CHICAGO--()--Fitch Ratings has downgraded the rating on the following revenue bonds issue on behalf of Elmhurst Memorial Healthcare (EMH) to 'BBB' from 'BBB+':
--$124.5 million Illinois Health Facilities Authority revenue refunding bonds, series 2002D;
--$120.5 million Illinois Finance Authority revenue bonds, series 2008A;
--$250 million Illinois Finance Authority variable-rate demand revenue bonds, series 2008B-E (*)
*Underlying Ratings. The series 2008B bonds are supported by a letter of credit (LOC) from JPMorgan Chase; the series 2008C bonds are supported by an LOC from RBS; the series 2008D bonds are supported by an LOC from the Northern Trust; and the series 2008E are supported by an LOC from Fifth Third Bank, N.A.
The bonds are removed from Rating Watch and have been assigned a Stable Rating Outlook.
Debt payments are secured by a pledge of the gross revenues of the obligated group.
FINANCIAL PERFORMANCE BELOW EXPECTATIONS: The downgrade reflects EMH's continued weak operating performance and debt service coverage levels compared to Fitch's expectations outlined in the February 2011 surveillance review.
MIXED LIQUIDITY: Days cash on hand of 205.5 at Nov. 30, 2012 (five-month interim) and cushion ratio of 8.4x during the same time period are in line with the respective 'BBB' category medians of 138.9 days and 9.4x. However, cash to debt of 40.4% at Nov. 30 was very light compared to the 'BBB' category median of 82.7%. Furthermore, liquidity is not expected to improve, as EMH is constructing a $21 million cancer center, which will mostly be funded from cash flow.
VOLUMES REMAIN UNDER BUDGET: Patient volumes continue to lag expectations since the move to the new facility, reflecting overall softness in the service area. Fitch expected EMH to capitalize on the benefits of the replacement facility to a greater degree and to increase top line growth through increased volumes and affiliation and alignment with physicians.
RISKY CAPITAL STRUCTURE: Fitch believes EMH's interest rate exposure in its debt structure (52% variable-rate debt), interest rate swap exposure, asset allocation (43% equities) and pension obligation has had a negative impact on the corporation's financial performance and will continue to elevate overall volatility going forward. EMH is in discussions with its LOC providers (JPMorgan, RBS, Northern Trust and Fifth Third) for renewal. Fitch expects renewals to be complete within the next couple months.
AFFILIATION DISCUSSIONS WITH EDWARD HOSPITAL: EMH signed a non-binding letter of intent with Edward Hospital and Health Service (not rated by Fitch) in January 2013 to merge. However, these discussions are preliminary and are subject to due diligence. In addition, the expectation is that the two organizations will maintain separate obligated groups. Fitch will assess the impact of the merger when it is completed.
WHAT COULD TRIGGER A RATING ACTION
Negative rating action is likely if EMH fails to renew its LOCs, has erosion in its volume growth, or if there is a deterioration in its financial profile.
The downgrade to 'BBB' reflects EMH's financial results in fiscal 2012, which were significantly below Fitch's expectations. In fiscal 2012, operating margin was negative 10.2% and operating EBITDA margin was 7.5%, below the respective 'BBB' category medians of 1.9% and 8.3%. The compression in profitability reflects softer than expected inpatient volumes and increased expenses associated with the new facility. Management began implementing expense control initiatives in 2012 that resulted in some expense savings in the fourth quarter of fiscal 2012 and through the Nov. 30, 2012 interim period. These expense reductions were focused in the areas of labor, supply chain management and clinical effectiveness. Fitch expects to see operational improvements and further progress in operating profitability in fiscal 2013. If operating profitability does not improve over the near to medium term, negative rating pressure may be warranted.
EMH's liquidity is mixed. At Nov. 30, 2012 EMH's unrestricted cash and investments totaled $204.7 million, which is an 8% increase from fiscal 2012 year-end but still below historical balances. Days cash on hand and cushion ratio of 205.5 and 8.4x, respectively, at Nov. 30 are in line with the respective 'BBB' category medians of 138.9 and 9.7x. However, cash to debt is very light for the category at 40.4% compared to the 'BBB' category median of 82.7%. In addition, cash to demand debt of 82% is a concern as EMH has significant variable-rate exposure. Fitch notes that EMH's liquidity position has been negatively affected by a $30.8 million collateral posting for its swaps as of November 2012 and $20 million draw on its lines of credit (which has been deducted from unrestricted cash and investments by Fitch). EMH is in process of building its cancer center on its new campus and is scheduled to be completed in the spring of 2013. The total project is expected to cost $21 million and will be funded mostly from cash and investments. After the completion of the cancer center in 2013, Fitch expects EMH to build up its balance sheet, as future capital spending requirements are minimal.
EMH's inpatient volumes have been relatively flat over the past four years, which has had an impact on operating profitability as management projected a 6% increase in volumes with the move to the new facility. However, resource consumption better aligned with utilization led to a staffing decrease of 80 FTEs in December/January of last fiscal year, which will result in an annual decrease in expenses of $4.8 million. Also, despite a decline in inpatient volumes, surgical and emergency room volumes are up for November 2012 compared to the same period the prior year. Physician visit volumes are also up almost 6% as of November 2012 compared to the same period in 2011. Fitch believes continued physician recruitment is important to bolstering volumes.
EMH's substantial debt burden is a credit concern with maximum annual debt service (MADS) a high 6.3% of fiscal 2012 revenue compared to the 'BBB' category median of 3.3%. EMH will need to realize the benefits from its new facility quickly as MADS coverage by EBITDA is currently low at 1.6x in fiscal 2012 compared to the 'BBB' category median of 2.8x. Management is projecting a 1.5x debt service coverage ratio for fiscal 2013, which Fitch expects it to meet. Failure to make at least 1.5x coverage will likely result in negative rating pressure. In addition, due to a 100 basis point decrease in its pension plan discount rate, EMH's pension expense has increased by about 47% in fiscal 2013 ($12.8 million expense up from $6.8 million in fiscal 2012), which will dilute profitability in 2013. Fitch views EMH's effort to pay down certain terminated vested pension plan participants positively as it will save the pension plan about $1 million annually.
Fitch views EMH's capital structure as being aggressive in light of its balance sheet liquidity, consisting of 52% variable-rate demand obligations (VRDOs) and six swaps with a total notional amount of $555 million. EMH has hedged its risk to any one bank through five different swap counterparties and four different LOC providers backing the variable-rate bonds with credit quality ranging from 'AA-' to 'A-'. The LOCs expire in May 2013, and management is currently in renewal discussions. However, the corporation remains exposed to interest rate, remarketing, renewal and put risks associated with the LOCs. EMH's collateral posting threshold is at mark-to-market with any one counterparty and at Nov. 30, 2012 EMH had $30.8 million posted as collateral.
EMH operates in the suburban area directly west of Chicago. Service area characteristics are strong, which is reflected in a favorable payor mix. However, the service area is very fragmented, with several strong competitors including Good Samaritan Hospital, part of Advocate Health Care Network (rated 'AA'; Stable Outlook by Fitch), Alexian Brothers Health System (rated 'A-'; Stable Outlook), Vanguard Westlake Hospital (not rated by Fitch) and Hinsdale Hospital, part of Adventist Health System - Sunbelt (rated 'AA'; Stable Outlook). Despite this competition, EMH has maintained a leading inpatient market share of roughly 26% in its primary service area over the last four years. EMH has signed a letter of intent with Edward Hospital (not rated by Fitch), which is located in Naperville, IL. Fitch believes this merger would be accretive to EMH as Edward is part of Illinois Health Partners - a partnership with DuPage Medical Group and many independent physicians- who manage about 100,000 HMO patients in the region. DuPage Medical Group has more than 370 physicians and has a strong presence in the western suburbs. The merger discussions are preliminary and subject to due diligence. Fitch will monitor the relationship and assess the impact of the merger when it is completed.
While Fitch views the long-term, strategic benefits of the replacement hospital project favorably, EMH will need to quickly realize the benefits of its investment in its new plant to service its high debt load. The Stable Outlook reflects Fitch's expectation that EMH will continue to achieve the benefits of its new facility and improve its financial performance over the near term. EMH should be able to stabilize operations and build up its liquidity with the completion of the Cancer Center, as future capital expenditures are expected to moderate materially after the cancer center project.
EMH operates a 259-staffed bed acute care hospital, a multi-specialty physician practice, three freestanding outpatient centers, and other health care entities. Located in Elmhurst, IL, approximately 17 miles west from downtown Chicago, EMH reported $409.9 million in total revenue in fiscal 2012. EMH covenants to provide annual audited financial statements within 150 days of fiscal year-end and unaudited quarterly statements within 60 days of quarter end to bondholders. Quarterly disclosure has been timely and includes a balance sheet, income statement, statement of cash flow, utilization statistics, and a management discussion and analysis. In addition, EMH's disclosure on its derivative instruments is very detailed and thorough, which Fitch views as a best practice.
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, June 12, 2012
Nonprofit Hospitals and Health Systems Rating Criteria, July 12, 2012
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Nonprofit Hospitals and Health Systems Rating Criteria