Fitch Affirms Southeastern Regional Medical Center (NC) at 'A'; Outlook Stable

CHICAGO--()--As part of its ongoing surveillance efforts, Fitch Ratings has affirmed the 'A' rating on the following North Carolina Medical Care Commission bonds issued on behalf of Southeastern Regional Medical Center's (SRMC):

--Approximately $15.9 million hospital revenue bonds series 1999

--Approximately $38.4 million hospital revenue bonds series 2002

The Rating Outlook is stable.

RATING RATIONALE:

--The affirmation and stable outlook are based upon SRMC's solid liquidity, moderate debt burden, and a strong market position in the primary service area.

--Liquidity levels have strengthened and are close to fiscal 2007 peak levels.

--SRMC's manageable debt burden allows for solid debt service coverage despite below average operating performance.

--Credit concerns include inconsistent and weak profitability levels and an unfavorable payor mix with over 20% of gross revenues from Medicaid payors and 10% from self pay resulting in very high bad debt expense.

KEY RATING DRIVERS:

--SRMC's ability to stabilize operating profitability;

--Managing future capital needs, which includes the potential construction of a standalone ambulatory care center. SRMC may issue additional debt within the next two years to fund a portion of its master facility plan, which could result in downward rating pressure absent improved operating performance.

SECURITY:

Debt payments are secured by a pledge of the Obligated Group's accounts receivable and a negative pledge of all other assets.

CREDIT SUMMARY:

The affirmation is based upon Southeastern Regional Medical Center's (SRMC) solid liquidity, moderate debt burden, and a strong market position in the primary service area. Since 2005, SRMC has held a consistently strong market share of 63% in its primary service area of Robeson County. SRMC's position as an essential services provider in the region is illustrated by a 14% increase in emergency room visits since fiscal 2008, increasing from 70,341 to 79,937 in fiscal 2010.

SRMC's historical operating performance has been inconsistent. Since 2005, operating margin fluctuated between 4.4% and 1.2% while operating EBTIDA margin fluctuated between 10.9% and 7.0%. Given volume declines, SRMC eliminated 180 full-time positions in January 2011 in efforts to reduce costs and is enhancing its flex staffing procedures. Despite this, operating performance through the six months ended March 31, 2011 is down compared to the prior year period with a 1.9% operating margin versus 3.1%, respectively. SRMC has enacted several initiatives to stabilize operating profitability and to increase operating margin to 4% as part of its strategic plan. To sustain consistent operating margins and increase profitability, SRMC is increasing its primary care network and hired five new surgeons and an urologist, all of whom will start at SRMC in calendar 2011. SRMC is currently budgeting operating margins of 3% and its strategic plan calls for operating margins of 4%.

Although SRMC maintains a strong market position, the service area characteristics are challenging. SRMC has an unfavorable payor mix that is highly exposed to government payors, with 68.3% of gross revenues derived from Medicare and Medicaid. In anticipation of potential decreases in Medicare reimbursement, SRMC prioritized cutting losses on its Medicare cases. SRMC made a profit on Medicare for the first time in fiscal 2010 due to the impact of the reduction in force and a reduction in average length of stay from 4.2 days in fiscal 2010 to 3.7 days in fiscal 2011. Management projected that SRMC will have to reduce expenses 4% per year to maintain Medicare profitability in light of potential reductions in Medicare reimbursement. Expense reductions are to be achieved through flex staffing, productivity management and LEAN operating principles.

SRMC has been impacted by the continuing recession by an increase in bad debt as a percent of revenue from 11.3% in fiscal 2008 to 22.1% in the interim period ending March 31, 2011. This is further reflected in SRMC's payor mix with self pay increasing from 5.5% in fiscal 2008 to 10.2% in the interim period. In efforts to reduce self-pay and bad debt, SRMC has nine full time staff to meet with self-pay patients to identify whether they are eligible for Medicaid or charity care. However, self-pay and bad debt continues to grow due to the economic environment, which has resulted in a decline in insured patients as well as higher deductible health plans.

As of March 31, 2011, unrestricted cash and investments equaled $140.7 million, exceeding SRMC's peak value of $135.9 million in fiscal 2007. This equates to 261.7 days cash on hand, a cushion ratio of 20.6 times (x) and cash to debt of 198.0% and compares favorably to Fitch's 'A' category medians of 183.8 days, 14.4x and 105.5%, respectively.

SRMC's debt burden is manageable with $74.3 million total debt as of September 30, 2010, which was 73% fixed rate and 27% variable rate. Fitch does not rate the $20 million series 2005 variable rate demand bonds (VRDBs). The VRDBs are supported by a letter of credit from BB&T, which expires in 2012. Given SRMC's moderate debt burden, debt service coverage is solid despite below average operating performance with MADS coverage of 4.2x in fiscal 2010 and 3.6x through the six months ended March 31, 2011 compared to the 'A' category median of 3.3x.

SRMC has fairly significant capital needs that total $148 million for fiscal 2011 - 2016. However, management stated that some of the projects may not occur depending on available funding sources. The highest priority capital project is the construction of a stand-alone ambulatory surgery center, which is expected to cost approximately $27 million. Management expects this will be a joint venture with surgeons to increase physician alignment. Other capital needs include the renovation of existing operating rooms and women's health facilities and the addition of an eighth floor on its bed tower. SRMC may issue $20 - $30 million in debt in fiscal 2013 to fund a portion of the construction costs. Fitch will evaluate the impact of additional debt at the time of issuance; however, Fitch believes there may be downward rating pressure absent solid and sustained operating performance. EBITDA was $18 million in fiscal 2010 compared to $15 million in fiscal 2009.

The Stable Rating Outlook reflects Fitch's belief that SRMC will improve its profitability and maintain its liquidity levels in addition to maintaining its strong market position.

Fitch expects SRMC to manage its capital spending relative to available funding sources.

Southeastern Regional Medical Center is a 337-bed acute care hospital located in Lumberton, NC. Total operating revenue in fiscal 2010 was $288 million. SRMC covenants to provide annual disclosure. Fitch views the lack of covenanted quarterly disclosure as a negative.

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

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (Oct. 8, 2010);

--'Nonprofit Hospitals and Health Systems Rating Criteria'(Dec. 29, 2009).

For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493186

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Contacts

Fitch Ratings
Primary Analyst
Adam Kates, +1-312-368-3180
Director
Fitch Inc.
70 West Madison Street
Chicago, IL
or
Secondary Analyst
Emily Wong, +1-212-908-0651
Senior Director
or
Committee Chairperson
Carolyn Tain, +1-415-732-7576
Senior Director
or
Media Relations:
Cindy Stoller, +1-212-908-0526
Email: cindy.stoller@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Adam Kates, +1-312-368-3180
Director
Fitch Inc.
70 West Madison Street
Chicago, IL
or
Secondary Analyst
Emily Wong, +1-212-908-0651
Senior Director
or
Committee Chairperson
Carolyn Tain, +1-415-732-7576
Senior Director
or
Media Relations:
Cindy Stoller, +1-212-908-0526
Email: cindy.stoller@fitchratings.com