NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the rating on the following bonds issued by the Massachusetts Development Finance Agency on behalf of Lawrence General Hospital (LGH) to 'BBB-' from 'BBB':
--$43.4 million revenue bonds, series 2014A.
The Rating Outlook is revised to Negative from Stable.
SECURITY
The bonds are secured by pledge of the obligated group's gross revenues, a first lien mortgage on LGH's hospital facility, and a debt service reserve fund.
KEY RATING DRIVERS
DRAMATICALLY WEAKENED OPERATING PERFORMANCE: The downgrade to 'BBB-' reflects LGH's dramatically weakened financial performance over the past year and expectations for challenged operations in fiscal 2016. In fiscal 2015, LGH and its consolidated affiliates experienced a $13.5 million negative swing in operating profitability mostly as a result of reduced volumes, governmental reimbursement pressures, and start-up expenses from physician practices and service expansions. Based on LGH's draft audit report, the operating margin declined to negative 2.9% in fiscal 2015 (Sept. 30 year-end) from positive 2.9% the prior year.
REDUCED LIQUIDITY LEVELS: The downgrade is also based on LGH's reduced liquidity levels. As of Nov. 30, 2015, LGH had $47.6 million of unrestricted cash and investments, equating to 73.7 days cash on hand, which is down from $63.9 million or 112.5 days cash on hand at the end of fiscal 2013. Liquidity levels are down due to the operating losses, heightened capital expenses, and strategic investments in related healthcare ventures and service line development.
SIZEABLE CAPITAL PLANS: LGH is in the midst of a $73 million master facilities plan (2014-2019) with major projects including inpatient renovations and a new surgical building. A portion was funded with the series 2014A bond issue and as anticipated, LGH is planning to close on $30 million of direct bank placements in February 2016, which will fund part of the surgical building project. Fitch views the investment in the facilities and surgical programs positively as it will provide improved access and enhanced clinical service capabilities.
INCREASED BUT MANAGEABLE DEBT POSITION: Pro forma maximum annual debt service (MADS) is low at 2.5% of total revenues despite the pending issuance of $30 million in new debt. However, some of LGH's other capital-related metrics are weak for the 'BBB' rating category.
AFFILIATIONS WITH OTHER PROVIDERS: LGH has clinical affiliations with Beth Israel Deaconess Medical Center (BIDMC), Floating Hospital for Children at Tufts Medical Center, and the Choice Plus PHO, which includes the Greater Lawrence Family Health Center, Beth Israel Deaconess Care Organization Physicians, and Pentucket Medical Associates. LGH and Pentucket Medical Associates have affiliated to provide primary, pediatric, and urgent care in Andover, MA. Fitch views these relationships favorably as they broaden LGH's geographic footprint and help stem patient outmigration.
RATING SENSITIVITIES
CONTINUED WEAK OPERATING PERFORMANCE: Management expects financial performance to remain soft in fiscal 2016 and is budgeting for an operating loss. If profitability and debt service coverage metrics are not improved over fiscal 2015 levels and more in line with 'BBB' category medians, further negative rating action could occur.
FURTHER LIQUIDITY REDUCTIONS: If LGH's cash position continues to erode in light of its capital spending plans and lower earnings, another downgrade is possible.
CREDIT PROFILE
LGH is a 189-licensed bed non-profit hospital located in Lawrence, MA approximately 25 miles north of Boston. The obligated group includes LGH and Lawrence General Hospital Charitable Trust, which is the hospital's foundation and fundraising enterprise. Non-obligated entities operate physician practices, a management services company, an imaging center, and a qualified low-income community business. LGH and its affiliates had total revenue of $232 million in fiscal 2015 according to its draft audit. For its analysis, Fitch uses the total system consolidated financial statements including all affiliates. In fiscal 2015, the obligated group represented 98% of total system revenues and nearly 92% of total system assets.
WEAKENED FINANCIAL PERFORMANCE
LGH experienced a large and unexpected negative swing in operating performance in fiscal 2015 due to lower volumes, governmental reimbursement pressures, and start-up expenses from service expansions. Partially due to the severe winter weather and slower than expected benefits from newly recruited physicians, discharges and total surgeries declined by 4% and 3.9%, respectively, in fiscal 2015. Additionally, Medicare and Medicaid reimbursement and certain supplemental funding programs were reduced. On the expense side, investments in employed physician practices, increased capital costs and higher wages and benefits contributed to the operating loss. As a result and based on the draft audited financial statements, LGH lost $6.76 million in fiscal 2015 after a $6.74 million gain in the prior fiscal year. Given the weakened operations, pro forma MADS coverage dropped to 1.1x in fiscal 2015 from 3.1x a year earlier. Fitch notes that the obligated group's financial performance and ratios are stronger than the consolidated system given the operating losses at the employed physician practices.
To respond to the financial challenges, management instituted a cost mitigation plan that resulted in the reduction of about 24 full-time equivalent positions which included one-time severance costs of about $700,000 in fiscal 2015. Management anticipates the labor cost saving measures, lower contracted services expenses, and volume gains from its strategic initiatives to improve financial performance, but is still budgeting for a $2.66 million operating loss in fiscal 2016. Continued reimbursement challenges from a payor mix with a 70% governmental concentration, limited pricing power with commercial health plans, competitive pressures from two nearby Steward Health Care System hospitals, and labor expense burdens from physician practices and a unionized work force limit LGH's budgetary flexibility.
LOWER LIQUIDITY LEVELS
As a result of the operating losses, heightened capital expenses, and strategic investments in related healthcare ventures and service line development, liquidity levels have declined. Moreover, since the Center for Medicare and Medicaid Services and the commonwealth of Massachusetts delayed $14.4 million of Delivery System Transformation Initiative (DSTI) funds prior to the end of the fiscal year, LGH was in violation of its liquidity covenant with its bank lender. Regardless, LGH received its DSTI funding in October and November of 2015 and it is expected that the bank will waive the liquidity covenant violation by Jan. 31, 2016. After the waiver from the bank is received, it is expected that the fiscal 2015 audited financial statements are released. As of Nov. 30, 2015, LGH had $47.6 million of unrestricted cash and investments amounting to 73.7 days cash on hand, 45.4% pro forma long-term debt, and 8.2x pro forma cushion ratio. These figures do not compare favorably to Fitch's 'BBB' category medians of 161.5 days cash on hand, 89.5% cash to debt and 11.1x cushion ratio. Fitch also notes that the obligated group's balance sheet and related ratios are stronger than the consolidated system given the affiliates narrow liquidity and long-term debt balances.
SUPPLEMENTAL FUNDING
In 2014, through the Massachusetts Medicaid Waiver extension, LGH was awarded a second phase of DSTI funding with annual payments of $15.8 million through June 2019. This funding is in addition to the $43.3 million of DSTI funding that LGH received for a three-year period ending June 2014, which allowed LGH to focus on population health and alternative payment models. Projects identified for phase two of the DSTI funds include upgrades to health information exchange technology, medication safety, post-acute care network development, and additional population health and alternative payment model programs. While Fitch views these incentive payments favorably, they are subject to annual appropriation from the Massachusetts legislature and have been reduced to $14.4 million during fiscal 2015. LGH is budgeting for a similar amount in fiscal 2016.
SIGNIFICANT CAPITAL INVESTMENTS
LGH is undertaking significant capital investments through 2019, which Fitch believes are strategic in nature and manageable if LGH stabilizes its cash flow and liquidity position. The total cost of LGH's master plan is about $73 million, of which approximately $14 million will be funded via operating cash flow and reserves. The new surgical building is expected to cost $55 million and is being funded with reserves, fund raising, $16.8 million of new-market tax credit loans, and a $30 million debt issuance expected to close in February 2016. While the new-market tax credit loans appear as long-term debt on the consolidated LGH balance sheet, the obligation is expected to be forgiven after seven years for a $1,000 payment. During the first seven years that these loans are outstanding, LGH will pay interest only of about $213,000 annually. In addition to the master facilities plan, routine capital expenditures have been reduced and are projected to cost about $4 million annually over the next three years.
DEBT PROFILE
After the issuance of $30 million of direct bank loans with two providers, LGH will have about $104 million in debt outstanding, of which about 70% is fixed-rate and 30% is variable-rate. The $14.2 million series 2013A variable-rate bonds are privately placed with TD Bank and not rated by Fitch. The pending $30 million of direct bank placements are expected to be fixed-rate obligations with a 10-year term and five-year amortization. The $16.8 million new-market tax credit loans are an obligation of LGH Administrative Services, a not-for-profit affiliate that acts as a qualified active low-income community business that is part of the development project for the surgical building. Pro forma MADS is about $5.83 million, and includes interest only for the new-market tax credit loans.
SUCCESSFUL PARTNERSHIPS
Fitch believes LGH's successful affiliations with physicians and other clinicians in certain service lines has resulted in expanded programs and access to providers. LGH has added service capabilities to address health care needs in the local area, including bariatrics, endocrinology, oncological surgery and pediatric specialties. LGH strengthened its clinical affiliations with BIDMC in 2014 and also joined its contracting and risk sharing organization. LGH also has an affiliation with Floating Hospital for Children at Tufts Medical Center and collaborates with Pentucket Medical Associates, opening an urgent care, women's and imaging center in the growing Andover, MA service area in 2015.
DISCLOSURE
LGH has covenanted to disclose annual financial statements to the Municipal Securities Rulemaking Board's EMMA system within 150 days of year end in addition to quarterly disclosure within 60 days of the end of each quarter.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Not-for-Profit Hospitals Rating Criteria (pub. 04 Dec 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=874120
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=997946
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