OREANDA-NEWS. Fitch Ratings has assigned a 'BBB+' rating to approximately $110,050,000 series H (2016) revenue bonds to be issued by the Massachusetts Development Finance Agency (MDFA) on behalf of South Shore Hospital (SSH).

In addition, Fitch has downgraded to 'BBB+' from 'A-' the rating on the following bonds issued by the Massachusetts Health and Educational Facilities Authority on behalf of SSH:

--$17.3 million series 1999F;
--$8 million series 1992D.

The Rating Outlook is Stable.

SSH has also outstanding approximately $86.7 million in series 2011 and 2012 bonds, which are not rated by Fitch but incorporated into the analysis.

The series H (2016) bonds are expected to be issued as fixed rate. Bond proceeds will be used to fund a portion of approximately $179 million of project costs and refund the series 1999F bonds in full. The bonds are expected to price the week of April 25, 2016. In conjunction with the series H issue, SSH plans to issue approximately $20 million of bonds as a private placement with Santander Bank.

SECURITY

The bonds are secured by a pledge of gross revenues.

KEY RATING DRIVERS

MATERIAL DEBT INCREASE: The downgrade to 'BBB+' from 'A-' primarily reflects the increased debt burden resulting from the 2016 financing, which will increase long-term debt by over 70%. As a result, pro forma maximum annual debt service (MADS) as a percent of revenue will increase to 4.3% of fiscal 2015 operating revenues from 3.4% at Fitch's last review, negatively impacting pro forma coverage metrics and making the overall financial profile more consistent with the 'BBB+' rating.

SOLID OPERATING FOOTPRINT: The Stable Outlook is supported by SSH's solid and growing operating footprint in South Weymouth, MA. SSH's market position was further bolstered by the recent closure of a competitor. As a leading provider with growing market share, integrated physician base, and strong clinical affiliations, Fitch believes SSH is well positioned to maintain its market leadership in an evolving healthcare environment.

STABLE CORE OPERATIONS: Robust volume increases from strategic expansions and a favorable competitive landscape has led to healthy revenue growth and stable operating profitability. Over the last three years, operating and operating EBITDA margins averaged 3.3% and 9.4%, respectively, compared to respective 'BBB' medians of 0.6% and 7.7%. Solid performance continued through the five months ended Feb. 29, 2016, with operating and operating EBITDA margins of 4.6% and 8.9%, respectively.

RATING SENSITIVITIES

STABLE OPERATING PERFORMANCE: South Shore Hospital expects to generate operating cash flow (i.e. operating EBITDA margins) sufficient to produce MADS coverage around 2.5x. Below budgeted operating performance resulting in deterioration in debt service coverage and/or liquidity could pressure the rating. Conversely, a return to a higher rating is possible with meaningful recovery in balance sheet metrics.

CREDIT PROFILE

SSH is a 370-bed (excluding 80 bassinets) hospital located approximately 16 miles from downtown Boston, in South Weymouth, MA. SSH is the only entity obligated for the rated debt and contributed 93% to system revenues in 2015.

Fitch used consolidated financial statements of South Shore Health and Educational Corporation and Subsidiaries (SSHEC), the parent and sole corporate member of SSH in its analysis. The consolidated results include certain non-obligated entities including a health provider services organization, physician hospital organization, and a physician ambulatory enterprise. In fiscal year ended Sept. 30, 2015, SSHEC generated $578.8 million in total operating revenues.

Material Debt Increase

At Feb. 29, 2016, long-term debt for SSHEC totaled $181.6 million (including $45.9 million issued on behalf of South Shore Property) with MADS of $17.2 million. Upon closing of the series 2016 issue, SSHEC's total outstanding debt will increase to nearly $302 million (approximately 60% fixed rate and 40% variable rate). Pro forma MADS increases to $25 million and equates to a high 4.3% of fiscal 2015 revenues.

Historical coverage of pro forma MADS by operating EBITDA was 2.1x in 2015 and is projected to range 2.3x-2.5x over the next five years, which Fitch believes would be adequate at the 'BBB+' rating. Inability to meet targeted coverage levels would be viewed negatively.

South Shore has one outstanding floating to fixed rate swap outstanding with Deutsche Bank as the counterparty. There is no collateral posting requirement for SSH.

An Independent Strategy

SSH is actively pursuing an independent strategy following an unsuccessful merger attempt with Partners HealthCare (Partners; rated 'AA') due to opposition from the State Attorney General's office. Despite a major shift in strategic plans, SSH's focus remains on regional growth, improving care delivery, population health management, and moving onto one electronic health record system. While a merger with Partners would have been beneficial, Fitch believes SSH is well-positioned to operate as an independent healthcare provider due to its leading market position, favorable service area characteristics, an aligned physician base, and a low cost structure.

Further supporting SSH's ability to operate independently are strong clinical affiliations with other regional providers including Brigham and Women's Hospital (part of Partners), Boston Children's Hospital, Atrius Health (a physician group), and Dana Farber Cancer Institute. SSH also maintains a strong relationship with Harbor Medical Associates, which was acquired by Brigham and Women's Physician Organization in 2015. Fitch views these long-standing relationships as proving a broader platform to provide stronger community based care.

Favorable Competitive Landscape

SSH is the only acute care hospital located in its primary service area (PSA), which generated 76% of discharges in 2014, and there is only one other acute care hospital in the secondary service area (SSA). As such, SSH considers its primary competitors Boston area hospitals 16 miles north. SSH's market position was bolstered with the closure of Quincy Medical Center (QMC) at the end of 2014, as QMC was a direct competitor located only eight miles away. SSH's pickup in market position is evidenced by over 10% growth in admission in 2015 and 2016. SSH's PSA market share increased to 49% in 2014 from 44% in 2007 and is likely to be even higher given the closure of QMC in 2014.

In August 2015, South Shore Medical Center (SSMC), a well-established multispecialty practice with a 50+ year relationship with SSH, joined SSHEC. Fitch views SSMC's 30 years of experience with global payments and risk based contracts positively as well as the medical group's current EPIC platform. Fitch believes this transaction further solidifies SSH's market position, while enhancing care coordination and risk management capabilities.

Strong Fiscal 2015 and 2016 Year to Date Performance

Despite experiencing significant change in strategic direction in the last few years, day to day operations at SSH have been strong. Favorable changes in competitive dynamics and fruition of strategic plans led to strong volume growth across the board and a 13.2% growth in total operating revenues in fiscal 2015. Operating and operating EBITDA margins of 3.5% and 8.9% in 2015 are strong compared to Fitch's 'BBB' medians of 0.6% and 7.7%, and represent consistent ability to exceed budget.

With pressure on reimbursement levels and growing expenses (especially ongoing costs related to EPIC), a number of financial improvement initiatives are underway. Key focuses include growing select clinical programs, improving operating efficiencies, and realizing benefits of IT implementation. Management expects to sustain current level of operating performance in 2016 and projects operating EBITDA margins near 8.5% in each of the next five years.

Large Capital Plans

A core part of SSH's long-term strategies involve significant investments in critical care and IT. Approximately $62 million is budgeted for the critical care project, a two-story addition to the existing Messina building consisting of one floor of a 24-bed critical care unit and another floor of shelled space. The budget also includes renovation of the existing ICU facilities into an intermediate medical/surgical platform with a net of 23 new private beds. The new ICU is expected to open early 2018 and renovation of the existing facility is expected to be completed in 2019. Approximately $117 million in capital expenditures is budgeted for EPIC installation including hardware, software, training, and contingency funds.

Altogether, $130 million will be debt funded with $29 million from cash flow and $20 million from fundraising and philanthropy. The majority of funds will be spent in the next two years, with $73 million budgeted for fiscal 2016 and $86.5 million budgeted for fiscal 2017 (including $6.5 million of routine capital) compared to 2015 depreciation of $23 million. Projected capital expenditure declines to $27.4 million in 2018.

Pressured Pro Forma Liquidity

At Feb. 29, 2016, unrestricted cash and investments totaled $308.8 million equating to 164 days cash on hand (DCOH) and 177% cash to debt compared to Fitch's 'BBB' medians of 162 days and 89.5%. Fitch notes while absolute liquidity has grown consistently, DCOH declined in 2016 due to the accrual of premium revenue and related expenses related to SSMC's managed care contracts. Adjusting for the related revenues and expenses, DCOH would increase by approximately 25 days.

While absolute liquidity levels are not expected to decline by the capital projects, the increased debt load negatively impacts certain liquidity metrics. Pro forma cash to debt of 106% and cushion ratio of 12.4x are favorable against the 'BBB' medians, and expected to improve at a steady pace. Should SSH continue to meet its budgeted cash flows (around 8.5% operating EBITDA margin), absolute liquidity balance should remain flat or grow during the construction period.