<0> Fitch Downgrades Doctors Community Hospital (MD) Revs to 'BB+'; Outlook Revised to Stable </0>
<0> Fitch RatingsPrimary AnalystJennifer Kim, +1-212-908-0740Associate DirectorFitch Ratings, Inc.One State Street PlazaNew York, NY 10004orSecondary AnalystEmily Wong, +1-212-908-0651Senior DirectororCommittee ChairpersonEva Thein, +1-212-908-5620Senior DirectororMedia RelationsElizabeth Fogerty, New York, +1-212-908-0526 </0>
Fitch Ratings has downgraded to 'BB+' from 'BBB-'the following bonds issued by Maryland Health and Higher Education Facilities Authority issued on behalf of Doctors Community Hospital:
--$82,670,000 fixed rate bonds, series 2010
--$66,180,000, fixed rate bonds, series 2007A
Fitch's analysis is based on Doctors Community Hospital and Subsidiaries (DCH). The obligated group is the hospital only. The hospital accounted for 99% of total assets and 91% of total revenue of the entire entity in 2012.
The Rating Outlook is revised to Stable from Negative.
The bonds are secured by a pledge of all receipts, a mortgage on the hospital, and a debt service reserve fund.
KEY RATING DRIVERS
CONTINUED WEAK FINANCIAL PROFILE: Although DCH's financial performance has remained relatively consistent, the rating downgrade is predicated on DCH's failure to improve performance, which was expected at the time of Fitch's last review. DCH's overall financial profile is more characteristic of a below investment grade credit. Of particular concern is DCH's liquidity, which did not rebuild after the payment of swap termination settlement fees in 2011 and lower capital spending following the completion of major capital projects in 2010. Liquidity metrics steadily deteriorated over the last four years and through the nine-month interim period ended March 31, 2013.
DECLINE IN PROFITABILITY: Operating margin in fiscal 2012 dropped to negative 0.1% from positive 1.1% in fiscal 2011. Some of the decline was due to the timing of payments from the state related to the readmissions reduction program, which were later recognized in fiscal 2013. However, despite significant one-time revenue gains in fiscal 2013, operating margin remained low at 1.3% through the interim period. The hospital is expected to end fiscal 2013 with a $1 million operating income, which includes about $7 million of one-time revenues. This results in a significant gap for fiscal 2014's operating performance and management is identifying various expense savings initiatives in addition to revenue growth enhancements.
ADEQUATE DEBT SERVICE COVERAGE: Maximum annual debt service (MADS) coverage by operating EBITDA was relatively stable at 1.7x in fiscal 2012 and 1.9x for the nine month interim period.
STATE LEVEL REVENUE PRESSURES: The Medicare waiver test, which allows the state of Maryland to operate a rate regulated environment for hospitals is at risk and has resulted in low rate increases to hospitals over the last several years. The design of the new waiver test is under development and it is unclear how future reimbursement will be determined. However, the state recently announced a 1.65% increase for fiscal 2014, which is at a higher level than in prior years.
IMPROVE FINANCIAL PERFORMANCE: A return to an investment grade rating will be dependent on DCH's ability to improve operating performance and build liquidity. The organization has several strategies underway, which could result in improved profitability. Deterioration in performance could lead to further negative rating action.
The rating downgrade to 'BB+' from 'BBB-' reflects an overall weak financial profile that is more consistent with a below investment grade rating. Following the completion of its capital projects and an $18.1 million swap termination payment, it was Fitch's expectation that liquidity would begin recovering in 2012. However, total cash and investments of $36.0 million at March 31, 2013 reflect a persistent decline over the last several fiscal years, which was partially driven by a computer conversion. Days cash on hand of 70.2, 3.3x cushion ratio, and 23.5% cash to debt compare unfavorably against Fitch's 'BBB' medians of 139 days, 9.4x, and 82.7% . While capital needs are manageable at around $3 million annually, liquidity growth will require improvement in cash flow from current levels.
In Maryland, the reimbursement for essentially all Medicare and Medicaid inpatient services is determined by the Maryland Health Services Cost Review Commission (HSCRC) under an agreement with the Centers for Medicare and Medicaid Services (CMS). This agreement includes meeting a Medicare waiver test, which demonstrates that the rate of increase for cost per hospital inpatient admission is below the national average. A new waiver test is under development but it is unclear how future reimbursement will be determined and when this will be finalized. Rate increases have been suppressed in recent years and was 0.3% in 2013. The 1.65% increase in 2014 is much higher than in recent years and should help revenue growth. DCH's small revenue base amplifies credit concerns going forward.
In 2012, DCH joined Maryland's Admissions-Readmissions Revenue (ARR) program, which provided financial incentives to reduce readmissions. While DCH successfully executed significant reductions, operating profitability declined to negative 0.1% in fiscal 2012 from 1.1% in fiscal 2011 due to $3.6 million of undercharging of services. DCH was later reimbursed for the undercharges and an additional $3.6 million was built into its permanent rate structure in fiscal 2013. Despite this, profitability has been pressured by the overall reduction in admissions, which was down 11% through the interim period compared the same prior year period. Operating income through the 9-month interim period was $1.9 million (1.3% operating margin), which included $4.6 million of meaningful use funds and the $3.6 million one-time payment related to ARR. Management projects operating income in fiscal 2013 to be around $1 million for the hospital (0.5% operating margin).
Given that several one-time revenues supported profitability in 2013, DCH has a fairly large gap to arrive to breakeven in fiscal 2014. The rate increase of 1.65% goes into effect on July 1, 2013, and should provide an additional $2 - 3 million in revenues. Also, DCH is in the process of finalizing an affiliation with an orthopedic group, which should result in increased surgical volume and revenues of about $3 million. Several expense reductions have been identified including supply-chain management, hiring freezes, and closing unprofitable services.
DCH is located in a fairly competitive market; however, management indicated that market share has remained stable despite the decline in admissions. Longer term capital needs include a renovation of its operating rooms. DCH maintains $11 million of bond funds for future capital projects.
As of March 31, 2013, long-term debt totaled $153.4 million. MADS as a percentage of revenues of 5.4% and debt to EBITDA of 7.5x reflect a very high debt burden even for a below-investment grade category rating. However, supporting the high debt burden is decent MADS coverage by operating EBITDA is adequate at 1.7x in fiscal 2012 and 1.9x through the 9-month interim. All debt is fixed rate and there are no swaps outstanding.
DCH is a 219 licensed bed hospital located in Lanham, MD, a suburb of Washington D.C. In fiscal 2012, DCH and subsidiaries had total operating revenue of $194.6 million. DCH covenants to provide quarterly financial information 45 days after quarter end and annual financial information within 120 days of fiscal year end via the Municipal Securities Rulemaking Board's EMMA system.
Additional information is available at ''.
Applicable Criteria and Related Research:
--'Revenue Supported Rating Criteria' (June 3, 2013);
--'Non-Profit Hospital and Health System Rating Criteria' (May 20, 2013).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Nonprofit Hospitals and Health Systems Rating Criteria -- Effective Aug. 12, 2011 to July 23, 2012