Moody's Investors Service has downgraded to Baa1 from A3 the rating assigned to Erlanger Health System's $172 million of outstanding bonds issued by the Chattanooga-Hamilton County Hospital Authority. The outlook is negative at the lower rating level, the report says.
Erlanger has lost over $17 million this fiscal year and reported a $771,000 loss for April on Monday night.
The downgrade to Baa1 from A3 "is attributable a material operating loss in FY 2012 in a competitive market following multiple years of low operating cash flow margins and an inability to improve performance in 2012 as expected.
The downgrade is further supported by a weaker balance sheet profile with under 80 days cash on hand, less than 80% cash-to-debt and peak debt service coverage expected to not meet the debt service coverage ratio bond covenant in 2012. Management is already in the process of hiring a consultant. Contributing to the negative outlook is an expectation for continued operating cash flow margins below peers and medians in the near term, and potential instability in performance levels as EHS works to regain lost surgical volumes. Balance sheet metrics need to improve and stabilize to provide cushion to the operating performance levels."
The report lists:
CHALLENGES
*Competitive health care market with three main providers in Chattanooga, including for-profit HCA and multi-state Catholic Health Initiatives, and several smaller providers in the surrounding areas
*Marked decline in operating performance and operating cash flow in fiscal year (FY) 2012 following loss of high acuity, high margin volumes with dissatisfied key admitting physicians redirecting patients to competitors, resulting in -4.6% operating margin and very low 1.2% operating cash flow margin; this decline follows multiple years of low and variable operating cash flow margins that did not meet budgeted levels in certain years
*Debt load is manageable at 28% debt-to-revenue, but other debt measures are weak at 40 times debt-to-cash flow, 78% cash-to-debt, and anticipated peak debt coverage under 1 times (on annualized nine month 2012 results)
*Decline in unrestricted liquidity to 79 days at March 31, 2012 from 130 days at fiscal yearend (FYE) 2010
*High 25% TennCare/Medicaid load and nearly 10% self-pay load
STRENGTHS
*A wide regional draw with unique high end acute care services (kidney transplantation, PICU, NICU III, Level I trauma) and a strong market share of 31.3% in the total fifteen-county service area, although Memorial Healthcare System (part of Catholic Health Initiatives) maintains a comparable 30.7%; HCA holds a distant 17.0% (management provided as of 2011). In addition, Erlanger receives over 4,800 patient referrals (mostly tertiary cases, which represent about 18% of its total admissions) from parts of Georgia, Alabama and Tennessee which are outside its fifteen-county service area.
*Designation as a "safety net" hospital has resulted in annual state-funded essential access payments and new disproportionate share payments, although funding of programs are not guaranteed into the future
*Conservative debt structure with 77% in fixed rate mode
*Good economy with the City of Chattanooga (Aa1 general obligation bonds) as the regional economic center of a six county area in southeastern Tennessee and northwest Georgia; economic development inside and outside the city has contributed to taxable growth in the county
*Recent layoffs, along with other revenue and expense initiatives projected to generate at least $26 million improvement in FY 2013
Outlook
The negative outlook reflects challenges in meeting expectations for improved operating performance in the last three years with high variability in operating cash flow margin. The decline in cash flow along with other liquidity delays and needs has continued a downward trend in days cash on hand. Major remediation efforts are underway, which will need to be successful if not exceeded, and result in longer term stability in performance and balance sheet profile to result in a stable outlook
WHAT COULD MOVE THE RATING UP
Marked improvement in, and sustainability of operating cash flow margins at much higher levels; sizable growth in liquidity to strengthen balance sheet measures; continued market share strength
WHAT COULD MOVE THE RATING DOWN
Inability to improve and stabilize operating performance; further decline in liquidity; increase in debt without a corresponding increase in cash flow
Erlanger officials said, "Moody’s latest report cited a number of strengths, including Erlanger’s wide regional draw with unique high end acute services and a strong market share. Moody’s also recognized Erlanger’s conservative debt structure as a key strength of the Chattanooga-based health system.As with many public healthcare systems throughout the country,
"Last year Moody’s issued downgrades to 34 hospitals compared with 23 upgrades, marking the sixth consecutive year in which downgrades outnumbered upgrades. The ratings firm noted at the time that it expected downgrades to outpace upgrades again in 2012, due to increasing payor pressures and potentially flat revenue growth.
"Erlanger now carries the same Moody’s bond rating, Baa1, as two other Tennessee safety net hospitals, the Mountain States Health Alliance and East Tennessee Children’s Hospital. In addition, Standard and Poor’s bond agency rates Wellmont and the UT University Health System as BBB+.
"In today’s report, Moody’s also maintained Erlanger’s outlook as negative, which is consistent with Moody’s negative outlook for the U.S. not-for-profit healthcare sector."
Erlanger Chief Finance Officer Britt Tabor said that while the lower bond rating is disappointing, “it is still a testament to Erlanger’s commitment to this community that we are on tap to provide over $90 million in uncompensated care this fiscal year and still achieved a Baa1 rating.”
“Erlanger provides a scope of services other area hospitals don’t,” Tabor said, noting that the rating agency “seems to have an appreciation of the value we bring to residents of the tri-state area.
“Even with the limited funding sources available to us, we have the region’s only level one trauma center, Children’s Hospital, highest level of neonatal intensive care, kidney transplant program, nationally recognized stroke program, a fleet of four air ambulances, the only neuro intensive care unit and three 24/7 emergency rooms.”
Donnie Hutcherson, Erlanger trustee and chairman of the board’s budget and finance committee, said he “was encouraged to see in the Moody’s report that Erlanger’s management had identified $26 million of strategic improvement initiatives for fiscal year 2013.
“I was pleased that the bond agency recognized Erlanger’s strategic improvement initiatives in recent months, such as the reduction in FTE’s, including management personnel, along with future efforts to improve patient throughput and surgical efficiencies, lengths of stay and reducing losses from employed physicians.”