Moody's Investors Service yesterday downgraded the debt rating of Mercy Health System by a notch, as Mercy prepares to sell $300 million in bonds to pay for a replacement for its downtown Baltimore hospital.
"We expected the downgrade when we planned the project," said Thomas R. Mullen, Mercy's chief executive officer. While it will mean Mercy will pay a somewhat higher interest rate on its borrowing, he said Mercy decided it could afford the higher debt service and that the new building is crucial to its future.
Once the new building opens in 2010 and generates revenue, Mullen said, Mercy expects its rating to go back up. It went through a similar down-and-up cycle when it undertook a $100 million expansion centered on a new outpatient center that opened in 2003. He said other Maryland hospitals with large building projects are likely to have a similar experience.
Mullen said Mercy would pay about $300,000 a year more in interest because of the downgrade - less than one-tenth of 1 percent in its annual budget of about $450 million.
Mercy is, in effect, taking out a big mortgage - borrowing the bulk of the projected $400 million cost of an 18-story patient tower, adjacent to its current building on St. Paul Place, to replace its 1963 main hospital building.
Moody's, the New York debt rating service, rated Mercy at Baa2, down one step from its previous rating of Baa1. At the same time, however, Moody's upgraded its outlook to "stable" from "negative." The previous negative rating indicated Moody's had been expecting a downgrade as the bonds were sold.
With the bonds, Moody's noted, Mercy's debt will equal 10.8 times its annual cash flow - up sharply from the current 3.2 times.
On the other hand, Moody's said in its report, "We view Mercy's track record of generating good operating margins, with significant improvement in recent years, as a key credit positive."
Moody's said Mercy had an operating margin of 6.2 percent in the fiscal year that ended June 30, up from 4.8 percent the year before, and generated cash flow of $55.4 million, up from $45.9 million in the previous year. It was the seventh year in a row that Mercy's cash flow has improved.
Among its concerns, Moody's wrote, are Mercy's position as a single hospital in a market that includes large health systems such as Johns Hopkins, University of Maryland, MedStar Health and LifeBridge Health.
Another negative, Moody's said, is that "the demographic characteristics of the city of Baltimore are generally modest."
But, Moody's said, this is offset by a state rate-setting system, which requires the Medicaid program for the poor to pay the same rate as private insurers. Medicaid patients account for 19 percent of Mercy's revenue, Moody's noted.
Mullen, however, said that Hopkins and University of Maryland tend to do more highly specialized treatments than Mercy, and that his hospital holds its own in market share for the services it offers.
The fact that Mercy could finance such a large project on its own shows that it doesn't need to be part of a system, he continued, and Mercy wants to continue to "maintain our identity and the ability to shape our program and our mission."
"Our strategy is to build programs that attract people from outside the city," said Mullen, who added that such patients accounted for about 40 percent of revenue.