NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB+' rating on approximately $98.1 million of series 2012A Maryland Health and Higher Educational Facilities Authority revenue bonds issued on behalf of Frederick Memorial Hospital (FMH).
The Rating Outlook is Stable.
FMH also has $66.1 million outstanding in series 2012B bonds (privately placed with BB&T Bank), which Fitch does not rate but incorporates into the analysis.
SECURITY
The bonds are secured by a pledge of gross receipts and mortgage.
KEY RATING DRIVERS
STABLE OPERATING AND COMPETITIVE ENVIRONMENT: The rating affirmation reflects operating and financial stability provided by FMH's participation in Maryland's Global Budget Revenue (GBR) program (effective July 1, 2013) as well as the organization's strong market leadership with 74% inpatient market share in its primary service area. Under GBR, FMH receives fixed annual revenues on its regulated service lines (approximately 76% of gross revenues).
RECOVERING PROFITABILITY: FMH posted a negative 0.3% operating margin ($1 million loss) in the fiscal year ended (FYE) June 30, 2015 (draft audit; adjusted to include swap payments in operating expenses). While operating margin lagged the respective median of positive 0.6%, it met the budget and was significantly improved from negative 2.2% in 2014 ($7.5 million loss). Operating EBITDA margin increased to a solid 8.2% in 2015 compared to 7.4% in 2014 and the median of 7.7%. Improvements primarily reflect strong expense controls as well as decline in bad debt, offset by some nonrecurring expenditures.
LARGE CAPITAL PLANS: FMH is entering Phase 2 of its master facilities plan, and has budgeted $49.5 million in capital expenditures for 2016 (approximately twice depreciation). Net of remaining bond funds and fundraising receipts, approximately $40 million will be funded out of cash flow and internal equity. Major items include equipment, renovations, ambulatory redevelopment, and IT.
SOUND LIQUIDITY: Unrestricted cash and investments were unchanged year over year at $165.6 million at FYE 2015, equating to liquidity metrics that compare favorably against Fitch's 'BBB' medians. Fitch believes there is adequate room for liquidity compression at the current rating, given the operating and financial stability provided by GBR.
RATING SENSITIVITIES
OPERATING STABILITY EXPECTED: Fitch expects FMH to continue leveraging its stable market leadership and manage its expense base to produce profitability and coverage metrics consistent with the rating. While not expected, reversal of improving profitability may lead to negative rating pressure.
CONSTRUCTION PROJECTS: Fitch expects FMH to complete its construction plans on time and on budget. Significant deviations resulting in cost overruns would be viewed negatively.
CREDIT PROFILE
Located in Frederick, Maryland, FMH is a 309 staffed bed acute care hospital. Total operating revenues were $367 million in fiscal 2015.
Maryland's GBR Program
FMH signed onto Maryland's GBR program in February 2014 (retroactively effective from July 1, 2013). Under this 5-year program, FMH receives fixed annual gross revenues on its regulated service lines (76% of gross revenues in fiscal 2015) based on factors including service area demographics, utilization trends, and market position. Regulated revenues are adjusted on an annual basis and are designed to incentivize hospitals to reduce avoidable volumes. Unregulated service lines include FMH's radiology, lab, hospice, home health and diabetes center services, among others.
Fitch believes that the program should provide stability as FMH navigates operating in a declining volume environment. As part of repositioning the organization for population health management, FMH formed the Frederick Integrated Healthcare Network as well as the Trivergent Health Alliance with two other regional providers.
Solid Market Position
One of FMH's key credit strengths continues to be its operating platform as a sole community provider in an affluent county of Frederick, Maryland (general obligation bonds rated 'AAA'; Stable Outlook). Market share in the primary service area is consistently above 70% and was most recently reported at 74% (2015). Fitch believes FMH's growing physician base and expanding outpatient network, combined with favorable demographics and limited competition, well-positions the organization to pursue population health management to meet the goals of GBR.
Recovering Profitability
Profitability rebounded in fiscal 2015 to negative 0.3% operating margin from a negative 2.2% in fiscal 2014, which was affected by one-time infrastructure costs, a spike in depreciation, and physician group losses. Fiscal 2015 reflected nearly $6.5 million in improvement, largely attributable to good expense control and a significant decline in bad debt. Expense reductions were offset by nearly $2 million in nonrecurring expenditures used to enhance population health management infrastructure and functionality. Fitch adjusts interest expense to include swap payments made related to the series 2012B bonds. For fiscal 2016, management is budgeting a 0.7% operating margin (before swap payments), which Fitch believes is achievable.
Sound Liquidity
Unrestricted cash and investments totaled $165.6 million at June 30, 2015, mostly unchanged from the prior year. Liquidity metrics of 175.5 days, 13.2x cushion ratio, and 99.7% cash-to-debt compared favorably against the respective 'BBB' medians of 161.5 days, 11.1x, and 89.5%.
Sizable Capital Plans
FMH has completed Phase 1 of its capital project, which included the construction of a new parking garage, the relocation of the hospital's helipad, and renovations to create additional inpatient private rooms (funded by 2012 bond issue).
FMH is entering Phase 2 of its master planning, which calls for the completion of FMH's emergency department, imaging renovations, as well as the start of the cancer treatment center at Rosehill and surgical service upgrades and development of the Mt. Airy ambulatory location. A total of $49.5 million is budgeted for fiscal 2016, which is large at roughly double depreciation expense.
Net of fundraising and bond funds, approximately $40 million of the project is expected to be funded out of cash flow and equity. As a result, liquidity is expected to decline over the next two years during the construction period. Fitch believes there is adequate room for liquidity compression at the current rating, especially given the operating stability provided by the GBR program. However, significant deviations from targeted spending may lead to negative rating pressure. Additionally, management has a history of conservatively budgeting capital projects and shifting plans based on need. There are no new debt plans.
Moderating Debt Burden
FMH's debt burden has moderated consistently over the last three years, and is now consistent with the 'BBB' medians. In fiscal 2015, maximum annual debt service was 3.4% of total revenues and debt-to-capitalization was 47.7%, closely in line with the respective medians of 3.6% and 48.1%.
DEBT PROFILE
FMH has approximately $166.1 million of outstanding debt which is composed of approximately 60% fixed-rate and 40% privately placed variable-rate debt. The private placement has an initial term of 10 years (2022). Further, FMH is counter-party to a $66.1 million floating- to fixed-rate swap with UBS (rated 'A/F1'). As of June 30, 2015, fair market value of the swap was negative $11.2 million. FMH has no collateral posting requirements associated with the swap.
DISCLOSURE
FMH provides annual and quarterly disclosure to EMMA. Overall, Fitch views FMH's disclosure favorably, which consists of a balance sheet and statement of profitability and loss, cash flow statement, and utilization information.
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=991087
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=991087
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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