Fitch Affirms East Texas Medical Center's (TX) Revs at 'BBB'; Outlook Remains Negative

CHICAGO--()--Fitch Ratings has affirmed the 'BBB' rating on the following revenue bonds issued on behalf of East Texas Medical Center (ETMC):

--$35.8 million Wood County Central Hospital District hospital revenue bonds, series 2011;

--$260.9 million Tyler Health Facilities Development Corporation hospital revenue bonds, series 2007A.

The Rating Outlook is Negative.

SECURITY

The bonds are secured by a pledge of gross revenues of the obligated group, a first mortgage lien on certain property and debt service reserve funds on the series 2007 and 2011 bonds.

KEY RATING DRIVERS

OPERATING LOSSES PERSIST: Fitch remains concerned with ETMC's light profitability through the 10 months ended Aug. 31, 2014, below the better-than-breakeven budget for fiscal 2014. The Negative Outlook also reflects the challenge ETMC may face in returning to positive operating performance in 2015. Through the 10-month interim period ended Aug. 31, 2013 ETMC posted a $7.8 million loss from operations which translates to a negative 1.1% operating margin and 8.6% operating EBITDA margin.

LIQUIDITY LIGHT BUT IMPROVING: As ETMC has completed nearly all its major capital projects and focused heavily on expense reduction, its liquidity improved materially and will likely be sustained. At Aug. 31, 2014 ETMC had $270.2 million in unrestricted cash and investments, equal to 122 days of cash on hand (DCOH) and 67.1% cash to debt. This is improved significantly over the 93 DCOH and 54.5% cash to debt at fiscal 2013. Further, ETMC is planning to maintain more moderate capital spending near $45 million for fiscal 2014 and 2015, which should allow for liquidity preservation.

SERVICE AREA PRESSURES: While ETMC maintains leading share within its nine-county primary service area, its position within Smith County is pressured by its competitor Trinity Mother Frances (revenues rated 'BBB+' by Fitch). Further, the decisions to cease inpatient operations at two of its rural facilities (Gilmer and Mount Vernon) and to not renew its lease in Clarksville are indicative of ongoing pressures on inpatient volumes in the region. ETMC's ability to successfully adjust its operations will be critical to sustaining budgeted operating cash flow and coverage going forward.

CONSERVATIVE AND MANAGEABLE DEBT: ETMC's fixed-rate debt structure, lack of swaps, and conservative investment mix are a significant mitigant to market risk. Further, coverage of maximum annual debt service (MADS) by EBITDA was adequate at 1.7x through Aug. 31, 2014 and is expected to improve slightly to 1.9x by fiscal year end. No additional debt is planned, and its frozen pension plan was 82% funded at fiscal 2013.

RATING SENSITIVITIES

CASH FLOW IMPROVEMENT: Fitch expects ETMC to improve its operating profitability to levels more consistent with historical and 'BBB' category median performance, via a robust expense management effort and reduced capital spending needs over the next 12 months. Negative rating pressure is likely if current operating losses are sustained or if liquidity levels decline unexpectedly.

CREDIT PROFILE

ETMC is an integrated health system servicing the east and northeastern regions of Texas. The system currently consists of 15 acute care affiliates and several other entities with approximately 875 staffed acute care beds. Total revenues were $971.4 million in fiscal 2013.

SUSTAINED OPERATING PRESSURE

The maintenance of a Negative Outlook reflects Fitch's concern with ETMC's weaker than expected operating performance, which has persisted through the 10-month interim period in 2014. ETMC is now projecting to finish fiscal 2014 with 0.3% operating margin, below the 1.3% budgeted expectation. The largest factors in this year's performance have been inpatient volume declines at ETMC's rural facilities, reimbursement pressures, as well as ongoing competition for clinical services within Tyler and Smith County. To offset, during CY2014, ETMC will cease its operations at its Clarksville and Mount Vernon facilities, and eliminate inpatient activity at its Gilmer facility. Together with other expense reduction initiatives, ETMC anticipates returning to a positive operating margin within the next 12 months.

ETMC is expecting to finish fiscal 2014 behind its original budget, but better than current performance through the 10-month interim. While the fiscal 2015 budget was not available for review, Fitch anticipates ETMC to return to a positive operating margin in fiscal 2015. A failure to improve on current operating performance over the next 12 months would likely pressure the rating. Fitch notes that a $21 million payment for disproportionate share hospital (DSH) and Texas Medicaid 1115 Waiver funds is anticipated within the next few months, which would materially improve profitability.

CONTINUING DISCLOSURE

ETMC covenants to provide bondholders with annual audited financial information to the Municipal Securities Rulemaking Board's EMMA system within 150 days of fiscal year end and quarterly financial statements within 45 days of fiscal quarter end.

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

Applicable Criteria and Related Research:

'Nonprofit Hospitals and Health Systems Rating Criteria', May 30, 2014.

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=746860

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=888454

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Contacts

Fitch Ratings
Primary Analyst
Emily E. Wadhwani
Director
+1-312-368-3347
Fitch Ratings, Inc.
70 W. Madison Street, Chicago IL 60602
or
Secondary Analyst
Alexander Vaisman
Associate Director
+1-212-908-0721
or
Committee Chairperson
Charles Giordano
Senior Director
+1-212-908-0607
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Emily E. Wadhwani
Director
+1-312-368-3347
Fitch Ratings, Inc.
70 W. Madison Street, Chicago IL 60602
or
Secondary Analyst
Alexander Vaisman
Associate Director
+1-212-908-0721
or
Committee Chairperson
Charles Giordano
Senior Director
+1-212-908-0607
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com