TEXT - Fitch California's Marshall Medical Center revs
Feb 27 - Fitch Ratings has downgraded the underlying rating to 'BB+' from 'BBB-' on the following revenue bonds issued on behalf of Marshall Medical Center (MMC), California, as follows: --$29,650,000 California Health Facilities Financing Authority insured hospital revenue bonds (Marshall Medical) 2004 series A, (insured by Cal Mortgage, whose Insurer Financial Strength is rated 'A-' by Fitch); and --$20,000,000 California Health Facilities Financing Authority insured hospital revenue bonds (Marshall Medical) 2004 series B, (insured by Ambac, which is not rated by Fitch); The Rating Outlook is Stable. SECURITY Gross revenue pledge of the obligated group and a deed of trust. KEY RATING DRIVERS PRECIPITOUS DROP IN LIQUIDITY: The rating downgrade is driven by MMC's eroded balance sheet, which exhibits liquidity metrics that are incongruent with an investment grade rating. As of January 31, 2013, MMC had $25 million in unrestricted cash and investments, or 48.3 days cash on hand and 33.9% cash to debt, compared to Fitch's respective 'BBB' category medians of 138.9 days and 82.7%. The sharp erosion resulted from large and unexpected cash spending to complete MMC's much delayed patient expansion wing. Fitch expects MMC to begin replenishing the balance sheet in fiscal 2013 though a material improvement is not expected. PRESSURED OPERATING ENVIRONMENT: Fiscal 2012 operations were hampered by declining inpatient volumes, along with increased operating expenses related to the opening of the new expansion project. Management is implementing a $2.5 million labor and supply expense reduction initiative, including a reduction in force. PROVIDER FEE BUTTRESSES PROFITABILITY: MMC reported an operating income of $4.2 million for FY 2012 (draft audit; Oct. 31 year end), or an adequate 2% operating margin down from 4.6% in the prior year, but is still in line with Fitch's 1.9% median for the 'BBB' category. Fitch notes that excluding the $12.8 million in net California provider fee benefit, MMC would have recorded a sizable operating loss of $8.6 million or a negative 4.7% operating margin. Management has budgeted for a $6.6 million in operating income for FY 2013, or a 3.1% operating margin for FY 2013, which includes expected receipt of $8.6 million in net provider fee benefit but excludes the aforementioned $2.5 million in ongoing cost control initiatives. On balance, this equates to a break-even FY 2013 absent any provider fee funds, which Fitch views favorably. SIZEABLE PROJECT FINALLY COMPLETE: In January 2013, and two years behind schedule, MMC opened its new three-story expansion wing which houses its new emergency department, a 16-bed obstetrics center, and shelled space for future ICU and laboratory expansion. MMC's five-year capital budget (2013-2017) is still fairly robust and totals $65.6 million, however $51.7 million is categorized as discretionary projects and management stated that the capital spending will be dependent on available funding sources. RATING SENSITIVITIES IMPROVING CORE PROFITABILITY AND CASH FLOW GENERATION: Fitch expects MMC to realize the full benefits of its cost control initiatives and achieve break-even profitability, excluding provider fee benefits. Additionally, Fitch expects MMC to resume stronger cash flow generation to support its capital plan and rebuild its balance sheet. The failure to accomplish either of these objectives could result in negative rating pressure. FURTHER EROSION IN LIQUIDITY: MMC was almost in violation of its liquidity covenant in the first quarter of fiscal 2013 (tested quarterly). Potential other demands on liquidity include pension funding contributions, which are expected to total $10 million in fiscal 2013. A further drop in liquidity will result in downward rating pressure. CREDIT PROFILE Marshall Medical Center is located in Placerville, California, and operates a 105 licensed-bed general acute-care community hospital and several clinics. In fiscal 2012 (Oct. 31 year-end), MMC reported $208.1 million in total operating revenue. Eroded Balance Sheet The rating downgrade to 'BB+' from 'BBB-' is driven by an eroded balance sheet and thin liquidity metrics that are inconsistent with an investment grade rating. Unrestricted cash and investments dropped from $44.3 million at fiscal year end fiscal 2011 to $30 million at fiscal year end 2012 and was $25 million at Jan. 31, 2013. The drop in cash has been due to large and unexpected cash spending to complete MMC's recently completed new wing project ($15.2 million), and a $10 million pension contribution in fiscal 2012. MMC has a liquidity covenant of 45 days that is tested quarterly, which was barely met for the first quarter 2013. Fitch expects liquidity to incrementally improve going forward as management intends to improve operations and rebuild the balance sheet. Pressured Profitability Operations were challenged by a sharp drop in inpatient volumes over the last six months of FY 2012 and through the interim period, which management attributes to an area-wide decline in utilization. Coupled with increased operating expenses related to the opening of the new expansion wing, profitability fell in FY 2012 as MMC reported $4.2 million in operating income, down from $9.6 million in the prior. While the 2% FY 2012 operating margin is in line with Fitch's 'BBB' median of 1.9%, Fitch is concerned that profitability was entirely aided by the receipt of $12.8 million in net California provider fee benefit. Absent these funds, MMC would have recorded an operating loss of $8.6 million or a negative 4.7% operating margin. In response to the pressured core profitability, MMC is implementing labor and supply cost control initiatives, including a reduction in force, that are expected to yield $2.5 million in savings. Management has budgeted for $6.6 million in operating income for FY 2013, which includes $8.6 million in net California provider fee benefit, but excludes the impact of the cost control measures. Fitch expects MMC to maintain cost control vigilance and achieve near-break-even profitability, excluding the provider fee funds. Future Capital Needs In January, 2013, and after a two year delay, MMC opened its new hospital expansion wing, which houses a new ED, a 16-bed obstetrics center, and shelled space for future ICU and laboratory expansion. The $59 million project was funded primarily by bond proceeds ($25.6 million) and cash spending ($27.6 million). MMC will make the final $2.6 million in cash disbursements on this project through April, 2013. This project was over budget and MMC's equity contribution was greater than Fitch's initial expectations. Further erosion in balance sheet metrics will result in negative rating pressure. MMC's five-year capital plan is still robust at $65.6 million, which includes $51.7 million in discretionary capital projects and $13.9 million in routine maintenance needs. The discretionary capital projects include the build out of the aforementioned shelled space, however, these plans are dependent on MMC's ability to shore up core profitability and resume stronger cash flow generation. If MMC undertakes its projected capital plan without an improvement in cash flow, negative rating pressure is likely. Long-Term Debt In September 2012, MMC issued $19.7 million in 2012 series A insured hospital revenue refunding bonds (not rated by Fitch) to advance refund $21.1 million in outstanding 1993 series A and 1998 series A insured revenue bonds. As of Oct. 31, 2012, Marshall had $72.5 million in long-term debt, including $69.3 million in revenue bonds outstanding, and $3.2 million in capital leases and notes payable. The bonds are in fixed-rate mode, except for the series 2004B bonds, which are in auction-rate mode. Maximum annual debt service of $5.6 million accounts for a moderate 2.7% of total revenue and coverage by FY 2012 EBITDA is good for its rating level at 2.3 times (x). Stable Outlook The Stable Outlook reflects Fitch's expectation that MMC will succeed in its cost control initiatives and achieve break-even profitability without reliance on provider fee funds. Additionally, Fitch expects MMC to resume stronger cash flow generation in support of its capital needs and steadily rebuild the balance sheet. Further erosion to the balance sheet or failure to improve core operating profitability would likely result in negative rating pressure. Disclosure Marshall Medical Center covenants to provide annual and quarterly disclosure through the Municipal Rule Making Board's EMMA system.
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