Fitch Ratings has assigned a 'BBB' rating to the following Wood County Central Hospital District bonds issued on behalf of East Texas Medical Center (ETMC):
--$35 million hospital revenue bonds, series 2011.
The bonds are expected to price the week of Nov. 14, via negotiation, and are expected to be fixed rate. Bond proceeds will be used to construct and equip a 25-bed replacement hospital, fund a debt service reserve, fund capitalized interest, and pay costs of issuance.
In addition, Fitch has affirmed the following Tyler Health Facilities Development Corporation bonds, issued on behalf of ETMC:
--$275.4 million hospital revenue bonds, series 2007A.
The Rating Outlook is revised to Stable from Negative.
SECURITY
The series 2007A bonds are secured by a pledge of gross revenues of the obligated group and by a first mortgage on certain hospital property. The series 2011 bonds are expected to be additionally secured by a debt service reserve.
KEY RATING DRIVERS
Weakened But Stable Profitability: The Outlook revision to Stable reflects an overall stabilization of ETMC's financial profile through the 11-month interim period ending Sept. 30, 2011, despite significant reduction in disproportionate share and managed care revenues and weaker patient volumes.
Manageable Debt Burden: The 'BBB' rating is supported by ETMC's moderate debt burden, and modest capital plans which should be sufficiently offset by cash flow.
Challenging Reimbursement Environment: Credit concerns include a challenging reimbursement environment, which suppressed revenue growth to 1.6% in fiscal 2010 over prior year, after 17.1% growth in 2009.
Light Liquidity: Capital spending needs will likely prevent significant balance sheet growth, and ETMC's liquidity compares unfavorably to Fitch's 'BBB' category medians.
CREDIT PROFILE
The Outlook revision to Stable from Negative reflects ETMC's stabilized financial profile for the interim period ended Sept. 30, 2011, and Fitch's expectation that ETMC will successfully complete its sizeable cost-reduction and revenue enhancement plans. In response to the expected $60 million negative impact from reduced revenues in 2011, ETMC implemented a plan to reduce its operating expenses by $60 million via reductions in force, reduced benefits, supply chain improvements, and operating efficiencies. While a large portion of the financial impact may not be realized until fiscal 2012, management reports they are on target to achieve the expected reductions.
Despite lagging revenues and reduced profitability in 2011, ETMC is on target to exceed its fiscal budget of $15 million in operating income (1.1% operating margin) by fiscal year end Oct. 31, 2011. Through the 11-month interim period ended Sept. 30, 2011, ETMC generated a 1.8% operating margin and 9.3% operating EBITDA margin, both ahead of Fitch's 'BBB' category metrics of 1.7% operating margin and 8.5% operating EBITDA margin. While significantly reduced from fiscal 2010's 4% operating margin and 11.1% operating EBITDA margin, it is Fitch's expectation that ETMC will continue to manage expenses in order to preserve cash flow at levels consistent with the rating category, and levels sufficient to address necessary capital expenditures.
The series 2011 bonds will be used to finance the replacement of the ETMC Quitman facility, which is a 25-bed critical access hospital (CAH) approximately 40 miles north of Tyler in Wood County. Fitch believes ETMC can absorb the additional $35 million in fixed rate debt at its current rating level, with only minimal impact to its balance sheet and coverage metrics. Pro forma maximum annual debt service (MADS) is estimated at $43.6 million per the underwriter, which ETMC covered at 2.1 times (x) by operating EBITDA as of Sept. 30, 2011. Following the series 2011 issuance, ETMC will have approximately $400 million in long-term debt including notes payable and capital lease obligations.
Fitch believes the replacement hospital will help to limit patient outmigration to other non-system facilities, and provide a needed replacement for the existing 50-year old facility. Wood County has a solid economic and demographic profile, with a growing population (especially in the 65+ age group), and a lower poverty rate than the state. Other annual routine capital expenditures are projected to be approximately $40 million-$55 million from 2012 onward.
ETMC's balance sheet metrics remain light for the 'BBB' rating category. At Sept. 30, 2011, ETMC had $231.8 million in unrestricted cash and investments, equating to 105 days of cash on hand (DCOH) and a 5.3x pro forma cushion ratio. These compare unfavorably to Fitch's 'BBB' category medians of 128.6 DCOH and an 8.8x cushion ratio. While Fitch expects that balance sheet growth will be hampered by capital spending through 2014, ETMC's limited balance sheet flexibility allows little room for any material erosion in liquidity at the current rating level.
Credit concerns include significant risks associated with ETMC's revenue base going forward, which will be challenged by any reductions in Texas State Medicaid and DSH/UPL payments, as well as ETMC's high level of reliance on government payors, which equaled 61% of gross revenues through Sept. 30, 2011. Any further deterioration in revenue which is not sufficiently offset by expense reductions could result in negative rating pressure, particularly if ETMC fails to achieve breakeven operating results.
ETMC is an integrated health system servicing the east and northeastern regions of Texas. The system consists of 15 facilities with approximately 1,000 staffed acute care beds. Total revenues were $1.055 billion in fiscal 2010. ETMC covenants to provide bondholders with annual audited financial information to the Municipal Securities Rulemaking Board's EMMA system within 150 days of fiscal year-end and quarterly financial statements within 45 days of fiscal quarter-end.
In addition to the sources of information identified in Fitch's Revenue Supported Rating Criteria, his action was informed by Bank of America Merrill Lynch as underwriter.
Additional information is available at 'www.fitchratings.com'. 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:
--'Revenue-Supported Rating Criteria', dated June 20, 2011;
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Aug. 12, 2011.
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=648836
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