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Rating Update:

MOODY'S AFFIRMS Aa3 RATINGS ASSIGNED TO THE UNIVERSITY OF PITTSBURGH MEDICAL CENTER'S BONDS; OUTLOOK REVISED TO POSITIVE FROM STABLE

31 Mar 2011

ACTION AFFECTS $2.74 BILLION OF OUTSTANDING DEBT

Allegheny County Hospital Dev. Auth., PA
Health Care-Hospital
PA

Opinion

NEW YORK, Mar 31, 2011 -- Moody's Investors Service has affirmed the Aa3 ratings assigned to the University of Pittsburgh Medical Center's (UPMC) outstanding bonds issued by the Allegheny County Hospital Development Authority, the Allegheny County Industrial Development Authority and the Pennsylvania Higher Educational Facilities Authority. The rating outlook has been revised to positive from stable. This rating action affects $2.74 billion of rated debt as listed at the conclusion of this report. Simultaneously, we are upgrading to Aa3 from Baa1 the ratings assigned to Hamot Health Foundation's (PA) bonds reflecting the change in corporate structure as of February 1, 2011 when UPMC became the sole corporate member of Hamot and assumed Hamot's debt (rated debt affected is listed at the end of this report)

SUMMARY RATINGS RATIONALE: The ratings affirmation is based on UPMC's leading market position in Western Pennsylvania and strong patient demand, preeminent clinical reputation rooted in tertiary and quaternary clinical campuses throughout the greater Pittsburgh area and a large network of well-positioned community hospitals, good operating margins and a long track record of effectively addressing operating challenges. These strengths compensate for a weak regional economy, higher leverage than is typical for the rating category, and material pension funding requirements. The positive outlook reflects our expectation that the system will continue to benefit from its notably strong fundamentals generating solid operating performance which translates into strengthened balance sheet and leverage measures.

STRENGTHS

*Preeminent clinical reputation and wide patient draw regionally and nationally, supporting future growth and compensating for stagnant population trends in the Pittsburgh area; unrivaled business platform in 29-county service area capturing

over 33% market share and a dominant 55.7% market share of Allegheny County

*Mature and successful integrated delivery system model with all divisions meeting financial and strategic imperatives

*Strong management capabilities evidenced by the organization's ability to absorb operating challenges and continue to grow absolute operating cashflow levels in each of the last three years

*Cash and investments have strengthened measurably. Now over $2.98 billion, as of December 31, 2010, investments are highly diversified across asset classes and managers. Total unrestricted cash and investments provides for over 5 times coverage of demand debt

*Substantial patient demand (over 182,000 impatient admissions and nearly 39,000 observation visits system wide in FY 2010) well secured by the geographic diversity of 21 hospitals (includes addition of Hamot Health in Feb 2011), ambulatory surgery centers, cancer centers, an array of post-acute care settings, insurance products and a formidable physician network

*Sound relationship with Aa1-rated University of Pittsburgh that bolsters research position

*Debt structure risks have been mitigated; debt is now approximately 80% fixed rate and swap exposure has been materially reduced (see Interest Rate Derivatives above). When including Hamot's obligations fixed rate debt approximates 82% of total debt

*Management reports no incremental debt plans through 2014

CHALLENGES

*UPMC is leveraged for the rating category with cash-to-debt of 97% as of December 31, 2010 (95% when including Hamot's obligations) and debt to cashflow of 3.6 times based on annualized 2011 performance

*Riskier and less liquid investment portfolio than most academic medical centers. Just $1.35 billion of the $2.47 billion is available monthly and slightly more than 50% of total investments are available within one year.

*Inpatient volume declines due to a shift to observation cases, closure of a hospital and a weaker economy

*Large funding requirements to meet pension obligations in excess of pension expense for the next several years (2011 contribution of $135 million has been made as of December 31, 2010)

*Weak demographics in Pittsburgh and the majority of the Western portion of Pennsylvania which is more pronounced given Commonwealth's budgetary challenges

*Exposure to the cyclical nature of the insurance business, through the UPMC Health Plan, a key component of the System's integrated delivery model

DETAILED CREDIT DISCUSSION:

LEGAL SECURITY: UPMC's parity debt, as listed at the conclusion of this report, enjoys a joint and several commitment of the obligated group secured by a lien on gross revenues. The Obligated Group under the 2007 Master Trust Indenture consists of the Parent Corporation, UPMC Presbyterian Shadyside Hospital, Magee-Womens Hospital of UPMC, UPMC Passavant and UPMC St. Margaret. The system includes the following hospitals in Western Pennsylvania: UPMC Presbyterian Shadyside (includes Western Psychiatric Institute and Clinic, the former UPMC Presbyterian, UPMC Shadyside, Eye and Ear Hospital and UPMC Montefiore); Children's Hospital of Pittsburgh of the UPMC Health System ("Children's"); UPMC Bedford Memorial; UPMC Horizon; UPMC McKeesport; UPMC Northwest; UPMC Passavant; UPMC Passavant Cranberry; UPMC St. Margaret; UPMC Mercy, Magee-Womens Hospital of UPMC and, as of February 1, 2011, UPMC Hamot (each a "Subsidiary Hospital").

INTEREST RATE DERIVATIVES: UPMC has four remaining debt-related derivative contracts with a total notional amount of approximately $275 million. UPMC's payment obligations on these swaps are obligations under UPMC's 1995 and 2007 Master Trust Indentures (MTIs), on parity with UPMC's rated debt. As of December 31, 2010 UPMC has posted no collateral

RECENT DEVELOPMENTS/RESULTS

UPMC's primary fundamental credit strength continues to be its preeminent national clinical reputation and strong local and regional market position (55.7% market share in Allegheny County and 37% market share of its immediate 10 county region), which has been enhanced by the system's growth. UPMC's wide patient draw supports volume growth, compensating for stagnant population trends in the Pittsburgh area. One of the largest not-for-profit healthcare systems in Moody's portfolio, with over $8.0 billion in annual revenues in FY 2010, UPMC primarily serves residents of western Pennsylvania, capturing a growing 33.3% market share of a 29 county area. UPMC also draws patients for highly specialized clinical services from across the nation and around the world. UPMC has most recently realized the benefits of its tightly managed and integrated network of hospitals, insurance services and physicians by implementing numerous system-wide strategies to enhance revenue, reduce costs and grow market share.

UPMC's primary competitor, B2-rated West Penn Allegheny Health System (WPAHS), reported accelerating volume declines throughout fiscal year 2010 and in the first quarter of fiscal year 2011, reportedly due to the early effects of the system's restructuring initiatives, the economy and growth in observation cases. Given the operational challenges facing WPAHS and its insular focus, it is our observation that UPMC's market opportunities to expand clinical reach and market penetration are significant.

However, we do note that operating momentum may be challenged by inpatient volume trends reflective of Western Pennsylvania's weak demographics, the current national economy and changing modalities of care. UPMC reported a 2.6% decline in admissions system-wide in FY 2010 and an additional 2.7% decline though six months of fiscal year 2011 (December 31, 2010). Management attributes the decline to the closure of UPMC Braddock, a move toward more outpatient cases, including observation cases, and a weak economy as patients deferred medical care due to higher out of pocket costs. In fact total medical-surgical discharges from all hospitals within UPMC's defined service areas decreased in FY's 2009 and 2010. It should be noted that when including observation volumes admissions were flat in FY 2010 and the current year to date period. Moreover, UPMC's market share in each of its three defined service areas, Allegheny County, Southwestern PA, and Western PA, has grown in spite of the volume declines.

UPMC reported operating and operating cashflow margins of 1.3% and 7.6%, respectively, in FY 2010, fairly consistent with the prior fiscal year, while the absolute operating cash flow grew by 10.8% to over $613 million. When normalizing investment returns at 6%, FY 2010 maximum annual debt service coverage improved to 3.4 times, up from 2.9 times in FY 2009. While revenues continue to show favorable growth of 4.3% in FY 2010 and 3.6% in the six months of FY 2011, driven by strong outpatient volumes and efficiencies, much of the improvement was driven by swift and wide-sweeping expense reductions as evidenced by expense growth of 3.7% and 1.7%, respectively. Potential reductions in Medicare and Medicaid reimbursement, which comprise 54% of gross patient revenue, may challenge margins in the near term, though UPMC's continuous focus on cost reduction should mitigate this risk. Finally, investments internationally that may require an increase in UPMC's existing financial and or managerial resources tempering future performance.

Despite making a $135 million cash funding payment to the pension plan in August 2010, UPMC's total absolute cash and investments has increased materially to over $2.9 billion as of December 31, 2010, equating to 141 days and nearly 97% cash to debt from a much weaker 119 days and 83% cash to debt at FYE 2010. Growth reflects solid operations and healthy investment market returns (investment portfolio return of 12% in the first six months of FY 11). However, UPMC has a relatively complex asset allocation model and we note that the health system maintains a less liquid investment portfolio than most academic medical centers with nearly 50% in private investments, real estate and hedged alternative investments. In fact just over 50% of the wealth of UPMC can be accessed within a year. Although the portfolio is much less liquid than desirable for a health care entity that can experience volatility in operating cash flow, it's well diversified asset allocation with numerous money managers (134 external managers) has continually outperformed expectations and industry benchmarks. With strong cashflow, reduced derivative exposure and modest variable rate debt the risk of the illiquid wealth is tempered. Nonetheless, a downturn in investment returns could materially curb the growth in liquidity and affect key balance sheet ratios.

Outlook

The positive outlook reflects our expectation that the system will continue to benefit from its strong fundamentals generating solid operating performance which translates into strengthened balance sheet and leverage measures.

What could change the rating--UP

Sustained improvement in operating margins, further strengthening of wealth and liquidity

What could change the rating--DOWN

With a positive outlook, a rating downgrade is not expected at this time; longer term, the greatest risks are a significant increase in debt beyond what is currently anticipated or a prolonged decline in operating performance

KEY INDICATORS

-Based on financial statements for University of Pittsburgh Medical Center

-First number reflects audit year ended June 30, 2009

-Second number reflects audit year ended June 30, 2010

-Investment returns smoothed at 6% unless otherwise noted

*Inpatient admissions: 187,685; 182,217

*Total operating revenues: $7.7 billion; $8.1 billion

*Moody's-adjusted net revenue available for debt service: $688.9 million; $794.5 million

*Total debt outstanding: $2.7 billion; $3.0 billion

*Maximum annual debt service (MADS): $235 million; $235 million

*MADS Coverage with reported investment income: 1.3 times; 3.8 times

*Moody's-adjusted MADS Coverage with normalized investment income: 2.9 times; 3.4 times

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

*Days cash on hand: 113 days; 119 days

*Cash-to-debt: 83%; 81%

*Operating margin: 1.3%; 1.3%

*Operating cash flow margin: 7.2%; 7.6%

RATED DEBT (as of December 31, 2010)

Allegheny County Hospital Development Authority

- Series1997B; fixed rate, financial guaranty policy from MBIA, underlying Aa3

-Series 1998B; fixed rate, financial guaranty policy from MBIA, underlying Aa3

-Series 2003B; fixed rate, unenhanced Aa3

-Series 2007A-1; fixed rate, unenhanced Aa3

-Series 2007B-2; indexed, unenhanced Aa3

-Series 2008A; fixed rate; unenhanced Aa3

-Series 2008B; fixed rate; unenhanced Aa3

-Series 2008 Note; indexed, unenhanced Aa3

-Series 2009A; fixed rate; unenhanced Aa3

-Series 2010A; fixed rate, unenhanced Aa3

-Series 2010B1 and B-2; variable rate demand bonds, underlying Aa3

-Series 2010C; variable rate demand bonds, underlying Aa3

-Series 2010D; Indexed Notes, unenhanced Aa3

-Series 2010F; Floating Rate Note, unenhanced Aa3

Allegheny County Industrial Development Authority:

-Series 2004A; variable rate demand bonds, underlying Aa3

Pennsylvania Higher Educational Facilities Authority:

-Series 1999A; fixed rate, financial guaranty policy from FSA, underlying Aa3

-Series 2001A; fixed rate, unenhanced Aa3 (no longer outstanding as of January 15, 2011)

-Series 2010E; fixed rate, unenhanced Aa3

Issued by Hamot Health (obligations of UPMC as of February 1, 2011 but not included in last two audited FY's):

-Series 2006; fixed rate, financial guaranty policy from CIFG

-Series 2007; fixed rate, financial guaranty policy from CIFG

-Series 2008; variable rate demand bonds (PNC LOC expiring 8/9/13)

CONTACTS

Issuer: C. Talbot Heppenstall, Jr., Treasurer, (412) 647 - 4894

Robert A. DeMichiei, Chief Financial Officer, (412) 647 - 4389

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

The last rating action was on March 17, 2010 when a Aa3 rating with a stable rating outlook was assigned to UPMC's Series 2010B, C, D & F bonds and the outstanding ratings of UPMC were affirmed at Aa3 and Aa3/VMIG 1 while the stable rating outlook was affirmed.

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

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

Nyisha Hohn
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 Aa3 RATINGS ASSIGNED TO THE UNIVERSITY OF PITTSBURGH MEDICAL CENTER'S BONDS; OUTLOOK REVISED TO POSITIVE FROM STABLE
No Related Data.
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