Rating Action: Moody's assigns A1 to Phoenix Children's Hospital's (AZ) Ser. 2020A; outlook stable

Global Credit Research - 29 Jul 2020

New York, July 29, 2020 -- Moody's Investors Service has assigned an A1 to Phoenix Children's Hospital's (AZ) proposed $290 million of Hospital Revenue Bonds (Phoenix Children's Hospital), Series 2020A to be issued by the Arizona Industrial Development Authority. The bonds are expected to be issued as tax-exempt fixed rate securities maturing in 2050. Simultaneously, the A1 assigned to Phoenix Children's Hospital's outstanding debt has been affirmed. The outlook is stable. The actions affect approximately $810 million of debt (including the proposed series).

RATINGS RATIONALE

The affirmation and assignment of the A1 reflects expectations that Phoenix Children's Hospital (PCH) will show strong financial performance in fiscal 2020, as steady reactivation, expense management, and CARES Act grants should mitigate the impact of COVID-19 on cash flow. PCH's strong, durable operating margins will be fueled by expansion strategies that will drive above average revenue growth to provide the platform to absorb the proposed, material 54% increase in financial leverage. That said, the A1 reflects a commitment to de-leverage with no incremental debt planned over the intermediate term. Though already strong absolute liquidity will build, as strategic capital investments will largely be funded with the proposed issuance, the sizable increase in permanent debt will translate into outsized leverage metrics until PCH begins to de-leverage. PCH, as the only standalone pediatric provider in the state, will continue to benefit from distinct tertiary service lines, leading market share, and significant expansion strategies in the demographically favorable service area. PCH's primary challenges will continue to be high financial leverage and execution of sizeable growth strategies in a highly competitive market. Also, high reliance on Medicaid and supplemental funding, which has fluctuated over the past several years, will also remain a credit risk.

The most immediate social risk is the impact of COVID-19, which has resulted in volume and short-term revenue losses. Though the organization's robust margins and healthy liquidity levels prior to COVID-19 and relief funding from the CARES Act have stemmed margin pressures in fiscal 2020, there is a high degree of uncertainty around the potential impact of COVID-19. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, low oil prices, and financial market declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented.

RATING OUTLOOK

The stable outlook anticipates that PCH's strong cashflow and robust enterprise growth will translate into incremental absorption of high financial leverage. The outlook also assumes that PCH will successfully execute its various concurrent strategic and capital projects while maintaining operating cash flow margins at historic levels. Nevertheless, a pronounced or prolonged impact from COVID-19 at PCH could lead to a change in outlook or rating if anticipated cashflow growth is thwarted.

FACTORS THAT COULD LEAD TO AN UPGRADE OF THE RATINGS

- Very material improvement of liquidity and debt measures, accompanied by continued strong operating performance, and material organizational growth

FACTORS THAT COULD LEAD TO A DOWNGRADE OF THE RATINGS

- Inability to maintain low double digit operating cash flow margins which are consistent with historic levels

- Additional financial leverage, beyond proposed issuance, or meaningful decline in liquidity

- Supplemental funding cuts or changes in Medicaid that lead to significant margin decline

- Greater than expected impact on performance from disruptions related to COVID-19

LEGAL SECURITY

Bonds will be issued under the 2019 restated Master Trust Indenture (2019 MTI), which will spring into effect with this issuance. All Bonds (outstanding and proposed) are a joint and several obligation of the obligated group, which currently consists of Phoenix Children's Hospital and The Phoenix Children's Hospital Foundation. Bonds are secured by a pledge of gross receivables. The 2019 MTI affords the ability to create a "Credit Group" that includes Designated Affiliates, Unlimited Credit Group Participants, and Limited Credit Group Participants. Covenants will now include a minimum annual debt service coverage requirement of 1.1 times (if less than 1.1 times consultant call in and if less than 1.0 times for two consecutive years an event of default (EOD)). The liquidity covenant and the deed of trust on mortgaged property, will fall away with the 2019 MTI taking effect.

The LOC agreements are consistent with 2019 MTI coverage covenant, but an EOD will occur if debt service coverage drops below 1.0 times for any Fiscal Year. The LOC agreements also contain a days cash on hand requirement of 45 days, measured annually. In addition, under the LOC agreements a downgrade of the long-term rating(s) assigned to any debt secured under the 2019 MTI below "Baa2" or "BBB" or a suspension or withdrawal constitutes an EOD.

USE OF PROCEEDS

The proceeds from the sale of the Series 2020A Bonds will be used to (i) finance, including reimburse for, costs of the acquisition, construction, equipping, improvement, renovation, rehabilitation, and/or remodeling of capital projects, including capitalized interest, at hospital, health care and related facilities owned and/or operated or to be owned and/or operated by PCH or certain of the other Obligated Group Members, and (ii) pay the costs of issuance of the Series 2020A Bonds.

PROFILE

Phoenix Children's Hospital is a large tertiary pediatric referral center serving the State of Arizona (over $1 billion in total revenues in fiscal 2019). PCH is the only licensed children's hospital in the state and is one of the 10-largest children's hospitals in the country (based on number of beds). The organization offers a very broad array of high-end pediatric services including level one trauma, level four NICU, and solid organ transplant. In addition to the 435-staffed bed flagship hospital in downtown Phoenix, the organization operates a 22-bed pediatric unit at Mercy Gilbert Medical Center, maintains numerous freestanding clinics in 7 different cities throughout the state, employs nearly 500 practitioners, and is closely affiliated with over 1,200 providers. Since 2011, the organization has been jointly controlled by Dignity Health (now CommonSpirit Health, rated Baa1 stable, with a 20% ownership stake) and Children's Healthcare of Arizona (the parent corporation, with 80% ownership stake). No cash distributions have ever been made to the members but could occur under certain circumstances. Bond holders have no recourse to the members, and our analysis is based on the credit quality of the operating entity Phoenix Children's Hospital.

METHODOLOGY

The principal methodology used in these ratings was Not-For-Profit Healthcare published in December 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBM_1154632. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Beth Wexler Lead Analyst PF Healthcare Moody's Investors Service, Inc. 7 World Trade Center 250 Greenwich Street New York 10007 US JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Eugene Spielman Additional Contact PF Healthcare JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653

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