Fitch criteria shift drove South Carolina healthcare downgrades
Recent multi-notch rating downgrades of two South Carolina healthcare providers don't signal a wider trend under new criteria for U.S. nonprofit hospitals and health systems, Fitch Ratings said Monday.
The new criteria drove a six-notch downgrade to junk level for the Lexington Medical Center’s bonds July 5. Fitch lowered the rating to BB-plus from A-plus, affecting $421 million of outstanding debt issued by the Lexington County Health Services District.
The new criteria resulted in a less severe three-notch downgrade for the Spartanburg Regional Health Services District June 26, whose ratings were lowered to BBB from A on $124 million of outstanding bonds.
In both cases, “outsized” net pension liabilities triggered multi-step downgrades under the new criteria, said managing director Jessalynn Moro.
“The updated criteria place a heightened emphasis on maintenance of leverage ratios and liquidity consistent with an issuer's operating profile through the cycle in a forward-looking rating case stress,” Moro said. “These leverage ratios explicitly incorporate lease and net pension liabilities as direct debt equivalents.”
Lexington’s nearly $1.1 billion adjusted net pension liability resulted in weak net leverage metrics when a moderate economic stress scenario was applied, supporting the rationale for the downgrade to below investment grade, Fitch said.
Spartanburg’s $904.8 million adjusted pension liability sent its leverage profile in a similar direction.
Since the release of the criteria on Jan. 9, Fitch said it has completed a review of 138 separate health care providers, or about half its hospital and health system portfolio, with reviews focused predominantly on issuers where the potential for change due to the application of new elements of the criteria might lead to changes in ratings.
The review resulted in 35 upgrades and 25 downgrades. Most of them were one-notch rating changes.
Three credits were upgraded three or more notches and five downgrades were three or more notches.
“To place these changes in a broader context, Fitch does not expect further rating changes solely based on criteria revisions for the remainder of the 270-plus portfolio,” Moro said.
To date, Fitch said rating actions included reviews of government-sponsored healthcare providers, which is a relatively small subset of its overall healthcare portfolio.
“These reviews incorporated the first application of Fitch's approach to evaluating public, defined-benefit pension liabilities in revenue-supported entities,” Moro said.
For many of these issuers, which participate in state-administered, cost-sharing multi-employer plans, Fitch said it looks to statement 68 of the Governmental Accounting Standards Board when considering where the proportionate share of a net pension liability should be placed among governmental units participating in such plans.
“GASB 68 generally assigns the liability where the primary funding obligation resides absent a clear legal and financial assumption of the liability by the state government,” said Moro. “Fitch applies this approach to both local government participants and to government enterprises participating in a state-administered cost-sharing plan, such as health care, utility and higher education enterprises.”
Fitch said it views direct employers as responsible for deferred compensation and future pension benefits, including when insufficient resources have been set aside and an unfunded liability exists.
Spartanburg Health and Lexington Health participate in the state-administered, cost-sharing South Carolina Retirement System. Both systems are statutory public hospitals and political subdivisions of the state. Neither has direct authority to levy a tax to support operations.
Each issuer reported its proportionate share of the system's large net pension liability in its financial statements in accordance with GASB 68, Fitch said.
Spartanburg reported a net pension liability of $656 million and Lexington reported a liability of $739 million, based on the 7.25% discount rate used by SCRS to calculate the liability.
Fitch said it adjusts the reported net pension liability using a standard 6% discount rate “to provide consistency among issuers and better reflect the magnitude of the commitment posed by pensions.” The lower discount rate boosted Lexington’s liability to $1.1 billion and Spartanburg’s to $904 million.
“Even without the Fitch adjustment, the size of the net pension liability as reported would have driven a rating action,” Moro said.
Fitch’s new methodology distorts Lexington Medical Center’s true financial condition, the center said in a statement to The Bond Buyer Tuesday.
“Fitch’s position that Lexington Medical Center is ultimately responsible for the pension liability is contrary to our interpretation of the South Carolina Code of Regulations,” the statement said. “All three rating agencies have consistently noted Lexington Medical Center’s significant and growing market position, strong profitability and conservative debt profile.”
The center said Fitch affirmed the hospital’s A-plus rating and assigned a stable outlook as recently as December.
“Lexington Medical Center believes Fitch did not have sufficient information to accurately rate Lexington Medical Center,” the statement said. “Consequently, we are requesting that Fitch withdraw its rating.”
Lexington’s BB-plus rating was based on its cash-to-adjusted debt of 40% and net adjusted earnings before interest, taxes, depreciation and amortization of 5.1 times over a five-year horizon.
The BBB rating on Spartanburg Health’s bonds was based on its cash-to-adjusted debt of 57% and net adjusted EBITDA to debt of 2.7 times over five-years, Fitch said.
In contrast, Moro said Texas hospital districts show how an unfunded pension obligation and overall leverage profile affect the assessment of an issuer's capacity to respond to an increased burden with available revenue tools or operating cost flexibility.
“Texas hospital districts have independent taxing powers and can levy property taxes within certain bounds to enhance revenues from operating resources,” she said.
In May, Fitch downgraded to A-plus from AA the ratings on the Dallas-area Parkland Health & Hospital System’s bonds based on the application of the new criteria. The three-notch drop reflected the system’s $718 million of long-term fixed rate general obligation debt and capital leases.
Parkland reported a net pension liability of $423 million, which became $588 million when adjusted by Fitch. Under the new criteria, Parkland’s relevant metrics resulted in net adjusted debt to EBITDA of 4.1 times and cash-to-debt of 37%.
“The district has substantial unused taxing power that can be tapped to maintain its financial balance and meet any increased pension liability without straining its financial profile,” Moro said.
Parkland has an estimated $1 billion taxing margin available for operations, an amount Fitch said mitigated its weaker net leverage position and allowed Parkland’s rating to be placed in the A category despite a weak financial profile that would typically result in a lower rating.