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Rating Update:

MOODY'S AFFIRMS ALL CHILDREN'S HOSPITAL'S (FL) A1 LONG-TERM BOND RATING; OUTLOOK IS REVISED TO STABLE FROM POSITIVE

02 Sep 2011

AFFIRMATION AFFECTS $222.6 MILLION OF RATED DEBT OUTSTANDING

St. Petersburg Health Facilities Auth., FL
Health Care-Hospital
FL

Opinion

NEW YORK, Sep 2, 2011 -- Moody's Investors Service has affirmed the A1 long-term ratings assigned to All Children's Hospital's (ACH) $222.6 million of outstanding bonds (see RATED DEBT section below) issued by the St. Petersburg Health Facilities Authority. The rating outlook is revised to stable from positive.

SUMMARY RATING RATIONALE: The affirmation of the A1 rating reflects ACH's leading market share as one of only two free standing children's hospitals in Florida, recent integration with the Johns Hopkins Health System, successful opening of a replacement hospital, and favorable volume trends in FY 2010. The revision of the rating outlook to stable from positive is due to FY 2010 system financial results that show a material departure from the prior year, as losses at ACH's growing physician division have put negative pressure on the system's financial performance.

STRENGTHS

*One of only two free-standing children's hospitals in the State of Florida, management-provided data indicates leading and growing market share of 24% in FY 2010 in a 17 county service area; ACH has strategically engaged in outreach to the surrounding communities with 11 outpatient facilities and seven hospital affiliations to help solidify referrals

*Recent affiliation with Johns Hopkins Medicine (ACH is a fully integrated member as of April 1, 2011) provides an opportunity for ACH to expand its research and teaching components and international outreach; under the terms of the agreement, the two systems' missions are aligned, with corporate functions assumed by Johns Hopkins and the ACH local board maintaining control of hospital operations

*Successful opening of a replacement hospital and connecting outpatient center in January 2010 provided ACH with much needed capacity, particularly with respect to NICU and cardiovascular intensive care space; management reports that approximately 70% of the hospital's bed population is geared toward intensive care

*Favorable volume trends for the past two fiscal years, with inpatient admissions growing a very strong 12.6% in FY 2010 and high acuity as evidenced by a case mix of 2.23

CHALLENGES

*System audited results show weakening of the system's margins in FY 2010, with a $8.8 million operating loss (-2.3% margin) compared to a $17.9 million operating gain (5.1% margin) in FY 2009; operating results were dampened in large part due to higher depreciation expense, but also affected by rapidly rising salaries and benefits expense and sizeable losses at the physician division; the system's operating cash flow margin declined to 8.8% in FY 2010 from 11.4% in FY 2009

*Recruitment of physicians, particularly of specialists, has resulted in strong volume trends and revenue growth (11.2% in FY 2010) for the system, but also establishes a rising expense base associated with physician compensation; losses at the physician division continue to grow (to $11.3 million in FY 2010 from $6.6 million in FY 2009) and will likely put ongoing pressure on the system's profitability margins

*Significant cost of the replacement facility results in high debt-to-revenue (57.7%) and relatively high debt-to-cash flow of 4.5 times; management reports no additional debt plans at this time

*Relatively small size at 259 beds and $388 million in system revenues compared to other children's hospitals across the country; modest fundraising ability demonstrated to date

DETAILED CREDIT DISCUSSION

LEGAL SECURITY: Bonds are secured by a joint and several pledge of gross revenues of All Children's Hospital which is the only member of the obligated group. Other system members include the Foundation, a research institute, employed physician group, home health service and physician hospital organization. Negative mortgage lien with permitted encumbrances. 100 days cash on hand covenant; 1.10 times maximum annual debt service test. Foundation is a restricted affiliate. Springing debt service reserve fund. Series 2005 bonds are secured by a Letter of Credit from Wells Fargo Bank, N.A. that expires in July 2012 and wraps the Ambac insurance policy.

INTEREST RATE DERIVATIVES: ACH has three swaps outstanding. Two of the swaps are with Citibank, N.A. ($25 million) and RBC Dain Rauscher ($15 million) and effectively hedge the Series 2005A-1 and 2005B-1 bonds; these swaps are long-dated and terminate on November 15, 2034 and are insured by Ambac. Under both of these swaps, ACH pays 3.6235% and receives 62.2% of one-month LIBOR plus 27 basis points. The remaining swap is associated with the Series 2005A-2 and 2005B-2 bonds ($60 million notional amount), under which ACH pays 3.8505% and receives 61.8% of one-month LIBOR plus 25 basis points. This swap is also with Citibank, N.A. and expires on November 15, 2047.

RECENT DEVELOPMENTS/RESULTS

On April 1, 2011, ACH signed a definitive agreement with the Johns Hopkins Health System (rated Aa3/stable) and is now a fully integrated member of Johns Hopkins Medicine. ACH entered into the arrangement with John Hopkins in order to expand its teaching and research programs, as well as to establish international outreach. Under the agreement, both systems' missions are aligned, and governance changes were implemented whereby Johns Hopkins assumes corporate functions, but ACH's local hospital board maintains control of operations. The restructured local board consists of 24 members, four of which are seats reserved for Johns Hopkins representatives. The ACH system board still exists, but will now act solely as a management board as the Johns Hopkins Health System Board assumes reserve powers and responsibilities of the former ACH system board. At this time, Johns Hopkins will not be assuming or guaranteeing ACH's outstanding debt, but ACH's system results will be incorporated into Johns Hopkins audit (ACH is changing its fiscal yearend to June 30 from September 30 in order to coincide with Johns Hopkins yearend). We view the relationship between ACH and Johns Hopkins favorably, as it does not change leadership of day-to-day operations, and offers ACH the ability to elevate its teaching and research profile. ACH also continues to maintain a pediatric residency program with University of South Florida (USF) through which the hospital trains approximately 45 residents annually. The affiliation agreement with USF expires in 2014, and at this time it is not clear if the agreement will be extended.

System financial performance in FY 2010 showed weakening from the prior year, despite strong inpatient volume gains of 12.6% and revenue growth of 11.2%. In FY 2010, the system reported a $8.8 million operating loss (-2.3% margin), down from an operating gain of $17.9 million (5.1% margin) in FY 2009. The operating loss in FY 2010 was partly a function of higher depreciation expense associated with the opening of the replacement hospital, but also a result of rapidly growing salaries and benefits expense (up 18.9% in FY 2010). The hospital generated a profit of $3.4 million in FY 2010, but the system's physician division posted a loss of $11.3 million. While the recruitment of physicians is essential for growing patient volumes and revenues and for expanding services, ACH's employed physician base has expanded substantially from 89 employed physicians in 2008 to 140 physicians as of May 2011. Management projects employing an additional 10 physicians in 2012. As a result, we expect a trend of growing physicians losses that will continue to put pressure on the system's profitability.

Operating cash flow at the system level declined by 14% in FY 2010, to $34.0 million (8.8% margin) from the $39.7 million (11.4% margin) the prior year. Subsequently, debt-to-cash flow increased unfavorably to 4.8 times, up from 4.0 times in FY 2009, and Moody's-adjusted MADS coverage declined slightly to 3.8 times from 4.1 times. Debt-to-revenues improved to 57.7% in FY 2010 from 65.1% in FY 2009.

Absolute levels of unrestricted cash and investments held steady as of FYE 2010 at $314.0 million compared to $315.7 million at FYE 2009. Rising expenses resulted in days cash on hand falling to 318 days at FYE 2010, down from 370 days cash on hand the prior year. ACH's asset allocation consists of 44% equity investments, 29% fixed income securities, 22% as cash and cash equivalents, and 5% in other asset classes. ACH can liquidate 97% of its investments in 30 days or less. System cash-to-debt measures compare similarly over the two fiscal years at 140%, although this metric is relatively light compared to other children's hospitals in Moody's portfolio.

In January 2010, ACH opened its replacement hospital which resulted in increased capacity to better serve patients in surrounding communities. The project represented a significant outlay of cash flow contributions, as well as a sizeable increase in debt, and we view the successful completion of the project favorably, as it has resulted in material volume increases and revenue growth. Additionally, all of ACH's major capital projects are now behind them, and management has stated that ACH currently has no plans for additional debt. ACH's existing debt profile consists of 47% variable rate demand bonds (Series 2005), supported by letters of credit from Wells Fargo Bank, N.A. that expire in July 2012. Three swaps are present that are tied to the Series 2005 bonds, although there are no collateral postings requirements.

Outlook

The revision of the outlook to stable from positive is due to FY 2010 system financial results that show moderation compared to the prior year as losses at ACH's growing physician division have put negative pressure on the system's financial performance.

WHAT COULD MAKE THE RATING GO UP

Material improvement in financial performance at the system level in conjunction with stable or growing liquidity balances and reduction in debt.

WHAT COULD MAKE THE RATING GO DOWN

Reduction in cash or increase in debt, further weakening of financial performance, continued sizeable growth in operating losses at the physician division without commensurate gains in profitability at the hospital, material loss of market share, disruption of operations associated with expiration of USF affiliation.

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for All Children's Health System, Inc. and Subsidiaries

-First number reflects audit year ended September 30, 2009

-Second number reflects audit year ended September 30, 2010

*Inpatient discharges: 8,642; 9,732

*Total operating revenues: $348.7 million; $387.7 million

*Moody's-adjusted net revenue available for debt service: $59.3 million; $53.6 million

*Total debt outstanding: $227.1 million; $223.6 million

*Maximum annual debt service (MADS): $14.4 million; $14.4 million

*MADS Coverage with reported investment income: 3.0 times; 4.3 times

*Moody's-adjusted MADS Coverage with normalized investment income: 4.1 times; 3.8 times

*Debt-to-cash flow: 4.0 times; 4.8 times

*Days cash on hand: 370 days; 318 days

*Cash-to-debt: 139%; 140%

*Operating margin: 5.1%; -2.3%

*Operating cash flow margin: 11.4%; 8.8%

RATED DEBT (debt outstanding as of September 30, 2010)

-Series 2009A, Fixed Rate ($63.0 million outstanding), rated A1

-Series 2007 B, Auction Rate Securities ($28.8 million outstanding), Ambac insured, underlying rating of A1

-Series 2005, ($105.5 million outstanding), supported by direct pay Letter of Credit provided by Wells Fargo Bank, N.A, Aa2/VMIG 1 (on watch for possible downgrade), also Ambac insured, underlying rating of A1

-Series 2002, Fixed Rate Securities ($25.4 million outstanding), rated A1

CONTACT

Obligor: Ms. Nancy Templin, Vice President and Chief Financial Officer, All Children's Hospital, (727) 767-2582

PRINCIPAL METHODOLOGY USED

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

Moody's adopts all necessary measures so that the information it uses in assigning a 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 Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

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

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Analysts

Sarah A. Vennekotter
Analyst
Public Finance Group
Moody's Investors Service

Lisa Goldstein
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 ALL CHILDREN'S HOSPITAL'S (FL) A1 LONG-TERM BOND RATING; OUTLOOK IS REVISED TO STABLE FROM POSITIVE
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