OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB+' rating on approximately $98.1 million of series 2012A Maryland Health and Higher Educational Facilities Authority revenue bonds issued on behalf of Frederick Memorial Hospital (FMH, or the hospital).

The Rating Outlook is Stable.

FMH also has $66.1 million outstanding in series 2012B bonds (privately placed with BB&T Bank), which Fitch does not rate but incorporates into the analysis.


The bonds are secured by a pledge of gross receipts and a mortgage.


STABLE OPERATING ENVIRONMENT: The rating affirmation reflects operating and financial stability provided by FMH's participation in Maryland's Global Budget Revenue (GBR) program (effective July 1, 2013) as well as the organization's strong market leadership with 73% inpatient market share in its primary service area. Under GBR, FMH receives fixed annual revenues on its regulated service lines (approximately 76% of gross revenues).

RECOVERING PROFITABILITY: Following negative operating performance in fiscal year 2014, FMH posted a balanced 0.4% operating margin ($1.4 million gain) in fiscal 2015 and continued this positive momentum with a 2.4% operating margin in fiscal 2016 (draft audit). Operating EBITDA margin has also continued on a positive trajectory to 9.76% in fiscal 2016 from 8.2% in 2015 compared to 7.4% in 2014 and the median of 8.7%. Improvements primarily reflect strong expense controls as well as decline in bad debt, and a successful negotiation with the state for a rate increase under the GBR.

LARGE CAPITAL PLANS: FMH is entering the final stages of Phase 2 of its master facilities plan. Its major focus for this upcoming year will be the construction of a new cancer center at Rosehill. The hospital has budgeted $60 million in capital expenditures for fiscal 2017, a high 2.5x depreciation. Net of remaining bond funds and fundraising receipts, approximately $40 million will be funded out of cash flow and internal equity.

SOUND LIQUIDITY: Unrestricted cash and investments were up slightly at $177.6 million as of June 30, 2016, equating to liquidity metrics that compare favorably against Fitch's 'BBB' medians.


OPERATING STABILITY: Fitch expects Frederick Memorial Hospital to continue leveraging its stable market leadership and manage its expense base to produce strong profitability and coverage metrics. Successful completion of construction projects, resulting in minimal to no dilution in liquidity metrics and a continuation of positive operating performance could result in upward rating movement.


Located in Frederick, Maryland, FMH is a 312 staffed bed acute care hospital. Total operating revenues were $367 million in fiscal 2015 and $383 million for unaudited fiscal 2016.


FMH signed onto Maryland's GBR program in February 2014 (retroactively effective from July 1, 2013). Under this five-year program, FMH receives fixed annual gross revenues on its regulated service lines (76% of gross revenues in fiscal 2015) based on factors including service area demographics, utilization trends, and market position. Regulated revenues are adjusted on an annual basis and are designed to incentivize hospitals to reduce avoidable volumes. Unregulated service lines include FMH's radiology, lab, hospice, home health and diabetes center services, among others.

Fitch believes that the program should provide stability as FMH navigates operating in a declining volume environment. As part of repositioning the organization for population health management, FMH formed the Frederick Integrated Healthcare Network as well as the Trivergent Health Alliance with two other regional providers.


One of FMH's key credit strengths continues to be its operating platform as a sole community provider in an affluent county of Frederick, Maryland (general obligation bonds rated 'AAA'/Stable Outlook). Market share in the primary service area is consistently above 70% and was most recently reported at 73% (2016). Fitch believes FMH's growing physician base and expanding outpatient network, combined with favorable demographics and limited competition, well-positions the organization to pursue population health management to meet the goals of GBR.

In May 2016, FMH's cancer program became a certified member of the MD Andersen Cancer Network(R), the only hospital in Maryland to have this distinction. This affiliation with MD Andersen should support operations in oncology services going forward, which Fitch views positively, especially as FMH embarks on construction of a new cancer treatment facility.


Profitability metrics have been on a positive trajectory, since FMH posted a negative 2.2% operating margin in fiscal 2014. Operating margin improved to 0.3% in fiscal 2015 and again to 2.4% in fiscal 2016, which would be the first time in the past three fiscal years that this ratio has exceeded rating category medians. Continued improvement is largely attributable to good expense control and a significant decline in bad debt. In addition, in 2016, FMH successfully negotiated with the state for a rate increase under the GBR. For fiscal 2017, management is budgeting a 1.3% operating margin, which Fitch believes is achievable.


Unrestricted cash and investments totaled $177.6 million at June 30, 2016, a $4 million improvement from the prior year. Liquidity metrics of 185 days, 14.2x cushion ratio, and 106.9% cash-to-debt compared favorably against the respective 'BBB' medians of 161.2 days, 11.7x, and 90.8%.


Having completed Phase 1, FMH is now in the final stages of Phase 2 of its master planning, which calls for the completion of the emergency department, imaging renovations, as well as the start of the cancer treatment center at Rosehill and surgical service upgrades and development of the Mt. Airy ambulatory location. A total of $60 million is budgeted for fiscal 2017, a high 2.5x depreciation expense, $36 million of which is for the Rosehill Cancer Center and related oncology projects.

FMH has set a fundraising target of $20 million for the capital plan ($17 million raised thus far), most of which will be used to fund the projects in oncology. Net of fundraising and bond funds, approximately $40 million of the capital plan is expected to be funded out of cash flow and equity. However Fitch estimates that this should result in minimal to no dilution in liquidity, assuming operating cash flows remain stable. Moreover, management has a history of conservatively budgeting capital projects and shifting plans based on need.


FMH's debt burden has moderated over the last three years, and is now favorable to the 'BBB' medians. In fiscal 2016, maximum annual debt service was 3.3% of total revenues and debt-to-capitalization was 47.4%, comparing favorably to the respective medians of 3.6% and 50.2%. There are no new debt plans.


FMH has approximately $166.1 million of outstanding debt which is composed of approximately 60% fixed-rate and 40% privately placed variable-rate debt. The private placement has an initial term of 10 years (2022). Further, FMH is counterparty to a $66.1 million floating - to fixed-rate swap with UBS (rated 'A/F1'). As of June 30, 2016, fair market value of the swap was negative $14.1 million. FMH has no collateral posting requirements associated with the swap.


FMH provides annual and quarterly disclosure to EMMA. Overall, Fitch views FMH's disclosure favorably, which consists of a balance sheet and statement of profitability and loss, cash flow statement, and utilization information.