UCH lease brings early rewards, thanks to stability

University of Colorado Health hasn’t officially started running Memorial Health System, but Memorial already is benefiting from the association.

After downgrading Memorial’s outlook to negative in March, Moody’s Investors Service is giving the three-hospital group an upgraded A3 bond rating and a stable outlook. University of Colorado Health has an A3 rating with a positive outlook, Poudre Valley Health Care has an A2 rating with a stable outlook, and Memorial has an A3 rating with a negative outlook.

Moody’s also upgraded Poudre Valley’s debt from A1 to A2, and upgraded its 2005E debt from A2 to A3, because that debt will be refunded with current financing.

The better rating and stable outlook stem from the merger of UCH and Poudre Valley Health Care, as well as the long-term Memorial lease.

Adding Memorial is clearly the linchpin in UCH’s plan to extend its reach along the Front Range — and to use Memorial as a jumping-off point to expand into Kansas and the Western Slope.

“The new entity combines strong clinical excellence at UCHA with an extensive, primary care physician, regional referral network,” the report said.

Together, UCH, Memorial and PVHC outperform national averages for similar-sized health systems.

The three hospitals have a combined revenue base of more than $2.2 billion and treat more than 70,000 patients. Combined operating cash-flow margins for 2012 were higher than 15 percent, and the operating margins were higher than 7 percent. Even Moody’s was impressed, calling the performance “better than national medians.”

Moody’s continues to heap praise on the decision to operate as one system. For one thing, the report said the combined group not only has significant scale, it more than doubles PVHC’s and UCH’s revenue base and utilization measures.

However, the hospital group isn’t without its challenges. Memorial’s low inpatient volume clearly makes it the weakest link in the three-hospital group.

The arrangement with Memorial, UCH and PVHC is unique, Moody’s said, because it’s anchored by an academic medical center, but the majority of revenue comes from the two regional hospitals. That gives it advantages over its competition.

But the news isn’t all good. Memorial has significant operating challenges, according to Moody’s.

“Memorial has recently seen a material dropoff in its operating performance,” the report said. “In FY 2011, operating cash flow hit a nine-year low. In 2011, there was a precipitous drop in profitability. Operating income dropped to a loss of $10.2 million from a gain of $11.6 million.”

The report said that before 2011, Memorial’s operating margin averaged 1.1 percent during the five previous years, and the cash-flow margin averaged 9.3 percent.

Moody’s said the drop was attributable to decreased hospital referrals, decreased utilization of health care service, and a decrease in total operating revenue and overall volume.

However, those challenges might be short-lived — again, thanks to the partnership with UCH.

“With the change in ownership of the facilities, and the strong relations that UCH can bring to bear, we expect performance at Memorial to improve,” the report said.

Still, Moody’s hits a note of caution. UCH already has a high level of debt, and taken together, the three hospitals have a cash-to-debt ratio of 82.9 percent. Debt-to-revenue equals 66.5 percent. Construction already is underway at UCH and the need for more construction at PVHC also make Moody’s cautious.

The report said that UCH paid $400 million for Memorial, funded with series 2012A bonds and a $110 million capital lease. It also has a $400 million capital project underway — the new addition and renovation of the cancer pavilion. UCH is paying for that with $200 million in bonds and $200 million in cash and cash flows.

“The project entails disruption risk, construction risk and implementation risk,” the report said. Still, it also notes that the project is both on time and under budget.

Other issues stated in the report: significant competition in all major markets and a high reliance on supplemental governmental funding. According to Moody’s the supplemental funding totaled $71 million in fiscal year 2012, compared to a total operating income of $170 million. Most of that money goes to Memorial and UCH to treat patients who use Medicare, Medicaid or TRICARE government programs.

As UCH takes over Memorial Health System, its high level of debt could make it difficult to start major capital projects. But, it can use its economies of scale and its physician network to increase patient volume — and therefore increase Memorial’s profit margins.

And that will benefit everyone involved.