Moody's downgrades UMass Memorial Health Care (MA) to Baa3; rating under review for downgrade

Moody's Investors Service has downgraded UMass Memorial Health Care's rating to Baa3 from Baa1. The rating remains under review for downgrade. The downgrade reflects multi-year deterioration of operating performance and debt service coverage that accelerated in FY 2013, timing variability in receipt of supplemental Medicaid funding resulting in a period of thinner liquidity, and forecasted breach of bank debt financial covenants during FY 2014 which could result in acceleration of debt. During the review period we will focus on revisions to debt financial covenants as well as the system's ability to improve quarterly operating performance through expense containment measures as well as growth of revenue.

SUMMARY RATING RATIONALE:

The Baa3 rating reflects the sharp decline in operating performance in FY 2013 that follows a recent history of eroding margins, exacerbated by pronounced and immediate debt structure and covenant issues (projected breach of debt service coverage covenant for bank debt at March 31, 2014

which could result in acceleration). The decline in performance reflects a largely unionized work force, decline in patient volumes, high Medicaid exposure, and growth of expenses. The system has also recently transitioned to a new senior management team with an interim CFO; the new management team is tasked with a multitude of strategies to improve financial performance. The Baa3 rating benefits from the system's role as a large and diversified health system serving central Massachusetts and

the Medical Center's important role as an academic medical center affiliated with University of Massachusetts Medical School (University of Massachusetts system rated Aa2). We are maintaining the rating under review at the Baa3 rating given immediate negotiations and strategies management is embarking upon to resolve the debt structure issues and avoid future breach of debt financial covenants.

CHALLENGES

*The system's operating performance and debt service coverage have steadily weakened over a multi-year period, with very thin operating cash flow in FY 2013 (2.5%, based on draft FY 2013 financial statements). Although the new senior leadership team has laid out steps for improving performance, we expect this will take time and an operating deficit and thin cash flow margin are budgeted for FY 2014.

*The system's debt documents (bonds as well as bank debt) contain a debt service coverage covenant, which could be breached as a result of weak operating performance and variable timing of the Medicaid funding. Breach of the debt service coverage covenant could result in acceleration of debt, and given current ratio calculation management forecasts a breach of the bank debt service coverage covenant as of the March 31, 2014 reporting date. Management is working with the banks to revise the covenant calculation methodology.

*The Medical Center has very high exposure to Medicaid (19.4% gross payer mix in FY 2013) and relies on the receipt of Supplemental Medicaid Funding which is appropriated by the Commonwealth annually ($45-48 million net revenue received annually after adjusting for contractual

obligations to the University of Massachusetts Medical School). Absent this funding, operating performance would be much weaker and in recent years the timing of receipt of the funding has been variable and resulted in depressed end-of-year liquidity for the system.

*The system's comprehensive debt (which includes unfunded pension liability and operating leases) was $773 million in FY 2013, much higher than direct debt. Although the defined benefit pension plan is large and underfunded, the obligation was reduced significantly during FY 2013 as a result of union negotiations as well as an increased discount rate ($153 million liability in FY 2013, down from $337 million in FY 2012).

*A large unionized employee base places some limitations on expense flexibility. In spring 2013 the Medical Center came close to but averted a nursing strike, resulting in approximately $10 million of additional costs and lost revenue due to hiring of nurse replacements and reduced occupancy in the hospital. The new contract with the nursing union extends through May 2015.

STRENGTHS

*The system is large and diversified, including the academic medical center which serves as a safety net healthcare provider for central Massachusetts as well as several other community hospitals. The entire

system had approximately $2.2 billion of operating revenue in FY 2013 (unaudited). Market share in the Worcester area remains dominant (61% combined volume market share for the Medical Center and member hospitals).

*The Medical Center maintains a close working relationship with the affiliated University of Massachusetts Medical School (University of Massachusetts System rated Aa2). The medical school and the University campus of UMass Memorial (one of two main hospital sites of the Medical Center) are housed on the same campus in Worcester and share some physical space.

*The system has a relatively low amount of direct debt outstanding given its large size (direct debt-to-revenue of 19% and cash-to-debt of 130% estimated in FY 2013).

Outlook

The rating remains under review reflecting the multitude of challenges which could impede the turnaround in performance of this large and complex health system, coupled with forecasted breach of debt financial covenants during the current fiscal year based on current covenant definitions.

WHAT COULD MAKE THE RATING GO UP

Although a rating upgrade is unlikely near term, the outlook could return to stable over the medium term if the system builds headroom under financial covenants and is able to achieve steady improvement in operating cash flow and liquidity. The rating could be upgraded longer term as a result of stabilization of patient volumes and sustained improvement in operating cash flow coupled with balance sheet strengthening.

WHAT COULD MAKE THE RATING GO DOWN

The rating could be downgraded if bank debt financial covenants are not revised to improve headroom or strategic initiatives are insufficient to return the system to positive operating performance and much stronger operating cash flow. Other factors which could contribute to a downgrade include declining liquidity or discontinuation of Supplemental Medicaid Funding from the Commonwealth.

For reprint and licensing requests for this article, click here.
MORE FROM BOND BUYER