Fitch Affirms Southeast Missouri Hospital Association (MO) at 'BBB+'; Outlook Revised to Stable

SAN FRANCISCO--(BUSINESS WIRE)--As part of its ongoing surveillance efforts, Fitch Ratings has affirmed the 'BBB+' rating on following series of revenue bonds issued through the Industrial Development Authority of the County of Cape Girardeau, MO for the benefit Southeast Missouri Hospital Association (SEMO):

--$7,915,000 health facilities refunding revenue bonds, series 1993;
--$6,945,000 health facilities revenue bond, series 2002;
--$99,500,000 health facilities revenue bonds, series 2007.

The Rating Outlook is revised to Stable from Positive.

RATING RATIONALE:
--SEMO's operating performance dropped dramatically in fiscal year 2010 which continues into fiscal year 2011, after several years of strong operating results.
--SEMO has had significant management turnover over the past 18 months since the retirement of the prior CEO in September 2009. A replacement CEO subsequently resigned after 18 months. The hospital is now managed by an interim CEO.
--Despite the recent operational decline, SEMO's liquidity metrics and debt service coverage ratios are comparable to the medians for the category.
--SEMO's modest debt burden results in solid debt service coverage of 2.8x MADS coverage by operating EBITDA versus the median of 2.4x.
--SEMO has maintained its solid market share in its competitive service area which is an additional positive rating factor.

KEY RATING DRIVERS:
Management reports that it has undertaken several immediate and long term initiatives designed to restore the hospital's historical financial profile which Fitch feels are achievable. However, negative rating pressure will occur if there is further deterioration in financial performance or balance sheet metrics or if SEMO fails to take appropriate actions to restore its historic financial trends in the near term.

SECURITY:
The bonds are secured by a pledge of the unrestricted receivables of SEMO. Additional security is provided by a debt service reserve fund.

CREDIT SUMMARY:
The revision in Outlook to Stable from Positive reflects the general deterioration in SEMO's financial performance which occurred in fiscal year 2010 and continuing into fiscal year 2011 resulting in profitability and debt service coverage ratios that are significantly behind the hospital's historical financial trends. In addition, there has been excessive management turnover over the past 24 months which Fitch believes is a contributing factor to the hospital's weakened financial performance. The rating is affirmed because SEMO's capital related ratios and liquidity metrics are comparable to the medians for the rating category and more than sufficient to maintain the rating at the current level. In addition, the hospital has maintained its market position in a competitive market environment and utilization trends are positive.

In fiscal year end Dec. 31, 2010, SEMO's operating income dropped 64% compared to the prior year. SEMO earned $6.7 million in operating income (2.1% operating margin, 7.9% operating EBITDA margin) in fiscal year 2010 compared to the prior year when the hospital earned $18.8 million in operating income (6.1% operating margin, 12.3% operating EBITDA margin). SEMO's profitability decline continues into the fiscal year 2011. For the period ending March 31, 2011, SEMO produced a 1% operating margin (versus 6.5% in the first quarter of 2010 [1Q'10]) and a 7% operating EBITDA margin (versus 8.8% in the prior period).

Liquidity metrics are comparable to the medians. At the three month interim period ending March 31, 2011, SEMO had $89.6 million in unrestricted cash and investments which calculates to 120 DCOH, an 11x cushion ratio and 77.4% cash to debt ratio, compared to the medians for the category of 122.2 days, 8.5x cushion ratio and 75.9% cash to debt. Debt burden is light compared to the medians with MADS as a percentage of revenue of 2.5x versus the median of 3.5x which results in solid debt service coverage numbers of 2.8x operating EBITDA MADS coverage (versus the median of 2.4x for the category) and EBITDA MADS coverage of 3.4x versus 2.5x for the category.

Among the major items contributing to SEMO's operational decline in 2010 were: unbudgeted or under-budgeted expense items related to several consultant engagements, and increases in salaries and expenses, drugs and pharma costs and bad debt expense. The increase in drugs and pharma stemmed from the increased utilization associated with the expansion of its oncology services; outpatient visits grew to 40,180 from 30,159 in 2008 and continue to grow in the interim period. Bad debt expense grew with the increase in co-pays and deductibles as employers shifted a greater percentage of insurance costs to employees, but also has been negatively affected by defaulted student loans associated with the hospital's school of nursing. Management reports that approximately $5 million of its bad debts are in the form of defaulted student loan payments. They have already reserved approximately $1 million for potential write-offs.

An additional rating concern which in Fitch's opinion contributed to the recent financial decline is the management turnover that has occurred over the past two years. After 21 years of service, SEMO's former CEO retired in September 2009. A new CEO with extensive prior experience within the Catholic Health Initiatives healthcare system (rated 'AA'/Stable Outlook by Fitch) left after 18 months with the hospital, citing philosophical differences with the board. The current interim CEO, who formerly held the position of vice president of Human Resources, has an extensive business background and has a solid business relationship with the hospital's medical staff.

SEMO's chief financial officer who was recruited to the position approximately nine months ago with the resignation of the prior CFO, reports that the hospital has implemented some immediate operational changes to reverse the operational decline. Bad debt and charity policies are currently under review, several point of service collection procedures have been implemented and certain employment policies are also under review. Management expects to end fiscal year 2011 with a 1% operating margin but feels confident that operating performance will begin to improve dramatically in fiscal year 2012 due to strong expense reduction efforts that could yield as much as $10 million in savings, which Fitch feels is achievable. SEMO's focus on cost containment and revenue cycle management should lead to gradual operational improvement over time.

SEMO's utilization trends are positive in 2010 after some deterioration in 2009 as a result of the addition of several sub specialists to replace physicians that had either retired or moved out of the area. Payor mix is stable though SEMO is vulnerable to adverse changes in governmental reimbursement regulations since approximately 60% of its gross revenues stem from a combination of Medicare and Medicaid. SEMO's market share is also stable; the market is essentially split between SEMO and St. Francis Medical Center (rated 'AA-'/Stable Outlook by Fitch).

SEMO has $114 million of long-term debt outstanding at March 31, 2011, consisting of long-term fixed rate debt. Due to its history of conservative financing principles, the hospital has not issued variable rate debt not has it employed swaps or other derivative instruments. The hospital has no plans to issue any new debt over the near term.

Located in Cape Girardeau, MO (approximately 100 miles south of St. Louis), SEMO is an acute care hospital with 249 staffed beds. In fiscal 2010, SEMO reported total revenues of approximately $321 million. SEMO covenants to disclose annual audited financial statements within 120 days after the end of the fiscal year and quarterly financial and operating information within 90 days at the end of each quarter. SEMO disseminates this information including a balance sheet, income statement, cash flow statement and utilization statistics through the Municipal Securities Rulemaking Board EMMA website.

Additional information is available at www.fitchratings.com.

Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' dated Oct. 8, 2010;
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Dec. 29, 2009.

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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