New York, December 05, 2012 --
Moody's Investors Service has downgraded to A2 from A1 the long-term unenhanced bond rating assigned to Henry Ford Health System's (HFHS) $855 million of outstanding bonds issued by the Michigan State Hospital Finance Authority (MSHFA). The outlook remains stable at the lower rating level.
HFHS is an integrated health system operating four acute care hospitals, two behavioral health hospitals, a complex distribution of ambulatory care and outpatient service facilities, a sizable health insurance business, and a large medical group.
SUMMARY RATING RATIONALE
The rating downgrade to A2 from A1 is attributable to a marked downturn in operating performance in the first nine months of fiscal year (FY) 2012 compared to the prior year's already low performance level and which is below our expectations for a continuation of improvement begun in FY 2010 with the implementation of remediation initiatives. Balance sheet metrics, while conservative with highly liquid investments and a low debt load that is mostly fixed rate debt, showed a slight decline in days cash on hand and flat cash-to-debt measures that remain weak to the A2 rating category. A weak economy in metropolitan Detroit along with a highly competitive healthcare market continue to generate financial pressures, that could be partly mitigated should a recently announced merger with a local competitor come to fruition. The outlook is stable at the lower rating level due to a stable and capable management team, strong clinical reputation, strong and stable market share, solid track record of fundraising, and proven ability to operate with low operating margins.
*Weak adjusted margins for an A2-rated credit with -1.4% operating margin and 3.0% operating cash flow margin on annualized FY 2012 results (A2 medians 3.0% and 9.8%, respectively), a reversal from recent annual operational improvement; sizable investment into EPIC implementation has negatively impacted performance in the short-term with goal for longer term benefits; margins hampered by the large, low margin insurance business line (investment returns are removed from operating revenues)
*Indirect debt increases debt load 40% (at fiscal yearend 2011) with sizable operating leases and underfunded pension plan liability of $145 million (78% funded) on a projected benefit obligation (PBO) basis; curtailment of defined benefit pension plan (frozen) effective December 31, 2010 minimized liability growth
*Balance sheet ratios for the system remain weak for an A2 rating with 93 days cash on hand and 124.5% cash-to-debt as of September 30, 2012 (A2 medians of 195 days and 143.0%, respectively); sizable liquidity balance held at Health Alliance Plan (HAP; insurance business line), where access to funds can be limited by the state's department of insurance
*Highly competitive environment for the hospital division, which competes against other sizable health systems as well as stand-alone hospitals, and strong competition from Blue Cross Blue Shield for HAP (whose premiums constitute 47% of the system's $3.4 billion revenue base in the first nine months of FY 2012)
*Challenging economy in the Detroit metropolitan area with the HFHS flagship hospital (40,086 admissions in FY 2011) located in the City of Detroit (general obligation (GO) bond rating of Caa1/negative) in Wayne County (GO limited tax bond rating Baa2/negative), which is characterized by weak demographic characteristics including a high unemployment rate
*Well integrated and nationally recognized health system with four acute care hospitals, one of the region's largest health maintenance organizations (HMOs), the well-established Henry Ford Medical Group, and other health services; leading 17.7% acute care market share in the Tri-county region (per management in 2011)
*Recent closure (March 2012) of acute care services at the Warren hospital removes sizable operating losses; management has taken efforts in the past to close or reconfigure facilities to improve performance
*Modest debt load (20% debt-to-total operating revenue as of September 30, 2012) and adequate Moody's-adjusted maximum annual debt service (MADS) coverage of 3.83 times on Moody's-adjusted annualized nine month FY 2012 performance (removes $30 million increase in prior year cost report settlements included in revenues)
*Conservative balance sheet structure with 76% of liquidity invested in cash, cash equivalents and fixed income securities and 98.5% of unrestricted cash available within one month at fiscal yearend (FYE) 2011; $26 million in incoming cash from FICA receivable expected no later than first quarter FY 2013; debt load is 77% fixed rate and 23% variable rate with 78% of variable rate debt supported by letters of credit not expiring until November 29, 2014; no additional debt plans at this time; $275 million in lines of credit established ($45 million borrowed against the lines as of September 30, 2012)
*History of successful fundraising efforts, with $205.5 million in temporarily and permanently restricted liquidity at September 30, 2012; with $24.3 million released for operations and $10.9 million released for capital in the first nine months of FY 2012
*Stable management team since 2003 with experience of operating in a challenging environment
The stable outlook at the lower rating level incorporates our expectation of continued cash flow pressures in FY 2013 as HFHS continues its implementation of EPIC (to be concluded in FY 2014), with modest improvement in FY 2014. Management continues to take actions to enhance revenues and reduce cost increases. The stable outlook also reflects the strong integration of the medical staff, insurance business, and patient care that assists in data analysis to improve care and reduce costs, which should be enhanced with the new EPIC system. Pending changes at the federal level, including potential cuts in physician reimbursement, Medicare rate reductions, and the development of healthcare exchanges may pressure the system further if implemented.
WHAT COULD MOVE THE RATING UP
Sustained improvement in financial margins; growth in operating cash flow and consistency in cash flow generation before prior year cost report settlements; strengthening of balance sheet measures; increase in market share; material improvement in local economy
WHAT COULD CHANGE THE RATING DOWN
Inability to improve operating performance by FY 2014; weakening of liquidity; increase in debt load without commensurate increase in cash flow
PRINCIPAL METHODOLOGY USED
The principal methodology used in this rating was General Not-For-Profit Healthcare Rating Methodology published in March 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
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