<0> Fitch Affirms Meritus Medical Center's (MD) Revs at 'BBB'; Outlook Stable </0>
<0> Fitch RatingsPrimary AnalystEva Thein, +1-212-908-0674Senior DirectorFitch Ratings, Inc.One State Street PlazaNew York, NY 10004orSecondary AnalystAdam Kates, +1-312-368-3180DirectororCommittee ChairpersonJames LeBuhn, +1-312-368-2059Senior DirectororMedia Relations:Elizabeth Fogerty, New York, +1 212-908-0526Email: </0>
Fitch Ratings affirms the 'BBB' rating on the approximately $259.8 million series 2008 bonds issued by Maryland Health and Higher Educational Facilities Authority on behalf of Meritus Medical Center (f/k/a Meritus Health).
The Rating Outlook is Stable.
SECURITY:
The bonds are secured by mortgage, gross receipts pledge, and debt service reserve fund.
KEY RATING DRIVERS:
CORPORATE REORGANIZATION: Effective Feb. 1, 2013 the issuer implemented a corporate reorganization in order to streamline organization and allow management to function more effectively. Several subsidiaries and Meritus Health, Inc., the parent company, were merged into Meritus Medical Center (Meritus), as the only surviving entity. Following the reorganization, Meritus will be the sole member of the obligated group. Prior to the reorganization, the obligated group consisted of Meritus Health, Inc., Meritus Medical Center and Meritus Endowment Fund. Meritus Medical Center will be the sole member of Meritus Healthcare Foundation, Inc., Meritus Holdings, LLC and Meritus Insurance Company, Ltd.
DOMINANT MARKET POSITION: Fitch views the dominant market share position held by Meritus in its primary service area (PSA) as a key credit strength. Market share of the PSA has been consistently increasing and was reported at 82.9% in 2012, up from 80.3% in the prior year.
ELEVATED DEBT BURDEN: Meritus' debt burden is high due to the large debt issuance which funded a replacement facility that opened in 2010. Coverage by EBITDA was 2.3x (times) in fiscal 2012 and was 2.2x though the six-month interim period ended Dec. 31, 2012. MADS as percent of revenues is elevated at 6.3% and debt to capitalization, while slowly declining, is still high at 56%.
NO MAJOR CAPITAL NEEDS: Mitigating the high debt burden is Meritus' brand new facility, which will require minimal capital investment over the near to medium term. Capital spending is budgeted to be well below the organization's depreciation expense.
CONTINUATION OF THE TPR PROGRAM UNCERTAIN: The participation in Maryland Health Care Cost Review Commission's (HSCRC) Total Patient Revenue (TPR) reimbursement methodology is viewed as a credit positive, as reimbursement is decoupled from volumes and does not penalize the issuer for lower volumes. However, the three-year program is in its last year, and it is unclear whether it will continue and, if so, how the program may be altered.
IMPROVING CORE OPERATING PROFITABILITY: While operating margin reflects the increase in depreciation and interest related to the new facility, operating EBITDA margin improved to 11.6% in fiscal 2012 from 9.9% in fiscal 2011 and 4.6% in fiscal 2010. Through the six months ended Dec 31, operating EBITDA margin was a strong 12.4%, well exceeding the Fitch's 'BBB' category median of 8.3%.
RATING SENSITIVITIES
POTENTIAL TERMINATION OF OR CHANGES TO TPR PROGRAM: Meritus has benefited from participation in the program and will need to maintain the current level of financial performance when the program is either terminated or altered, with the further expectation that over time, the high leverage will moderate.
CREDIT OVERVIEW:
The rating affirmation reflects the organization's dominant market position, the successful completion of a replacement facility and improving operating performance. Fitch's main concern remains the elevated debt burden, which is only slowly declining. However, it is partially mitigated by the new facility, which will not require any significant capital investment over the next several years, and the all fixed rate nature of the hospital's long-term debt.
Meritus' operating EBITDA margin of 11.6% is an improvement over the prior year and exceeds the 'BBB' category median of 8.3%. The 2012 operating results reflected several factors including $10 million of additional capital costs related to the new facility and $1.3 million of one-time costs, such as demolishing of the old hospital facility and one time pension costs. Management has a plan to continue to reduce operating costs by $10 million in order to prepare the organization for better performance going forward. During 2012, a reference lab was converted to a tax-exempt status, which should result of tax savings estimated at$1.2 million annually, but resulted in a one-time conversion tax of $3.2 million, included in non-operating expenses.
Through the six months ended Dec. 31, 2012, Meritus posted a 1.3% operating margin and a 12.4% operating EBITDA margin. Management projects to end fiscal 2013 with operating income of $7 million, equal to a 2% operating margin. The Meritus defined benefit pension plan was terminated effective June 30, 2012, with final distribution of $42 million completed in Nov. 30, 2012. Fitch has excluded the impact of a non-cash pension settlement of $11.3 million, included in the interim financial statements. Days in accounts receivable (DAR) have spiked to 68 days through the interim period due to several factors including a delay of CMS reimbursement for six months pending the recertification of the lab under a new name, the use of an outside collection agency to pursue outstanding receivables that in the past would have been written off as bad debt, as well as the lag of some payments under the TPR program. DAR's have already declined since December and management expects DAR's to return to their typical level of mid-50 days by calendar year end.
Inpatient volumes declined by 4.2% in fiscal 2012 and a further 1.5% though the interim period, without negatively impacting reimbursement under the TPR program, which guarantees a predetermined level of revenues, regardless of volumes or case mix, adjusted for population, bad debt and inflation. Fiscal 2013 is the last year in what was initially a three-year program, and there is no certainty whether or in what form the program will continue. Management is in negotiations with the Maryland HSCRC and is of the opinion that the program will be extended beyond 2013. However, if extended, it is likely that the program will incorporate a number of changes and that the payors will likely want to share in the potential savings that the program generates. At this time there is no certainly that the program will continue.
ELEVATED DEBT BURDEN AND LIGHT LIQUIDITY
The primary credit concern remains the high debt position. MADS at 6.3% as percent of revenues is high for the rating category, compared to the 'BBB' median of 3.3%, and EBITDA coverage of MADS ($22.7 million, including capitalized leases) of 2.2x through the six-month interim period is lower than the median of 2.8x. Meritus' long-term indebtedness is all fixed rate, and the issuer has no swaps. Liquidity is light compared to the category medians; cushion ratio and cash to debt at 4.6x and 39% are weak as a consequence of the large issuance for the replacement hospital. Meritus had $104.3 million of unrestricted cash and investments at Dec. 31, 2012, equal to 116 days cash on hand (DCOH), with a relatively conservative investment allocation of 29% in cash, 28% in fixed income and 41% in equities.
The Stable Outlook is based on Fitch's expectation that the combination of the revenue predictability stemming from the TPR participation together with the implemented expense reductions will enable Meritus to attain the budgeted $7 million operating income for fiscal 2013. Fitch also believes that the more moderate capital investment needs given the new facility will enable the organization to grow its liquidity over time. However, termination of the TPR program or changes in the program that would negatively impact the current level of financial performance or cause deterioration in the liquidity position would likely introduce negative rating pressure.
Meritus Medical Center is a 272-bed hospital located in Hagerstown, MD. And, following the corporate reorganization effective Jan. 1, 2013, is the only member of the obligated group. Fitch reports on the performance of the consolidated system. Total system revenues in fiscal 2012 were $372.9 million. Meritus covenants to disclose audited and quarterly financial and utilization statements to the Municipal Securities Rulemaking Board's EMMA system. Fitch views favorably Meritus Health's practice of including management discussion and analysis with its disclosure statements.
Additional information is available at ''. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Nonprofit Hospitals and Health Systems Rating Criteria', July 23, 2012;
--'Revenue-Supported Rating Criteria', June 112, 2012.
Applicable Criteria and Related Research
Nonprofit Hospitals and Health Systems Rating Criteria
Revenue-Supported Rating Criteria
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