[February 04, 2016]

Fitch Downgrades Parrish Medical Center, FL to 'BBB'; Outlook Revised to Negative

Fitch Ratings has downgraded the rating on the following bonds issued by the North Brevard County Hospital District on behalf of Parrish Medical Center (PMC) to 'BBB' from 'BBB+':

--$30.8 million revenue refunding bonds, series 2008.

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are collateralized by a pledge of and a security interest in net revenues and a debt service reserve account funded at maximum annual debt service (MADS).

KEY RATING DRIVERS

CONTINUED AND INCREASED OPERATING LOSSES: The downgrade to 'BBB' reflects PMC's steady operating losses, with a negative 18.9% operating margin in fiscal 2015 (Sept. 30 year-end), continuing a six-year trend of poor profitability. Excluding a $12 million non-recurring accounts receivable adjustment, negative operations are attributed to ongoing losses at PMC's employed physician group, additional costs relating to revenue cycle improvements, higher contracted services expenses, and increased medical malpractice settlements.

ACCOUNTS RECEIVABLE WRITE-DOWN: Because of the poor installment of a new billing information system which resulted in dramatically overstated net patient service revenues, PMC wrote off $12 million of accounts receivable balances during the fourth quarter of fiscal 2015 (4Q15). In addition, PMC experienced about $2.5 million of one-time expenses from consulting services, contract labor and overtime costs associated with the billing system. As a result, PMC violated its debt service coverage ratio (DSCR) and has engaged a management consultant to provide a performance improvement plan. Despite the DSCR being below 1x, it is not an event of default under either the Master Trust Indenture (MTI (News - Alert)) or bank financing agreements.

REDUCED BUT GOOD LIQUIDITY POSITION: The downgrade is also based on PMC's lower cash position which provides a slimmer financial cushion in light of its operating challenges. As of Sept. 30, 2015, PMC had $93.2 million of unrestricted cash and investments, equating to 216 days cash on hand, which is down from $111.4 million or 277 days cash on hand two years earlier. Liquidity levels are down due to steady operating losses, heightened capital expenses in fiscal 2014, and poor accounts receivable collections and unrealized investment losses in fiscal 2015.

DECLINED BUT LEADING MARKET POSITION: As of 2014, PMC secured a leading 63% inpatient market share in its primary service area. However, PMC's market share declined three percentage points over two years and inpatient use rates in the primary service area decreased steadily from 2011-2014. The closest competitor is Wuesthoff Hospital (part of Community Health Systems; rated 'B+'/Stable Outlook), which holds a 10% inpatient market share.

RATING SENSITIVITIES

CONTINUED WEAK OPERATING PERFORMANCE: Despite a substantial projected turnaround, Parrish Medical Center (PMC) expects financial performance to remain weak in fiscal 2016 and is budgeting for another operating loss. If profitability and debt service metrics are not dramatically improved over fiscal 2015 levels, further negative rating action could occur.

FURTHER LIQUIDITY REDUCTIONS: If PMC's cash position continues to erode in light of its lower earnings and revenue cycle challenges, negative rating pressure is possible.

CREDIT PROFILE

PMC is operated as a district hospital and is a governmental entity, the North Brevard County Hospital District, created under the laws of the state of Florida. PMC's main hospital campus has 210 licensed beds (160 staffed beds) and is located in Titusville, FL (45 miles east of Orlando). In fiscal 2015, PMC had total revenues of approximately $142 million. Fitch's financial ratio calculations are based on the reclassification of PMC's employed physician activities to operating revenue and expenses from non-operating revenues and expenses. As a result, the $8.7 million in physician practice losses is incorporated into Fitch's operating margin and operating EBITDA margin calculations.

As a district hospital, PMC has the authority to levy up to five mills of taxes on district property to support operations. Based on the district's taxable property values, management estimates the maximum levy would generate approximately $15 million per year in revenue. However, property taxes have not been levied since 1994 and are not expected to be levied over the near term.

PMC continues to focus on quality improvements and clinical efficiency initiatives, which positions them well for the emerging value-based reimbursement environment. One indicator of success is the Center for Medicare and Medicaid Services ranking PMC as central Florida's leading hospital and in the top 6% of all U.S. hospitals based on certain clinical care, patient satisfaction and cost of care metrics.

WEAK OPERATING PERFORMANCE

Excluding the non-recurring accounts receivable adjustment and other one-time expenses in fiscal 2015, PMC continued its six- year trend of operating losses. After operating losses of about $3.9 million during fiscal 2013 and 2014, PMC lost nearly $27 million in fiscal 2015. Even after removing the $12 million non-recurring accounts receivable adjustment, $3.4 million of one-time expenses, and a negative $2 million accounting change relating to indigent care programs, operating profitability remained negative. Negative earnings are due to ongoing losses at PMC's employed physician group, additional costs relating to rvenue cycle improvements, and higher contracted services expenses. Through 1Q16 (three-month period ending Dec. 31, 2015), operating losses continue at $1.33 million, producing a negative 3.4% margin.

ACCOUNTS RECEIVABLE WRITE-DOWN AND DEBT SERVICE COVERAGE

Due to the poor information systems implementation, PMC wrote off $12 million of accounts receivable balances during 4Q15. Most of the write-down ($10.5 million) related to fiscal 2015 accounts receivable balances, so the issue does not appear to be chronic in nature. As a result, PMC violated its DSCR and has engaged a management consultant to provide a performance improvement plan. Additionally, PMC's chief financial officer (CFO) resigned his position during August 2015 and the current controller is serving as the acting CFO. According to Fitch's calculation, the DSCR was a negative 1.9x in fiscal 2015.

The management consultant, Berkeley Research Group (BRG), was engaged on another project when the billing system implementation issue was identified. When PMC noticed some preliminary issues with the new system, it provided BRG with the opportunity to review the revenue cycle process. After identifying the billing system issue, PMC originally retained BRG to perform a comprehensive operating assessment. The assessment report was provided to PMC in June and will serve as the basis for the management consultant's report to bondholders as a result of the rate covenant violation.

BRG's assessment report identified both revenue and expense opportunities, with a recurring range of between $12.1 million and $21.1 million. Additionally, BRG estimates a one-time cash acceleration benefit ranging from $2.2 million to $3.3 million in fiscal 2016. Major opportunities include revenue cycle and workforce productivity improvements, and employee benefit modifications. Many of these initiatives began the implementation process during August 2015 and are led by working groups that include both BRG staff and PMC executives. Importantly, the BRG consultants that performed the assessment are part of the implementation teams.

WEAKENING BALANCE SHEET MEASURES

PMC's liquidity levels are down due to steady operating losses, heightened capital expenses in fiscal 2014, and poor accounts receivable collections and unrealized investment losses in fiscal 2015. As of Dec. 31, 2015, PMC had $83.2 million of unrestricted cash and investments, equating to nearly 200 days cash on hand, which is down from $111.4 million or 277 days cash on hand at the end of fiscal 2013. As another pressure on liquidity, Fitch also notes that days in current liabilities increased to 65 in fiscal 2015, up from 50 in the prior fiscal year. For the three-month period ending Dec. 31, 2015, days in current liabilities remain approximately 11 days above prior year levels.

As a result of the continuing financial losses, unrestricted net assets have declined, pushing debt-to-capitalization to 50.8% in fiscal 2015, which is slightly above Fitch's 'BBB' category median of 48.1%. In addition, cash- to long-term debt is down from historical levels, but amounted to a solid 92.3% as of Sept. 30, 2015.

MARKET POSITION AND PATIENT VOLUMES

While still the leader, PMC's market share fell slightly to 63% in 2014 from 66% in 2012. Moreover, inpatient use rates in the primary service area declined steadily from 2011-2014. The closest competitor, Wuesthoff Hospital, part of Community Health Systems, is located about 27 miles south and holds a 10% inpatient market share. Community Health Systems also has another hospital further south in Melbourne. Other secondary service area competition is significant and is derived from the large and influential Orlando-based health systems and Health First, which is located in and around Melbourne 30-40 miles south. Health First's growth has been somewhat brisk over the past several years and it owns four hospitals, a very large multi-specialty physician group and a health plan in central and southern Brevard County. Moreover, Health First's health plan also operates the service area's only Medicare Advantage product, which is shifting patient volumes to its network of physicians and medical facilities.

Prior to fiscal 2015, PMC experienced a five-year deterioration in many inpatient and surgical volumes mostly due to soft economic trends and a movement to outpatient modalities. Admissions increased 4.3% to 6,919 in fiscal 2015 after declining 14.1% from fiscal 2010-2014. However, outpatient surgeries declined 11% in fiscal 2015 to 3,600 cases after dropping nearly 37% from fiscal 2010-2014 as a result of competition from ambulatory surgery centers. In addition, even though emergency room visits increased 5.3% in fiscal 2015, observation cases and outpatient visits declined, 15.6% and 3.9%, respectively, during the same one-year period. Management has been attempting to implement a number of strategic initiatives to mitigate the volume declines, but results so far have been marginal.

DEBT PROFILE

PMC's outstanding debt is all fixed-rate. The series 2014 direct bank placement bonds have a 3% interest rate, an initial tender date of Oct. 1, 2029 and a maturity date of Oct. 1, 2043. MADS as a percent of revenues is manageable at 4.1% for fiscal 2015. The bank and MTI financial covenants are essentially the same, with the bank securing a tighter additional bonds test if days cash on hand falls below a certain threshold. While the DSCR fell below 1x in fiscal 2015, it is not an event of default under the MTI or bank agreement unless the violation occurs two years in a row.

As of Sept. 16, 2015, PMC terminated its two basis swap agreements, which resulted in a net positive settlement to PMC of $4.25 million. Favorably, PMC's defined pension plan is overfunded by 12% as of Sept. 30, 2015, so it enjoys a $6.5 million net pension asset on its balance sheet.

DISCLOSURE

PMC covenants to provide annual and quarterly disclosure through the Municipal Securities Rule Making Board's EMMA system.

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

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866807

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=999044

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=999044

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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