News Column

Fitch Downgrades Dickinson County Healthcare System (MI) Revs to 'B'; Outlook Remains Negative

September 3, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has downgraded to 'B' from 'BB-' the rating on $21,455,000 fixed rate bonds, series 1999, issued by Dickinson County Healthcare System (DCHS).

The Rating Outlook is Negative.

SECURITY

The bonds are secured by a pledge of net revenues, investment income, and bond funds under the indenture agreement.

KEY RATING DRIVERS

VERY WEAK LIQUIDITY: The downgrade to 'B' is driven by continued decline in unrestricted cash and investments, which totaled $7 million at June 30, 2014 compared to $10.7 million one year prior. Liquidity metrics of 29.8 days cash on hand, 1.7x cushion ratio, and 27.4% cash to debt provides very limited cushion against negative operating variability. However, unrestricted cash and investments at July 31, 2014 were reported at $8.8 million, a 25% improvement from the prior month.

IMPROVING OPERATIONS: At the time of Fitch's last review, DCHS posted an operating loss of $3.8 million in the six months ended June 30, 2013. In the following year, profitability improved dramatically, and DCHS posted an operating loss of $1.7 million in the fiscal year ended (FYE) Dec. 31, 2013, and a gain of $484,000 in the six months ended June 30, 2014. Management attributes the positive trend to recovering inpatient volumes, enhanced other revenues, and expense reduction initiatives taking hold.

HIGH DEBT BURDEN: Debt burden is relatively high with maximum annual debt service (MADS) a high 4.6% of revenues. Combined with weak cash flows, MADS coverage was 1.5x in fiscal 2013 and 2012. However, DCHS has consistently met the debt coverage ratio requirement under the bond indenture.

LEADING MARKET POSITION: DCHS continues to maintain its dominant market position in the region. Market share in the primary service area was 87% for inpatient services and 77% for outpatient services in 2013.

RATING SENSITIVITIES

LIQUIDITY GROWTH NEEDED: The Negative Outlook reflects Fitch's concerns around continued balance sheet deterioration despite operational improvements realized in 2014. A return to Stable Outlook will be predicated on DCHS's ability to sustain better performance exhibited year to date and to reverse the erosion in unrestricted cash and investments.

CREDIT PROFILE

DCHS is a 96-bed acute care hospital providing primary and secondary services located in Iron Mountain, on Michigan'sUpper Peninsula. In fiscal 2013, DCHS generated total revenues of $89.8 million.

Signs of Operational Turnaround

DCHS was able to reduce its operating loss to $1.7 million through the 2013 year-end, compared to a loss of $3.8 million posted through the six months ended June 30, 2013. Financial improvement was supported by inpatient volume growth, enhanced 340B program revenue, electronic health record incentive revenue, and expense reductions. Signs of continued recovery were evident through the six months ended June 30, 2014, with an operating income of $484K (1.1% operating margin). Management expects the positive trend to continue and end fiscal 2014 with a positive operating income for the first time since 2007, which Fitch believes is attainable.

Very Low Liquidity

Liquidity declined further in 2014 with $7 million of unrestricted cash and investments at June 30, 2014 compared to $9.7 million at FYE 2013 and $19.9 million at FYE 2010. Liquidity metrics of 29.8 days cash on hand, 1.7x cushion ratio, and 27.4% cash to debt compare unfavorably against Fitch's below investment-grade medians and is a key credit concern. Management reported unrestricted liquidity improved to $8.8 million at July 31, 2014.

Modest Increase in Capital Spending

Investments in capital are expected to increase following few years of muted capital spending. Excluding the medical office building project that has been on hold, capital spending is budgeted at $5.3 million in 2014 and $5.8 million in 2015, which would slightly exceed depreciation levels. Fitch believes it is imperative that DCHS maintain its improved cash flow in order to fund necessary capital expenditures. Any further erosion to DCHS's current liquidity position due to capital spending will lead to negative rating action.

Unfavorable Debt Metrics

At June 30, 2014, DCHS had $25.7 million in long-term debt outstanding, consisting of $21.5 million in series 1999 fixed rate bonds, $3.9 million in series 2004 fixed rate loan, and small notes and leases. Debt burden is relatively high with 4.6% in MADS as a percentage of revenues and 60.1% debt to capitalization. Due to weak profitability and EBITDA generation, coverage of MADS was also weak at 1.5x in 2013 and 2012. However, DCHS has consistently met its debt coverage ratio required under the bond indenture, despite significant variability in operating performance.

Leading Provider as a Sole Community Hospital

DCHS is designated as a sole community provider, as its closest competitor is approximately 43 miles away. Given its geographic location, DCHS continues to hold a dominant market position, with 87% of inpatient market share and 77% of outpatient market share in 2013. DCHS continued to enhance its service offerings in the last few years, opening a wound care clinic and adding physicians in cardiology, urology, pulmonology, orthopedics, and ENT. While DCHS's dominant market position is viewed favorably, Fitch also recognizes that DCHS's performance is highly dependent on the service area utilization trends and is susceptible to resulting operating and financial volatility.

DISCLOSURE

DCHS discloses annual financial statements within 120 days and quarter unaudited financial statements within 60 days through the MSRB EMMA website. Disclosure to Fitch has been timely and extremely thorough.

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

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', June 16, 2014;

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

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

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

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=863554

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Jennifer Kim, CFA, +1 212-908-0740

Associate Director

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Michael Burger, +1 415-659-5470

Director

or

Committee Chairperson

James LeBuhn, +1 312-368-2059

Senior Director

or

Media Relations:

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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