Fitch Ratings has affirmed the outstanding series 2016 revenue bonds issued by the City of Gulfport, MS on behalf of Memorial Hospital at Gulfport (MHG) at 'BBB-'.

Fitch has also affirmed MHG's Issuer Default Rating at 'BBB-'.

The Rating Outlook is revised to Stable from Negative.

SECURITY

The bonds are secured by a pledge of net revenues of the obligated group.

ANALYTICAL CONCLUSION

The Outlook revision to stable and rating affirmation reflects management's turnaround initiatives and prior year disproportionate share (DSH) settlements that Fitch expects to materially reduce MHG's fiscal 2022 operating loss and restore the hospital to profitable operations in fiscal 2023.

In fiscal 2021 MHG experienced a $64 million operating loss (as calculated by Fitch, including CARES Act funding in operations). Following the loss, MHG brought in an interim turnaround CFO and engaged Huron Consulting to help identify and validate revenue cycle and expense improvement initiatives, including charge capture and collections, labor and supplies cost reductions, and clinical and staff productivity.

MHG expects to realize about $65 million of sustainable improvements from various revenue and cost opportunities with the majority being fully realized in fiscal 2023. MHG also expects to realize $31.4 million in fiscal 2022 and between $20 million to $27 million in fiscal 2023 for prior year Medicaid DSH settlements. With revenue and expense improvements realized to-date, DSH funding reconciliation, and realized and expected FEMA settlement funds, management believes that MHG will achieve breakeven operations in the final months of fiscal 2022. Fitch believes a moderate loss of $10 million-$15 million is likely for full fiscal 2022 given the uncertainty around timing for receipt of DSH settlement and FEMA funds. Fitch expects operating performance improvements to be more pronounced beginning in fiscal 2023.

MHG's 'bb' operating risk and financial profiles suggest a rating lower than 'BBB-', but Fitch expects the hospital's turnaround initiatives to bear fruit in fiscal 2022 and restore it to positive operations in fiscal 2023, along with a corresponding improvement to the balance sheet.

Fitch also believes that MHG's leading market position with limited competition and its essentiality as a safety net provider offset its high dependence on government payors and the comparatively more modest demographics of the service area.

Fitch downgraded MHG's rating in 2021 and revised its Outlook to Negative following significant deterioration in operating margins due to pandemic-related disruptions. MHG was affected by high COVID-19 censuses and staffing pressures, which led to high agency nursing costs and revenue shortfalls. Those pressures led to significant operating losses and diminished balance sheet resources that strained the hospital's financial flexibility and resulted in a violation of its 1.15x minimum debt service coverage covenant. The covenant violation required MHG to engage an outside consultant. Management and Fitch expect MHG to be compliant with the debt service coverage covenant in fiscal 2022.

KEY RATING DRIVERS

Revenue Defensibility: 'bbb'

Leading Market Position in a Challenging Market

Revenue defensibility is well supported by its leading market position with a 74% primary service area market share. In 2019 and 2020 MHG expanded its footprint with a number of acquisitions including Stone County Hospital (a small, rural hospital in an adjacent county), two surgery centers, and two nursing homes. Additionally, an affiliation with Merit-Biloxi, in which MHG has a 50% ownership interest, has led to additional referral streams with further growth expected going forward. Combined PSA market share with Merit is just over 85%.

MHG's position as safety net provider in the service area provides a level of revenue dependability despite somewhat challenging service area demographics and reliance on governmental payors including substantial disproportionate share payments. MHG's payor mix remains midrange, with self-pay and Medicaid totaling 17%, but Medicare remains somewhat high at 54%.

Operating Risk: 'bb'

Turnaround Underway Following Sizable Losses

Revenue interruption and pandemic-related expenses, with high agency nursing costs and staffing pressures over the past two years depleted MHG's balance sheet resources and was the primary driver of the rating downgrade last year. While MHG has made progress in alleviating staffing pressures, it still faces significant constraints related to staffing.

Going forward, Fitch expects that new revenue streams and synergistic opportunities from the Merit affiliation and previous acquisitions, along with its turnaround initiatives, will serve as a catalyst for operating performance improvement; however, the hospital will continue to face considerable near-term operating pressure until post pandemic-related disruptions and inflationary pressures subside.

After achieving modest operating income in fiscal 2020 (as calculated by Fitch), supported by $41 million of CARES Act stimulus, MHG incurred a $64 million operating loss in fiscal 2021, the result of staffing shortages driving wage and benefit increases and the need for high cost contract labor. Additionally, MHG's purchased services and supplies expense increased 21% in fiscal 2021 largely from provider expansion but also from lab, pharmacy, and other pandemic related expense increases.

MHG's revenue base grew in 2021 with the rebound of patient volumes, particularly from through the Emergency Department (ED) and ambulatory visits, and from $52 million of Medicaid supplemental funding which was about $4 million higher than in fiscal 2020. Inpatient volumes were flat relative to fiscal 2020. The 2021 loss resulted in a technical breach of the hospital's 1.15x rate covenant, requiring MGH to engage an outside consultant (below 1.0x coverage is a default).

Huron Consulting was engaged early in calendar 2022 to help identify and validate various performance improvement initiatives. Between management and Huron identified initiatives, MHG has found about $78 million of revenue cycle and expense improvement opportunities including billing and collections, length of stay, workforce and clinical staff productivity, contract labor, and supply chain. MHG also brought in an experienced interim CFO under a one-year contract to help drive turnaround efforts. Of the $78 million target, MHG expects to achieve about $65 million of sustainable improvements achieved in fiscal 2023, which are expected to restore the hospital to operating profitability.

Operating results through the six months ended March 2022 remained pressured with MHG incurring a $24 million operating loss (and a negative 3.1% operating EBITDA margin and below the minimum rate covenant debt service coverage threshold). However, management indicated that the month of June 2022 was profitable, and, with various turnaround initiatives underway, MHG will materially reduce its fiscal 2022 operating loss, possibly even approaching breakeven depending upon the timing for receipt of previous year's Medicaid DSH settlement and FEMA funds. MHG expects to be in compliance with its 1.15x rate covenant in fiscal 2022.

No major projects or debt issuances are expected during the Outlook period while management focuses its efforts on turnaround initiatives. Capital spending is expected to be minimal for the next few years and will most likely be limited to addressing repairs and maintenance needs.

Financial Profile: 'bb'

Weakened Financial Profile

Operating losses have weakened MHG's financial profile with unrestricted cash and investments declining to just under $100 million, from $182 million at FYE 2020, and days' cash on hand falling to a low 49 days in fiscal 2021, from 106 days at FYE 2020. Cash to adjusted debt also remains weak at 50%. As of March 31, 2022, MHG's liquidity improved modestly to $126 million, equal to 60 days' cash on hand, and Fitch expects liquidity to continue to improve as MHG reduces operating losses, receives Medicaid DSH settlement and FEMA funds totaling about $28 million.

If these funds are not received as expected and MHG's turnaround initiatives fall short of expectations, its balance sheet will remain under significant pressure, which could result in a negative rating action. Due to a very conservative asset allocation consisting of only cash and fixed income, a low debt burden, and the expectation for operational improvement, MHG is expected to restore its leverage ratios to a level consistent with the midrange category assessment in the out years of Fitch base and stress case scenarios.

Asymmetric Additional Risk Considerations

No asymmetric additional risk considerations were applied in this rating determination

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Failure to achieve targeted turnaround initiatives or receipt of expected government funding where operating EBITDA margins are sustained below 5%;

Failure to improve balance sheet strength over the intermediate term, where cash-to-adjusted debt is sustained below 80%;

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Further positive rating action is unlikely during the outlook period, pending full realization of management's turnaround initiatives and stabilization of MHG's operating performance.

Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

CREDIT PROFILE

MHG is a 279 staffed-bed hospital located in Gulfport, MS. It is jointly owned by the City of Gulfport and the Gulfport-West Harrison Hospital District. MHG is the largest civilian hospital in its PSA of Harrison County and a prominent safety net provider. Despite the partial municipal ownership, the hospital does not benefit from any tax support. Total operating revenues were approximately $703 million in fiscal 2021.

Asymmetric Additional Risk Considerations

There are no asymmetric risk considerations associated with MHG's rating. Debt Profile: Total bonded debt as of March 31, 2022 was approximately $45 million. MHG maintains a conservative debt profile with all fixed rate debt and has no interest rate swap agreements

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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