Fitch rates Forrest Health ‘A’; outlook is negative

HATTIESBURG — Fitch Ratings has affirmed the ‘A’ rating on Forrest Health, Miss.’s (FH) outstanding debt, listed at the end of this release.
The Rating Outlook remains “negative.”

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

KEY RATING DRIVERS
WEAK OPERATING PERFORMANCE: The maintenance of the Negative Outlook is due to ongoing pressure on operating performance. Operating performance in fiscal 2013 continues to be challenged by expenses related to Epic implementation and slower than expected volumes at its newest facility, a 30 bed orthopedic hospital. The receipt of meaningful use funds should bridge FH to its original projected operating income budget.
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.
GOOD MARKET POSITION: FH has a good market position and has developed 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 over 15% of gross revenue from Medicaid and over 10% self pay volume. This has resulted in a high reliance on disproportionate share/upper payment limit funding, which actually increased in 2013. In addition, the continuation of the state Medicaid program is uncertain as the program sunsets on June 30, 2014 and will require legislative reauthorization to continue.
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.
RATING SENSITIVITIES
DOWNWARD RATING ACTION: Fitch expects FH’s strategic investments in its regional growth strategy and information technology will be accretive to FH’s financial profile over the near term. However, if operating cash flow and debt service coverage levels decline further, downward rating action is likely.
CREDIT PROFILE
Forrest Health owns and operates two hospitals including Forrest General Hospital, a 400-staffed bed, acute-care hospital, with an 88-bed chemical dependency and psychiatric facility and 24-bed rehabilitation unit, located in Hattiesburg, MS, and Highland Community Hospital, a 60-bed, full-service acute care medical facility located in Picayune, MS. FCGH also leases 33 beds for long-term acute care to Select Medical, and 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.
Maintenance of Negative Outlook
Fitch assigned a Negative Outlook to FH’s ‘A’ rating during Fitch’s last review in October 2012. Operating performance in fiscal 2013 (Sept. 30 fiscal year end) remains pressured largely due to over budgeted expenses related to its Epic installation. The maintenance of the Negative Outlook is due to Fitch’s continued concern about FH’s weak operating performance and debt service coverage levels that has been exacerbated by its front loaded debt structure.
Through the 11 months ended Aug. 31, 2013, operating margin was 2.3% compared to 3.4% in fiscal 2012 and 7.6% in fiscal 2011. Operating EBITDA margin did improve to 10.5% compared to 9% in fiscal 2012 but down from historical levels around 13%. Fiscal 2013 is the first year of increased depreciation and interest expense 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 implemented its electronic medical record, Epic, at its main facility at a total cost of over $40 million. In addition, the impact on operating expenses was over budget by $8.6 million in fiscal 2013 due to higher than expected expenses related to the implementation. The electronic medical record went live in April 2013 and the hospital is entering phase II of the implementation.
If FH meets its operating income budget in fiscal 2013, it will largely be due to the receipt of meaningful use funds. The operating income budget was $13.56 million for fiscal 2013 and through the 11 months ended Aug. 31, 2013, FH’s operating income was $9.7 million (includes $1.9 million of meaningful use funds). A total of $8.7 million of meaningful use funds is expected for fiscal 2013. FH’s financial projections are pretty grim with an expected fiscal 2014 operating loss due to continued revenue pressure. However, FH’s projections are fairly conservative and do not factor in the benefits from various strategic initiatives.

Unfavorable Payor Mix
The state Medicaid program could expire on June 30, 2014 if there is no legislative reauthorization of the act. Fitch believes this situation is remote, however, if it did occur, it would have a significant negative effect on FH. Total disproportionate share funding (Medicare and Medicaid) and upper payment limit funding (net of taxes) that FH receives totaled $40.9 million in fiscal 2011, $37.5 million in fiscal 2012, and $44.2 million in fiscal 2013. FH has assumed a $9.5 million decline in this funding stream in its financial projections.

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 increased slightly to 33.4% in 2013 (Medicare inpatient market share for 19 county service area) from 33.2% in 2012 compared to its closest competitor, Wesley Medical Center, with 9.7% down from 10% the prior year. Management believes there are further opportunities for gaining market share due to its recent capital investment and successful physician recruitment.

Capital Spending Subsides
FH’s capital spending is projected to decline to approximately $25 million a year beginning in fiscal 2014 from $50 million in fiscal 2013, $77 million in fiscal 2012 and $46 million in fiscal 2011. There are a few capital projects that management is contemplating and although not expected, the issuance of any additional debt would be viewed negatively and would likely result in downward rating pressure.

Adequate Liquidity
Liquidity had been solid but declined as of Aug. 31, 2013 due to capital spending. Unrestricted cash and investments was $217.9 million that equated to 186 days cash on hand and 115% cash to debt compared to the ‘A’ category median of 196.3 and 129.2%. Management is contemplating paying off approximately $14 million of debt with cash, which would reduce its debt service requirements by approximately $1 million and would be viewed favorably by Fitch.

High Debt Burden
FH had total debt of $191.3 million as of Aug. 31, 2013, which includes $111 million of bonded debt, $63.6 million of capital leases and $16.7 million of bank debt. The debt is 100% fixed rate. FH has a basis swap outstanding that has a collateral threshold requirement of $15 million and as of Aug. 31, 2013 the current mark to market valuation was negative $807 thousand.
Debt service is front loaded with MADS of $18.7 million in fiscal 2013, which steadily declines to $12.7 million in fiscal 2017. MADS coverage was 2.8x through the 11 months ended Aug. 31, 2013 compared to 2.1x in fiscal 2012, 3x in fiscal 2011 and the ‘A’ category median of 3.8x.

Litigation
FH is involved in ongoing litigation related to its ambulance company and the lawsuit was brought by its competitor, Wesley Medical Center. The impact of this pending litigation is still unknown.

Disclosure
Forrest Health covenants to disclose quarterly and annual financial information and utilization statistics to the MSRB’s EMMA system.

Outstanding Debt:
–$70,000,000 Mississippi Hospital Equipment & Facilities Authority (MS) (Forrest County General Hospital Project) revenue bonds (Federally Taxable – Build America Bonds – Direct Payment) series 2010;
–$40,960,000 Mississippi Hospital Equipment & Facilities Authority (MS) (Forrest County General Hospital) revenue refunding bonds series 2009.

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