NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns a 'BBB' rating to the approximately $268.5 million series 2015 bonds issued by the Maryland Health and Higher Educational Facilities Authority on behalf of Meritus Medical Center (Meritus).
Additionally Fitch affirms the 'BBB' rating on the following series of bonds:
-- $250.2 million Maryland Health and Higher Educational Facilities Authority series 2008.
The Rating Outlook is Stable.
The series 2015 bonds will be sold as fixed rate and proceeds will be used, together with other available funds, including the released series 2008 debt service reserve fund (DSRF), to advance refund Meritus' series 2008 bonds and provide approximately $20 million to fund various system project needs. The series 2015 will have a July 2045 final maturity and debt service will be level with pro forma maximum annual debt service (MADS) of $20.2 million. A DSRF will not be funded in connection with the series 2015 bonds. The refunding is currently estimated to generate approximately $12.5 million of net present value savings. The bonds are expected to sell the week of June 22.
SECURITY
The bonds are secured by mortgage and gross receipts pledge.
KEY RATING DRIVERS
IMPROVED 2015 INTERIM RESULTS: The benefits of a financial improvement plan launched mid-fiscal 2014 was able to only partially impact the 2014 fiscal year (June 30), which ended with a breakeven operating performance. The results through the third quarter of fiscal 2015 ended March 31 showed the full impact of the operational improvement; Meritus recorded operating income of $8.7 million equal to an operating margin of 3.2% and operating EBITDA margin of 13.1%.
EXTENSION OF THE TPR PROGRAM: Maryland Health Care Cost Review Commission's (HSCRC) Total Patient Revenue (TPR) reimbursement methodology program was approved to run through fiscal year-end 2016. The program provides revenue predictability for hospitals participating in the program by guaranteeing a predetermined level of revenue, regardless of volume or case mix, but is adjusted for population demographics, bad debt and inflation.
DOMINANT PROVIDER IN ITS MARKET: Meritus has maintained a leading market share of 81% in its service area characterized by solid demographic profile. Fitch views Meritus' participation in the Trivergent Health Alliance (Trivergent) with two other area hospitals positively; Trivergent has produced savings from reducing the costs of several back-office functions, and is facilitating the implementation of population health initiates around a regional ACO strategy.
ELEVATED DEBT BURDEN: Meritus' debt burden is still elevated due to the large debt issued in connection with a replacement facility that opened in 2010, which is being refunded in the current transaction. However, Fitch does not expect the leverage metrics to be negatively impacted by the inclusion of approximately $20 million of new money in the current transaction. Coverage of pro forma MADS by EBITDA was 2.2x in fiscal 2014 and 2.5x through the nine-month interim period ended March 31, 2015. MADS as percent of revenues and debt to capitalization, while slowly declining, are still higher than the 'BBB' medians at 5.6% and 51%, respectively.
RATING SENSITIVITIES
NEED TO SUSTAIN OPERATIONAL IMPROVEMENT: Fitch expects Meritus Medical Center to maintain the improved operating profile reflected in the 2015 interim period, which would be expected to produce positive rating momentum over the next 12-24 months.
CREDIT PROFILE
Meritus Medical Center is a 251-bed hospital located in Hagerstown, MD. Following a corporate reorganization effective Jan. 1, 2013, Meritus is the only member of the obligated group and represents 82% of consolidated system revenues and 96% of system assets. Fitch's analysis is based on the consolidated system. Total system revenues in fiscal 2014 (June 30 year-end) were $358.7 million. The rating reflects the organization's dominant market position of over 80% in conjunction with participation in the TPR program, which provides institutions with a predictable stream of revenue.
TRIVERGENT HEALTH ALLIANCE
Fitch views favorably the formation of a regional alliance with Frederick Memorial Hospital (230 beds, Fitch rated 'BBB+'/Outlook Stable) and Western Maryland Hospital System (283 beds). The alliance has a board consisting of the Chair, Vice-chair and CEO of the three hospitals and the CEO of Trivergent, who was the former CFO of Meritus. The three member hospitals have total revenues of approximately $1.3 billion and are jointly managing revenue cycle, lab, IT, materials management, human resources and pharmacy. The savings were $6 million in the first year of the Alliance's operation, of which $2.2 million accrued to Meritus. The alliance provides increased scale to more efficiently operate support functions, creates a platform to jointly work on clinical quality improvements and facilitates a base for population health management.
IMPROVED INTERIM RESULTS
After a solid fiscal 2013, mid-way through fiscal 2014 Meritus experienced higher than expected inpatient volumes with an increase of 6.9%, which has a negative financial impact under TPR unless accompanied by a concomitant decrease in expenses. A financial improvement plan with the help of consultants was put in action in January 2014 with the goal to reach a 3% operating margin in 2015. The plan target was to address avoidable admissions and readmissions issues and implement a cost reduction effort to reduce expenses by $10 million over the next 18 months. Management implemented a reduction of 100 positions during the second half of fiscal 2014 and focused on expenses producing a breakeven operating performance by end of fiscal 2014. The interim period ended March 31, 2015 is reflecting the full benefit of the financial improvement plan with Meritus reporting operating income of $8.7 million, consistent with the financial improvement plan goal and favorable to Fitch's 'BBB' median of 1.1%. The operating EBITDA margin, at 13.9%, is also better than the median of 7.9%. The budget for fiscal 2015 is $8.6 million, which Fitch feels is realistic based on the year to date results.
ELEVATED DEBT BURDEN
The elevated debt position remains the major credit negative. MADS at 5.6% as a percent of revenues is high compared to the 'BBB' rating category median of 3.6%. Coverage of pro forma debt has improved to 2.5x through the interim period from 2.2x in fiscal 2014. Through savings from the refunding (estimated at 5%) and the release of the series 2008 DSRF, Meritus is able to include $20 million of new money in the transaction without further negatively impacting leverage. Given the high debt burden, Meritus needs to maintain its improved operating performance in order to further moderate its leverage position. With a new replacement facility, Meritus' capital budget is a fairly modest at $12-13 million annually over the next three years, only slightly more than 50% of its depreciation expense. A stepped up investment in EMR will be needed three years out, which will be coordinated with Trivergent.
MIXED LIQUIDITY
Unrestricted cash and investments have grown to $179.5 million at March 31, 2015 from $110 million at 2012 fiscal year end, translating to 198 days cash on hand (DCOH), favorable to the 'BBB' median of 145 DCOH. Contributing to the liquidity improvement was good cash flow, as well as the sale of a pharmacy for $0.4 million and $1.3 million from Meritus' participation in Premier group purchasing. Cushion ratio at 8.9x is close to the median but cash to the $268.5 million of pro forma debt at 67%, while improved since the 2008 issuance, still materially lags the 93.6% category median.
DEBT PROFILE
Following the issuance of the series 2015 bonds Meritus will have approximately 98% of its debt is fixed rate. The proposed series 2015 extends the final maturity of the refunded series 2008 bonds by only two years and the refunding will reduce annual debt service payments by an approximately $980,000, despite the addition of $20 million of new money in the transaction. New money proceed will fund routine capital and equipment expenditures. Management entered into a capital lease with PNC Equipment Finance LLC in August 2014. The maximum borrowing allowed is $9 million, with $3.4 million drawn down to date. The loan has a five-year term and 2.3% interest initially, then at a five- or seven-year Swap Rate. Fitch includes the maximum debt service of $1.9 million in the $20.2 million of total MADS, which assumes the entire $9 million is drawn down. Meritus has no swap exposure.
DISCLOSURE
Meritus covenants to disclose audited and quarterly financial and utilization statements to the Municipal Securities Rulemaking Board's EMMA system.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Not-for-Profit Hospitals and Health Systems Rating Criteria (pub. 23 Sep
2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=779548
U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 30 May
2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860
Additional Disclosures
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985715
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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