CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded the rating on the following bonds issued on behalf of KershawHealth, SC (Kershaw) to 'BBB' from 'BBB+':
--$19,595,000 South Carolina Jobs-Economic Development Authority hospital facilities revenue bonds, series 2008.
The Rating Outlook has been revised to Stable from Negative.
The bonds are secured by a pledge of gross revenue, a mortgage on the primary facility and a fully funded debt service reserve fund.
KEY RATING DRIVERS:
WEAKENED OPERATING PERFORMANCE: The downgrade reflects the continued decrease in Kershaw's operating profitability with operating margin decreasing to negative 4.7% in fiscal 2013 and negative 5.2% in the six-month interim period ending March 31, 2014 (the interim period). However, 98.6% of the interim period operating loss occurred in the first quarter, and operations subsequently appear to be improving. The Outlook revision to Stable reflects a combination of the improving operating profitability in the second quarter, a materially declining debt burden and solid liquidity metrics which provide a measure of bondholder security in the short term. Failure to sustain operating improvements will lead to further negative rating pressure.
DECLINING DEBT BURDEN: Kershaw's debt burden remains moderate, but continued poor operating performance in fiscal 2013 and the interim period provided weak maximum annual debt service (MADS) coverage, resulting in a rate covenant violation in fiscal 2013. However, coverage should be bolstered in the coming years by bond amortization which decreased MADS from $3.7 million in fiscal 2013 to $2.6 million in fiscal 2014 and will further decrease MADS in fiscals 2015 and 2016.
SOLID LIQUIDITY: Unrestricted liquidity metrics remain solid with 155.6% cash-to-debt and 12.4x cushion ratio comparing favorably to Fitch's respective 'BBB' category medians of 91.7% and 10.2x. The solid liquidity metrics relative to debt provides a cushion to allow management time to improve operations in the near term.
LEADING MARKET SHARE: Kershaw's status as the only hospital in its primary service area (PSA) and its 49% leading inpatient market share are credit positives and should contribute to management's initiatives to stabilize operations. However, market share has eroded from 54.7% in fiscal 2011 due to decreasing inpatient volumes and increasing competition from Columbia area hospitals.
IMPROVED OPERATIONS EXPECTED: Fitch expects Kershaw's operating profitability to continue the improvement trend that began in the second quarter of fiscal 2014, which combined with the declining debt burden, should provide for adequate MADS coverage. Failure to continue operating improvements and to improve MADS coverage will result in further negative rating pressure.
Kershaw operates the only acute care hospital in Kershaw County, South Carolina, with 121 licensed acute care beds and 96 long-term care beds. Kershaw's long-serving CEO retired in 2013 and an experienced interim CEO was hired in December 2013. Total operating revenues equaled $103.7 million in fiscal 2013.
WEAKENED OPERATING PERFORMANCE
The downgrade reflects the increased operating losses in fiscal 2013 and the first quarter of 2014. Operating margin decreased to negative 4.7% in fiscal 2013 from negative 2.7% in fiscal 2012.
After an extremely poor first quarter, operating performance is starting to show signs of improvement in fiscal 2014. Operating margin further decreased to negative 5.2% in the interim period; however, 98.6% of the operating loss occurred in the first quarter. Operating margin in the first quarter equaled negative 10.8%, but improved to negative 0.1% in the second quarter. The improved operations in the second quarter reflect the early successes of a new strategic plan and a new operational improvement plan.
The profitability decline was primarily due to decreased inpatient admissions and inpatient surgeries, a previous 7% cut to South Carolina Medicaid reimbursement, decreased supplemental government funding, increased bad debt and increased self-pay. These factors caused net patient revenue to decline 4.0% in fiscal 2013 and 3.6% in the interim period. Management had effectively managed costs, with total operating expenses decreasing 0.2% in fiscal 2013 and increasing a modest 0.2% in the interim period. However, the effective cost management was unable to mitigate the decrease in revenues.
Fiscal 2014 operating performance has been negatively impacted by South Carolina's decision not to expand Medicaid under the PPACA, which would have alleviated some of Kershaw's bad debt and would have helped to offset the decreases in supplemental government funding.
DECLINING DEBT BURDEN
Kershaw's credit profile will benefit from a declining debt burden (including capital leases) with MADS decreasing to $2.6 million in fiscal 2014 (2.5% of fiscal 2013 revenue) from $3.7 million in fiscal 2013 (3.6% revenue). MADS is expected to further decrease to $2.2 million in fiscal 2015 (2.1% of fiscal 2013 revenue) and $1.9 million in fiscal 2016 (1.8% of fiscal 2013 revenue). Fitch expects that improving profitability and the declining debt burden will produce coverage more consistent with the rating category by fiscal 2015.
Despite a moderate debt burden, the poor operating performance in fiscal 2013 compressed MADS coverage to a weak 1.2x (based upon MADS of $2.6 million). Based on the fiscal 2013 rate covenant calculation using MADS of $3.7 million, coverage equaled 0.9x, causing a violation of the rate covenant which requires actual annual debt service coverage of 1.2x. The rate covenant violation resulted in a mandatory consultant engagement. Failure to improve actual annual debt service coverage to 1.2x or greater in the subsequent two fiscal years following a rate covenant violation will result in an event of default. Kershaw received a waiver from bondholders for fiscal 2013 from a provision that may have caused an event of default should coverage be less than 1.0x. So long as Kershaw follows the consultant recommendations to the extent feasible (as determined by Kershaw's board of trustees) and permitted by law, the hospital has two fiscal years following the fiscal year in which the covenant violation took place to demonstrate compliance with the rate covenant.
Liquidity metrics remain solid relative to debt and provide a degree of flexibility as management executes its operating improvement plan. With $32.6 million of unrestricted cash and investments at March 31, 2014, equating to 155.6% cash-to-debt and 12.4x cushion ratio, liquidity metrics exceed Fitch's 'BBB' category medians of 91.7% and 10.2x. However, liquidity is light for the rating category relative to operating expenses with 116.7 days cash on hand.
LEADING MARKET SHARE
Kershaw maintains a leading 49% market share and is the only hospital in its primary service area; however, market share has eroded due to decreasing inpatient volumes, operational issues with its emergency room and increasing competition from Columbia area hospitals. Management has taken steps to regain inpatient market including a new public relations campaign highlighting Kershaw's competitiveness with Columbia area hospitals, recruitment of key physicians, including an orthopedic surgeon and two general surgeons, and hiring a new management company to operate the hospital's emergency room. Approximately 80% of Kershaw's inpatient admissions originate from its emergency room and the emergency room has been historically challenged with physician staffing issues. Initial feedback of the new ER management company has been encouraging.
Kershaw covenants to provide annual disclosure within 150 days after fiscal year end and quarterly disclosure within 45 days after the first three fiscal quarters. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA system.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', May 30, 2014.