NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded to 'A-' from 'A' the rating on $47.9 million State of Connecticut Health and Educational Facilities Authority revenue bonds, series F (2011) issued on behalf of Lawrence & Memorial Hospital (LMH).
The Rating Outlook is revised to Negative from Stable.
LMH also has outstanding approximately $58 million in other long-term debt and leases, which are not rated by Fitch.
SECURITY
The bonds are secured by a pledge of gross revenues and a mortgage.
Fitch reports on the results of the consolidated Lawrence+Memorial Corporation (LMC), as defined in the Credit Profile section of the press release.
KEY RATING DRIVERS
CONTINUED OPERATING LOSSES: The downgrade to 'A-' is driven by continued trend of weakening profitability stemming from softer volumes, shift to outpatient utilization, less favorable reimbursement and the escalating Connecticut provider tax burden. The revision of the Outlook to Negative is based on Fitch's expectation that despite management's significant efforts at reversing the losses, a return to positive margin will only be achieved once the benefits from the anticipated joining of the Yale New Haven Health System (YNHHS; 'AA-', Stable Outlook) will be realized, which could take some time. Operating margin was a negative 4.1% in fiscal 2014 and 2.2% in fiscal 2015 (fiscal year-end [FYE] Sept. 30) and losses continued through the nine months ended June 30, 2016 with negative operating margin of 4.2%.
ANTICIPATED BENEFITS FROM JOINING YNHHS: LMC and YNHHS entered into an affiliation in July 2015 and the transaction has received FTC approval, but the Certificate of Need (CON) for the corporate member substitution has met regulatory delays at the state level. LMC and YNHHS already cooperate clinically in several areas, but the full integration with YNHHS would bring significant positive financial benefits to LMC, estimated at $9 million-$15 million annually, returning LMC to positive operating territory. Additionally, YNHHS has committed to directly contribute approximately $85 million to LMC.
ADEQUATE LIQUIDITY: Despite the operational challenges, liquidity metrics have remained largely sound and the balance sheet provides the organization with a sufficient cushion to weather the delay in implementation of the full integration with YNHHS. Cash to debt of 167.6% and cushion ratio of 19.8x at June 30, 2016 are consistent with Fitch's respective 'A' medians of 144% and 18.5x, but days cash on hand (DCOH) of 147.4 lags the median of 205.3 days.
MANAGEABLE DEBT BURDEN: LMC's debt burden remains light for the rating category, as evidenced by maximum annual debt service (MADS) at 1.9% of revenue in 2015, which compares favorably against the median of 3.6%. However, weak cash flows resulted in MADS coverage by EBITDA declining to 1.8x through the interim period from 3.8x in fiscal 2015.
SOLID MARKET POSITION: LMC has a dominant market share of approximately 67% in the combined primary service area (PSA) of the two LMC hospitals. The ability to use YNHHS in physician recruitment and the planned investment in clinical programs, once the full affiliation is realized, should further secure market share.
RATING SENSITIVITIES
RETURN TO IMPROVED PROFITABILITY: The 'A-' rating is contingent upon Lawrence+Memorial Corporation executing the full YNHHS affiliation which is expected to generate improved financial performance through efficiencies and benefits of scale. The return to Stable Outlook would require Lawrence+Memorial Corporation to demonstrate the traction of the Yale New Haven Health System relationship, leading to material improvement in operating performance.
CREDIT PROFILE
Lawrence+Memorial Corporation operates Lawrence & Memorial Hospital, consisting of Lawrence & Memorial Hospital (LMH) in New London, Connecticut with 198 staffed beds, and Westerly Hospital in Washington County (Westerly), Rhode Island with 40 staffed beds, as well as a number of other subsidiaries, including the L&M Physician Association (LMPA). The obligated group includes LMH and the LMC Parent only. For fiscal year ended Sept. 30, 2015, LMC had total revenues of $460 million.
BENEFITS OF JOINING YNHHS
LMC and YNHHS signed an affiliation agreement in July 2015 and the full merger would take the form of a member substitution, whereby YNHHS would become the sole corporate member of the LMC, but LMC would not be a member of the YNHHS obligated group, similar to the status of Greenwich Hospital ('AA-', Stable Outlook) in YNHHS. The merger with YNHHS is expected to bring significant benefits to LMC, estimated at $300 million over the next five years. Of this amount, approximately $85 million represents a direct commitment from YNHHS with half contributed fairly quickly once the formal corporate reorganization is completed for various initiatives, including population health management, rebranding, IT investment and physician recruitment focused on several specialty areas, in addition to primary care. The balance of the $300 million benefit will be realized from further clinical investments and from LMC operations and efficiencies and synergies and gained scale from being part of the large, fully integrated YNHHS, with revenues of $3.5 billion.
CONTINUED WEAK PROFITABILITY
LMC continues to be affected negatively by soft volumes, shift to observation patients and to outpatient utilization, and lower state and federal reimbursement rates. A significant contributor to the lower profitability is the escalating provider tax in Connecticut; the net impact of the provider tax offset by supplemental payments increased from a negative $3.9 million in 2014 to negative $9.1 million in 2015 and is expected to be as high as $13 million in this fiscal year, even after the recent reinstating of some of the supplemental payments.
Operating losses were $18.7 million in fiscal 2014 and $10.3 million in 2015, equal to negative operating margins of 4.1% and 2.2%, and operating loss through the nine months ended June 30, 2016 was reported at $14 million, a 4.2% negative operating margin. Management expects to end the 2016 fiscal year with an operating loss of $22.3 million, with the most significant variances from the $8.7 million budgeted loss stemming from the LMPA medical group and Westerly hospital. A number of initiatives from an earlier consulting engagement have already been operationalized, with over $36 million of expenses taken out. Based on initiatives continuing to be implemented currently and additional expense management likely to be realized, the 2017 budget would be close to $10 million-$13 million loss. Management has been successful in negotiating a new union contract in the spring of 2016, ahead of the expiration of the prior contract. Any relief in the state provider tax would further help improve profitability.
ADEQUATE LIQUDITY AND LOW DEBT BURDEN
LMC's liquidity in relation to its debt remains solid for the rating category, with cash of $175.4 million at June 30, 2016 equal 167.6% of debt and cushion ratio of 19.8x at June 30, 2016, both above Fitch's category medians. Overall, Fitch considers LMC's liquidity position as a partial mitigant against its compressed profitability, providing a temporary cushion until such time as LMC can see the benefits of the integration into YNHHS.
LMC's debt burden is light with MADS equal to 2% of revenues through the nine-month interim period. MADS coverage by EBITDA of 1.8x and by operating EBITDA of 1.5x were both weak against Fitch's 'A' medians at 4.2x and 3.5x, respectively, somewhat offset by a relatively conservative debt structure with 80% of debt in fixed rate mode.
DISCLOSURE
LMH covenants to provide quarterly and annual financial disclosure 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=1010219
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1010219
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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