Fitch Affirms Sheppard Pratt Health System's Revs (MD) at 'A-'; Outlook to Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings takes the following rating action on Sheppard Pratt Health System, Maryland as part of its continuous surveillance effort:

--Approximately $85 million Maryland Health and Higher Educational Facilities Authority revenue bonds, series 2003A and 2003B, affirmed at 'A-'.

The Rating Outlook is revised to Stable from Positive.

RATING RATIONALE:

--The Outlook revision to Stable from Positive reflects weakened profitability and moderating balance sheet metrics from investment losses and a small increase in total debt.

--After producing a 0.8% operating margin in fiscal year (FY) 2008, Sheppard Pratt had a negative 0.9% operating margin in FY09 and negative 1.6% operating margin for the first six months of FY10. The losses are mainly due to operating challenges at some of its smaller service agencies, employed physician practice costs, medical records conversions, and non-routine investments in energy efficient equipment and lighting. Despite this, management expects improved results for the rest of FY10, mainly as a result of rate increases and reorganization efforts at its smaller service affiliates.

--Investment losses in FY08 and FY09 caused unrestricted cash and investments to fall to $133 million or 224 days operating expenses as of Dec. 31, 2009 from $140.5 million or 233 days operating expenses in FY08. Regardless, Sheppard Pratt's liquidity ratios remain inline with Fitch's 'A' category medians for days cash on hand (171.2) and cash to debt (113.4%). Sheppard Pratt's cash to long-term debt at Dec. 31, 2009 amounted to a favorable 121.7%.

--Total debt increased by $14 million as Sheppard Pratt secured and then refinanced a note to acquire a campus and renovate facilities that replaced its largest special education school.

--The system enjoys a favorable market position as central Maryland's leading provider of mental health services and the state's leading provider of special education programs.

--The business base is diversified with patient service (44% of operating revenue) and residential and educational service (49% of operating revenue) revenue comprising nearly equal parts of revenues.

--Sheppard Pratt's payor mix is concentrated with Medicaid (25% of gross revenue) and the Maryland Department of Education (22% of gross revenue) comprising a majority of its business. Large exposure to these governmental agencies leaves the system susceptible to program modifications or reimbursement reduction.

KEY RATING DRIVERS:

--Improving operating performance;

--Stabilized balance sheet measures.

SECURITY:

The bonds are secured by a security interest in the obligated group's revenues and a debt service reserve fund.

CREDIT SUMMARY:

The rating reflects strong cash position, adequate operating cash flow, investment return reliance, favorable business position, and concentrated payor mix. Despite investment losses and heightened pension contributions, Sheppard Pratt maintains $133 million of unrestricted cash and investments amounting to 224 days cash on hand (DCOH) and 121.7% of total debt. These metrics compare favorably to Fitch's 'A' category medians of 171.2 DCOH and 113.4% cash to debt, respectively. While operating profitability has been weaker, operating cash flow is adequate, with a 6.6% operating EBIDA margin and 2.5 times coverage of maximum annual debt service by operating EBIDA in FY09. Given Sheppard Pratt's restrictive payor mix and healthy cash position, they rely upon investment returns for a majority of profitability. While the operating margin is typically negative, the excess margin averaged 4.5% from FY04-FY08. However, lower interest income and realized losses caused $3.47 million of investment losses in FY09, resulting in a negative 2.1% excess margin in FY09. The excess margin rebounded to 2.2% through the first six months of FY10 as a result of $4.16 million of investment income.

Sheppard Pratt enjoys a favorable market position as central Maryland's leading provider of mental health services and the state's leading providers of special education programs. Business volumes at its psychiatric hospital remain relatively stable, with an average daily census of 238 patients in FY09, up slightly from 225 patients in FY07. However, outpatient services and day hospital visits declined slightly over the past few years due to a general economic weakness. Average daily census (ADC) at its educational facilities jumped to 608 students in FY09 from a 544 ADC in FY07. Finally, utilization at its residential treatment centers is up slightly over the past few years, with a 118 ADC in FY09 versus a 115 ADC fin FY07. Volume trends during the first six months of the current fiscal year indicate some growth at its psychiatric businesses, flat educational services utilization, and modest growth from residential treatment facilities.

Sheppard Pratt provides a variety of mental health, special education, and residential services throughout central Maryland. Its flagship facility is a 322-bed psychiatric hospital located on an 80-acre campus in Towson, Maryland, about seven miles north of downtown Baltimore. In FY09, they generated $253.8 million in total operating revenue. Sheppard Pratt covenants to disclose quarterly and annual financial and utilization information to the Municipal Securities Rulemaking Board's EMMA system.

Applicable criteria available on Fitch's website at www.fitchratings.com:

--'Revenue-Supported Rating Criteria', dated Dec. 29, 2009;

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

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

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