Fitch Affirms Rehoboth McKinley's (NM) 2007A Bonds at 'BB-'; Outlook to Negative

As part of its ongoing surveillance efforts, Fitch Ratings has affirmed the 'BB-' rating on the $6.87 million New Mexico Hospital Equipment Loan Council (NM) (Rehoboth McKinley Christian Hospital) hospital facility improvement and refunding revenue bonds, series 2007A.

The Outlook has been revised to Negative from Stable.

RATING RATIONALE:

--The Negative Outlook reflects additional challenges that Rehoboth McKinley Christian Hospital (Rehoboth) is facing in the interim period, which have resulted in a downturn in financial performance through the four months ended April 30, 2011.

--The 'BB' category rating reflects a number of credit concerns including its weak financial profile, poor payor mix and small revenue base.

--Financial performance had been steady through fiscal 2010, with solid operating profitability and a rebuild of its liquidity position; however, this has reversed in the interim period due to physician turnover that resulted in lower volume, higher expenses, and increased contractuals.

--Main credit strengths include its dominant market position and manageable debt burden, which have resulted in solid debt service coverage.

--Rehoboth is dependent on supplemental funds (sole community provider and tax revenue) for profitability.

WHAT COULD TRIGGER A DOWNGRADE?

--Continued deterioration in financial performance.

--Reduction in supplemental funds.

SECURITY:

The bonds are secured by a pledge of revenues and equipment. In addition, there is a debt service reserve fund.

CREDIT SUMMARY:

Rehoboth's rating history has fluctuated between the 'B' and 'BB' category since 2005 and reflects the volatility in Rehoboth's financial performance in addition to constant management turnover. The current CEO and CFO have been at Rehoboth since 2009 and 2008, respectively, but key senior management positions remain on an interim basis.

Fiscal 2010 performance was solid and continued a trend of steady improvement in profitability and liquidity. Operating income was $3.3 million (3.6% operating margin) for fiscal 2010 (16 months, due to change in fiscal year end to Dec. 31, 2010) compared to 1.8% the same prior year period. Liquidity improved to 62.5 days cash on hand and 139.7% cash to debt ($9.8 million unrestricted cash and investments) at Dec. 31, 2010, from a low 7.3 days cash on hand and 23.7% cash to debt at Aug. 31, 2006. The financial performance was driven by revenue growth due to higher volume and a focus on expense control. Fitch notes that the 2010 numbers are unaudited and the last audited figures Fitch has received are for fiscal 2009 (Aug. 31, 2009 year end). Although the fiscal 2010 audit is essentially complete, management stated it cannot be shared until the state auditor approval process is complete. Management stated that there are no material changes between the unaudited figures provided to Fitch and the audited results. The lack of timely release of audited financial statements is viewed negatively.

One of Rehoboth's main credit strengths is its dominant market position of 67%; however, the service area characteristics are unfavorable, resulting in a payor mix with almost 30% of revenues from Medicaid and 8% self-pay. Given its location, Rehoboth benefits from sole community provider (SCP) funds as well as a mill levy imposed by the county. The mill levy expires in 2012 and requires further voter approval; however, the mill levy has existed since 2004. Total supplemental funds were $9 million in fiscal 2009 ($7.7 million SCP, $1.3 million mill levy), $8.9 million in fiscal 2010 ($7.5 million SCP, $1.3 million mill levy), and expected to total $10.1 million in fiscal 2011. Rehoboth is dependent on these funds for profitability and any reduction in the supplemental funding would likely result in negative rating pressure. In addition, Rehoboth's debt service coverage calculation excludes the mill levy revenue as a source of funds for debt service.

Through the interim period, Rehoboth is significantly under budget with a $314,000 operating loss (-1.3% operating margin) compared to 3.8% the prior year period. The main drivers of the poor profitability include several physician departures, which affected volume, higher expenses related to a consulting engagement to prepare for its JCAHO survey, and increased contractuals due to higher charity care and reduction in reimbursement from Medicaid. The state has reduced its Medicaid reimbursement to approximately 30% of charges from 77% plus, historically. Management has committed to several expense reduction items and believes they will achieve a positive bottom line by the end of the year. Expense reductions are mainly in the areas of labor and productivity and purchased services with targeted savings of $1 million in fiscal 2011 and $2.5 million in fiscal 2012. The fiscal 2011 budget is for $1.4 million operating income (2% operating margin). The inability to improve financial performance would likely result in downward pressure on the rating. In addition, the JCAHO survey will occur later this year (August-September) and Rehoboth has engaged an outside firm to assist in meeting the requirements. The failure to achieve this accreditation would clearly be a credit negative.

Liquidity is weak at April 30, 2011 with $7.4 million unrestricted cash and investments (42.9 days cash on hand, 106.7% cash to debt) because the state withheld an SCP payment that was due in April; however, these funds have been received and unrestricted cash in May increased by $2.2 million.

Total debt outstanding was $7.6 million including $6.87 million of bonds and $723,000 of capital leases. All of the debt is fixed rate and Fitch used maximum annual debt service (MADS) of $1.1 million, which includes the capitalized leases. MADS coverage is solid at 3.5x for fiscal 2010 (12 months) compared to 3.4x for fiscal 2009 (these figures exclude the mill levy funds).

The Negative Outlook reflects Fitch's concern as to Rehoboth's ability to turnaround its financial performance as there are several revenue enhancement pressures. While the achievement of projected expense reductions would be favorable, long-term stability of the organization is dependent on its ability to sustain consistent revenue growth. Rehoboth is considering opening a specialty hospital for medical detox, which would enhance revenue and would require capital costs of approximately $500,000. Management would need to obtain a license for the service and believes it would be another year before the additional service line is available.

Rehoboth McKinley Christian Hospital is a 69-bed general acute care hospital located in Gallup, New Mexico (138 miles east of Albuquerque, NM and 180 miles west of Flagstaff, AZ). Rehoboth changed its fiscal year end in fiscal 2010 to December from August. Total operating revenue in fiscal 2010 (12 months) was $67 million. Rehoboth covenants to provide annual financial statements within 30 days after the approval of the report by the state auditor, which has usually resulted in fairly late receipt of audits. Management stated that the audit should be available within the next several months. Rehoboth has also been posting monthly financial statements on EMMA.

Additional information is available at 'www.fitchratings.com'

In addition to the sources of information identified in the Revenue-Supported Rating Criteria this action was additionally informed by information from the Underwriter.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', dated Oct. 8, 2010

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Dec. 29, 2009.

For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493186

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