NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed at 'BBB' the following series of bonds issued by the Maryland Health and Higher Educational Facilities Authority on behalf of Meritus Medical Center (Meritus):
--$257,300,000 series 2015.
The Rating Outlook is Stable.
Additionally, Fitch has withdrawn the ratings for the following bonds due to prerefunding activity:
--Maryland Health & Higher Educational Facilities Authority (Meritus Health) revenue bonds series 2008 (prerefunded maturities only).
SECURITY
The bonds are secured by mortgage and gross receipts pledge.
KEY RATING DRIVERS
SOLID 2015 AND INTERIM RESULTS: The benefits of a financial improvement plan launched mid-fiscal 2014, which only partially impacted the 2014 fiscal year (FYE June 30), resulted in a solid fiscal 2015 and a strong interim performance through the third quarter of fiscal 2016 ending March 31 (the interim period). Meritus recorded operating income of $10.4 million in fiscal 2015 and $11.2 million for the third quarter interim period, equal to operating margins of 2.8% and 4%, respectively.
ELEVATED DEBT BURDEN: Meritus' debt burden is still somewhat elevated due to the large debt issued in connection with a replacement facility that opened in 2010. Coverage of maximum annual debt service (MADS) by EBITDA was 2.8x in fiscal 2015 and 2.9x through the nine-month interim period, consistent with the Fitch's 'BBB' rating category, but MADS as percent of revenues at 5% and debt to capitalization of 54.7%, while slowly declining, are still higher than the 'BBB' medians.
MIXED LIQUIDITY: At March 31, 2016 Meritus had $207.1 million of unrestricted cash and investments, which translate to a better than the category median 272 days cash on hand (DCOH), but cash to debt at 74% lags Fitch's median. Fitch does not expect liquidity to increase materially in the near term as Meritus is planning to fund the installation of a new electronic health record (EHR) platform from internal reserves.
DOMINANT PROVIDER IN ITS PRIMARY MARKET: Meritus has maintained a leading market share of medical services of 87.7% in its primary service area (PSA), characterized by solid demographic profile. A weaker 18.5% market share in the secondary area (SSA) is viewed as a challenge and management is focusing on recruitment of primary care physicians in the SSA to booster market presence.
RATING SENSITIVITIES
CONTINUED OPERATIONAL IMPROVEMENT: A continuation of the operational improvement generated in in fiscal 2015 and year to date 2016 resulting in further improvement in liquidity and moderation in debt burden is likely to trigger a positive rating action.
CLARITY AROUND EHR IMPLEMENTATION: Positive rating action is somewhat constrained by the uncertainty regarding the cost and timing on the installation of a new electronic medical record platform. Fitch will evaluate the operational and financial impact of the new EHR once final decision will be made. At this time management does not expect to issue debt to finance the install.
CREDIT PROFILE
Meritus Medical Center is a 243-bed hospital located in Hagerstown, MD. Meritus is the only member of the obligated group and represents 85% of consolidated system revenues and 97% of system assets. Fitch's analysis is based on the consolidated system. Total system revenues in fiscal 2015 (June 30 year-end) were $367.6 million.
SOLID 2015 AND INTERIM RESULTS
After an essentially breakeven fiscal 2014, the benefits of a financial improvement plan launched in 2014 aimed at reducing avoidable admissions and controlling expenses were more fully realized in fiscal 2015 and have continued through the third quarter of fiscal 2016. Fiscal 2015 ended with operating income of $10.8 million, equal to operating and operating EBITDA margins of 2.8% and 12.8%. Expenses in 2015 were kept level with the prior year, partially due to reduced salary and benefit costs, while operating revenues increased by 2.5%. Tight expense control was carried through the 2016 nine-month interim period in 2016, producing operating income of $11.2 million, equal to a 4% operating margin, exceeding the 3% operating margin goal set for the financial improvement plan. Management expects to end the year with operating income of $12 million. Based on the lower rate increases under the Maryland Health Cost Review Commission Total Patient Revenue (TPR) program, as well as a need for nursing salary adjustment in order to reflect market compensation levels, management has budgeted slightly lower operating income of $10 million for fiscal 2017.
TRIVERGENT HEALTH ALLIANCE
Fitch views favorably Meritus's participation in the Trivergent regional alliance with Frederick Memorial Hospital (230 beds, Fitch rated 'BBB+'/Stable Outlook) and Western Maryland Hospital System (283 beds). The three alliance member hospitals have total revenues of approximately $1.1 billion and are jointly managing revenue cycle, lab, IT, materials management, human resources and pharmacy. The alliance provides increased scale to more efficiently operate support functions, and creates a platform to jointly work on clinical quality improvements and facilitates a base for population health management initiatives. Trivergent was recently awarded a $3.2 million grant, which will be used to help with needed care transformation. Meritus anticipates realizing savings of approximately $3.5 million in next year from participation in Trivergent, slightly less than in the current fiscal year, with total actual savings estimated at $14 million over a three year period.
ELEVATED DEBT BURDEN
Meritus's leverage still remains high. MADS at 5% as a percent of revenues is unfavorable compared to the 'BBB' rating category median of 3.6%. Coverage of MADS is slowly improving, and at 2.8x in fiscal 2015 and 2.9x through the interim period, is consistent with the rating category median. The inclusion of $20 million of new money in the 2015 transaction did not negatively impact coverage due to the significant savings from the refunding. With a new replacement facility in 2010, Meritus' routine capital budget is fairly modest at $10 - $13 million annually over the next three years, slightly more than 50% of its depreciation expense. Meritus needs to preserve liquidity in order to be able to fund a planned replacement of its EHR, that current industry standards estimate at approximately $30 - $50 million, and which management is planning to fund from operating cash-flow and internal reserves. Approximately $15 million of bond proceeds from the 2015 transaction are still available to fund capital expenses.
In addition to the routine capital investment, $6.4 million is slated for refitting an ambulatory surgery facility on the main campus before the end of calendar 2017, which had been closed in early 2015, moving the service into the main hospital. However, management had recently decided to reopen the facility in order to free up needed operating room capacity at the main hospital and to provide the services under a more optimal business model for ambulatory care.
DEBT PROFILE
Following the issuance of the series 2015 bonds, approximately 97% of Meritus' debt is fixed rate. Management entered into a capital lease with PNC Equipment Finance LLC in August 2014. At March 31, 2016 $7.3 million was outstanding. The lease has a five-year term. Fitch includes the maximum debt service of $1.9 million in the $18.6 million of total MADS. 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
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866807
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1005430
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1005430
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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