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.
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
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
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.
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.
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
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.
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%
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.
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).
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.
Marshall Medical Center covenants to provide annual and quarterly disclosure
through the Municipal Rule Making Board's EMMA system.