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Fitch Upgrades Mountain States Health Alliance (Tennessee) to 'BBB+'; Outlook Stable

Posted on: Tuesday, 12 December 2006, 15:00 CST

Fitch Ratings has upgraded the rating on Mountain States Health Alliance's (MSHA) outstanding bonds listed below to 'BBB+' from 'BBB'. The Rating Outlook is revised to Stable from Positive.

The rating upgrade is supported by MSHA's stable financial profile and operating performance, strong market position and growing patient volume. Fiscal 2006 was MSHA's fourth consecutive year of operating profitability following large negative operating margins in fiscal years (FY) 1999 and 2000. MSHA posted operating margins of 0.7%, 2.1%, 1% and 1.9% in FY 2003, 2004, 2005 and 2006, respectively. Profitability has been driven by rising patient volumes, increased referrals from surrounding counties, physician recruitment and strong management practices. MSHA's EBITDA margin remains one of the strongest in Fitch's portfolio averaging 19.6% over the last four fiscal years, well above Fitch's 'BBB' median of 10.7%. At fiscal 2006 (June 20, 2006), MSHA reported an impressive 259 days cash on hand (DCOH), which is nearly double Fitch's 'BBB' median of 130.5 DCOH. MSHA remains the market leader in its eight county primary service area with a market share of 52.6% in calendar year 2005, compared to its closest competitor Wellmont Health System (rated 'BBB+'; Stable Outlook by Fitch) with a 28.8% share. MSHA's market share has grown from 48.5% in 2002, supported by a strong 31.2% growth in admissions from fiscal years 2003-2006.

Credit concerns include MSHA's high debt burden, future capital needs and debt plans, exposure to TennCare and an extensive derivatives program. MSHA's debt burden is high due to the original acquisition costs of its facilities in 1998. While MSHA's debt burden has declined somewhat due to its improved financial performance, leverage ratios compare unfavorably to Fitch's 'BBB' medians. At fiscal year 2006, MSHA's cash to debt, debt to capitalization and MADS as a percent of revenues was 51.7%, 66.0% and 8.3%, compared to Fitch's 'BBB' medians of 76.1%, 47.1% and 3.5%, respectively. MSHA future capital plans include a new Children's Hospital at its flagship Johnson City campus (estimated cost of $34.2 million), a new facility combining and redistributing the services currently provided at North Side Hospital and Johnson City Specialty (estimated cost of $118 million) and either a refurbishment or replacement of the recently affiliated Smyth County Hospital (estimated cost of $31 million) of which MSHA has an 80% ownership effective November 1, 2006. Funding for these projects is expected to come from cash flow, philanthropy and past (the series 2006A bonds will fund the Children's Hospital project) and future bond issues. MSHA expects to issue approximately $53 million in debt sometime in mid-to-late 2007 to fund the project at Smyth County Hospital and additional debt may be issued in 2009 to fund the North Side Hospital and Johnson City Specialty project. Fitch also expects MSHA to issue additional debt in or around 2011 to refinance some of its existing outstanding bonds. Fitch took the 2007 debt issue into account on this analysis assuming that profitability remains at historical levels, liquidity remains stable and there is no significant increase in the expected par amount of the new debt. Due to a reduction at the state level in the total number of disenrollees from TennCare, the effect of the TennCare changes were not as dire as expected. MSHA's TennCare volume as a percent of gross revenue dropped to 14% for fiscal 2006, from 17.7% for fiscal 2005, while charity/self pay volume only increased to 6% from 4.5% for the same period. The total impact of the TennCare changes was approximately $13 million ($18 million estimated) and management's actions to offset the reductions negated the impact of TennCare. Nonetheless, the state could look to expand these cuts in the future and given MSHA's high TennCare volume this remains a credit risk.

MSHA's derivative program is extensive for this rating category. However, Fitch believes management has implemented appropriate controls through its written swap policy, engagement of an independent swap advisor and oversight by management and the board. MSHA has executed a total of 16 swaps, basis swaps and swaptions with a total notional amount of $1.25 billion. Counterparties include Merrill Lynch, Bear Stearns and Lehman Brothers. The program is designed with interlocking transactions that should mitigate significant exposure to changes in interest rates. Management has estimated that the total cash benefit from the program has been $18.5 million over the past five years. MSHA's swap position is marked-to-market daily. As of November 30, 2006, the mark-to-market value of all the derivatives was negative $28.3 million. At the end of fiscal year 2006, MSHA had a designated reserve fund of $35.6 million, which was not included in MSHA's unrestricted cash but included the posted collateral requirements. For further information on MSHA's swap program see Fitch research 'Mountain States Health Alliance, Tennessee,' published on January 23, 2006.

The Stable Rating Outlook is based on Fitch's expectation that MSHA's profitability, liquidity and EBITDA margins will remain at historic levels. Through September 30, 2006, MSHA's reported a $2.7 million loss from operations (negative 1.8% operating margin) due to conservative reserve practices and increased interest and depreciation expense however; MSHA reports that through November, 2006, the system is operating profitably. MSHA is budgeting an operating income of $8.68 million (1.4% operating margin) for fiscal year 2007 and Fitch expects MSHA to meet or exceed this budget.

Headquartered in Johnson City, Tennessee, MSHA is a large, integrated health care system with six hospitals (1,100 staffed beds) and other related entities, primarily serving the northeast portion of Tennessee and neighboring states. In fiscal year 2006, MSHA had total operating income of $601 million. Through its bond documents, MSHA covenants to provide annual and quarterly financial and operational disclosure to the nationally recognized municipal information securities repositories (NRMSIRs). However, as a matter of practice management does not disclose quarterly information to the NRMSIRs, which Fitch views negatively. Management indicates that, due to strategic and competitive considerations, MSHA only discloses annual information to the NRMSIRs. Fitch notes that MSHA's continuing disclosure practices are indicative of a poor management practice and believes that investors should impose stricter disclosure requirements on hospitals that only covenant to provide annual disclosure.

Outstanding issues:

--$173,206,504 The Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue bonds (Mountain States Health Alliance) series 2006A;

--$66,500,000 The Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue bonds (Mountain States Health Alliance) series 2006B;

--$26,000,000 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue bonds (Mountain States Health Alliance) series 2001A;

--$202,727,726 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue and refunding bonds (Mountain States Health Alliance) series 2000A (certain maturities are insured by MBIA Insurance Corp., insurer financial strength 'AAA' by Fitch);

--111,783,044 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue and refunding bonds (Mountain States Health Alliance) series 2000B (Certain maturities are insured by MBIA);

--$38,655,000 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage (taxable) revenue bonds (Mountain States Health Alliance) series 2000C (insured by MBIA);

-- $16,660,000 Health and Educational Facilities Board of the City of Elizabethton, Tennessee hospital first mortgage (taxable) revenue bonds (Mountain States Health Alliance) series 2000D (insured by MBIA);

-- $31,766,277 Health and Educational Facilities Board of the City of Johnson City, TN hospital revenue bonds (Johnson City Medical Center) series 1994 (insured by MBIA);

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Source: Business Wire

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