Fitch Ratings – Austin – 16 Jun 2021: Fitch Ratings has affirmed the ‘AA’ Issuer Default Rating (IDR) on Texas Children’s Hospital (Texas Children’s), TX and has assigned a ‘AA’ long-term rating to the following bonds: –$250,815,000 Harris County Cultural Education Facilities Finance Corp.’s hospital revenue bonds series 2021A; […]
Fitch Ratings - Austin - 16 Jun 2021: Fitch Ratings has affirmed the 'AA' Issuer Default Rating (IDR) on Texas Children's Hospital (Texas Children's), TX and has assigned a 'AA' long-term rating to the following bonds:
--$250,815,000 Harris County Cultural Education Facilities Finance Corp.'s hospital revenue bonds series 2021A;
--$75,465,000 Harris County Cultural Education Facilities Finance Corp.'s hospital revenue bonds series 2021B; and
--$100,000,000 Harris County Cultural Education Facilities Finance Corp.'s hospital revenue bonds series 2021C.
The series 2021C VRDBs are expected to be supported by a standby bond purchase agreement (SBPA) from Bank of America; short-term ratings are expected to be assigned at a later date.
Fitch has also affirmed the following bonds at 'AA':
--$139 million Harris County Cultural Education Facilities Finance Corp.'s hospital revenue bonds series 2019A;
--$79 million Harris County Cultural Education Facilities Finance Corp.'s hospital revenue bonds series 2019B;
--$157 million Harris County Cultural Education Facilities Finance Corp.'s hospital revenue bonds, series 2015-1; and
--$110 million Harris County Cultural Education Facilities Finance Corp.'s hospital revenue bonds, series 2015-3.
In addition, Fitch has affirmed Texas Children's $50 million series 2015-2 revenue bonds, issued by the Harris County Cultural Education Facilities Finance Corporation, at 'AA'/'F1+'. The series 2015-2 bonds are in "windows" mode, and the 'F1+' short-term liquidity rating is based on Fitch's criteria, mapping directly to Texas Children's long-term rating.
The Rating Outlook is Stable.
Bond proceeds will be used to fund Texas Children's construction costs for a new hospital to be built in Austin, TX. Proceeds will also be used to current refund Texas Children's outstanding series 2008-1, series 2008-2 and series 2015-4 bonds and pay the costs of issuance.
The bonds are a general and unsecured obligation of Texas Children's Hospital.
Texas Children's has one MTI Financial Covenant, a debt service coverage ratio (DSCR) of 1.0x. Texas Children's will be revising the MTI event of default related to the rate covenant to two years below 1.0x rather than one year. In addition, language is being added to allow Texas Children's to avoid a consultant call in for the violation of a rate covenant violation below 1.10x and the violation of other covenant defaults that are the result of a force majeure event.
The 'AA' rating reflects Texas Children's solid position as the largest freestanding children's hospital in the country with a broad geographic footprint in the greater Houston market and a focus on high acuity pediatric and women's services that insulates the hospital from direct local competition. The rating also reflects the organization's robust balance sheet position and consistent operating performance in recent years that provides financial flexibility to absorb the upcoming debt issuance and expected pressures in profitability due to start-up costs associated with strategic growth initiatives that are being undertaken.
KEY RATING DRIVERS
Revenue Defensibility: 'bbb'
Leading Pediatric Provider with Growing Demand
Texas Children's revenue defensibility is midrange, reflecting its position as the leading pediatric provider with solid demand, an aligned medical staff and a health plan. Texas Children's provides tertiary and quaternary pediatric and obstetric services for a growing geographical region that has generated significant volume increases over the past decade.
Operating Risk: 'a'
Solid Profitability from Existing Operations; Period of High Capex Expected
The operating risk assessment of 'a' reflects Texas Children's stable profitability of 7.9% operating EBITDA over the past three years despite the revenue dislocation due to the coronavirus pandemic. Fitch expects operating performance will be compressed over the coming years as a result of startup costs associated with a multi-year plan to grow the organization's presence in the Austin, TX market through inpatient and outpatient facilities and women's services. Though Texas Children's will be ramping up capital spending, Fitch believes the organization has flexibility to manage its routine capital spending given its recent capital spending of 193.6% of depreciation over the last five fiscal years on significant projects including a new community hospital in Woodlands, TX and a 19-story specialty care tower on the main campus.
Financial Profile: 'aa'
Strong Balance Sheet Metrics and Liquidity
The hospital's financial profile remains very strong in the context of the hospital's midrange revenue defensibility and strong operating risk profile assessments. Even with expected operating pressures, Fitch's forward-looking scenario analysis supports the view that Texas Children's will be able to absorb the debt issuance and still maintain leverage metrics consistent with a 'AA' rating. Given the hospital's robust cash position, solid demand and historical track record of successful completion and execution of strategic projects, Fitch expects leverage metrics to remain stable over the next five years.
ASYMMETRIC ADDITIONAL RISK CONSIDERATIONS
No asymmetric risk considerations affected this rating determination.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Fitch views a positive rating action is unlikely given elevated capex plans over the next several years and operating EBITDA margins are below 10%.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--Although unlikely, if Texas Children's experiences significant cost overruns or project delays that erode operations and/or liquidity metrics where cash to adjusted debt drops below 200% on a consistent basis;
--Any sudden negative change in reimbursement programs that may result in an Operating Risk assessment of 'bbb'; however, only severe and extended declines in operating income levels would trigger a negative action.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Located in Houston in the heart of the well-known Texas Medical Center, Texas Children's operates almost 1,000 pediatric and OB/GYN beds. Fitch's analysis is based on the consolidated system. Total operating revenue in fiscal 2020 (audited results through Sept. 30 year end) was $4.4 billion. It is important to note that the Health Plan is not a part of the Obligated Group Structure, and accounts for approximately 40% of total annual revenues.
Fitch views Texas Children's market position favorably as it is the leading pediatric provider in a growing service area, with eight of 10 subspecialties listed in US News and World Report's Top 5. Texas Children's is the largest freestanding children's hospital in the country and has significantly grown its revenue base through multiple capital expansions by adding inpatient capacity, investing in research and significant expansion into women's services.
The organization has broadened its geographic footprint and developed two additional campuses (the West Campus and the Woodlands) outside the Texas Medical Center, as well as outpatient facilities in the greater Houston market.
Texas Children's has an aligned medical staff, which is primarily the pediatric and OB/GYN faculty at Baylor College of Medicine (BCM), in addition to its own employed medical groups. Based on the Medicaid and CHIP managed care program, Texas Children's health plan has a large membership of approximately 516,000 lives as of March 2021.
Fitch believes Texas Children's can utilize its integrated delivery platform and expanding presence to very effectively manage a broad pediatric population.
Similar to most children's hospitals, Texas Children's is highly exposed to Medicaid reimbursement, which accounted for 54% of gross revenues in fiscal 2020. Texas has a Medicaid 1115 waiver in place, originally expiring at the end of 2016 and now extended through Sept. 30, 2022. The waiver created a funding pool to promote health system transformation (DSRIP), a funding pool to assist providers with uncompensated care costs (UC) and allowed the state to expand Medicaid managed care. Texas Children's recognized $42.3 million and $32.4 million in DSRIP funding in fiscal 2019 and 2020 and funding is expected continue to decline in fiscal 2021 into 2022 as the DSRIP funding pool is being phased out at Sept. 30, 2021. Texas Children's recognized $103.7 million in UC revenue funding in fiscal 2020, consisting of $39.8 million in fiscal 2020 UC revenue and $63.9 million in fiscal 2014-fiscal 2017 UC revenue that was received in fiscal 2021 due to litigation.
Texas Health and Human Services is currently seeking feedback on a draft request to extend and amend the 1115 waiver. Fitch will continue to monitor ongoing negotiations surrounding the waiver as the supplemental payments have historically supported Texas Children's revenue generation and proposed directed payment programs may potentially impact rates and provide new supplemental revenue opportunities to Texas Children's.
Texas Children's admitted approximately 33,600 patients in fiscal 2020, which was down compared to 36,300 patients in fiscal 2019 as a result of the coronavirus pandemic, forcing the system to defer pediatric care and lose patient volumes. Management commenced a phased reopening starting in April 2020 and was able to reopen all services by the end of May 2020. Emergency room and primary care practices have been the slowest service lines to recover, but management notes that volumes have rebounded to pre-pandemic levels in recent months. Given Texas Children's success in implementing new workflows and technological improvements to reopen services, Fitch believes that the system will be able to return to its historical trajectory of volume growth going forward.
Texas Children's is the largest provider of pediatric services in the Houston market, with a market share of about 50%. The next most significant competitor is Memorial Hermann's pediatric hospital, which captures about 20% of the market share. While Memorial Hermann remains a significant presence in the market, Texas Children's secures a substantially stronger market share (approximately two-thirds in key high acuity service areas) providing Texas Children's with a certain level of market essentiality.
Texas Children's has been expanding their presence in the rapidly growing Austin, TX market, with a plan for 18 primary care locations and three urgent care locations, along with specialty care locations and maternal fetal medicine (MFM) clinics. In May 2021, Texas Children's held a ground breaking and started site development for a new inpatient facility in North Austin, its first hospital outside the greater Houston service area.
Fitch views Texas Children's primary service area of the Houston MSA as a growth market with overall population growth above the national average, median household income commensurate with national levels and rising home prices. Furthermore, the addition of the Austin market is viewed positively as the new service area exhibited a five-year population percent increase that is over twice the national average and favorable unemployment and median household income levels that should enhance growth prospects over the next decade.
Texas Children's saw continual growth in total revenues and stable profitability in fiscal 2020 despite volume pressures due to the coronavirus pandemic. Texas' governor issued an executive order in March 2020 halting non-emergent surgeries and procedures and resulted in a reduction of weekly gross patient revenue of over 40% from pre-pandemic levels in February 2020. Texas Children's management was able to plan quickly for a phased reopening that brought all services back online by the end of May 2020. Though hospital operations were significantly impacted by the coronavirus pandemic, overall financial results in fiscal 2020 were supported by $105.7 million of CARES Act grants that helped offset revenue losses and increased expenses.
Consolidated profitability in fiscal 2020 was also positively supported by the Texas Children's Health Plan, which experienced a large increase in membership, that was the result of the waiver of renewal requirements by Texas Health and Human Services and lower medical claims activity. This provided for a large swing in profitability seen in the improvement in operating margin from negative $46.9 million in fiscal 2019 to $94.1 million in fiscal 2020. Management expects the health plan to produce better profitability in fiscal 2021 than fiscal 2020 as a result of additional membership growth, core operating improvements and the continuation of lower utilization. Though the consolidated operating EBITDA margin of 7.8% in fiscal 2020 is somewhat modest, Fitch views this level of cash flow as strong in the context of TCH's integrated delivery platform that provides operating stability and revenue diversification.
Fitch expects favorable performance in fiscal 2021 through strong health plan performance, rebounding volumes and $82.8 million in CARES Act funds. Financial performance in fiscal 2022 is expected to be weaker as a result of multiple factors including lower health plan profitability (due to increased utilization, decreased membership and premium rate decreases) and an increase in labor costs from a proactive pay increase that Texas Children's gave to its entire workforce to support and retain staff following a challenging year.
Furthermore, Texas Children's is expected to experience a large increase in operating expenses over the medium term related to new/expanded facilities coming online in fiscal 2024 that will likely keep the system's operating EBITDA below the 7.2% average produced over the past five fiscal years. One of TCH's main credit strengths is its strong liquidity, which affords it some financial flexibility. However, given the expectation of weakened operating performance, a significant deterioration in balance sheet metrics without the expectation of a rebound in operating profitability, could result in negative rating pressure.
Texas Children's average age of plant is young at 9.8 years as of fiscal 2020 and capital spending has averaged a very healthy 193.6% over the last five fiscal years, primarily as a result of the $1.7 billion expansion in the Houston market that was completed in 2018.
Texas Children's is now entering a new growth phase at its Pavilion for Women, which opened in 2012 and has already exceeded its capacity. The organization is also commencing construction on the inpatient and outpatient facilities that will be located on their new North Austin campus, which will be funded from a combination of the 2021 debt issuance, cash flow and fundraising. Fitch believes that Texas Children's maintains significant capital spending flexibility, even with the large upcoming construction projects. Texas Children's has a highly successful track record of spending on strategic projects, with capital spending producing solidly accretive returns.
Texas Children's unrestricted liquidity position has consistently improved over the last several years on an absolute level, increasing to $3.6 billion as of March 31, 2021 from $2.1 billion in fiscal 2016. Cash to adjusted debt (which includes $6.7 million in unfunded pension liability) has improved to 368.9% as of March 31, 2021 from 198% in fiscal 2016. Net adjusted debt to adjusted EBITDA, which is a measure of how many years of cash flow would be required to repay debt, was a favorably negative 2.6x as of March 31, 2021, indicating that Texas Children's has sufficient resources to pay all outstanding debt and debt equivalents at this time.
In the five-year stress scenario, Fitch expects that Texas Children's operating EBITDA margin will be around 9% in fiscal 2021 followed by a multi-year period of cash flow below the 7.2% operating EBITDA average produced over the last five fiscal years due to increased labor expense, lower health plan profitability, the initial expenses of the added women's services capacity and startup costs related to the North Austin campus. The stress case incorporates both an issuer-specific revenue stress and a portfolio sensitivity analysis based on Texas Children's portfolio asset allocation.
Based on Fitch's scenario analysis, Texas Children's capital-related ratios should remain consistent with our 'aa' assessment of its financial profile, given the organization's mid-range revenue defensibility and strong operating risk profile assessments. Net adjusted debt-to-adjusted EBITDA remains negative and pro forma cash-to-adjusted debt remains above 220% throughout Fitch's stress scenario, consistent with a strong assessment of Texas Children's financial profile and supporting the 'AA' rating.
In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
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