Fitch Affirms Upper Chesapeake Health System's (Maryland) Revs at 'BBB+'; Outlook to Evolving

NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms Upper Chesapeake Health System's (UCHS) $124,100,000 series 2008A, B, and C outstanding bonds issued through the Maryland Health and Higher Educational Facilities Authority at 'BBB+'.

The Rating Outlook is revised to Evolving from Stable.

The revised Outlook reflects the presence of strong conflicting positive and negative factors that may affect the rating over the near- to medium-term. Fitch's primary concern is UCHS' heavy debt burden, with a disproportionately large amount of variable rate demand debt for the rating category, coupled with the system's slim liquidity reserves and the need for additional capital to accommodate growing service area needs. However, these negative credit factors are offset by the potential benefits of the recently announced strategic affiliation with the Baltimore based University of Maryland Medical System (UMMS) (Fitch rated 'A'; Outlook Stable), a nine-hospital network anchored around the University of Maryland Medical Center and closely affiliated with the University of Maryland Medical School. UCHS' historically strong operating performance, robust volumes, and dominant market position in the growing Harford County service area additionally support the affirmation of the 'BBB+' rating.

UCHS has continued to post strong operating results that exceed the 'BBB' rating category medians. Operating margin was 2.7% ($7.5 million) for the fiscal year ended Dec. 31, 2008 and was reported at 4.9% ($7.1 million) for the six months ended June 30, 2009 (the 2009 interim period), compared to the Fitch 'BBB' median of 1%. UCHS benefits from strong volume growth at both UCHS hospitals, Upper Chesapeake Medical Center (UCMC) and Harford Memorial Hospital (HMH). Net revenues increased by 17.4% during fiscal 2008 and by 7.7% during the first six months of 2009. System admissions increased by 15.9% during fiscal 2008 and are 2.2% ahead of last year for the 2009 interim period. UCHS also benefits from the area's attraction as a bedroom community to the Baltimore and Wilmington (DE) metropolitan area and from a recent population surge. The influx is a result of the U.S. Defense Department Base Realignment and Closure Commission's decision to expand the role of the Aberdeen Proving Grounds (APG), located in eastern Harford County (GO bonds rated 'AA+' by Fitch). The new patient tower constructed at UCMC, various renovations and addition of 9 beds at HMH with approval for an additional 16 beds to be added in 2010, have made it possible to capture additional market share, which increased to 59.4% from 55.1% in fiscal 2007.

As part of the affiliation agreement, UMMS purchased the right to appoint two members to UCHS' Board of Directors. The next step in the affiliation process is for UMMS to provide significant capital infusions to invest in clinical programs and services at the UCHS facilities in two phases, the first in October 2009 and the second in October 2010, at each step increasing UMMS' ownership interest in UCHS. The affiliation agreement is expected to ultimately lead to a full merger by 2013. An immediate benefit of the UMMS affiliation will be the significantly enhanced ability to recruit physicians to the area, which is essential given the observed and expected population increase with projections calling for additional population of 27,500 by 2015. It is anticipated that upon the full merger of the two organizations in 2013, UMMS would issue debt to address the needed expansion of inpatient capacity at UCHS.

The hospital is highly leveraged with significant exposure to variable rate demand debt. Approximately $124 million (69%) of UCHS' long-term debt is in the form of variable rate demand debt secured by letter of credit (LOC) commitments. Given the credit deterioration in the global banking sector, borrowers have a heightened exposure to renewal and credit risk. UCMC's LOC commitments run through 2011 and 2013 which mitigates the near-term risk of non-renewal. Further, Fitch believes that under a bank bond scenario (resulting from an inability to remarket bonds due to market turmoil or credit deterioration of the LOC provider) the hospital's strong cash flow abilities would allow it to survive an accelerated amortization of its variable rate debt. The growing support of UMMS is an additional mitigant to Fitch's concerns.

Because of unrealized losses, unrestricted cash and investments declined to $61.7 million during fiscal 2008 from $68.2 million in the prior year, resulting in a decrease in cash on hand relative to expenses to 95.1 days from 121.9 days in fiscal 2007. For the interim period, however, cash improved slightly to $69.5 million, equal to 104.2 days cash on hand. Cash to debt was a slim 39.7% at June 30, 2009. The hospital investment portfolio is conservative with 57% in cash and cash equivalents and no alternative investments.

UCHS' debt to capitalization increased to 96.8% as of the end of fiscal 2008 from already historically high range of 60% due to investment losses, swap valuations and increased pension obligation liabilities, requiring waivers from the banks providing letters of direct for the series 2008A and 2008B bonds. UCHS was able to obtain waivers from the banks and expects debt to capitalization to moderate to 70% range by the end of fiscal 2009. Due to strong operating performance (operating EBITDA margin was 10% and 12% for fiscal 2008 and the interim period, respectively) pro forma coverage of maximum annual debt service (MADS) was 2.5 times (x) in fiscal 2008, and at 3.7x for the interim period, exceeding the Fitch 'BBB' median of 2.5%. UCHS has two swaps, a fixed payor and a basis swap with notional amount of $219.2 million; the June 30, 2009 mark-to-market on the swaps was negative $22.1 million. UCHS is not required to post collateral.

Upper Chesapeake Health System has 311 staffed beds at two hospitals in Bel Air and Havre de Grace, MD, located approximately 30 and 55 miles northeast of Baltimore, respectively, as well as other related facilities. In 2008, UCHS had $273.9 million in total operating revenue. UCHS covenants to disclose quarterly and annual audited financial statements to the Nationally Recognized Municipal Securities Information Repositories. Quarterly disclosure has been timely and includes a balance sheet, income statement, and utilization statistics but excludes a cash flow statement.

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