Moody's Investors Service last week downgraded the Davis Health System to Ba2 from Ba1.

The action affects $14.7 million of outstanding Series 1998 and 1999 fixed-rate revenue bonds issued by the Randolph County Commission. The outlook remains negative.

"The rating downgrade to Ba2 from Ba1 reflects continued weak operations in addition to a substantial increase in debt load despite a financial performance that brings the system in close proximity to debt covenants," said analyst Carrie Sheffield.

While Davis Health has fulfilled its financial covenants to date, Sheffield said the negative outlook reflects the uncertainty of the hospital's ability to sustain its operating performance due to variability in volumes and performance over the years, increased competition and weak service area demographics.

The health system operates hospitals in Elkins and Philippi, and maintains the only acute-care hospital in Randolph County. The nearest competitor is about 29 miles away.

Sheffield said the system faces a number of challenges, including an operating loss and decline in cash flow through the first four months of fiscal 2012, and a decline in cash due to implementation of new electronic health records system.

The system has also taken on $2.5 million of new debt to pay off its pension plan, and $10 million to construct a new medical office building and outpatient facility through private financing with Huntington National Bank, which places additional stress on debt ratios, Sheffield said.

The system also has a low liquidity position equating to 52 days' cash on hand and cash-to-debt coverage of 68.5%.

David Health also has a high dependence on government payors, with Medicare representing 48% of billings and Medicaid at 17%.

The service area also has weak demographics characterized by flat population growth and lower income levels, according to Moody's.

In fiscal 2011, admissions increased by 9.3% and the health system also saw growth in emergency and outpatient visits and surgeries.

The board approved termination of a frozen defined benefit plan in March, and the accumulated pension liability of $12 million was paid down through existing pension funds, Sheffield said.

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