Fitch Ratings has downgraded the rating on the following bonds issued on
behalf of KershawHealth, SC (Kershaw) to 'BBB' from 'BBB+':
--$19,595,000South Carolina Jobs-Economic Development Authority
hospital facilities revenue bonds, series 2008.
The Rating Outlook has been revised to Stable from Negative.
The bonds are secured by a pledge of gross revenue, a mortgage on the
primary facility and a fully funded debt service reserve fund.
KEY RATING DRIVERS:
WEAKENED OPERATING PERFORMANCE: The downgrade reflects the continued
decrease in Kershaw's operating profitability with operating margin
decreasing to negative 4.7% in fiscal 2013 and negative 5.2% in the
six-month interim period ending March 31, 2014 (the interim period).
However, 98.6% of the interim period operating loss occurred in the
first quarter, and operations subsequently appear to be improving. The
Outlook revision to Stable reflects a combination of the improving
operating profitability in the second quarter, a materially declining
debt burden and solid liquidity metrics which provide a measure of
bondholder security in the short term. Failure to sustain operating
improvements will lead to further negative rating pressure.
DECLINING DEBT BURDEN: Kershaw's debt burden remains moderate, but
continued poor operating performance in fiscal 2013 and the interim
period provided weak maximum annual debt service (MADS) coverage,
resulting in a rate covenant violation in fiscal 2013. However, coverage
should be bolstered in the coming years by bond amortization which
decreased MADS from $3.7 million in fiscal 2013 to $2.6 million in
fiscal 2014 and will further decrease MADS in fiscals 2015 and 2016.
SOLID LIQUIDITY: Unrestricted liquidity metrics remain solid with 155.6%
cash-to-debt and 12.4x cushion ratio comparing favorably to Fitch's
respective 'BBB' category medians of 91.7% and 10.2x. The solid
liquidity metrics relative to debt provides a cushion to allow
management time to improve operations in the near term.
LEADING MARKET SHARE: Kershaw's status as the only hospital in its
primary service area (PSA) and its 49% leading inpatient market share
are credit positives and should contribute to management's initiatives
to stabilize operations. However, market share has eroded from 54.7% in
fiscal 2011 due to decreasing inpatient volumes and increasing
competition from Columbia area hospitals.
IMPROVED OPERATIONS EXPECTED: Fitch expects Kershaw's operating
profitability to continue the improvement trend that began in the second
quarter of fiscal 2014, which combined with the declining debt burden,
should provide for adequate MADS coverage. Failure to continue operating
improvements and to improve MADS coverage will result in further
negative rating pressure.
Kershaw operates the only acute care hospital in Kershaw County, South
Carolina, with 121 licensed acute care beds and 96 long-term care beds.
Kershaw's long-serving CEO retired in 2013 and an experienced interim
CEO was hired in December 2013. Total operating revenues equaled $103.7
million in fiscal 2013.
WEAKENED OPERATING PERFORMANCE
The downgrade reflects the increased operating losses in fiscal 2013 and
the first quarter of 2014. Operating margin decreased to negative 4.7%
in fiscal 2013 from negative 2.7% in fiscal 2012.
After an extremely poor first quarter, operating performance is starting
to show signs of improvement in fiscal 2014. Operating margin further
decreased to negative 5.2% in the interim period; however, 98.6% of the
operating loss occurred in the first quarter. Operating margin in the
first quarter equaled negative 10.8%, but improved to negative 0.1% in
the second quarter. The improved operations in the second quarter
reflect the early successes of a new strategic plan and a new
operational improvement plan.
The profitability decline was primarily due to decreased inpatient
admissions and inpatient surgeries, a previous 7% cut to South CarolinaMedicaid reimbursement, decreased supplemental government funding,
increased bad debt and increased self-pay. These factors caused net
patient revenue to decline 4.0% in fiscal 2013 and 3.6% in the interim
period. Management had effectively managed costs, with total operating
expenses decreasing 0.2% in fiscal 2013 and increasing a modest 0.2% in
the interim period. However, the effective cost management was unable to
mitigate the decrease in revenues.
Fiscal 2014 operating performance has been negatively impacted by South
Carolina's decision not to expand Medicaid under the PPACA, which would
have alleviated some of Kershaw's bad debt and would have helped to
offset the decreases in supplemental government funding.
DECLINING DEBT BURDEN
Kershaw's credit profile will benefit from a declining debt burden
(including capital leases) with MADS decreasing to $2.6 million in
fiscal 2014 (2.5% of fiscal 2013 revenue) from $3.7 million in fiscal
2013 (3.6% revenue). MADS is expected to further decrease to $2.2
million in fiscal 2015 (2.1% of fiscal 2013 revenue) and $1.9 million in
fiscal 2016 (1.8% of fiscal 2013 revenue). Fitch expects that improving
profitability and the declining debt burden will produce coverage more
consistent with the rating category by fiscal 2015.
Despite a moderate debt burden, the poor operating performance in fiscal
2013 compressed MADS coverage to a weak 1.2x (based upon MADS of $2.6
million). Based on the fiscal 2013 rate covenant calculation using MADS
of $3.7 million, coverage equaled 0.9x, causing a violation of the rate
covenant which requires actual annual debt service coverage of 1.2x. The
rate covenant violation resulted in a mandatory consultant engagement.
Failure to improve actual annual debt service coverage to 1.2x or
greater in the subsequent two fiscal years following a rate covenant
violation will result in an event of default. Kershaw received a waiver
from bondholders for fiscal 2013 from a provision that may have caused
an event of default should coverage be less than 1.0x. So long as
Kershaw follows the consultant recommendations to the extent feasible
(as determined by Kershaw's board of trustees) and permitted by law, the
hospital has two fiscal years following the fiscal year in which the
covenant violation took place to demonstrate compliance with the rate
Liquidity metrics remain solid relative to debt and provide a degree of
flexibility as management executes its operating improvement plan. With
$32.6 million of unrestricted cash and investments at March 31, 2014,
equating to 155.6% cash-to-debt and 12.4x cushion ratio, liquidity
metrics exceed Fitch's 'BBB' category medians of 91.7% and 10.2x.
However, liquidity is light for the rating category relative to
operating expenses with 116.7 days cash on hand.
LEADING MARKET SHARE
Kershaw maintains a leading 49% market share and is the only hospital in
its primary service area; however, market share has eroded due to
decreasing inpatient volumes, operational issues with its emergency room
and increasing competition from Columbia area hospitals. Management has
taken steps to regain inpatient market including a new public relations
campaign highlighting Kershaw's competitiveness with Columbia area
hospitals, recruitment of key physicians, including an orthopedic
surgeon and two general surgeons, and hiring a new management company to
operate the hospital's emergency room. Approximately 80% of Kershaw's
inpatient admissions originate from its emergency room and the emergency
room has been historically challenged with physician staffing issues.
Initial feedback of the new ER management company has been encouraging.
Kershaw covenants to provide annual disclosure within 150 days after
fiscal year end and quarterly disclosure within 45 days after the first
three fiscal quarters. Disclosure is provided through the Municipal
Securities Rulemaking Board's EMMA system.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', May 30,
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Source: Fitch Ratings