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Fitch Revises Covenant Health (Tennessee) Outlook to Positive; Affirms 'A' Rating

Posted on: Wednesday, 17 September 2008, 18:00 CDT

Fitch Ratings has affirmed the underlying 'A' rating on Covenant Health's (Covenant) approximately $210,000,000 million series 2006A and 2006B refunding and improvement bonds. Fitch also affirms the rating on the system's series 2002 bond issue. Additionally, Fitch has revised the Rating Outlook to Positive from Stable.

Both bond series were issued by the Knox County Health Educational and Housing Facility Board. The 2006B bonds, originally issued as auction rate securities, are insured by Assured Guaranty (IFS rated 'AAA' by Fitch). The system intends to convert all of the outstanding 2006B bonds to variable rate bonds with liquidity and credit support provided by SunTrust Bank. The conversion is expected to take place the week of Sept. 22, 2008. Fitch has not been asked to provide a short term rating.

The Outlook revision to Positive reflects Fitch's expectation that Covenant will maintain its current market leadership with improved profitability as its construction projects are completed. In addition, Covenant's recently announced sale of its health plan to Humana for approximately $245 million is expected to immediately benefit the system by improving its already strong liquidity position. The sale is subject to the approval of the Department of Justice, but management is confident that the sale will be completed by the end of the year. Covenant is not planning to issue any additional debt in the near term.

The 'A' rating is supported by Covenant's leading market position in an over bedded competitive market, strong liquidity, and good service area characteristics. In 2007, Covenant had a leading market share of 39.9% in its primary service area, leading its two competitors, Mercy Health Partners (MHP) and University of Tennessee by a substantial margin. MHP was created from the recent merger (January 2008) of Baptist Health System of East Tennessee and St. Mary's Health System.

At year-end 2007, Covenant had $804 million in unrestricted cash and investments with 226 days of cash on hand, a 117% cash to debt ratio and a 17.9 times (x) cushion ratio, all above Fitch's 'A' medians of 185.2 days, 111.6% and 15.4 x, respectively. Utilization trends are positive, despite the system's ongoing construction projects at several of its facilities. The system's major project, a replacement hospital at its Fort Sanders Sevier Hospital, is on budget and is expected to be completed on schedule by January 2009. Discharges were generally flat between 2006 and 2007, but six months interim numbers are ahead of the prior period. Emergency room visits and outpatient visits also show solid increases between 2006 and 2007. The Knoxville service area continues to experience strong population growth, albeit more slowly than in prior years.

Credit concerns include Covenant's competitive market, historically weak operating margins and a relatively high exposure to TennCare. The creation of Mercy Health Partners has had a negligible impact on Covenant's market position but further consolidation is expected to occur in the market. MHP has consolidated inpatient services from two hospitals to one and has announced plans to build a new hospital in Knoxville. Covenant's debt burden is above average for the rating category, with MADS coverage of 3.0 x, MADS as a percentage of revenues of 3.3%, and debt to capitalization ratio of 51.3% in fiscal 2007, all of which compare unfavorably to Fitch's 'A' medians of 4.0 x, 3.1% and 38.9%, respectively.

Covenant's operating margins have historically been light partly due to conservative accounting practices related to reserves for both the hospital and the health plan, and well below Fitch's 'A' medians of 3.2%. Covenant's operating performance (excluding investment income from the health plan) declined to 0.2% in fiscal 2007 with further declines to negative 0.6% for the six month period ending June 2008. However, in its initial projections, the system expected operating margins to remain at current levels through fiscal 2010, with gradual improvement as the system's ongoing construction projects are completed and come into service. The projections did not include the anticipated sale of the system's health plan. Payor mix has been stable for the system with the percentage of revenues from TennCare declining slightly from 12.4% to 11.7%.

Covenant has one floating- to fixed-rate swap outstanding for a notional amount of $30 million. The swap was entered into in 2001 in conjunction with a variable-rate operating lease and terminates in 2009. Covenant has the option to terminate the swap at any time. Swap and termination payments are not on parity with existing debt. The swap counterparty is SunTrust Bank (rated 'A+/F1+' by Fitch, negative outlook). The mark to market valuation of the swap at December 2007 was negative $818,000.

Covenant consists of six hospitals with 1,383 licensed beds located throughout counties that make up the Knoxville metropolitan service area, Cariten-PHP, the area's second largest health plan, due to be sold by the end of the year to Humana, and several other health care related organizations. Covenant had total operating revenues of $1.4 billion in 2007. Through a continuing disclosure agreement Covenant agrees to provide annual audited and quarterly financial statements to the Nationally Recognized Municipal Securities Information Repositories. Recent disclosure has been timely and thorough and has included a balance sheet, income statement, cash flow statement, utilization and management discussion and analysis.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Source: Business Wire

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