Fitch Affirms Scheurer Hospital (MI) Revs at 'BBB-'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'BBB-' rating on the approximately $5.8 million outstanding Huron County Economic Development Corporation (MI) revenue bonds, series 2001*, issued on behalf of Scheurer Hospital (Scheurer).

*Underlying rating. The bonds are supported by a letter of credit (LOC) from Charter One Bank. Fitch was not asked to provide a rating based on the LOC support.

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group. In addition, a mortgage on various properties provides additional security for the bond issue.

KEY RATING DRIVERS

SOLID FINANCIAL PERFORMANCE: Scheurer has demonstrated good financial performance with operating profitability in line with the 'BBB' category medians over the last three years. Through Dec. 31, 2013 (six-month interim), operating performance declined slightly from 2013 audited results to an 8.5% operating EBITDA margin, but it remains in line with the Fitch's 'BBB' category median of 9%, providing for robust debt service coverage of 3.4 times (x) by operating EBITDA.

LOW DEBT BURDEN: Scheurer's debt burden is appropriate for its revenue base, with total debt outstanding at approximately $5.8 million on a consolidated basis at fiscal 2013 year end. However, Scheurer's debt portfolio is aggressive with 100% variable rate demand bonds (VRDBs), which subjects the hospital to inherent put, renewal, and remarketing risk.

CRITICAL ACCESS DESIGNATION: Scheurer's operating performance continues to be bolstered by the associated revenues afforded by its critical access hospital (CAH) designation. Scheurer has a stable and leading market position in its rural service area, which has limited competition. While the supplemental revenue provided to Scheurer helps to mitigate some of the risks inherent to small, rural facilities, Fitch notes that the CAH program has been a target for reductions at the federal level and changes to this program would likely have a material impact on Scheurer's financial performance.

SMALL REVENUE BASE: Scheurer's small revenue base of approximately $35.5 million (as of fiscal 2013; June 30 year end), coupled with its small medical staff (currently seven physicians), is a credit concern as minor changes in Scheurer's operating environment has the potential to cause large swings in financial performance.

RATING SENSITIVITIES

MAINTAIN OPERATING PERFORMANCE: Fitch expects Scheurer to continue to maintain solid cash flow and debt service coverage consistent with historical performance. In addition, Fitch expects Scheurer's cash to debt to continue to exceed 1x due to its aggressive debt structure.

CREDIT PROFILE

Scheurer is located in Pigeon, Michigan, approximately 120 miles north of Detroit. The obligated group includes Scheurer, an acute care facility with 25 licensed beds and 19 long-term care beds; Scheurer Community Services, a senior living facility with 51 independent living units and 30 assisted living units; and Scheurer Healthcare Network, the parent corporation. Audited financials are available for the hospital only. Scheurer provides unaudited consolidated statements and several bank covenants are tested at the consolidated level.

SOLID FINANCIAL PERFORMANCE
Operating profitability has been relatively consistent and solid for the rating category from 2010-2013 with an average operating ratio of 3.67% and average operating EBITDA ratio of 10.2% over these four years. Through Dec. 31, 2013 (six-month interim), operating profitability was in line with 'BBB' category medians, though slightly below the hospital's four year average. Management expects to end fiscal 2014 with positive operating income of approximately $330,000, which is down from the prior year budget of $1 million due to anticipated reduced reimbursement from sequestration and less supplemental revenue. Fitch views Scheurer's 2014 budget as reasonable and attainable. Scheurer continues to receive supplemental payments in the form of disproportionate share payments ($363,000 in fiscal 2013) and the Michigan provider fee program (revenue of $728,000 in fiscal 2013). As such, Fitch believes Scheurer is especially susceptible to any unfavorable changes in governmental reimbursement.

Scheurer completed its expansion and renovation project of its acute care wing and heating/cooling system, which was expected to cost about $3.4 million, including equipment, and was paid out of cash flow. A total of 25 beds were enhanced during the project with 11 private rooms and seven semi-private rooms resulting at completion. Upon completing the expansion and renovation project, Scheurer elected to use 10 of its 25 total beds as swing beds, which has allowed for reimbursement at cost and could potentially increase utilization, which Fitch views positively. The associated costs are minimal and management anticipates an additional $1 million-$2 million in revenue annually.

LOW DEBT BURDEN
Scheurer's debt portfolio is aggressive with 100% daily VRDBs supported by a letter of credit (LOC) from Charter One Bank. The LOC commitment was extended in 2012 and runs through Nov. 15, 2015. Under the reimbursement agreement, a draw on the LOC would need to be repaid before the expiration date. Bank covenants include maintaining at least 1.25x maximum annual debt service (MADS) coverage and maintaining 70 days cash on hand (which will increase to 80 days as of July 2014). MADS coverage by EBITDA was healthy at 4.0x in fiscal 2013. Through the six months ended Dec. 31, 2013, debt service coverage declined minimally to 3.7x, but is still in line with the 'BBB' category median of 3.1x.

Scheurer has approximately $2 million in trustee held funds required by the LOC provider (Charter One Bank), which is available to pay debt service and is included in its liquidity covenant calculation. Fitch does not expect Scheurer to issue additional debt in the near term.

Scheurer has a floating to fixed rate swap outstanding, which matures in November 2015. As of Jan. 31 2014, the mark-to-market was negative $297,940 and there are no collateral posting requirements.

CRITICAL ACCESS DESIGNATION
The 'BBB-' rating is supported by Scheurer's CAH designation, which provides the hospital with enhanced cost-based Medicare reimbursement. Fitch notes the long term viability of the CAH program is uncertain.

DIP IN LIQUIDITY
Operating performance indicators are in line with the rating level, but liquidity declined in fiscal 2013 to approximately $7.8 million in unrestricted cash and investments from $8.8 million in fiscal 2012. This recent drop in liquidity is largely the result of increased capital spending from approximately $2.2 million to $3.8 million in fiscal 2013. The six-month interim improved slightly totaling $8.2 million, which equated to 85.4 days cash on hand and a cushion ratio of 8.7x compared to Fitch's 'BBB' respective medians of 144.7 and 10.2x. Through fiscal 2014, Scheurer's capital budget decreases to closer to historical levels, which Fitch anticipates will assist in rebuilding liquidity metrics going forward.

DISCLOSURE
Scheurer does not covenant to provide bondholders with annual or quarterly financial disclosure.

Additional information is available at www.fitchratings.com.

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 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=827001
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Contacts

Fitch Ratings
Primary Analyst:
Gary Sokolow, +1-212-908-9186
Director
Fitch Ratings, Inc.
One State Street Plaza
New York NY 10004
or
Secondary Analyst:
Katie Proux, +1-312-368-3348
Analyst
or
Committee Chairperson:
Emily Wong, +1-415-732-5620
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst:
Gary Sokolow, +1-212-908-9186
Director
Fitch Ratings, Inc.
One State Street Plaza
New York NY 10004
or
Secondary Analyst:
Katie Proux, +1-312-368-3348
Analyst
or
Committee Chairperson:
Emily Wong, +1-415-732-5620
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com