Fitch Affirms Forrest Health, MS' Rev Bonds at 'A'; Outlook Revised to Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the following debt issued on behalf of Forrest Health (FH), MS at 'A':

--$70 million Mississippi Hospital Equipment & Facilities Authority (Forrest County General Hospital Project) revenue bonds (Federally Taxable - Build America Bonds - Direct Payment) series 2010;

--$37.75 million Mississippi Hospital Equipment & Facilities Authority (Forrest County General Hospital) revenue refunding bonds series 2009.

The Rating Outlook is revised to Stable from Negative.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group.

KEY RATING DRIVERS

CONSISTENT PERFORMANCE: FH's rating was assigned a Negative Outlook in 2012 due to a decline in profitability and increased debt burden. The revision of the Outlook to Stable from Negative reflects FH's consistent financial performance over the last two years and although it is lower than historical performance, financial metrics remain adequate for the rating level.

GOOD MARKET POSITION: A factor supporting the maintenance of the 'A' rating is FH's good market position and its progress in developing a hub and spoke model with regional facilities that refer tertiary volume to the main facility, Forrest General Hospital. FH continues to gain market share due to successful physician recruitment and capital investment.

CHALLENGING PAYOR MIX: FH's payor mix is unfavorable with almost 25% of gross revenue from Medicaid and self-pay. The state's decision not to expand Medicaid under the Affordable Care Act (ACA) will be negative for FH as there will be a reduction in disproportionate share funding (DSH) without any benefit from reduced uncompensated care. Medicare DSH was reduced by $2.1 million in 2014.

HIGH DEBT BURDEN: FH has a high debt burden and with the heavy use of bank notes and capital leases, debt service is front loaded. Debt service coverage is weak for the rating level but should improve over the next three years as some of the bank notes mature.

COMPLETION OF HEAVY CAPITAL SPENDING: FH has completed its major capital projects that are expected to secure and grow its market position while becoming more closely integrated with the largest multispecialty clinic in town, Hattiesburg Clinic. These investments include the replacement of Highland Hospital, a new 30 bed orthopedic hospital, and Epic.

RATING SENSITIVITIES

STABLE OPERATING PROFITABILITY AND IMPROVED COVERAGE: FH has several strategic initiatives in place to grow revenue and Fitch expects operating profitability to at least remain stable. Debt service coverage is expected to improve as its bank notes mature. There are no additional debt plans and an increase in debt would be viewed negatively and would likely result in negative rating pressure.

CREDIT PROFILE

Forrest Health owns and operates two hospitals including Forrest General Hospital, a 410-staffed bed, acute-care hospital, with an 88-bed chemical dependency and psychiatric facility, 24-bed rehabilitation unit, and 20 bed skilled nursing facility located in Hattiesburg, MS, and Highland Community Hospital, a 60-bed, full-service acute care medical facility located in Picayune, MS. FCGH also operates, but does not own, Walthall County General Hospital in Tylertown, MS, Jefferson Davis Community Hospital in Prentiss, MS, and Marion General Hospital in Columbia, MS. Total revenue in fiscal 2013 (Sept. 30 year end) was $472 million.

Revision of Outlook to Stable

Fitch believes that FH's operating environment has stabilized from last year's review as several areas of concern have been addressed including the uncertainty surrounding the extension of the Medicaid program as well as ongoing litigation. In addition, FH has several initiatives in place to improve its profitability including reducing the losses at its Highland facility.

Consistent Profitability

Through the 11 months ended Aug. 31, 2014, operating margin was 2.4% compared to 2.5% in fiscal 2013 and 3.4% in fiscal 2012. Operating EBITDA margin was solid at 11.5% through the 11 months ended Aug. 31, 2014 compared to the A category median of 9.5%. FH had increased depreciation and interest expense beginning in fiscal 2013 related to its new building projects including a replacement facility for Highland Hospital that opened in July 2012 and a new orthopedic hospital that opened in October 2012.

FH was close to meeting its fiscal 2013 budget and year to date performance in fiscal 2014 is ahead of budget. FH is projecting a $3.2 million operating income for fiscal 2015 and management has a history of being conservative.

Operating income was $11.8 million in fiscal 2013 and included $16 million of operating losses at Highland. Fitch believes there is significant opportunity for profitability improvement if management's strategies to turn operations around at Highland are successful.

Unfavorable Payor Mix

FH is dependent on Medicare and Medicaid DSH and upper payment limit funding (UPL; net of taxes) due to its unfavorable payor mix. Medicare DSH has historically been stable around $15-16 million a year, but was reduced by $3 million in 2014 due to the change in formula under the ACA. Medicaid DSH and UPL funding is more volatile and management monitors operating performance excluding these funds. Medicaid DSH and UPL totaled $22 million in fiscal 2012, $28.6 million in fiscal 2013 and expected to total $25.1 million in fiscal 2014.

Good Market Position

One of FH's main credit strengths is its market position, which should further be solidified by its recent capital investments. FH has an interdependent relationship with Hattiesburg Clinic, a large multispecialty clinic with 250 physicians that account for over 80% of FH's volume. FH continually evaluates additional initiatives that will further align the two organizations.

Market share has continued to increase to 34% in 2014 (Medicare inpatient market share for 19 county service area) from 33.2% in 2012 compared to its closest competitor, Wesley Medical Center, with 8.2% down from 10% in 2012. Management continues to grow its regional referral relationships and its service area is likely to extend to George County with a pending affiliation.

Capital Spending Subsides

FH's historical capital spending has been healthy with its new building projects and investment in Epic. Capital spending is projected to decline to approximately $25-26 million a year beginning in fiscal 2014 from $47 million in fiscal 2013, $77 million in fiscal 2012 and $46 million in fiscal 2011. Reduced capital spending should result in improved liquidity, however, management may increase pension funding above the annual required amount to lower the liability.

Adequate Liquidity

Liquidity metrics are in line with the A category medians. Total unrestricted cash and investments was $235 million at Aug. 31, 2014, which translated to 198.9 days cash on hand and 129% cash to debt compared to the 'A' category medians of 199.2 and 131.2%, respectively.

High Debt Burden

FH had total debt of $182 million as of Aug. 31, 2014, which includes $109 million of bonded debt, $60 million of capital leases and $13 million of bank debt. FH's debt portfolio is 100% fixed rate and includes a series that are Build America Bonds (BABs). The debt service requirements on the BABs are treated net of the subsidy and interest expense is also net of the subsidy. The reduction in BABs subsidy due to sequestration is minimal at approximately $130,000 a year.

FH has a basis swap outstanding that has a collateral threshold requirement of $15 million and as of July 31, 2014 the current mark to market valuation was negative $533 thousand.

Debt service is front loaded with MADS of $18.6 million in fiscal 2014, which steadily declines to $12.5 million in fiscal 2018. MADS coverage was 3.2x through the 11 months ended Aug. 31, 2014 compared to 2.9x in fiscal 2013, 2.1x in fiscal 2012 and the 'A' category median of 3.8x.

Disclosure

FH covenants to disclose quarterly and annual financial information and utilization statistics to the MSRB's EMMA system. Litigation that was pending during last year's review has been settled in FH's favor.

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

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2014.

Applicable Criteria and Related Research:

Not-for-Profit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=779548

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=884834

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Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1-415-732-5620
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Dmitry Feofilaktov
Analyst
+1-212-908-0345
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1-415-732-5620
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Dmitry Feofilaktov
Analyst
+1-212-908-0345
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com