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Rating Update:

MOODY'S AFFIRMS A1 BOND RATING ON CATHOLIC HEALTH PARTNERS' (OH) OUTSTANDING BONDS; OUTLOOK REVISED TO POSITIVE FROM STABLE

18 May 2011

RATING ACTION AFFECTS APPROXIMATELY $2.1 BILLION OF RATED DEBT

Health Care-Hospital
OH

Opinion

NEW YORK, May 18, 2011 -- Moody's Investors Service has affirmed the A1 unenhanced and underlying bond ratings on Catholic Health Partners' (CHP) outstanding rated debt, as listed at the end of this report. At this time, we are revising the rating outlook to positive from stable.

SUMMARY RATINGS RATIONALE

The A1 rating is based on CHP's large state-wide presence in Ohio, leading and growing market share in most markets, operating improvement achieved through 2009 that was sustained in 2010, notable growth in the system's unrestricted investment position to a strong level, manageable debt structure risks, and nearly fully funded pension plan. The system's challenges include a relatively high leverage position resulting in comparatively modest leverage measures, sizable volume declines, and economic challenges in part because of the system's concentration in Ohio.

The outlook revision to positive reflects our belief that the system will continue to improve operating margins and unrestricted investment position as well as manage capital spending and future debt issuances, to improve overall debt measures. CHP's historical track record of effectively managing expenses to overcome revenue challenges as well as specific improvement initiatives suggest the system is capable of margin improvement; specific improvement initiatives include the pending divestiture of the Tennessee operations, better margins in Cincinnati in the absence of transition costs related to the acquisition of Jewish Hospital, and continued benefits from a progressive and sharp focus on process improvement system-wide. Investment balances are expected to improve with proceeds from the completed sale of the Pennsylvania operation and pending sale of the Tennessee operations.

STRENGTHS

*Large, state-wide presence, primarily in Ohio, following the divestiture of the Pennsylvania region and pending divestiture of the Tennessee region; on balance we believe the divestitures of these regions are positive

*First or second market position in eight of nine markets with market share growth or relative stability in seven markets in 2010

*Operating improvement achieved over several years through fiscal year 2009 was sustained in fiscal year 2010, resulting in strong operating cashflow margins of 10%, indicating the system's ability to effectively manage costs to compensate for volume and revenue pressures noted below; significantly, the system's three largest revenue-generating markets (Toledo, Cincinnati, and Youngstown) produced 10%-12% operating cashflow margins in 2009 and 2010

*Sizable growth in unrestricted investments in fiscal year 2010 to a strong 182 days and additional cash expected from the proceeds of selling the Pennsylvania operation

*Nearly fully funded pension plan and status as a church plan, which does not require compliance with ERISA

*Manageable debt structure risks with 27% demand debt, which is amply covered with unrestricted cash by over 300%, providing cushion in the event of an unexpected expiration or acceleration of bank support; CHP has good diversification of banks and, following a recent restructuring, has spread put risk over multiple years

CHALLENGES

*Following the completed and pending divestitures of the Pennsylvania and Tennessee markets, CHP will be concentrated in Ohio, where many hospitals are located in demographically challenged areas with high unemployment and stagnant or declining populations

*Decline in system-wide acute admissions of 2% in 2010 on a same-facility basis with six markets reporting declines, ranging from 0.4% to 9%, due to economic issues and some shift to observation cases

*Revenue challenges continuing in 2010 that resulted in total operating revenue growth of a modest 2.4% on a same-facility basis, following a minimal 1% growth in 2009; both years experienced revenue shortfalls to budget that were compensated for with cost reductions

*Debt measures indicate higher leverage than is typical for the A1 rating category with a high 50% debt-to-revenue, modest peak debt service coverage of 3.3 times and somewhat high debt-to-cashflow of 4.5 times; although improved with growth in investments, cash-to-debt is still moderate at 91%

*Increased capital spending anticipated compared with the last several years and prior projections which will require the system to rely on investment returns and future debt to supplement operating cashflow

DETAILED CREDIT DISCUSSION

LEGAL SECURITY: The bonds are issued under a Restricted Affiliate structure, whereby the Bonds are an unsecured obligation of the corporate parent only - the individual hospitals are not legally liable for the debt. We believe this is a weaker legal structure than is a joint and several structure, whereby all operating entities are legally liable for the debt.

INTEREST RATE DERIVATIVES: Currently, the system has $589 million in fixed payer swaps and $250 million in a constant maturity swap. As conditions improve, CHP will selectively unwind more swaps. J.P. Morgan is the counterparty on all swaps, exposing CHP to concentration risk. As of March 31, 2011, the mark-to-market was a negative $48 million, requiring $15 million in collateral posting.

RECENT DEVELOPMENTS/RESULTS

CHP continues to maintain the first or second market share position in eight of its nine local markets in 2010, providing a strong credit foundation. The system maintains a leading position in six markets (Lima (OH), Springfield (OH), Lorain (OH), Youngstown (OH), Knoxville (TN) and, with the acquisition of Jewish Hospital, Cincinnati (OH)) and holds a solid secondary position in its largest cash flow producing market in Toledo. Following a long and successful history of market share growth, seven markets grew market share in 2010.

The most significant new developments for CHP are the divestiture of the Pennsylvania market and the pending divestiture of the Tennessee market. On balance, we believe these divestitures are positive to CHP's overall credit profile in eliminating losses in these markets, allowing the system to concentrate management and financial resources in markets that are better positioned competitively. Additionally, net proceeds from the sale of the Pennsylvania market, closed May 1, 2011, will add approximately $80 million in cash to CHP's balance sheet.

The downside to the divestitures is that CHP's cashflow will be disproportionately concentrated in the state of Ohio, which at this time makes the system particularly vulnerable to comparatively weaker demographic trends in the state. Most Ohio markets have weakened in the economic downturn and population trends are either declining or relatively flat. The impact of the economy on CHP has been felt mostly in declining volumes, even with market share gains. Following a decline in 2009, system-wide acute admissions declined 2% on a same-facility basis. Six markets reported declines, ranging from moderate declines of under 1% (Youngstown, Lima) to more meaningful declines of 3-5% for Youngstown and Knoxville; Springfield declined by a significant 9%. Some markets experienced a shift in admissions to observation cases. System-wide outpatient surgeries declined 2% on a same-facility basis.

CHP has pursued a strategy of creating a physical presence in attractive areas of its local markets where this is possible or expanding key service lines, which has driven market share gains but has required significant capital investment. Capital spending slowed in fiscal years 2009 and 2010, but updated projections indicate higher spending over the next several years than anticipated in our last review and compared with historical spending levels. CHP's largest projects include the opening of a replacement facility in Springfield in 2011, to consolidate the two existing campuses in that market. Starting in 2011, CHP will begin construction of a replacement hospital (close to $300 million), consolidating two existing hospitals in Cincinnati. Total capital spending could average close to $500 million annually over the next several years, although the system has demonstrated an ability to restrain capital in the past if needed.

Despite economic challenges and lower revenue growth, CHP slightly improved its absolute cashflow and maintained margins in fiscal year 2010. In both fiscal years 2009 and 2010, the system missed its revenue budget, reflecting challenges in predicting volume trends and charity care levels. The system compensated for revenue shortfalls with close expense management, enabled by rigorous benchmarking, monitoring and controlling of costs. Based on the adjustments below, operating income was $94 million (2.2%) in 2010, on par with $92 million (2.2%) in 2009. Operating cash flow was maintained at $422 million (10.0%) in 2010, compared with $416 million (10.2%) in 2009. Revenue growth in 2010 was low at 2.4% on a same facility basis, following very low growth of 1% in 2009, reflecting volume declines discussed above. The system's expenses relative to a weighted volume measure indicate expense declines in 2007 and 2008 and flat expenses in 2009 and 2010, demonstrating very effective long-term cost management.

The three largest revenue-generating markets reported strong margins in 2010. Toledo represents the largest contribution at 22% of total operating cash flow. Despite competition from Promedica Health System and a 3.5% decline in admissions, Toledo maintained operating cashflow and generated a strong margin of 11% in 2010. Youngstown contributed 17% and did experience an 11% decline in operating cashflow in 2010 in part due to low revenue growth but maintained a strong 12% operating cashflow margin. The Cincinnati hospitals contributed 23% of total system cash flow and reported a significant increase in cashflow following the acquisition of Jewish Hospital; operating cashflow is strong at 10%, although lower than the long-term potential because of integration and transition costs associated with absorbing Jewish Hospital. Lima contributed 11% operating cashflow and continued with strong 12% operating cashflow margins. After Knoxville, which is pending divestiture, Springfield is CHP's most challenging market with a 9% admissions decline and an almost 6% revenue decline. Despite lack of direct hospital competition, Springfield has lost market share to outmigration to Dayton as well as a physician-owned surgical hospital in the area. The new replacement hospital is expected to better position Springfield to recapture volumes and benefit from its dominant market position.

CHP's unrestricted cash and investment position increased significantly in fiscal year 2010 to reach a strong level of $1.9 billion or 182 days cash on hand, compared with $1.6 billion or 161 days cash on hand as of fiscal yearend 2009. Growth in cash is due to lower capital spending, the use of bond proceeds to fund capital, operating performance and positive investment returns.

Risks in CHP's investment allocation are manageable with a healthy allocation to fixed income and cash as well as alternatives. As of December 31, 2010, including current cash and investments, approximately 44% is allocated to fixed income or cash, 25% to traditional equities, and 31% to alternatives (including hedge funds and private equity). CHP's investments are fairly liquid with about 70% that can be liquidated within a month. CHP's pension is 92% funded and is a church plan, which is not subject to ERISA regulations.

Following a decline in capital spending in 2009 and 2010, capital spending is projected to increase over the next several years to levels above operating cashflow, which means the system will rely on investment returns or debt to fund capital. Projections indicate spending could be between $470 million and $500 million annually (2 times depreciation) over the next several years; in addition to the major projects discussed above, CHP's projections include spending on electronic medical records and contingencies for strategic initiatives.

CHP's debt measures indicate higher leverage than is typical for the A1 rating category, suggesting that the system does not have capacity for new debt at the current rating level. The system's leverage position is due to significant investment over the last decade in strategies that have resulted in market share gains. Debt-to-revenue is high at 50%, peak debt service coverage is modest at 3.3 times and debt-to-cashflow is somewhat high at 4.5 times. Although improved with growth in investments, cash-to-debt is still moderate at 91%. We see meaningful strengthening of leverage measures a material element of consideration for upward rating movement. While the divestiture of the Tennessee market is likely to result in significant reduction in debt, the system may consider issuing additional debt of a similar amount.

We believe the risks in CHP's debt structure are manageable and a recent credit support restructuring has reduced overall risk. CHP has 27% demand debt, which is amply covered with unrestricted cash by over 300%, providing cushion in the event of an unexpected expiration or acceleration of bank support. CHP has good diversification of banks with 5 banks providing letters of credit or providing direct purchases of bonds. Following a recent restructuring, the system has effectively spread put risk over multiple years, limiting the amount of bank facility expirations or mandatory tenders related to the direct purchases in any year. CHP has adequate headroom under its covenants in its existing letter of credit and direct purchase agreements, which include 65% debt-to-capitalization, 75 days cash on hand and 1.25 debt service coverage.

Outlook

The outlook revision to positive reflects our belief that the system will continue to improve operating margins and unrestricted investment position as well as manage capital spending and future debt issuances, to improve overall debt measures. CHP's historical track record of effectively managing expenses to overcome revenue challenges as well as specific improvement initiatives suggest the system is capable of margin improvement; specific improvement initiatives include the pending divestiture of the Tennessee operation, better margins in Cincinnati in the absence of transition costs related to the acquisition of Jewish Hospital, and continued benefits from an advanced and sharp focus on process improvement system-wide. Investment balances are expected to improve with proceeds from the completed sale of the Pennsylvania operation and pending sale of the Tennessee operation.

WHAT COULD MAKE THE RATING GO UP

Improved debt measures achieved with further improvement in operating margins, reduction in debt as a result of divestitures or moderation in projected capital spending and debt plans; at least maintenance of current cash levels; progress on stabilizing volume trends and improving in revenue growth.

WHAT COULD MAKE THE RATING GO DOWN

With a positive outlook, a downgrade is less likely in the short-term; a downgrade would be considered if the system experiences lower margins from current levels for several years, issues additional debt that results in a deterioration in current debt measures, or acquisition or merger is completed that dilutes current measures.

KEY INDICATORS

Assumptions and adjustments:

-Based on financial statements for Catholic Health Partners

-First number reflects audit year ended December 31, 2009

-Second number reflects audit year ended December 31,2010 (excluding PA region, accounted for as discontinued operations; including 10 months of Jewish Hospital)

-Investment returns smoothed at 6% unless otherwise noted

-Adjustments: Foundation net operating activity reclassified from non-operating to operating expenses

*Inpatient admissions: 231,821; 227,118

*Total operating revenues: $4.09 billion; $4.21 billion

*Moody's-adjusted net revenue available for debt service: $530 million; $550 million

*Total debt outstanding: $1.83 billion; $2.12 billion

*Maximum annual debt service (MADS): $140.9 million; $168.4 million

*Moody's-adjusted MADS Coverage: 3.8 times; 3.3 times

*Debt-to-cash flow: 4.0 times; 4.5 times

*Days cash on hand: 161 days; 182 days

*Cash-to-debt: 90%; 91%

*Operating margin: 2.2%; 2.2%

*Operating cash flow margin: 10.2%; 10.0%

RATED DEBT (as of December 31, 2010):

-Series 2001A fixed rate bonds ($292 million) and Series 2002A fixed rate bonds ($108 million): A1

-Series 2002 (Baptist Health System) fixed rate bonds ($135 million): A1

-Series 2002B auction rate securities ($64 million) and Series 2003C auction rate securities ($34 million): A1 underlying rating; insured by Ambac

-Series 2003C1, C2 fixed rate bonds ($181 million) and Series 2006A-B fixed rate securities ($97 million): A1 underlying rating; insured by FSA

-Series 2006H fixed rate bonds ($73 million): A1 underlying rating; insured by Assured Guaranty

-Series 2008A variable rate bonds, TN ($30 million) and Series 2008B variable rate bonds, TN ($45 million): A1 underlying rating; supported by letter of credit from LBBW (substituted with U.S. Bank after FYE10, expires March 1, 2014)

-Series 2008A variable rate bonds, OH ($125 million): A1 underlying rating; supported by letter of credit from Bank of America (expires May 13, 2016)

-Series 2008B variable rate bonds, OH ($75 million): A1 underlying rating; supported by letter of credit from JPMorgan Chase (expires May 13, 2013)

-Series 2008C ($37.5 million), Series 2008D ($32.5 million), Series 2008E ($30 million) variable rate bonds, OH: A1 underlying rating; supported by letters of credit from Wachovia (substituted with direct purchases by Wells Fargo after FYE10)

-Series 2010A ($152 million) fixed rate and Series 2010B ($330 million) fixed rate bonds: A1

-Series 2010C variable rate bonds ($100 million): A1 underlying rating; supported by letter of credit from Bank of Nova Scotia (expires May 4, 2012)

-Series 2010D variable rate bonds ($95 million): A1 underlying rating; supported by letter of credit from JPMorgan Chase (expires May 3, 2013)

CONTACTS

Issuer: James Gravell, Senior Vice President and Chief Financial Officer 513-639-2789; Jerry Judd, Vice President, Treasury, 513-639-2720

Underwriter: Kimberly Allen, J.P. Morgan Securities Inc., 415-315-5795

PRINCIPAL METHODOLOGY USED

The principal methodology used in this rating was Not-for-Profit Hospitals and Health Systems published in January 2008.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of maintaining a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Lisa Martin
Analyst
Public Finance Group
Moody's Investors Service

Beth I. Wexler
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

Journalists: (212) 553-0376
Research Clients: (212) 553-1653


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MOODY'S AFFIRMS A1 BOND RATING ON CATHOLIC HEALTH PARTNERS' (OH) OUTSTANDING BONDS; OUTLOOK REVISED TO POSITIVE FROM STABLE
No Related Data.
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