Fitch Rates Houston County Health Care Authority, AL Revenue Bonds 'BBB+'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'BBB+' rating to the following bonds issued by Houston County Health Care Authority, AL (the authority):

--$44.6 million revenue bonds, series 2016-A.

Bond proceeds will refund the Authority's series 2006 bonds and pay issuance costs. The bonds are scheduled to sell via negotiated sale during the week of June 27, 2016.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by the Authority's 'Pledged Revenues', including gross revenues, receipts and income, and related accounts and contract rights.

KEY RATING DRIVERS

LEADING MARKET POSITION: The Authority's wide range of service offerings and strategic initiatives designed to grow its referral network results in a leading market position. In the two Alabama counties of its primary service area, the Authority's Southeast Alabama Medical Center (SAMC) secures about 55.5% of the inpatient market. Its nearest competitor, located about seven miles away, serves about 23% of the inpatient market.

MODEST FINANCIAL PERFORMANCE: The Authority routinely generates negative operating earnings that were also adversely affected by start-up costs for its newly developed medical school in fiscal 2013 and 2014 (Sept. 30 year-end). The operating margin and operating EBITDA margins averaged negative 1.9% and positive 7%, respectively, from fiscal 2012-2015. These metrics are below Fitch's respective 'BBB' category medians of 0.6% and 7.4%. However, the Authority receives property tax revenues to support operations and performance improved in both fiscal 2015 and the six-month unaudited period ending March 31, 2016.

GOOD LIQUIDITY INDICATORS: Unrestricted cash and investments have slightly declined over the past several years, but remain solid at $157.4 million as of March 31, 2016. This level of liquidity amounts to 168.5 days operating expenses, 12.3x cushion ratio, and 93.1% of debt and compare well to Fitch's 'BBB' category medians of 161.5 days, 11.1x cushion ratio, or 89.5% of debt.

MANAGEABLE DEBT POSITION: The Authority's debt position is manageable with pro forma maximum annual debt service (MADS) at 3.7% of fiscal 2015 revenue compared to the 'BBB' median of 3.6%. Additionally, pro forma MADS coverage (2.5x), debt to EBITDA (5.3x), and debt to capital (43.8%) are somewhat in line with similarly rated healthcare credits.

RATING SENSITIVITIES

IMPROVED OPERATING RESULTS: Continued progress in Houston County Health Care Authority's operating performance that is expected to be supported by increases in governmental reimbursement and process improvement initiatives that are driven by a new CEO could lead to positive rating movement.

STRENGTHENED BALANCE SHEET: Upward rating pressure is feasible if Houston County Health Care Authority's expected cash flow improvements and debt repayments result in liquidity and capital-related metrics that are more in line with Fitch's 'A' category medians. In addition, unrestricted liquidity balances are anticipated to be bolstered during fiscal 2017 by the release of about $34.5 million in escrowed funds that are being held until its medical school receives full accreditation.

CREDIT PROFILE

The Authority is a public corporation organized under the laws of the state of Alabama doing business as Southeast Alabama Medical Center (SAMC). The Authority owns and operates SAMC and several related health care entities. SAMC is a 420-bed, acute care hospital and regional referral center located in Dothan, AL. The Authority also owns and operates a variety of related health care entities including the Southeast Alabama Regional Healthcare Authority (that leases a 74-bed governmental hospital, Medical Center Barbour), Alabama College of Osteopathic Medicine (ACOM), Statera Health (a physician-hospital organization), the Southeast Alabama Medical Center Foundation, and several joint-venture companies providing health care services. In fiscal 2015, the Authority generated $343.6 million of operating revenues.

The Authority has the ability to levy a 4-mill ad valorem tax on property in Houston County. It currently levies 1 mill to support SAMC operations and 1.5 mills to secure the series 2011 note that funded the escrow required to establish ACOM. Fitch includes the 1.5-mill ad valorem tax ($2.03 million in fiscal 2015) in operating revenue, since they are used to pay interest expenses on ACOM's series 2011 note. In fiscal 2015, the 1-mill tax generated $1.36 million for SAMC operations.

The Authority's main affiliates are Medical Center Barbour and ACOM. At the end of 2006, the operations of Medical Center Barbour were acquired by the Southeast Alabama Regional Health Care Authority. This authority was created by Houston County and is controlled by SAMC. Medical Center Barbour operates 49 beds in Eufaula, Alabama that is located about 50 miles north of Dothan. Medical Center Barbour's average daily census has been stable at about 24 patients and they have also been growing outpatient visits. In fiscal 2015, Medical Center Barbour produced a slight operating income of $33,722 on $16.86 million of total revenues (including property taxes).

ACOM was established in 2010 to operate a college of osteopathic medicine. ACOM is one of 29 osteopathic colleges in the nation and was the first osteopathic college in Alabama. ACOM's inaugural class of 162 students started in August 2013 with an expected graduation in 2017. Application, admission and matriculation trends have been very favorable and ACOM is on track to receive final accreditation next year. Financial performance improved during each year of operations and ACOM generated $2.34 million of operating income on $15.2 million of revenues in fiscal 2015. Importantly, it is expected that about $34.5 million of escrowed funds will be released to unrestricted monies next year after ACOM receives final accreditation. Fitch views the Authority's ACOM investment as a positive credit factor given the physician recruitment, clinical program development, and financial benefits it provides.

MARKET POSITION

The Authority's main hospital, SAMC is situated in the city of Dothan and Houston County which is the regional trade center of a geographically large 12-county service area in southeast Alabama that includes two counties in Georgia and three counties in Florida. Dothan is located about 200 miles southeast of Birmingham, AL and 95 miles northwest of Tallahassee, FL. Houston County's economy is characterized by steady population increases (about 15% since the 2000 census), a somewhat diverse and slightly growing employment base, unemployment rates that are similar to state of Alabama averages (6.2% in 2015), and income levels that are just below state averages, but about 20% lower that national averages.

SAMC's primary service area includes Houston County and the county to its immediate north, Henry County, where SAMC generates only about 50% of its inpatient business. The secondary service area covers five additional counties in southeast Alabama, three counties in northern Florida and two counties in southwest Georgia where SAMC obtains most of the rest of its inpatient discharges.

SAMC's broad array and increased service offerings, coupled with its strategic initiatives designed to grow its referral network and business base results in a leading market position. In the primary service area, SAMC secures about 55.5% of the inpatient market. In the total service area, SAMC secured the leading inpatient market share for Medicare patients which averaged 27.5% in calendar-year (CY) 2015. Key factors supporting SAMC's business position are unique programs including a Level II Trauma Center, neonatal intensive care unit, a tele-medicine-driven stroke center, and behavioral health programs. Moreover, successful strategic projects such as its employed physician network, lease of Medical Center Barbour, clinical affiliations, medical practice management services, and a stroke care network are driving business growth.

The next closest hospital, located about seven miles away, serves about 23% of the inpatient market. SAMC's nearest competitor is Flowers Hospital. Flowers Hospital is owned by Community Health Systems, Inc. ('B+'/Stable) which is licensed for 235 beds and also provides a comprehensive level of services. In the total service area, Flowers Hospital serves the second highest market share for Medicare patients that averaged 15.9% in CY 2015. Community Health Systems, Inc. also owns and operates Medical Center Enterprise, which is located about 25 miles west of Dothan in the secondary service area. Fitch views the total service area as moderately competitive given the presence of a formidable health system with a solid market presence in the region.

FINANCIAL PERFORMANCE AND POSITION

The Authority has been producing negative operating margins that were also adversely affected by ACOM start-up costs in fiscal 2013 and 2014. The operating margin and operating EBITDA margins averaged negative 1.9% and positive 7%, respectively, from fiscal 2012-2015. Regardless, the Authority receives non-operating property tax revenues to support programs and results improved in both fiscal 2015 and the six-month unaudited period ending March 31, 2016. The Authority's non-operating income also benefits from the steady receipt of equity in net earnings from its joint venture companies that averaged nearly $2 million from fiscal 2012-2015. Notwithstanding the modest operating performance, pro forma MADS coverage is adequate at 2.5x in fiscal 2015 and 3.1x for the six-month unaudited period of fiscal 2016. Coverage remains satisfactory despite a front-loaded debt service schedule that drops by more than half in 15 years.

Margin improvement initiatives that are producing early results even with Medicare payment reductions in fiscal 2016 include a modified employee health benefit plan, length of stay reductions from a new care coordination program, clinical documentation improvement with the assistance of outside consultants, and focus on LEAN process improvement techniques. For fiscal 2017, operations are expected to be augmented by an updated Medicare wage index classification, new diagnostic-related group reimbursement system for Alabama Medicaid, and interest-cost saving from the series 2016-A bond refinancing. Additionally, the new CEO that just replaced the retired president has a long track record of operating financially sound healthcare entities.

Regardless, Fitch notes the Authority's reliance on governmental funding (54.3% of gross revenues in fiscal 2015), Alabama Medicaid supplemental funding, and a large commercial payor (Blue Cross at 19.3% of gross revenues in fiscal 2015) for a substantial portion of its revenues. For instance, the Authority received $11.27 million of supplemental funding in fiscal 2016 and the existing legislation providing these monies expires on Dec. 31 2016. In addition, the state of Alabama is in the process of reforming its Medicaid system to a capitated managed care system coordinated through patient-centered medical homes and risk-based payments. The Authority's earnings improvement program could be affected by these programmatic modifications. Moreover, Blue Cross has been adjusting its reimbursement methodology with tiered networks, risk transfer programs and lower rate increases.

The Authority's balance sheet is characterized by good liquidity indicators and a manageable debt position. Unrestricted cash and investments have declined slightly over the past several years, but remain solid at $157.4 million as of March 31, 2016. This level of liquidity amounts to 168.5 days operating expenses, 12.3x cushion ratio, and 93.1% of debt and compare well to Fitch's 'BBB' category medians. Pro forma long-term debt after the refunding will amount to about $150.2 million, resulting in an improved cash-to-debt ratio of 105%. Moreover, incorporating the anticipated release of the $35.4 million escrow funds held for ACOM in 2017 results in much improved cash-to-debt (128%) and days cash on hand (206 days) ratios that are approaching Fitch's 'A' category medians.

DEBT PROFILE

After the series 2006 refunding and payment of the current installment of bonds and notes, the Authority will have about $150.2 million of long-term debt outstanding, down from $164.6 million at the end of fiscal 2015. The release of the existing $6.3 million debt service fund is expected to reduce the par amount of the series 2016-A refunding bonds from $58.8 million currently outstanding. In addition, the Authority's long term debt amortizes quickly with principal payments ranging from $6.3 million to $9 million over the next ten years. As a result, MADS of approximately $12.83 million drops to about $6 million in fifteen years.

Of the Authority's $ 150.2 million pro forma debt, only the $44.6 million series 2016-A bonds are fixed-rate obligations. The remainder of the Authority's long-term debt is variable-rate loans and direct purchases from commercial banks. Fitch views the Authority's level of uncommitted and unhedged floating-rate debt as a moderate credit risk that is offset by its healthy liquidity position. About $56 million (series 2008 and 2010 B) are parity obligations secured by the Authority's pledged revenues. These notes contain financial covenants including a 1.15x debt service coverage ratio, 75 days cash on hand test (both of which are similar to the MTI) and an additional leverage ratio test of less than 0.9x. The series 2008 note is fully committed until maturity in 2023. The series 2010 B note is committed until 2027 and is amortized through 2034.

The Authority's other long-term debt was issued for ACOM and is also variable-rate obligations from commercial banks. The $33 million series 2012 note funded the acquisition, construction and equipping of the new medical school. The series 2012 note is guaranteed by the Authority and secured by its pledged revenues, as well as a mortgage on ACOM's facilities. The $18.2 million series 2011 note was used to fund a portion of the escrow required for ACOM's accreditation. The series 2011 note is secured by a 1.5-mill property tax assessed and collected within Houston County, as well as a guaranty by the Authority. These notes also include additional financial covenants. The series 2012 note has a tender date in 2024 and a maturity date in 2039. The series 2011 note has a maturity in 2021 and is amortizing on a 10-year schedule.

To hedge the variable rates on the series 2008 loan and 2011 note, the Authority entered into two fixed payor interest rates swaps. The swaps are not secured by the Authority's pledged revenues, but they are required to post collateral under certain circumstances. As of March 31, 2016, about $2.5 million of collateral is posted. The market value of both swaps was approximately negative $4 million as of March 31, 2016.

DISCLOSURE

The Authority covenants to disclose annual operating and audited financial statements within 180 days and quarterly statistics and financial statements within 60 days to the Municipal Security Rulemaking Board's EMMA system.

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

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866807

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1005981

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Contacts

Fitch Ratings
Primary Analyst
Paul Rizzo, +1-212-612-7875
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Ryan Pami, +1-212-908-0803
Associate Director
or
Committee Chairperson
Jim LeBuhn, +1-312-368-2059
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Paul Rizzo, +1-212-612-7875
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Ryan Pami, +1-212-908-0803
Associate Director
or
Committee Chairperson
Jim LeBuhn, +1-312-368-2059
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com