Fitch Affirms Union Hospital (Affinity Health Alliance), MD Hosp Rev Bonds at 'A'; Outlook Stable

      

The affirmation is supported by Affinity's return to positive operations, its leading market share, and management's strong investment in plant and information technology. The main credit concerns are Affinity's debt burden, especially relative to its small revenue base ($134 million in fiscal 2009) and competition from larger tertiary hospital systems located in Baltimore and Delaware. An additional credit positive is the federal government's Base Realignment and Closure (BRAC) starting near the end of 2011, which is expected to grow the population in Affinity's service area by 25% by 2020 and should support solid volume growth over this time.

After two years of operating losses in fiscal 2006 and 2007 (June 30 year-end), Affinity returned to historical levels of operations in 2008, with a 3% operating margin and 12.7% operating EBITDA margin. Fiscal 2009 also ended positive, but with weaker margins, with Affinity finishing the year with a 1.1% operating margin and 10.2% operating EBITDA margin. Operations were affected by softer inpatient volumes and higher levels of bad debt and self-pay, pressures experienced across the industry, but were offset by solid growth in outpatient volume of 6.3% and a higher inpatient case mix. First quarter fiscal 2010 unaudited results show a solid start to the year with a 2.6% operation margin and 11.4% operating EBITDA margin. Affinity is budgeting for a 3% operating margin for fiscal 2010.

Affinity maintains a leading 52.6% market share (2009 data) in a service area that includes Cecil County and the region just across the border in Delaware, but has a higher 82% inpatient market share in more concentrated primary service area that surrounds the hospital in Elkton, Maryland, which is in the northeast corner of Cecil County. Market share slipped in 2006 and 2007--it was 51.3% in 2007--due to the disruption caused by a new tower construction project, which also fed into the decline in profitability over those years. The strong turnaround in operations in fiscal 2008 coincided with the finishing of the tower in late fiscal 2007.

The tower project culminated a half decade long series of capital projects, including the renovation and expansion of Affinity's emergency room and intensive care units, which exemplifies management's excellent history of investing in its plant. This is reflected in Affinity's average of plant, which at 8.5 years, is better than Fitch's 2008 'A' category median of 9.7 years. Affinity also has excellent information technology systems, especially for a community hospital of its size, with computerized physician order entry, bedside medication verification, physician documentation, and a web-based PACS system, which allows doctors to check results remotely.

Moving forward, most of Affinity's capital spending above routine capital is focused on revenue generating projects. In the current fiscal year, Affinity is borrowing $16 million through a bank qualified loan to renovate its operating rooms. The loan is structured with a 27 year final maturity, no put risk, level debt service and the same security provisions and covenants as the series 2005 MHHEFA Master Loan Agreement. The project will include a new endoscopy suite and wound center, as well as the purchase of a replacement open MRI machine and a new interventional radiology lab. The wound care center will be a new service for Affinity and a new vascular surgeon, who started in October, will also be providing new services at Affinity. The $16 million in new debt will increase Affinity's debt burden, raising its maximum annual debt service (MADS) by approximately $1.02 million. Pro forma analysis shows debt service coverage in fiscal 2008 at 2.5 times (x) and MADS as a percentage of revenue at 4.7x, both weaker than Fitch's 2008 medians. A main credit concern is that at the current rating level, Affinity is fairly leveraged, especially given its small revenue base, and any stress from a weakening in operations or additional borrowing could put negative pressure on the rating.

Liquidity for the rating level remains adequate. Affinity's days cash on hand remained strong at 226.3 days as of Sept. 30, 2009, above Fitch's 2008 'A' median of 171.2 days. However, the pro forma cushion ratio at 11.9x and cash to debt of 101.7% were below category medians.

The Stable Outlook reflects Fitch's belief that Affinity will be able to maintain current levels of operational performance over the medium term, which should help ease Affinity's leverage over time. While rate increases from Maryland's rate setting commission have diminished, Union is consistently in the highest quartile in terms of the size of its yearly increase, as well as one of the state's lowest cost providers, which further supports operating stability.

A credit concern for Affinity had been its reliance on a few physicians to drive volumes. Affinity has addressed this concern by initiating a hospitalist program, diversifying its base of primary care physicians, and adding specialists, most recently in vascular surgery and rheumatology. A key driver for Affinity is its ability to continue to execute this strategy, which should help grow volumes, extend its presence in the service area, and support profitability over the medium term.

Finally, a credit positive for Affinity is BRAC, which beginning in late 2011 will relocate approximately 10,000 government personnel to Aberdeen Proving Ground, plus numerous other private sector jobs to follow, with many of these individuals relocating to Cecil County. Growth estimates show the area's population increasing by 25% by 2020. Affinity should benefit from this population increase and given its strong investment in plant, with the new tower, should be positioned well to handle the growth without having to make major capital improvements.

Located in Elkton, Maryland, Affinity consists of Union Hospital, a general acute care hospital with 122 staffed beds, and other entities. Affinity reported total revenues of $134.1 million. Affinity covenants to provide annual audited financials and quarterly disclosure to bondholders through the Municipal Securities Rulemaking Board. Since Fitch's last rating action, Affinity has expanded its quarterly disclosure to include management discussion and analysis, a cash flow statement, and utilization statistics. Fitch notes this as a positive change; prior to that Affinity's quarterly disclosure included only a balance sheet and income statement.

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