Fitch Affirms Temple University Health System's (PA) Revs at 'BB+'; Outlook Stable

Fitch Ratings has affirmed its 'BB+' rating on the following series of bonds issued by the Hospital and Higher Education Facilities Authority of Philadelphia on behalf of Temple University Health System (TUHS):

--$308.3 million series 2012A and B;

--$208.3 million series 2007 A and B.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a pledge of gross revenues of the obligated group, mortgages on certain properties of the obligated group, and a debt service reserve fund. The obligated group represented approximately 94% of the assets and 100% of the revenues of the consolidated system in fiscal 2014. Fitch reports on the performance of the consolidated system.

KEY RATING DRIVERS

IMPROVING OPERATING PERFORMANCE TREND: TUHS ended fiscal 2014 (year-end June 30) with an operating loss of $15.8 million, exceeding the budgeted loss of $10 million, but better than the $24.8 million operating loss in the prior year. The improving trend continued through the nine-month interim period ended March 31, 2015, with the system recording an operating loss of $7.2 million, a significant, $35 million year-over-year improvement, and management expects to end the 2015 fiscal year with a close to breakeven performance, projecting a small $1.2 million loss from operations.

ESSENTIALITY OF INSTITUTION AND DEPENDENCE ON SUPPLEMENTAL PAYMENTS: TUHS's flagship facility - TUH - serves both as a provider of high-end specialty services and as a de facto safety net hospital for North Philadelphia. As such, its continued viability is of critical importance to the greater Philadelphia market, which has been reflected in the significant support the institution has been receiving in the form of supplementary revenues, which in fiscal 2015 are expected to remain significant and level with the prior year.

LOWER VOLUMES, HIGHER ACUITY: While overall volumes have declined reflecting the general decreasing volume trend in the greater Philadelphia market, a major driver for the improved operating performance, in addition to better results at Jeanes and Fox-Chase division, was the system's ability to attract higher acuity, more highly reimbursed cases. TUH's case mix index was 1.98 in March 2015, as compared to 1.77 in March of last year and the system has actually increased its share of the high-end cases to 6% from 4.9% since 2011.

MODEST LIQUIDITY: Unrestricted liquidity has remained essentially unchanged since 2013 year end. TUHS reported $352.3 million of unrestricted cash and investments at March 31, 2015, translating to 90 days cash on hand (DCOH), cushion ratio of 9.1x and cash equal to 66% of debt. Liquidity metrics are slightly higher than Fitch's NIG medians, but still materially lag the 'BBB' medians of 145 DCOH, 10.5x cushion ratio and 93.6% cash to debt.

SLIM COVERAGE: The system's coverage of maximum annual debt service (MADS) of $38.9 million by EBITDA was 2x in fiscal 2014 and through the 2015 interim period. Offsetting the relatively weak coverage is the system's manageable leverage of MADS equal 2.8% of revenues, an all fixed rate debt structure and no swap exposure. The obligated group reported a higher 2.8x coverage of annual debt service in fiscal 2014.

RATING SENSITIVITIES

NEED TO MAINTAIN OPERATING IMPROVEMENT: Fitch expects Temple University Health System to maintain the improved operating performance, as reflected in the interim 2015 results. A return to the investment grade rating category would require sustained operating improvements, leading to strengthened coverage and balance sheet metrics.

CREDIT PROFILE

TUHS is a Philadelphia based health care system, whose flagship is TUH, a 721-bed teaching hospital located on the campus of Temple University in North Philadelphia, which also includes the Temple University School of Medicine, as well as other research and educational facilities. TUHS also owns and operates Jeanes Hospital (Jeanes), a 176-licensed bed community hospital located in a residential area in Northeast Philadelphia and the adjoining 98-bed American Oncologic Hospital d/b/a Fox Chase Cancer Center (Fox Chase), one of only 41 National Cancer Institute designated Comprehensive Cancer Centers in the nation. TUHS reported $1.4 billion revenues in fiscal 2014.

IMPROVING OPERATING PERFORMANCE TREND

Operations improved in fiscal 2014, with TUHS recording a $15.8 million operating loss, equal to a negative 1.1% operating margin and a 4.6% operating EBITDA margin compared to an operating loss of $24.8 million in fiscal 2013 (negative 1.8% operating margin, 3.9% operating EBITDA margin). The improvement was even more significant through the third quarter of the current fiscal year ended March 31, 2015 with operating loss of $7.2 million versus a budgeted loss of $15.5 million, and compared to a significantly larger $42 million loss for the same period last year. A truly meaningful comparison of the two interim periods is not possible given the lumpy flow of supplemental payments, but the third quarter 2015 supplemental payments are on track as budgeted. Regardless, operations are well ahead in this fiscal year.

The improved performance had several components including a rather significant turnaround at the Fox-Chase and Jeanes divisions. The Fox-Chase improvement included both more robust outpatient volumes as management continued to recruit physicians and develop programs, including launching the Access Service, which offers new patients a guaranteed next-business-day appointment with the relevant specialist, as well as expense management and revenue cycle improvement and better managed care contracts. Jeanes results also improved materially from a focus on cost reductions and improved physician relations under a new CEO, who also serves as the head of Temple Physicians Inc. While the improvement at Fox-Chase is sustainable, management will have to find a more optimal operating platform for Jeanes, whose operations will need to be more closely integrated into one of TUHS's system components.

Profitability improvement was somewhat hampered by lower results at TUH compared to the prior year, which saw a reduced level of University support (as expected), increased pharma expenses, while carrying a higher portion of IT implementation costs. Management expects more robust results for TUH in the coming year, as it continues to generate revenues from the higher volume of high acuity patients, while better managing the expense side of the operation.

LOWER VOLUMES, HIGHER ACUITY

The Philadelphia market has seen a continuing decline in inpatient volumes, but the decline for TUHS has been lower than the market in general. TUHS's discharges were 3.4% lower in 2014 and 2.3% lower through the 2015 interim period. However, TUHS has been able to garner a higher market share of the better reimbursed high acuity cases, which increased to 6% from 4.9% four years ago. Between 2011 and 2015 (annualized based on nine months), TUH had a 15.9% increase in high acuity cases, and most notably, that increase came from referrals outside of the PSA. TUH's transplant program increased 38% in 2014 and a further 27% through the third quarter of 2015.

ESSENTIALITY OF INSTITUTION

The need for supplementary payments is essential to address the organization's position as a 'safety net provider' to inner city Philadelphia. Management has historically worked closely with the Commonwealth of Pennsylvania (Commonwealth) and the critically needed supplemental payments received in this fiscal year are expected to be level with the prior year. TUHS management was requested by the new Commonwealth administration to come up with a proposal, which would help to permanently stabilize the supplemental support, replacing the need for protracted annual negotiations. The proposal would have TUH serve as the anchor for the plan to address the needs of the North Philadelphia indigent and underinsured population that is the major determinant of the level of the supplemental funding it receives; TUHS's payor mix includes close to 46% of revenues from Medicaid.

DEBT PROFILE

TUHS had $533.9 million of long-term debt in fiscal 2014, all of which is fixed rate and the system has no swaps. Coverage of MADS of $38.9 million was 2.0x in fiscal 2014, as well as through the third quarter of 2015 and MADS is a manageable 2.8% of revenues, which is lighter than Fitch's NIG median of 4%. Fitch's calculation of TUHS's metrics exclude the non-preferred appropriations ($6.4 million), for which TUHS only serves as a conduit for Temple University.

DISCLOSURE

TUHS covenants to provide timely annual quarterly financial and operating data to MSRB's EMMA system.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Not-for-Profit Hospitals and Health Systems Rating Criteria (pub. 23 Sep 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=779548

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 30 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985400

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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