Fitch Affirms FirstHealth of the Carolinas, NC's Revs at 'AA'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the 'AA' rating on the following revenue bonds issued by the North Carolina Medical Care Commission on behalf of FirstHealth of the Carolinas (FirstHealth):

--$40.6 million variable-rate revenue refunding bonds, series 2008A;

--$39.6 million fixed-rate revenue refunding bonds, series 2009C.

--$45.3 million fixed-rate revenue refunding bonds, series 2012A.

Fitch Ratings has withdrawn its ratings on FirstHealth's series 2009A bonds as the bonds were prerefunded by the series 2012A bonds.

The Rating Outlook is Stable.

SECURITY

Bond payments are general unsecured obligations of the restricted group.

KEY RATING DRIVERS

STRONG MARKET POSITION: FirstHealth has consistently maintained a dominant market share in its primary service area (PSA) and faces limited competition with three community hospital located in its PSA and only two tertiary care hospitals located over 40 miles away in its total service area.

ROBUST LIQUIDITY: Liquidity metrics have been strong despite relatively high levels of capital spending, with 279.9 days cash on hand, 31.0x cushion ratio and 189% cash to debt at Dec. 31, 2013 exceeding Fitch's 'AA' category medians of 254.3 days, 23.4x, and 173.6% respectively.

SLIGHTLY COMPRESSED PROFITABILITY: After a period of relative stability, with operating EBITDA margin averaging 11% between fiscal years 2008 and 2011, operating profitability has been volatile the past three fiscal years. After a decline in fiscal 2011, operating EBITDA margin strengthened to 11.9% in fiscal 2012, but compressed to 9.3% in fiscal 2013.

MODERATE DEBT BURDEN: Despite the compressed profitability, FirstHealth's moderate debt burden allowed for maximum annual debt service (MADS) coverage by EBITDA of 4.9x in fiscal 2013, which is consistent with Fitch's 'AA' category median of 5.0x. However, MADS coverage by operating EBITDA was somewhat light at 3.8x relative to Fitch's 'AA' category median of 4.3x.

RATING SENSITIVITIES

STABILIZED OPERATING CASH FLOW: Fitch expects that FirstHealth will maintain strong liquidity metrics while operating cash flow stabilizes at levels that will provide MADS coverage by operating EBITDA consistent with the rating category.

CREDIT PROFILE

FirstHealth, headquartered in Pinehurst, North Carolina, operates two hospitals on four distinct campuses with 531 licensed beds. Additional operations include a health insurance company, 12 primary care clinics, 16 specialty clinics, home health services, a foundation and other healthcare related services. FirstHealth opened a new eight-bed hospital campus, Hoke Hospital, in October 2013. The hospital cost $37 million and was funded through cash and cash flow. Total operating revenue equaled $565.1 million in fiscal 2013.

Fitch's analysis is based upon consolidated financial statements. The restricted group is composed of FirstHealth and the foundation, accounting for 87.3% of consolidated operating revenue and 93.4% of consolidated total assets in fiscal 2013.

STRONG MARKET POSITION

FirstHealth's dominant market share position is a primary credit strength and is expected to enhance operating stability. The nearest competing tertiary care hospitals are located over 40 miles away. FirstHealth holds a leading 54.7% in its six county primary service area, with no other hospital holding over 10% share. Further, the system's market share in the six county PSA increased from 52.6% in fiscal 2011. The PSA was recently expanded from five counties to six counties and accounts for 85% of admissions.

ROBUST LIQUIDITY

Despite relatively high capital spending, with capital expenditures averaging 182% of depreciation between fiscal years 2010 and 2013, FirstHealth's liquidity position continues to be robust, providing a strong cushion for timely payment of debt service. Unrestricted cash and investments equaled $422 million at Dec. 31, 2013, equating to 279.9 days cash on hand, 31.0x cushion ratio and 189% cash to debt, exceeding Fitch's 'AA' category medians of 254.3 days cash, 23.4x and 173.6%, respectively.

Capital spending is projected to decrease to $15.7 million in fiscal 2014 (48.6% of fiscal 2013 depreciation) and $25.2 million in fiscal 2015 (78.1% of fiscal 2013 depreciation), which should allow for further strengthening of the systems' liquidity metrics. Capital spending could increase in fiscal years 2016 and 2017 with potential major projects including an expansion of the new Hoke Hospital to 28 beds (pending certificate of need approval) and replacement of FirstHealth's IT system. However, the increase is not expected to negatively impact the system's liquidity position.

SLIGHTLY COMPRESSED PROFITABILITY

After a period of strength and stability, operating profitability has been volatile the past three fiscal years. Operating EBITDA margin decreased from 11.2% in fiscal 2010 to 9.9% in fiscal 2011 before rebounding to 11.9% in fiscal 2012. The volatility during this period was primarily due to the opening of the Reid Heart Center and the departure of four surgeons and one specialist. Operating EBITDA margin declined to 9.3% in fiscal 2013 and further declined to 7.6% in the three month interim period ending Dec. 31, 2013. The declines were primarily due to a continuing shift from inpatient admissions to less profitable observation stays and increasing provisions for bad debt.

Management implemented several operational improvement initiatives which are expected to achieve almost $11 million of operating improvement in fiscal 2014. Initiatives include labor productivity, changes to salary and benefit levels and the closure of unprofitable units amongst others. Management expects operating EBITDA margin to improve to 8.9% in fiscal 2014 and 9.2% in fiscal 2015.

FirstHealth's high exposure to Medicare and Medicaid make the system's operating profitability vulnerable to state and federal budget cuts. Medicare and Medicaid accounted for 69.4% of gross revenue in fiscal 2013. FirstHealth's payor mix has deteriorated slightly over the past six years with Medicare and Medicaid increasing from 67.1% of gross revenue in fiscal 2008 and with commercial insurance and managed care decreasing from 25.5% to 21.7%. Given this payor mix and the fact that North Carolina is not expanding Medicaid under the PPACA, Fitch is concerned that operating profitability could be pressured.

MODERATE DEBT BURDEN

Despite the compressed operating profitability, debt service coverage metrics remain adequate for the rating category due to FirstHealth's moderate debt burden. FirstHealth's debt burden has moderated with MADS decreasing from 2.9% of revenue in fiscal 2011 to 2.4% in fiscal 2013. MADS coverage by EBITDA equaled 4.9x in fiscal 2013 and was consistent with Fitch's 'AA' category median of 5.0x while MADS coverage by operating EBITDA of 3.8x was adequate but light relative to Fitch's 'AA' category median of 4.3x.

DISCLOSURE

FirstHealth covenants to provide annual disclosure no later than 120 days after each fiscal year end and voluntarily provides quarterly disclosure. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA website.

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

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 30, 2013.

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=825094

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Contacts

Fitch Ratings
Primary Analyst
Adam Kates, +1 312-368-3180
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Gary Sokolow, +1 212-908-9186
Director
or
Committee Chairperson
Jim LeBuhn, +1 312-368-2059
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Adam Kates, +1 312-368-3180
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Gary Sokolow, +1 212-908-9186
Director
or
Committee Chairperson
Jim LeBuhn, +1 312-368-2059
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com