[October 13, 2014]

Fitch Affirms UF-Health Jacksonville's (FL) Rev Bonds at 'BBB+'; Outlook Stable

Fitch Ratings affirms the 'BBB+' rating on the following debt issued on behalf of UF Health-Jacksonville (UFH-J):

--$64.24 million Florida Development Finance Corporation healthcare facilities revenue bonds (UF Health-Jacksonville Project), Series 2013A;

--$59.4 million Florida Development Finance Corporation healthcare facilities revenue bonds (UF Health-Jacksonville Project), Series 2013B (R-FLOATs).

The Rating Outlook is Stable.

SECURITY

The master trust indenture (MTI (News - Alert)) includes a gross revenue pledge and mortgage pledge of the obligated group (OG). The obligated group includes Shands Jacksonville Medical Center (now dba UF Health - Jacksonville), Shands Jacksonville HealthCare, and Shands Jacksonville Properties. The OG accounted for 95% and 99.6% of the consolidated entity's assets and revenue, respectively for fiscal 2014 (June 30 year end; audit). Fitch's analysis is based on the consolidated entity.

KEY RATING DRIVERS

INTEGRAL COMPONENT OF UNIVERSITY OF FLORIDA: Fitch views UF Health-Jacksonville's (UFH-J) relationship with University of Florida (UF; housing bonds rated 'AA') as its primary credit strength and believes that UFH-J serves an essential role as part of the UF system. UFH-J is one of two academic teaching sites for UF, and UFH-J has the third-largest post-graduate medical training program in Florida with 334 residents and fellows and 411 UF faculty. UFH-J is a component unit of UF.

BENEFITS OF SYSTEM RELATIONSHIP: Although UFH-J and its sister organization, Shands Gainesville (Gainesville) are legally separate and distinct entities (separate obligated debt), the organizations share a common strategic vision led by the UF&Shands Strategic Health Care Cabinet made up of key leadership from UFH-J, Gainesville, and UF. In addition, UFH-J and Gainesville have various shared services in addition to joint managed care contracting and supply chain management.

CONTINUED IMPROVEMENT IN OPERATING PERFORMANCE: UFH-J's operating performance continued to improve in fiscal 2014; however, its liquidity and debt metrics are weak for the rating level. Improved profitability has been driven by increased volume and commercial payor mix, higher acuity, and better management of its uninsured population.

CHALLENGING PAYOR MIX: UFH-J has an extremely high percentage of Medicaid and self-pay payors that totals approximately 46% of gross revenue. This results in a dependence on supplemental funding from the city and state which totaled $81.9 million in fiscal 2014. The lack of Medicaid expansion in the state has left UFH-J without approximately $37 million of additional revenue a year.

GROWTH STRATEGY: UFH-J is developing a campus on the north side of the city, which will include a medical office building (MOB) and outpatient services intended to increase its insured population as well as develop relationships with unaffiliated community physicians. This growth strategy will be key to improved financial performance to offset its indigent care burden. The construction of the MOB is ahead of schedule and expected to open in March 2015, and is developer-financed and will be leased to UFH-J. UFH-J will fund the medical equipment and UFH-J's capital budget for fiscal 2015 is $15 million higher than originally anticipated.

LIMITED DEBT CAPACITY: During Fitch's initial rating assignment in 2013, approximately $20 million (direct bank loan) of UFH-J's original plan of finance was not issued. Management is now planning on up to $45 million of additional debt (bank-financed) in the next few months to fund a portion of its capital budget. Fitch's analysis incorporates this additional debt; however, future debt capacity at the current rating level is limited.

RATING SENSITIVITIES

FUTURE EXPANSION PROJECT: UFH-J received a certificate of need (CON) in July 2014 for 92 beds at its north campus. Although Fitch views the north campus strategy positively, the projected cost is approximately $80 million and UFH-J will start construction sometime within the next 18 months; the exact timing of the construction will be dependent on volume once the MOB opens. UFH-J is evaluating its financing options and Fitch believes there is limited debt capacity at the current rating level without a commensurate improvement in balance sheet metrics.

CREDIT PROFILE

UFH-J is an academic medical center located in Jacksonville, FL with 695 licensed beds. UFH-J has an extensive outpatient network with 38 primary care clinics in the service area. UFH-J is an integral component of UF and serves as one of their two academic teaching sites. Total revenue in fiscal 2014 was $541 million.

UF and Shands Relationship

Gainesville is an 852-bed academic medical center and was UF's primary academic teaching hospital. This expanded to UFH-J in 2003 when UFH-J became part of the UF/Shands organization and Gainesville became UFH-J's sole corporate member. Sine that time, there has been significant growth in UFH-J's teaching and clinical activities and, in 2010, there was a corporate reorganization which made Gainesville and UFH-J affiliates of UF. Through common governance and a shared mission with UF, there is a strong relationship between UF, Gainesville, and UFH-J, which Fitch views as UFH-J's primary credit strength. UF faculty accounts for the majority of UFH-J's medical staff with 411 faculty physicians and 177 community physicians on staff.

Challenging Population

UFH-J is challenged by a high indigent population, which has resulted in weak financial performance and a dependence on supplemental funding. UFH-J's payor mix in fiscal 2014 (based on gross revenues) included 28.1% from Medicaid and 18.2% self-pay and Medicaid pending. UFH-J has an indigent care contract with the city of Jacksonville that provides funding for indigent care. This funding has been fairly flat and remains well below cost as UFH-J carries the majority of the burden of serving the indigent population in the service area. Management has implemented several strategies in order to better manage the costs of the uninsured population including a patient-centered medical home model. Total disproportionate share (DSH) and city funding was $81.9 million in fiscal 2014 compared to $79.8 million in fiscal 2013 and $76.1 million in fiscal 2012. The amount expected for fiscal 2015 is $86.8 million.

Strategic Growth Initiatives

UFH-J is developing a north medical campus in a favorable location that will include a medical office building with outpatient services and is expected to open in March 2015. The north campus is expected to enhance relationships with additional community physicians, which for the majority remain unaffiliated in a rather competitive market. The facility will include urgent care, emergency care, imaging, laboratory, surgical space as well as medical office space. The construction of the MOB will be developer financed and management expects this strategy to result in additional, better payor-mix volume, which is projected to have a favorable impact on profitability by fiscal 2016. UFH-J received a CON in July 2014 for 92 beds at the north campus and foundation work is required to begin within 18 months of receiving the CON approval. Management indicated that the timing and construction of the inpatient bed tower will be dependent on volume trends once the MOB opens.

The total capital budget for fiscal 2015 is $81 million and includes $10 million carry-forward from the fiscal 2014 budget and $51 million for equipment at the north campus.

Good Operating Performance

Fiscal 2014 operating performance exceeded budget with a $23 million operating income (4.2% operating margin) compared to the 'BBB' category median of 1.1%. Operating performance excludes transfers to UF, which are negotiated annually for the support of clinical and research activities and were $23.1 million in fiscal 2014 and $22.3 million in fiscal 2013 (down from approximately $27 million in prior years) . Fiscal 2014 performance has been driven by increased volume in surgeries, higher case-mix index, better retention of commercial population within the UF primary care network, and continued focus on costs.

The operating income budget for fiscal 2015 is $20.2 million or 3.5% operating margin. The budget includes initial startup losses for the north campus of $6 million. Fitch expects profitability to continue to be solid over the next three years as the north campus strategy materializes.

Moderate Debt Burden But Light Debt Service Coverage

Total outstanding debt is $161 million as of June 30, 2014 and is approximately 60% fixed rate and 40% variable rate. UFH-J completed a debt restructuring last year, which resulted in higher committed capital structure and implementation of an MTI. UFH's debt includes the $64.2 million series 2013A fixed-rate bonds, $59.4 million series 2013 variable-rate (R-Floats), and $37.3 million subordinated note payable to Gainesville for their investment in UFH-J.

Although there is no put risk, the R-Floats have remarketing risk as the rate is set by the remarketing agent weekly. If there are non-remarketed bonds for a period over six months, the bonds convert to a two-year term loan. The conversion to a two-year term loan would also occur if UFH-J fails to maintain at least two investment grade ratings.

The MTI includes maintaining maximum annual debt service (MADS) coverage of at least 1x and 45 days cash on hand. Debt service coverage of below 1x for two consecutive years or failure to comply with the liquidity covenant would result in an event of default. Fitch used MADS of approximately $16.3 million, which is calculated per the MTI definition and excludes subordinated debt service (includes $45 million of additional debt in the next few months). MADS including the subordinated debt service is approximately $17.5 million.

UFH-J has one floating- to fixed-rate swap ($21 million notional) that requires collateral posting at a $7.5 million threshold at its rating level. No collateral is being posted.

The debt burden is fairly moderate with MADS comprising 3.2% of total revenue compared to the 'BBB' category median of 3.6%. Debt service coverage is pressured due to the inclusion of transfers to UF in EBITDA. MADS coverage (excluding subordinated debt per the MTI) was 2.1x in fiscal 2014, improved from 1.4x the prior year but still low for the rating level compared to the 'BBB' category of 2.6x. Debt service coverage is projected to improve to levels around 3x over the next three years.

Weak Liquidity

UFH-J's liquidity is weak with $93.7 million unrestricted cash and investments at June 30, 2014, which translated to 69.1 days cash on hand and 56.3% cash to debt compared to 82.2 and 73.4%, respectively, the prior year. Liquidity is weaker than expectations and driven by higher pending receivables from city/state funding ($16 million), $7 million related to the Recovery Audit Contractor (RAC) take-backs, all of which is expected to be recouped, as well as the paydown of accounts payable. Liquidity should also further improve with the proceeds of a pending sale of its Medicaid HMO plan, which should result in $20 million in fiscal 2015, as well as a potential capital infusion from the city through a purchase/lease structure on one of UFH-J's properties, which would add approximately $50 million to unrestricted cash and investments. Although not expected, a further decline in balance sheet metrics would likely result in negative rating pressure.

Disclosure

UFH-J covenants to provide annual audited information within 120 days of fiscal year end and quarterly financial information within 45 days of quarter end for all four quarters.

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

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2014

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=896294

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