Fitch Affirms CSAHS/UHHS-Canton, Ohio's Revs at 'BBB'; Assigns Negative Outlook

SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings takes the following rating action on the County of Cuyahoga, OH (CSAHS/UHHS Canton) as part of its continuous surveillance effort:

--Approximately $77 million hospital facilities revenue bonds, series 2000 affirmed at 'BBB'.

In addition, Fitch has removed the bonds from Rating Watch Positive and assigned a Negative Outlook. The placement on Rating Watch Positive occurred in December 2009 following the announcement of the restructuring of the co-ownership agreement between University Hospitals Health System (UHHS) and the Sisters of Charity Health System (CSAHS), the co-owners of CSAHS/UHHS-Canton, Inc. (Canton) and UHHS/CSAHS-Cuyahoga, Inc. (Cuyahoga). In December 2009, Cuyahoga left the obligated group and Canton assumed 100% of the debt obligation. Canton also changed its name and is now known as Mercy Medical Center (MMC).

RATING RATIONALE:

The Negative Outlook assignment reflects MMC's drop in operating profitability in 2009, which continues through the second quarter of 2010 (2Q'10). For FY2009, MMC produced a 0.5% op margin and 6% op EBITDA margin, which is a considerable decline from MMC's FY2008 operating results of a 4.1% operating margin and a 9.3% op EBITDA margin.

The financial deterioration is a result of slowing revenue growth and increased bad debt stemming from the severely weakened regional economy. In addition, several new expense items exacerbated the hospital's weak financial performance including: the imposition of a management fee as a result of the hospital's change in ownership, an assessment of a hospital tax enacted in FY2009, and legal costs associated with the hospital's suit against a competitor.

Despite the drop in profitability, MMC's capital related ratios are sufficient to maintain the rating category. Maximum annual debt service (MADS) coverage was 2.3 times (x) and MADS coverage by op EBITDA was 2.0x in FY2009, versus the medians for the category of 2.5x, and 2.4x, respectively.

MMC has a manageable debt burden. MADS as a percentage of revenue was 3%, which is below the median for the category of 3.5%. MMC's debt to capitalization ratios were moderate at 41.6% compared to the category median of 50.1%.

In addition, MMC's liquidity indicators mitigate immediate concern regarding this negative operating trend. At fiscal year end 2009, the hospital had $81.5 million in unrestricted cash and investments, not including a fully funded debt service reserve fund of approximately $8 million, versus $83 million in long term debt. This calculates to 125.3 days of cash on hand, a 10.5x cushion ratio, and a cash to debt ratio of 93.3%, all of which compare favorably to medians for the rating category of 122.2 days of cash, 8.5x cushion ratio and a cash to debt ratio of 75.9%.

WHAT WOULD TRIGGER A DOWNGRADE?

Fitch is concerned about the hospital's inability to generate sufficient cash flow to support its debt service at the present rating level despite relatively moderate debt burden indicators. Fitch expects to see evidence of a sustainable improvement in profitability and maintenance of MMC's current liquidity levels at year end 2010. Failure to meet the rate covenant at year end and/or further deterioration in liquidity levels may result in negative rating action.

SECURITY:

Debt payments are secured by a pledge of the gross revenues of the obligated group and a mortgaged lien on the hospital property.

CREDIT SUMMARY:

The rating affirmation at 'BBB' is supported by MMC's stable market position and liquidity and leverage ratios which are comparable to Fitch's 'BBB' category medians. Fitch believes that these credit strengths mitigate any immediate concern relating to this operating trend.

The assignment of a Negative Outlook reflects MMC's financial deterioration in 2009 and 2010 that is primarily due to the economic slump that continues in Ohio compounded by significant expense increases that occurred in 2009 and 2010. Almost all of the hospitals in Ohio had flat to declining admission trends in 2009 which continue into 2Q'10. Utilization trends were mixed at MMC, with a 3.37% drop in admissions but emergency room visits, outpatient visits and observation days were up 5.51%, 4.16%, and 1.76% respectively. Stark County unemployment level of 12% is one of the highest unemployment rates in the state. In addition, poverty levels have increased, resulting in a 33% increase in bad debt expense between 2008 and 2009. Management reports that the primary drivers behind the increase in bad debt is the growth in the uninsured population and working insured. Management doesn't anticipate any recovery in volume until the unemployment level returns to normal.

MMC also had new expense items in FY2009 and 2010. Ohio enacted a Medicaid Assessment Tax on state hospitals to run for the next two years. MMC was assessed $2.9 million for 2009 and 2010. MMC expects to get back at least $1 million and may possibly receive additional rebate funds in 2011. In addition, as a consequence of the change in sponsorship, MMC's management fee expense increased in fiscal year 2009 and 2010. In response to the operating decline, management implemented a reduction in force of 40 employees in 2010 and may take further action as appropriate.

MMC has a stable secondary market position in its service area after Aultman Health with a 27% market share versus Aultman's 43% market share. In the latest Ohio Hospital Association data for Stark County, MMC's market share has increased for three years in a row while Aultman has lost market share for two years in a row. MMC sued Aultman Health in 2009, alleging unfair business practices. MMC won a $6.1 million judgment in 2010. Aultman is expected to appeal. As part of any potential settlement, MMC is requesting full recovery of all legal fees.

Fitch's primary concern is the declining operating trend that continues into fiscal year 2010. MMC's ability to generate sufficient cash flow to support operations has been severely impacted. For the six-month period ending June 2010, MMC's total net revenues were essentially flat. MMC has lost $9.1 million from operations (negative 7% operating margin and 1.2% op EBITDA) versus a gain of $4.4 million in the prior period. MADS coverage is currently 0.4 times (x) and coverage by EBITDA is currently 0.6x for the interim period.

In addition, cash and unrestricted investments have declined to $72 million from $81 million at year end, because of ongoing capital expenditures funded from internal cash reserves. As a consequence, liquidity ratios have declined slightly to 104.3 days cash on hand, a 9.3x cushion ratio, and a 93.3 cash to debt ratio. Management is projecting that MMC's financial profile may recover slightly by year end due to an expected rebate of the tax assessments for FY2009 and other expense initiatives. However, should trends continue at the present level, MMC may have less than 1x coverage of MADS by year end 2010.

Mercy Medical Center is an acute care teaching hospital with 340 operated beds located in Canton, OH. In fiscal 2009, MMC earned $262 million in total operating revenues. MMC's disclosure practices are very good. The hospital disseminates both annual and quarterly financial statements, including an income statement, balance sheet, cash flow statement, utilization statistics and management discussion and analysis via the Municipal Securities Rulesmaking Board web site.

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

Related Research:

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

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

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

Related Research:

Nonprofit Hospitals and Health Systems Rating Criteria

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

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548606

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