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New Issue:

MOODY'S ASSIGNS Baa2 RATING TO MERCY MEDICAL CENTER'S (MD) $78.83 MILLION SERIES 2011 BONDS; OUTLOOK IS STABLE

08 Feb 2011

PARITY RATINGS AFFIRMED; $353.3 MILLION OF DEBT AFFECTED

Maryland Health & Higher Edl. Fac. Auth.
Health Care-Hospital
MD

Moody's Rating

ISSUE

RATING

Fixed Rate Revenue Bonds, Series 2011

Baa2

  Sale Amount

$78,825,000

  Expected Sale Date

02/10/11

  Rating Description

Health Care Revenue

 

 
Moody's Outlook   Stable
 

Opinion

NEW YORK, Feb 8, 2011 -- Moody's Investors Service has assigned a Baa2 long-term rating to $78.83 million of Mercy Health Services' (MHS) Series 2011 Fixed Rate Bonds to be issued through Maryland Health and Higher Educational Facilities Authority. The rating outlook remains stable. Simultaneously, we are affirming the Baa2 ratings with stable rating outlook on rated bonds outstanding as listed at the conclusion of the report; $353.3 million of debt affected. MHS also has approximately $113.2 million of unrated debt outstanding.

RATINGS RATIONALE: The Baa2 rating and stable rating outlook reflect Mercy Medical Center's consistent and strong financial performance, solid clinical demand, and slight improvement in balance sheet measures since incurring the borrowings for the replacement hospital. Ongoing challenges such as the continuing weakness in service area demographics, high leverage, and Mercy's status as a stand-alone facility among a group of competitors that are part of larger systems that have access to significant financial resources temper the rating profile.

USE OF PROCEEDS: The proceeds of the Series 2011 Bonds will be used to refund up to $70,000,000 aggregate principal amount of the Series 2007B and Series 2007C bonds, fund a debt service reserve and pay the cost of issuance.

LEGAL SECURITY: The bonds are secured by a pledge of receipts from the obligated group and a mortgage on MHS facilities (including the Mercy Medical Center), running in favor of the Maryland Health and Higher Educational Facilities Authority for the benefit of bondholders. The obligated group includes the Mercy Health Services parent, and Mercy Health Foundation, in addition to the Mercy Medical Center (MMC). Collectively, the obligated group represents approximately 95% of system assets and 74% of system operating revenues. Stella Maris, Inc. (a 406-bed long-term care facility) and St. Paul Place Specialists (a multidisciplinary physician practice) represent the bulk of non-obligated system assets and revenues.

INTEREST RATE DERIVATIVES: MMC has entered into a number of interest swap agreements, which we believe remains a potential credit risk for the organization. MHS currently has eight swap agreements in place, including two basis swaps (total current notional amount of $260 million), three floating payer swaps (total current notional amount of $513 million), and three fixed payer rate swaps (total current notional amount of $118 million). Merrill Lynch is the counterparty on all eight MMC swaps. Given MHS' Baa2 credit profile and leveraged position (42% cash-to-debt at FYE 2010) we retain concerns regarding MHS' relatively complex derivative structure. Most of the swaps may be terminated at any time at MHS' option, or at the counterparty's option upon downgrade of MHS' rating to below Baa3. The total net termination value of the swaps as of February 3, 2011 was a negative $27.4 million to MHS.

STRENGTHS

*Track record of very good operating results that exceeds medians of comparably rated peers with a 5.7% operating margin and 11.9% operating cash-flow margin in FY 2010 (Baa2 medians are 1.5% and 8.4%, respectively)

*MHS benefits from strict state certificate of need laws and state rate regulation, the latter of which helps to offset MHS's high reliance on Medicaid patients (19.8% of gross revenues in FY 2010).

*Above average and growing liquidity, from a cash on hand perspective. At FYE 2010 (June 30), MHS's cash on hand measured 151 days (the Baa2 median is 102 days).

*Mercy's employed physicians accounted for over 90% of admissions in FY 2010 contributing to solid clinical demand

*Construction project finished early and below budget; new patient tower opened without disruption to operations

*Reduction of demand debt with this refinancing to just 14% of total debt with unrestricted cash now providing over 290% coverage of remaining demand debt

*No new formal debt planned through FYE 2014 and capital needs are more modest with brand new patient tower recently brought online

CHALLENGES

*MHS's Moody's adjusted debt coverage ratios are quite leveraged despite the system's strong cash flow generation

*MHS maintains a complex derivative structure for a Baa credit, with approximately $429 million of swaps in place (see Interest Rate Derivatives).

*Single hospital facility in the competitive system-based Baltimore marketplace

*The top ten admitting physicians accounted for approximately 46.4% of admissions in calendar year 2010.

MARKET/COMPETITIVE POSITION

Mercy Medical Center is located in downtown Baltimore, part of a primary service area that continues to experience unfavorable demographic characteristics. The population in the primary service area, comprised of the majority of Baltimore City and portions of Baltimore and Anne Arundel Counties, is declining and the median household income is only 57% of the State income and 72% of the national average. A weak labor market continues to undermine recovery. The statistics for the secondary service area are somewhat better, with BRAC influencing growth and income and unemployment levels more comparable with the national averages. We note that the negative impact of a less affluent service area remains somewhat mitigated under the State's regulated rate setting environment. While a substantial portion of Mercy's gross revenues are derived from Medicaid, Mercy receives essentially the same rate of reimbursement under Medicaid as it does from any other payer.

Local competition includes prominent sizeable systems such as A2-rated University of Maryland Medical System (UMMS), Aa3-rated Johns Hopkins Health System, Sinai Hospital (a member of A2-rated LifeBrige Health), and the four facilities of A2-rated MedStar Health. We note favorably that MHS maintains a stable to growing market position, in its primary service area (PSA) of 10.2%. The PSA covers the majority of the City of Baltimore as well as a number of communities in the Baltimore area. Johns Hopkins, UMMS and MedStar capture leading market shares of the greater market, with each maintaining several access points throughout the PSA and SSA. Mercy is one of 16 hospitals located in its primary and secondary service area, six of which it considers to be major competitors. These six are actually part of three of the multi-site hospital systems cited above, which we believe places Mercy at a disadvantage. All of these competitor facilities are located within 3 ½ miles of Mercy. In fact, Mercy is one of only two stand-alone hospitals in the entire service area (the other is A2-rated Greater Baltimore Medical Center). The new patient tower at MHS provides sate of the art clinical space, while ambulatory development in the contiguous service area continue to support enterprise growth. We do believe that MHS is fundamentally well positioned to continue to capture solid market share as an independent facility in Baltimore.

OPERATING PERFORMANCE

MHS has recorded double-digit operating cash flow margins since FY 2004, a key strength which supports the Baa2 rating in spite of the higher than average leverage (88.5% debt-to-revenue). In FY 2010, MHS generated over $30 million from operations, recording operating cash flow of $62.5 million (11.9% operating cash flow margin) and providing for good coverage of its high debt position (2.7 times maximum annual debt service). Management attributes the favorable operating performance in recent years to good inpatient, outpatient, and surgical volume growth (which have continued despite MHS's significant patient tower construction project), improved efficiencies, increased acuity as the Medicare case mix index increased from 1.32 in FY 2006 to 1.49 in FY 2010, and good expense management, particularly in FY 2009 and FY 2010 to match lower rate increases from the Maryland Health Services Cost Review Commission.

Interim FY 2011 (YTD November 2010) operating results remain strong with operating cash flow of $25.2 million (11.2% operating cash flow margin), though down from the prior year largely reflecting a lighter flu season and very modest rate increases from the Maryland Health Services Cost Review Commission. However, MHS is on track to meet its 2011 budget which calls for $62.7 million of operating cash flow this year. Management expects favorable operating performance to continue as MHS's operating cash flow margin is projected to range between 11.5% and 13.0% between FY 2011 and FY 2014. Expected performance provides for stable, but modest, coverage of MHS's above average leverage (ranging between 2.75 times to 3.31 times coverage of maximum annual debt service)

BALANCE SHEET PROFILE

Absolute unrestricted cash and investments grew to nearly $193.7 million at FYE 2010, providing a more than adequate 151 days cash. Moreover, MHS's unrestricted cash and investments are allocated in a fairly conservative fashion among approximately 85% cash/fixed income, 10% equities, and 5% alternative investments. Approximately 97% of unrestricted cash and investments can be liquidated within one month. Monthly liquidity provides over 290% coverage of the reduced demand debt (post refinancing).

Leverage remains a key concern, though we are encouraged that this refinancing reduces demand debt exposure. Based on audited FY 2010 results, the system's cash-to-debt measured a thin, but improved, 42% (Baa2 median is 59.6%), debt-to-total operating revenue a very high 88.5% (Baa2 median is 39.8%), and debt-to-cash flow a high 6.9 times (Baa2 median is 4.8 times). We do note that exposure to M&T Bank for $16.2 million of letters of credit, majority for non-rated Stella Maris debt, carries heightened risk as M&T's A2 /P1 rating is on Watchlist for downgrade.

Outlook

The stable outlook reflects our belief that MHS will continue to generate favorable operating results and to strengthen liquidity over time.

What could change the rating -- UP

Continued volume growth; materially improved debt coverage ratios and balance sheet build; significant market share capture for profitable services

What could change the rating -- DOWN

Material market share loss; thinner debt ratios and liquidity; increase in debt without commensurate increase in cash flow generation; inability to sustain current performance

KEY INDICATORS

Assumptions & Adjustments:

-Based on Mercy Health Services, Inc. and Subsidiaries audited consolidated financial statements

-First number reflects audited FY 2009 for the year ended June 30, 2009

-Second number reflects pro forma on audited FY 2010 for the year ended June 30, 2010, factoring refunding of $70 million of VRDO bonds

-Interest expense "grossed up" to include capitalized interest

-Investment returns smoothed at 6%

*Inpatient admissions:18,214; 18,253

*Total operating revenues: $508 million; 523 million

*Moody's-adjusted net revenues available for debt service: $70.5 million; $74.7 million

*Total debt outstanding: $468 million; $472 million

*Maximum annual debt service (MADS): $27.5 million; $28.1 million

*MADS Coverage with reported investment income: 2.0 times; 2.3 times

*Moody's-adjusted MADS Coverage with normalized investment income: 2.6 times; 2.7 times

*Debt-to-cash flow: 8.2 times; 8.7 times

*Days cash on hand: 130 days; 151 days

*Cash-to-debt: 35%; 42%

*Operating margin: 4.5%; 4.3%

*Operating cash flow margin: 11.8%; 11.9%

RATED DEBT

Issued through Maryland Health and Higher Educational Facilities Authority:

-Series 2011 Fixed Rate, rated Baa2

-Series 2008 VRDO; supported by direct pay letters of credit from M&T.; Baa2 underlying rating

-Series 2007A Fixed Rate; rated Baa2

-Series 2007B&C VRDO; supported by direct pay letters of credit from Bank of America, N.A.; Baa2 underlying rating (to be refunded)

-Series 2007D VRDO; supported by direct pay letter of credit from Wells Fargo.; Baa2 underlying rating

-Series 2001 Fixed Rate; rated Baa2

-Series 1996 Fixed Rate, insured by Assured Guaranty; Baa2 underlying rating

CONTACTS

Obligor: John Topper, Chief Financial Officer, (410) 332-9313

Financial Advisor: John Cheney, Senior Vice President, Ponder & Co., (410) 435-6745

Underwriter: James Olsen, Director, Bank of America Merrill Lynch, (212) 449-0630

The last rating action was on March 22, 2010 when MHS's Baa2 rating was affirmed and the outlook remained stable. The rating was subsequently recalibrated to Baa2 global scale rating on May 7, 2010

The principal methodology used in this rating was Not-for-Profit Hospitals and Health Systems published in January 2008.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Beth I. Wexler
Analyst
Public Finance Group
Moody's Investors Service

Jennifer Ewing
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

Journalists: (212) 553-0376
Research Clients: (212) 553-1653


Moody's Investors Service
250 Greenwich Street
New York, NY 10007
USA

MOODY'S ASSIGNS Baa2 RATING TO MERCY MEDICAL CENTER'S (MD) $78.83 MILLION SERIES 2011 BONDS; OUTLOOK IS STABLE
No Related Data.
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