<0> Fitch Affirms Lawrence & Memorial Hospital's (CT) Revs at 'A+'; Outlook Revised to Negative </0>
<0> Fitch RatingsPrimary AnalystMichael Burger, +1-212-908-0555DirectorFitch Ratings, Inc.33 Whitehall StreetNew York, NY 10004orSecondary AnalystEva Thein, +1-212-908-0674Senior DirectororCommittee ChairpersonJeff Schaub, +1-212-908-0680Managing DirectororMedia RelationsElizabeth Fogerty, New York, +1-212-908-0526 </0>
Fitch Ratings has affirmed the 'A+' rating on the following State of Connecticut Health and Educational Facilities Authority revenue bonds issued on behalf of Lawrence & Memorial Hospital (LMH):
--$56 million series F
--$22.9 million series E
The Rating Outlook has been revised to Negative from Stable.
For the series E bonds, which are supported by a direct-pay letter of credit (LOC) provided by JPMorgan Chase Bank (rated 'AA-/F1+'; Stable Outlook), the rating is an underlying rating. Fitch was not asked to rate the series E bonds based on bank support.
SECURITY: Both series are secured by a pledge of gross revenues and a mortgage. The series E bonds are additionally secured by the LOC.
KEY RATING DRIVERS
DECLINE IN OPERATING PERFORMANCE: The Negative Rating Outlook is primarily due to LMH's reduced operating profitability since fiscal 2011 (Dec. 31 year end), which has continued through the ten months ended July 31, 2013 (unaudited interim period).
Weakened operating performance has been largely driven by a drop in inpatient volumes and state and federal reimbursement declines. Additional increased expenses in fiscal 2013 are related to the organization's recent acquisition of Westerly Hospital (Westerly). Overall, Fitch views the long-term pressure on LMH's operating cash flow as a primary credit concern.
STRONG MARKET POSITION: Lawrence and Memorial Hospital has a dominant market share of nearly 70% in its primary service area (PSA). The organization's closest competitor is William W. Backus Hospital (revenue bonds rated 'A+' with a Stable Rating Outlook), which has an 11.2% market share position.
ROBUST LIQUIDITY POSITION: As of July 31, 2013, LMH had $216.4 million in unrestricted cash and investments, which equated to a robust 215.5 days cash on hand, 36.6x cushion ratio, and 195.3% cash to debt.
LIGHT DEBT BURDEN: Despite the profitability decline, LMH's very light debt burden results in solid historical pro forma EBIDTA debt service coverage, averaging 5.3x over the past four fiscal years. Through the 10-month interim period LMH's coverage was 4.5x.
WESTERLY HOSPITAL ACQUISITION: In June 2013, LMH acquired Westerly Hospital (Westerly), which is a full service 125-bed hospital with approximately $80 million in total revenues located in Rhode Island, 17 miles from LMH's main campus. Overall, Fitch views the market strategy behind transaction favorably, but notes that Westerly is dilutive to LMH's financial profile.
INABILITY TO IMPROVE OPERATING PROFITABILITY: Management has identified several revenue enhancement and various cost cutting items that are intended to improve operating profitability over the medium term. Fitch expects to see improved performance in 2013 and beyond with the full realization of performance improvement initiatives in 2014 and 2015. An inability to improve operating cash flow from current levels could pressure the rating.
Lawrence and Memorial Hospital operates a 308 licensed bed hospital in New London, CT, and Westerly Hospital in Washington County, Rhode Island. Additionally, LMH operates seven ambulatory facilities located off the hospital's main campus. For fiscal year 2012, LMH had total revenues of $370 million. LMH covenants to provide annual financial disclosure to the Municipal Securities Rulemaking Board's EMMA system.
NEGATIVE TREND IN OPERATING PERFORMANCE
Since fiscal 2011 LMH's operating performance has trended negatively as the organization recorded a low 0.2% operating margin and 6% operating margin in fiscal 2012, which compared negatively against Fitch's medians of 3.3% and 10.7%, respectively. Management attributes the steady decline in profitability to several factors that include: inpatient volume declines, enhanced observation stays, state and federal reimbursement cuts, and several one-time related expenses from the Westerly transaction (primarily affecting fiscal 2013). Specifically in 2013 alone, unbudgeted state and federal reimbursement cuts cost LMH more than $5 million, which was in addition to approximately $3 million of legal expenses related to the Westerly transaction.
MANAGEMENT'S PLANS TO ADDRESS OPERATING CHALLENGES
Management has begun to implement various cost reduction efforts as well as initiating growth projects over the next five years. These expense reductions are in addition to various expense reductions that have already occurred in fiscal 2013 (totaling $9.2 million). Through the July 2013 interim period (which includes two months of Westerly financial performance), operating cash flow has begun to slightly improve to a 6.8% operating EBITDA margin, from fiscal 2012's 6% margin. Fitch views the interim performance favorably and believes the organization must continue to drive sustained performance in order to maintain its current rating level.
STRONG MARKET POSITION
LMH maintains the top market position of a nearly 70% market share in its primary service area, which Fitch views as a primary credit strength. Despite the softened volume situation occurring within LMH's service area and throughout the state of Connecticut, LMH's market share has not been negatively impacted. Strategically, Fitch views LMH's acquisition of Westerly as favorable to its market position which should further solidify LMH's presence in eastern Connecticut and western Rhode Island.
Through the July 2013 interim period LMH had $216.4 million of unrestricted cash and investments, which translated into 215.5 days cash on hand, 36.6x cushion ratio, and 195.3% cash to debt, as each liquidity metric compared favorably against Fitch's 'A' category medians of 196.3 days, 15.6x, and 129.2%, respectively. Fitch views LMH's balance sheet and a primary credit strength that provides adequate financial cushion for the 'A+' rating level. Any significant deterioration to LMH's balance would be viewed negatively.
HIGH EXPOSURE TO GOVERNMENTAL FUNDING
Medicaid as a percentage of gross revenues totaled a high 17.1% in 2012, which Fitch views as high. LMH's Medicaid exposure has consistently increased since 2009's 14.3%. Ultimately Fitch believes having a high Medicaid load poses risk for LMH, which can leave the organization susceptible to negative cuts in reimbursement.
Approximately 75% of LMH's outstanding debt is fixed rate with the remaining 25% in variable-rate mode supported by an LOC from JPMorgan Chase Bank, which expires in January 2014. LMH has no outstanding swaps. Management intends to issue approximately $30 million of additional debt later in calendar year 2013 to reimbursement the organization for prior capital expenditures. This issuance is planned to be a direct bank loan with a fixed interest rate.
Overall, Fitch views LMH's outstanding debt structure as relatively conservative.
Additional information is available at ''
Applicable Criteria and Related Research:
--'Nonprofit Hospitals and Health Systems Rating Criteria'(May 20, 2013).
Applicable Criteria and Related Research:
Nonprofit Hospitals and Health Systems Rating Criteria -- Effective Aug. 12, 2011 to July 23, 2012