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Rating Update:

MOODY'S AFFIRMS BAPTIST HEALTHCARE SYSTEM OBLIGATED GROUP'S (KY) Aa3 BOND RATING; OUTLOOK REMAINS STABLE

25 Mar 2011

AFFIRMATION AFFECTS $492.0 MILLION OF RATED DEBT OUTSTANDING

Kentucky Economic Development Finance Auth.
Health Care-Long-term Care
KY

Opinion

NEW YORK, Mar 25, 2011 -- Moody's Investors Service has affirmed the Aa3 unenhanced ratings assigned to Baptist Healthcare System Obligated Group's (BHSOG) $492.0 million outstanding Series 2009A and B revenue bonds issued by the Kentucky Economic Development Authority (see RATED DEBT section in this report). The Series 2009B bonds are also supported by letters of credit. The outlook remains stable.

SUMMARY RATINGS RATIONALE

The affirmation of the Aa3 rating and stable outlook are attributable to a strong state-wide market position with growing volumes for this comprehensive provider with a good balance sheet and comfortable debt coverage. Financial performance has declined in recent years due to a physician employment strategy; we expect financial performance to improve beginning in fiscal year 2012.

DETAILED CREDIT DISCUSSION

LEGAL SECURITY: The bonds are secured by a joint and several obligation of the Members, which includes Baptist Healthcare System, Inc. (BHS) and Baptist Healthcare Affiliates, Inc., which together own five hospitals comprising the majority of the system (122% of total system operating cash flow in FY 2010). The master trust indenture includes a debt service coverage test of 1.10 times and additional debt tests. No debt service reserve fund.

INTEREST RATE DERIVATIVES: None.

STRENGTHS

*Multi-hospital (five facility) state-wide health system and the largest system in the State of Kentucky, operating in four distinct regions and generating over 72,700 acute care admissions

*Distinctly leading market share in two markets (Paducah and Corbin) representing 36% of system operating cash flow up from 30% in fiscal year 2008), and positioned third overall and a close second in the primary markets in the Lexington and Louisville markets; state maintains certificate of need regulation

*Well seasoned management team

*Capital spending exceeding depreciation expense in each of the past seven years providing for continued investment in facilities

*Liquidity exceeding 200 days cash on hand in each of the past audited seven years, for a very good 219 days at fiscal yearend (FYE) 2010 with management projecting liquidity to remain above 200 days through FYE 2011; good cash-to-debt ratio of 173% at FYE 2010

*Good Moody's-adjusted maximum annual debt service coverage of 5.85 times on FY 2010 results

CHALLENGES

*Fifth consecutive year of declining operating profit and operating margin (to 0.9% in fiscal year (FY) 2010) and fourth year of declining operating cash flow (7.8% margin), below Aa3 medians of 3.4% operating and 10.0% operating cash flow; margins remained low in fiscal years 2009 and 2010 due to investment in strategic initiatives including growth in employed physician base which has experienced increasing losses ($28.9 million loss in FY 2010 compared to $9.6 million loss in FY 2008) with faster than anticipated expansion

*Unfavorable operating performance in the first quarter of FY 2011 due to reduced Medicare reimbursement, a decline in volumes, and increased costs associated with physicians expansion strategy; management is still projecting operating improvement throughout the remainder of the year as physician and volume strategies mature, but margin improvement not projected until FY 2012

*Two largest volume hospitals operate in highly competitive markets where they do not hold leading market positions but market shares are stable in the primary service area

*Sizable capital plans expected to reduce liquidity in the near term through FY 2013, then grow thereafter; projections include full allocation of budgeted capital yet historically capital spending has been less than budget

RECENT RESULTS/DEVELOPMENTS

In late calendar year 2010, BHS signed an agreement with 105-bed, 4,400 admission Pattie A Clay Regional Medical Center in Madison County, expanding its service area in the state and providing a link between its Central (Lexington) and Regional (Corbin) markets. Metropolitan Louisville, where BHS has two hospitals, continues to generate the largest portion of net patient revenues (39.6%). Management shows an increase in acute care primary service area market share to 25.6% from 23.2% two years prior, but remains behind Norton Healthcare's 39.6%. Jewish Hospital & St. Mary's HealthCare, currently holding a 24.2% acute care market share, and University of Louisville Hospital have signed a letter of intent to merge, which would result in a combined market share of 32.8%. Should this merger be completed, BHS would hold the trailing market share of three systems in Louisville. In Lexington, where 31.4% of FY 2010 net patient revenues were generated by BHS Central, BHS's primary service area market share is stable at 27.5%, and continues to place the hospital second behind Catholic Health Initiatives 31.1% share. BHS continues to hold the leading market shares in Paducah and Corbin, but still competes with a sizable competitor.

As a system, discharge trends have varied by market but have increased annually over the past five years to reach 72,700 in FY 2010. Outpatient registrations and surgeries have also increased. We note a 1.7% decline in discharges in the first quarter of FY 2011 over the same period the prior year, with corresponding declines in outpatient and total surgeries. Over half the decline in discharges occurred in Paducah where discharges were below the prior year but above that of first quarter FY 2009.

BHS has steadily grown system operating revenues by greater than 6% in each of the past three years to reach $1.52 billion. Operating profitability, however, has declined across the same period. Continued investments in physician practices, clinics and the growth in the number of express care locations (non-obligated group members) resulted in losses from these investments of $28.9 million in FY 2010, up from $15.0 million in FY 2009 and $9.6 million in FY 2008. As a result, system operating profitability declined to $13.8 million (0.9% margin) in FY 2010 from $18.4 million (1.3% margin) in FY 2009 and $24.0 million (1.8% margin) in FY 2008. Operating cash flow margins for the system showed the same trend, declining to 7.8% in FY 2010 from 8.9% in FY 2008.

We note that the obligated group, which excludes the losses from the physician and clinic expansion strategy, fared much better. In FY 2010, the obligated group reported an operating profit margin of 3.5% and an operating cash flow margin of 11.7%. Management will continue to invest in these strategies in FY 2011, budgeting for system performance to be slightly below that of FY 2010, with operational improvement in FY 2012 as expense growth from these initiatives stabilize and revenue generation grows faster. Despite the decline in operating performance, debt metrics are reasonable within the Aa3 rating category. Debt-to-cash flow of 3.13 times is comparable to the 2.9 times Aa3 median, and Moody's-adjusted maximum annual debt service coverage of 5.85 times is slightly higher than the 5.6 times median. Subsequent rating reviews will focus on BHS' ability to improve system-wide operating performance; absent improvement, there will likely be pressure on the rating.

Liquidity remains above 200 days (219 days at fiscal yearend 2010) but continues to decline as expected. As a result, cash-to-debt is good at 173% at FYE 2010. Management is continuing to budget for a decline in liquidity across the next two years with increased investments in capital (see discussion below), resulting in a projected low of 167 days in 2013. Liquidity would grow thereafter as major capital projects would be completed. With a practice of not spending 100% of budgeted capital, however, it is more likely that days cash would not decline this far.

BHS's full five year (2011-2015) capital budget of $732.4 million compared to $597.5 million the past five years is a 22.6% increase. Management states a history of spending below annual budget levels, and is carrying over into FY 2011 $16 million in capital budgeted in FY 2010. Furthermore, the timing of certain hospital expansion and renovation projects is being developed in phases, allowing for the ability to delay the timing of projects if needed. The current five year plan anticipates an increase in debt, which has not been incorporated into this analysis as timing and amount are not set. The current rating, however, could be negatively impacted should debt increase without improvement in operating performance.

Approximately 58% of BHS's debt is in a variable rate mode supported by letters of credit. Cash-to-demand debt is very good at 299% at FYE 2010. Management is considering the issuance of additional debt as early as late 2011, but no definitive plans have been made. Moody's will evaluate the impact of additional debt on the credit rating when more substantial plans are available.

Outlook

The stable outlook reflects our belief that operating performance will remain stable in FY 2011 and improve in future years to adequately support the modest debt load for this sizable health system with good liquidity and good debt service coverage. An inability to meet projected cash flow levels for FY 2011 or 2012 or a decline in liquidity at greater levels than projected could result in an outlook or rating change.

WHAT COULD MAKE THE RATING GO UP

Growth in volumes and market position that enhances cash flow generation; improvement in liquidity

WHAT COULD MAKE THE RATING GO DOWN

Weakening of liquidity position below expectations; inability to improve operating cash flow in FY 2012 to support increased debt load; an increase in debt without commensurate increase in cash flow; material weakening of market positions

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for Baptist Healthcare System, Inc. and Affiliates

-First number reflects audit year ended August 31, 2009

-Second number reflects audit year ended August 31, 2010

-Excludes $14.8 million of non-recurring revenues for prior year cost report settlements in FY 2009

-Investment returns normalized at 6% unless otherwise noted

-Interest expense "grossed up" to include capitalized interest of $883,000 and $253,000 in FY 2009 and FY 2010, respectively

*Inpatient acute care admissions: 71,023; 72,702

*Total operating revenues: $1.43 billion; $1.52 billion

*Moody's-adjusted net revenue available for debt service: $172.9 million; $172.8 million

*Total debt outstanding: $500.5 million; $492.0 million

*Maximum annual debt service (MADS): $32.9 million; $29.5 million

*MADS Coverage with reported investment income: 3.49 times; 5.10 times

*Moody's-adjusted MADS Coverage with normalized investment income: 5.26 times; 5.85 times

*Debt-to-cash flow: 3.13 times; 3.13 times

*Days cash on hand: 228 days; 219 days

*Cash-to-debt: 166%; 173%

*Operating margin: 1.3%; 0.9%

*Operating cash flow margin: 8.4%; 7.8%

RATED DEBT (debt outstanding as of August 31, 2010)

-Series 2009A fixed rate bonds ($207.6 million outstanding), rated Aa3

-Series 2009B variable rate bonds ($284.4 million outstanding), rated Aa1/VMIG1 under the joint default rating methodology; subseries B-1 and B-2 supported by letter of credit (LOC) from JPMorgan Chase expiring June 30, 2013; subseries B-3 and B-4 supported by LOC from Branch Banking and Trust Co. expiring February 19, 2016

CONTACT

Obligor: Carl Herde, Chief Financial Officer, Baptist Healthcare System (502) 896-5011

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 and confidential and proprietary Moody's Investors Service 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

Kay Sifferman
Analyst
Public Finance Group
Moody's Investors Service

Jennifer Ewing
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 BAPTIST HEALTHCARE SYSTEM OBLIGATED GROUP'S (KY) Aa3 BOND RATING; OUTLOOK REMAINS STABLE
No Related Data.
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