November 11, 2008

Fitch Rates Froedtert & Community Health (Wisconsin) $197MM 2008 Revs ‘AA-‘; Outlook Stable

Fitch Ratings has assigned an 'AA-' rating to approximately $196.6 million of Wisconsin Health and Educational Facilities Authority revenue bonds, series 2008A&B issued on behalf of Froedtert & Community Health Obligated Group (F&CH).

Fitch also affirms the 'AA-' ratings on approximately $290 million of Wisconsin Health and Educational Facilities revenue bonds, series 2001 and 2005A-D currently outstanding. The Rating Outlook is Stable.

The series 2008A bonds are expected to be issued as uninsured, traditional fixed rate bonds while the series 2008B bonds are expected to be issued as weekly variable rate demand revenue bonds. Bond proceeds will be used to refund approximately $184.5 million of F&CH outstanding series 2005B&C Ambac insured variable rate demand bonds, pay a swap termination fee related to the series 2005B&C bonds and pay associated costs of issuance. The series 2008 bonds are expected to be sold in early December.

The 'AA-' rating is based on F&CH's solid profitability and debt service coverage, strong balance sheet liquidity, growing market share position and the excellent clinical reputation of Froedtert Memorial Lutheran Hospital (FMLH). In the twelve months ended Dec. 31, 2007, F&CH reported operating income of $74 million which represents an 8.2% operating margin and 13.1% operating EBITDA margin. In the six months ended June 30, 2008 operating and operating EBITDA margins dipped to 4.1% and 10.0%, respectively. Six month results were negatively impacted by increased average length of stay related to high acuity volumes and inpatient capacity constraints at FMLH and increased costs associated with the opening of the new Cancer Care Center. Coverage of historical maximum annual debt service (MADS) coverage by earnings before interest, taxes, depreciation, and amortization (EBITDA) in the twelve months ended Dec. 31, 2007 and the six months ended June 30, 2008 was 8.7 times (x) and 6.4x, respectively.

FC&H's strong cash flow generation has driven growth of unrestricted cash and investments. At June 30, 2008 F&CH had unrestricted cash and investments totaling $580.9 million which translates into 262 days cash on hand and 195% unrestricted cash to debt. F&CH's strong financial performance has been powered by increasing utilization and favorable managed contracts, which, in turn, have been driven by FMLH's and Community Memorial Hospital's (CMH) locations in the growth corridor northwest of Milwaukee. F&CH has a leading market share position in the US-41 corridor that runs through parts of Milwaukee, Waukesha and Washington Counties. Fitch believes the recent affiliation of St. Joseph's Community Hospital and the West Bend Clinic into the F&CH obligated group complements F&CH's outreach strategy to into Washington County. The clinical reputation of FMLH, its linkage to the Medical College of Wisconsin (MCW), and proximity to Children's Hospital of Wisconsin all serve to enhance FMLH's visibility in a competitive marketplace.

Fitch's primary credit concern is the successful integration of St. Joseph's Community Hospital (SJH) and the West Bend Clinic (WBC) into the F&CH obligated group. On July 1, 2008 F&CH became the sole corporate member of SJH and the WBC (formerly known as SynergyHealth, Inc). SJH is an 80-staffed bed community hospital located approximately 35 miles northwest of Milwaukee. The WBC is a 515 employee, 52 physician multi-specialty clinic with 9 locations in and around the SJH service area. For the fiscal year ended June 30, 2008, SynergyHealth posted a $4.5 million operating loss on total revenues of $147.4 million (-3% operating margin). Although SJH and the WBC are expected to account for just 14% of the total obligated group revenues in fiscal 2009, the cumulative results of SJH and WBC will be dilutive in the near term as management looks to build patient volumes through physician recruitment efforts.

Additional concerns include an increased debt burden and the recent acquisition of two physician groups in CMH's service area by competing health providers. On Sept. 1, 2008 the master note on approximately $74 million of Wisconsin Health and Educational Facilities Authority revenue bond series 2001, 2003 and 2005 (SynergyHealth, Inc) was exchanged for an F&CH master note. With closing of the series 2008 bond issue and the assimilation of the SynergyHealth debt, MADS is expected to increase to $27.3 million from $17.6 million. Pro-forma MADS as a percentage of 2007 revenue increases to 2.9% from 1.9% while historical coverage of pro-forma MADS for the six month ended June 30, 2008 falls to 4.2x.

Moreover, F&CH intends to issue between $60-$100 million of reimbursement/new money debt in early 2009 to fund various capital projects primarily at FMLH and CMH. Finally, two large physician groups that generated a large portion of admissions at CMH were acquired by competing hospital providers in 2008. To date, CMH has not seen a noticeable change in admitting patterns. However, Fitch believes over the medium term material erosion in referrals from those physician groups may occur.

The Stable Rating Outlook reflects Fitch's expectation that F&CH's operating profitability will be depressed over the next one to two years as management integrates SJH and WBC and implements its physician alignment and recruitment strategy. Moreover, F&CH and Columbia St Mary's (part of Ascension Health, revenue bonds rated 'AA+') recent formation of Progressive Health Partners Joint Operating Agreement, if approved by federal regulatory authorities, should benefit both organizations through better coordination of clinical services and managed care contracting in the service area north and northwest of Milwaukee.

F&CH is an integrated health system that includes FMLH, a 451 staffed-bed tertiary and quaternary academic medical center located in Wauwatosa, WI, (approximately seven miles west of Milwaukee); CMH, a 214 staffed-bed community hospital located in Menomonee Falls, WI (approximately 20 miles northwest of Milwaukee) and SJH, an 80-staffed bed community hospital located in West Bend, WI (approximately 35 miles northwest of Milwaukee). F&CH continuing disclosure is expected to provide audited financial statements and utilization data with 180 days of each fiscal year-end and quarterly financial statement and utilization data within 60 days of each fiscal quarter-end.

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