25 year average discount rate, which was 7 %) the funded status is over 100%. The financing allowed for more dollars to be invested in DH's liability driven investment strategy, which hedges interest rate risk. The pension assets are now over 70% hedged to interest rate changes, decreasing the volatility of the pension liability. Further reducing the pension liability is management's plan to settle approximately $320 million of the pension liabilities over the next seven years. Although the pension financing elevated DH's debt burden and limits its additional debt capacity at the current rating level, Fitch views management's plan to reduce the volatility associated with its pension plan favorably. In addition, the projected cash outflow for funding pension requirements over the next seven years is neutral with or without the pension financing. Limited Debt Capacity With the $150 million pension financing, DH's debt capacity is limited. Total outstanding debt is approximately $558 million and is 83% fixed rate and 17% variable rate. DH has one floating to fixed rate swap outstanding that does not have any collateral posting requirements. The majority of DH's outstanding debt is direct bank loans and factoring in the current amortization of the loans the putable debt is $79 million in 2018, $128 million in 2019 and $102 million in 2022. Fitch believes DH's access to capital and liquidity position somewhat mitigates this risk. The balloon indebtedness is amortized over 20 years for debt service calculation purposes under its master trust indenture (MTI). Maximum annual debt service (MADS) for DH is $38.8 million and debt service coverage was only 2.5x in fiscal 2012 and 1.6x in fiscal 2011 compared to the A category median of 4.1x. With the improved profitability through the five months ended Nov. 30, 2012 and greater than normal realized investment gains, debt service coverage improved to 3.8x for the interim period. Flexible Capital Spending DH's future capital needs are manageable with no large projects projected. Total capital spending for FY 2013 - 2017 is projected at $468 million and will be scaled back if there is a shortfall in available funding sources. Recent major projects include new ambulatory facilities to alleviate capacity at DH's main hospital. Stable Liquidity Total unrestricted cash and investments was $464 million as of Nov. 30, 2012, which equated to 137 days cash on hand and 83.2% cash to debt, which both compare unfavorably to Fitch's 'A' category medians of 194.1 and 113.8%, respectively. However, these ratios have been relatively stable over the last four years. A decline in liquidity would be of concern especially due to DH's potential put risk. Stable Outlook The Stable Outlook reflects Fitch's expectation that DH will continue to improve its operating performance, which is necessary given DH's historically weak financial profile for its rating level. However, Fitch weighs DH's qualitative factors heavily as we believe the organization is a leader in its approach to healthcare delivery and believes that DH's goals position the organization well in a reduced reimbursement environment. About the Organization DHOG historically comprised four members - Mary Hitchcock Memorial Hospital (MHMH), Dartmouth Hitchcock Clinic (DHC), Cooley Dickinson Hospital (CDH) and CVMC. CVMC exited the OG as of Nov. 1, 2011 and CDH intends to exit the OG in 2013. Audited financials from fiscal 2012 (June 30 year end) going forward will be for DH and CDH separately compared to a combined statement for the OG historically. DH had total annualized revenue of $1.3 billion in fiscal 2012 (June 30; 9 months due to fiscal year end change from Sept. 30), and covenants to provide annual and quarterly financial statements to bondholders through the MSRB's EMMA system. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria and Related Research: --'Revenue-Supported Rating Criteria' (June 12, 2012); --'Nonprofit Hospitals and Health Systems Rating Criteria' (July 23, 2012). Applicable Criteria and Related Research: Nonprofit Hospitals and Health Systems Rating Criteria Revenue-Supported Rating Criteria