Rating Action Commentary
ֳ Upgrades Confluence Health Obligated Group (WA) to 'A'; Outlook Stable
Thu 30 May, 2024 - 12:21 PM ET
ֳ - San Francisco - 30 May 2024: ֳ has upgraded Confluence Health Obligated Group's (WA) Issuer Default Rating (IDR) and revenue bond ratings to 'A' from 'A-'. The revenue bond ratings apply to the series 2015 revenue bonds issued by the Washington Health Care Facilities Authority.
The Rating Outlook is Stable.
The IDR upgrade to 'A' reflects Confluence's stronger and improved balance sheet metrics, consistently positive and improving operating performance, combined with CH's already dominant market position. In fiscal 2023 (Dec. 31; draft audit), Confluence had total unrestricted cash and investments of approximately $295.2 million, which translated into approximately 122 days cash on hand and cash-to-adjusted debt of approximately 170%, which is strong. These metrics are improved from the prior year's $253 million unrestricted cash and investment absolute balance, which equated to 106 days cash on hand and 136% cash to adjusted debt position, respectively.
In fiscal 2023, the system earned approximately $9.5 million in operating income, 1.0% operating margin and 3.8% operating EBITDA margin, which was improved from the prior year's slightly better than breakeven performance (0.1% operating margin and 2.8% operating EBITDA margin). Confluence has been able to generate positive operating income over the past five fiscal years, despite significant macro labor and inflationary challenges faced by the entire sector, especially in the Pacific Northwest.
Thus far, through fiscal 2024 (March 31, unaudited), Confluence earned $7.1 million in operating income, which led to an enhanced 3.1% operating margin and 5.9% operating EBITDA margin, which ֳ views favorably. Similarly, liquidity improved through the interim period with the system recording a stronger 192% cash to adjusted debt position. ֳ anticipates the organization will achieve an operating EBITDA margin of around 7.4%, which is also a factor in ֳ's rating actions.
ֳ's scenario analysis, which factors in a period of elevated (but manageable) capex, supports the expectation of rating stability at the 'A' rating level over the next several years. In the medium-term, ֳ expects the organization will continue to make meaningful capital investments in order to maintain its facilities and the organization's dominant long-term market position, which remains a primary credit strength.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group (OG), which includes Confluence Health, Central Washington Hospital (CWH) and Wenatchee Valley Hospital (WVH). The bonds are also secured by a mortgage pledge on Central Washington Hospital's hospital facilities in Wenatchee, Washington. Wenatchee Valley Medical Group (WVMG), while affiliated with CH, is not obligated to the bonds. ֳ's analysis is based on consolidated CH results.
KEY RATING DRIVERS
Revenue Defensibility - 'bbb'
Strong & Dominant Market Position in Service Area with Moderate Growth
Confluence's revenue defensibility is assessed as 'mid-range' and reflects the organization's very strong market position, which has been consistently above 80% for the past several years and is viewed as a primary credit strength. The system is the largest healthcare provider in central Washington state, covering a large four-county area across 12,000 square miles and a population base over 250,000.
The system's market share in its secondary service area of Grant and Okanogan counties was most recently around 53%, which is also viewed as strong, with Samaritan Healthcare being the next closest competitor in the two counties. Confluence has continued to strategically grow in its secondary service area and has focused on growing oncology services over the medium term.
Confluence generates nearly all its patient admissions from the four Washington counties of Chelan, Douglas, Grant and Okanogan. The primary service area counties of Chelan and Douglas have shown good five-year population growth of 4.9% and 5.3%, respectively, which is above the nation's level of 2.5%. Confluence's combined self-pay and Medicaid payor mix has been stable around 20% over the past few years. ֳ expects that the combination of self-pay and Medicaid will continue to remain under 25% of gross revenues over the medium term.
Operating Risk - 'bbb'
Positive & Satisfactory Operational Performance; Elevated Capex Program
In fiscal 2023, Confluence produced an 1.0% operating margin and 3.8% operating EBITDA margin, which marked the fifth consecutive year of profitable operations for the system. Although the operating EBITDA margin has more recently been at relatively lower levels, meaningful margin improvement is expected in fiscal 2024, with the system already posting improved performance, recording more than $7 million in operating income already through the first quarter (5.9% operating EBITDA margin).
Over the past five fiscal years, Confluence's operating EBITDA margin has averaged approximately 5.2%, which incorporates the past two years of lower relative profitability, which has been primarily related to pressures associated with heighted labor and inflationary expenses, along with higher average length of stay.
Since fiscal 2022 (when Confluence had slightly better than breakeven operations), management has focused improving operating performance with various initiatives, which has come from favorable renegotiation of commercial payor contracts, along with enhanced Medicaid reimbursement, revenue cycle improvement, labor productivity growth, throughput initiatives, and expense reductions across departments. The combination of these efforts is expected to yield further operational improvement in fiscal 2024 and beyond with operating EBITDA margins above 7%, which ֳ believes is attainable.
The system's capex requirements are considered elevated given the system's five-year capex plan to invest around $300 million over the next five years. Capex in fiscal 2023 increased to approximately 101% of depreciation expense and has averaged almost 90% over the past four years. Capex is expected to be budgeted so it allows the system to incrementally improve its balance sheet while consistently paying down outstanding debt, spend on routine needs and execute on strategies that will expand its presence into Grant County. ֳ views the Grant County strategy favorably, as it should provide CH with an expanded patient base and new revenue generation opportunities.
Financial Profile - 'a'
Consistent & Strong Financial Profile
The 'a' financial profile assessment reflects Confluence's improved liquidity position and manageable leverage position, which has in part been supported by the organization's consistent and positive historical operating performance. In fiscal 2023 (Dec. 31; draft audit), Confluence had approximately $295 million in unrestricted cash and investments, which was improved from fiscal 2022's $253.1 million balance, and translated into a robust 170% cash to adjusted debt position, which ֳ views favorably. Additionally, net adjusted debt to adjusted EBITDA measured a favorably negative 3.2x.
Through ֳ's baseline scenario, or ֳ's best estimate of the most likely scenario of financial performance over the next five years, given the current economic conditions and expectations for operational performance, ֳ expects Confluence's operating performance to be consistent and positive with operating EBITDA margins ranging from around 5% to 7.5%, which ֳ believes is achievable.
Capex plans are expected to be above depreciation levels and fund routine capital needs along with strategic growth projects totaling approximately $295 million over the next five years. With consistently positive operations, manageable capex plans, continual debt paydowns with no new medium-term debt plans, ֳ expects unrestricted resources relative to the organization's leverage position to continue to improve over time.
ֳ's forward-looking analysis shows cash to debt remaining consistently above 160%, even under a potential stress scenario where ֳ mimics both an issuer-specific revenue stress and a portfolio sensitivity stress analysis based on Confluence's portfolio asset allocation, which is sufficient for an 'a' assessment given the system's 'bbb' revenue defensibility and 'bbb' operating risk profiles.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
--Although unanticipated, if operating EBITDA margins weaken consistently below 5% for a sustained period, which is led by negative income from operations.
--A lower unrestricted cash and investments balance or debt issuance that causes cash/adjusted debt to be consistently below 120% in ֳ's stress scenario analysis.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
--Although unlikely given the positive rating action, significantly improved operating performance from ֳ's expectations combined with continued outsized balance sheet growth such that cash to adjusted debt in ֳ's stress scenario analysis is consistently above 200%.
--Operating EBITDA margins that improve to be consistently at or above 9%-10%.
PROFILE
Confluence includes the 176 bed CWH, 20 bed WVH (11 acute and nine acute rehab beds) and multiple outpatient sites throughout North Central Washington. CWH and WVH are located in Wenatchee, WA, approximately 150 miles east of Seattle and 170 miles west of Spokane. In fiscal 2023 (Dec. 31; draft audit), CH had approximately $915 million of total revenue.
CWH, WVMG and WVH entered into a Master Affiliation Agreement on Jan. 1, 2013 and formed Confluence Health. Confluence Health is the sole corporate member of CWH and WVH. The hospitals contract with WVMG for physician services under a professional services agreement. WVMG's goals are further aligned with Confluence Health through a co-management agreement that includes an annual incentive payment related to contributions to quality, patient satisfaction, financial measures and the overall success of Confluence Health.
Sources of Information
In addition to the sources of information identified in ֳ's applicable criteria specified below, this action was informed by information from Lumesis.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. ֳ's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on ֳ's ESG Relevance Scores, visit /topics/esg/products#esg-relevance-scores.
Additional information is available on
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
- Portfolio Analysis Model (PAM), v2.0.0 (1)
ADDITIONAL DISCLOSURES
ENDORSEMENT STATUS
| Washington Health Care Facilities Authority (WA) | EU Endorsed, UK Endorsed |