July 16 - Fitch Ratings has affirmed its 'BBB+' rating on $109 million Mississippi Hospital Equipment and Facilities Authority revenue bonds, series 2007A, issued on behalf of Mississippi Baptist Health System (MBHS). The Rating Outlook is Stable. SECURITY Debt payments are secured by a pledge of the gross revenues. A fully funded debt service fund provides additional security for the bonds. KEY RATING DRIVERS STRONG LIQUIDITY FOR THE RATING CATEGORY: Fitch views MBHS' excellent balance sheet ratios as a mitigating factor against a history of four successive years of operating losses. FINANCIAL IMPROVEMENT PLAN GAINING TRACTION: Financial results through the nine-month interim period (ended May 31, 2012) have rebounded strongly following an unbudgeted operating loss in fiscal 2011 (Aug. 31 year end). The healthy improvement reflects financial initiatives begun in fiscal 2011 to address persistent operating losses. NEW DEBT PLANNED: MBHS plans to issue $20 million in private placement fixed-rate bonds with Regions Bank. Fitch believes MBHS' debt burden is already high; however, pro forma debt metrics are still in line for the rating level. HEAVY CAPITAL SPENDING CONTINUES: MBHS' five-year capital plan (2013-2017) totals $240 million, averaging 135% of annual depreciation, which could pressure liquidity metrics if operating performance through the nine-month interim period is not sustained. CREDIT PROFILE STRONG BALANCE SHEET Liquidity remains MBHS' key credit strength, as balance sheet ratios have remained consistently stronger than Fitch's 'BBB' rating category medians despite weak cash flow. As of May 31, 2012, MBHS had $230.7 million in unrestricted cash and investments, which amounted to 222.5 days cash on hand and a pro forma cash to debt position of 101.3%, compared to Fitch's respective 'BBB' category medians of 128.6 days and 79.8%. IMPROVING PROFITABILITY Profitability has reversed course through the interim period following four years of consecutive operating losses. The favorable performance to date is a result of a financial improvement plan begun in 2011 to address a history of persistent losses. Further, management is readying for healthcare reform as it anticipates the gradual phase-out of governmental supplemental payments and lower commercial rates in the future. Initiatives include strategic cost and supply reductions, utilization improvement, and better revenue cycle management. MBHS has historically received sizeable supplemental funding (upper payment limit, or UPL) that has been volatile at $9.9 million in fiscal 2009, $18.9 million in fiscal 2010, $7 million in fiscal 2011 and $10.7 million for fiscal 2012. The reduction in funding in fiscal 2011 led to the unanticipated loss as management budgeted for breakeven performance. Through the interim period, MBHS posted $6.3 million in operating income or a 2.0% operating margin, following a $6.6 million operating loss in fiscal 2011 (-1.7%). Fitch views the improvement especially in core operations favorably, but MBHS is still reliant on the supplemental funds for profitability. Management has budgeted for a 1.1% operating margin for fiscal 2012 that assumes $7 million of UPL funding (compared to actual of $10.7 million) and has also budgeted the same level (1.1% operating margin; $7 million UPL funds) for FY 2013 and a gradual reduction in the UPL benefit thereafter, which Fitch views positively. ONGOING GROWTH STRATEGY In recognition of the competitive marketplace in which it operates, MBHS is buttressing its regional and referral relationship with a multitude of critical access hospitals, specialty provider networks, and primary care physicians. Ongoing service line expansions are another area of strong focus as MBHS has grown its cardiovascular services, neuroscience programs, and women's services. Management reports that these actions led to increased surgical and specialty outpatient volume as well as other high-margin ancillary services. Recent market share data was not available and the latest data (FY 2008) indicated that MBHS secures about 21% of the inpatient market in its three county primary service area. Other competitors include St. Dominic Health Services (23% market share), University of Mississippi Medical Center (19% market share), and Health Management Associates (five hospitals) with 32% market share. SIZABLE CAPITAL PLAN Capital spending needs over fiscals 2013-2017 address campus renovation, IT investments, strategic initiatives, and routine maintenance and operations. Projected annual capital spending of $61 million in fiscal 2013, $47 million in fiscal 2014, $43 million in fiscal 2015, $44 million in fiscal 2016, and $45 million in fiscal 2017 will be funded primarily from operating cash flow, $20 million in new debt, and $10 million in expected funds related to meaningful use. The new borrowing will fund a portion of a parking garage and a connector to a new medical office building, and will fund expansion of the hospital imaging area. This level of capital spending could pressure liquidity metrics, since EBITDA has averaged $33 million a year over the last three years. However, Fitch expects cash flow to improve due to MBHS' performance to date and believes some of its capital plan could be scaled back. DEBT PROFILE MBHS plans to issue $20 million of direct placement bonds with Regions Capital Advantage, Inc. (a subsidiary of Regions Bank), which will be at a fixed rate with an initial 10-year term (20-year amortization). The financing is expected to close in July or August 2012. Pro forma maximum annual debt service (MADS) is estimated to increase to $15.8 million from $14.7 million. Fitch views MBHS' debt profile as aggressive with 49% uncommitted funding. Total pro forma debt is $223.4 million and includes $109 million of series 2007A which are in fixed-rate mode; an $80 million variable-rate bank qualified series 2009 bonds (2016 put date), a $14.4 million variable-rate bank loan (2015 put date) and the new $20 million financing. MBHS has a fixed payor swap associated with the 2009 bonds, with a current mark-to-market value of negative $29.1 million as of May 31, 2012, which currently does not require collateral posting. MBHS' debt burden is high with 4.1% pro forma MADS as a percent of revenue and an 8.1 times (x) debt to operating EBITDA in FY 2011, which are weak relative to Fitch's 'BBB' medians of 3.3% and 4.7x, respectively. STABLE OUTLOOK The Stable Outlook reflects Fitch's expectation that operating performance will continue to improve as a result of its revenue growth and expense reduction initiatives, which should maintain balance sheet levels despite increased capital spending. ABOUT THE ORGANIZATION MBHS' main line of business is a 435 staffed-bed hospital in Jackson, MS. Total revenues in FY 2011 were about $387 million. MBHS provides quarterly and annual utilization and financial statements to the Municipal Securities Rulemaking Board's EMMA system. MBHS also includes a quarterly management discussion and analysis.