Fitch Ratings has downgraded the credit rating of Catholic Health, a change reflecting the hospital system's weak profitability for the past three years.
However, Fitch expects the hospital network's operating margins to improve in the future at a level in line with its lower "BBB" rating and assigned it a "stable outlook." Fitch previously rated Catholic Health BBB+ on approximately $173 million in revenue bonds.
The lower credit rating, because it is a sign that lenders face a higher - but still unlikely- risk of not getting repaid, could push up borrowing costs for Catholic Health.
"While we did receive a BBB rating, we voluntarily subject ourselves to this rating to give us the utmost flexibility to raise capital. In doing that, we are compared to a national standard. We are only one of eight health systems to have an investment graded rating in New York. We believe in comparison our balance sheet looks good," said James Dunlop, executive vice president and chief financial officer.
Fitch said Catholic Health finances should improve as it moves forward with new initiatives, including rebuilding of its cardiology program, to generate better operating margins than the average 5.8 percent in recent years.
A credit rating is an assessment of the creditworthiness of a borrower. Fitch examines a hospital system's operating profitability before such non-operating expenses as interest and non-cash charges, including depreciation and amortization, are taken into account.
Catholic Health includes Mercy, Kenmore Mercy, Mount St. Mary's and Sister's hospitals, as well as primary care locations. Its main competitor, Kaleida Health, also has a strong market share, and both providers have their own large networks of aligned physicians.
Catholic Health holds a slight competitive lead in its primary service area of Erie and Niagara counties, with a 43 percent market share in Erie County compared to Kaleida Health's 41.4 percent share, with the remaining share belonging to Erie County Medical Center, according to Fitch. The 2015 acquisition of Mount St. Mary's Hospital in Lewiston allowed Catholic Health to expand into Niagara County, where the system's market share has grown to 32.1 percent, Fitch said.
"CHS (Catholic Health system) operates in a competitive market with weaker demographics, which somewhat limits its ability to generate significantly stronger operating results," said primary analyst Olga Beck.
Fitch said a rating downgrade would be considered if the system's annual net income continues to consistently fall below 6 percent or if there is significant new debt issued for the organization. Similarly, the agency said a rating upgrade may be warranted if there is a significant and sustained improvement in profitability.
The main driver for the weaker profitability was a decrease in inpatient and outpatient surgical volumes. A portion of the decrease arose from the departure of two cardiovascular surgeons at Mercy Hospital's heart center in 2016.
The hospital system reorganized the program in 2017 with the acquisition of two of the largest cardiology groups in the Buffalo area -- the Buffalo Heart Group and Cardiology Group of Western New York. Fitch said management reported that cardiology patient volumes have returned to levels prior to the disruption in 2016, which should result in stronger finances in 2018.
"Since then, we've been able to grow the program, exceeding levels in the Fitch report," said Dunlop.
"We are good shape and more in a growth mode, and actually have picked up some market share," he said.
One financial drag on Catholic health noted by Fitch was its underfunded pension plan -- approximately 52 percent funded at the end of 2017 -- that continues to be a credit concern. Based on current projections and an increase in annual funding, management reported to Fitch that the plan's funded status should reach 86 percent by 2026.
"The 86 percent is a conservative estimate. Our expectation is that it will be higher," Dunlop said.
Based on $1.13 billion in operating revenue in 2017, the system ended the year with $24.5 million in net income and a $3.7 million operating income. It finished 2016 with $2.3 million in operating income and a $10.6 million in net income.