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Rating Update:

MOODY'S AFFIRMS CAREGROUP'S (MA) A3 DEBT RATING; OUTLOOK REVISED TO POSITIVE FROM STABLE

09 Feb 2011

AFFIRMATION AFFECTS TOTAL OF $650 MILLION OF RATED DEBT OUTSTANDING

Massachusetts Health & Educ. Fac. Auth
Health Care-Hospital
MA

Opinion

NEW YORK, Feb 9, 2011 -- Moody's Investors Service has affirmed the A3 rating assigned to CareGroup's bonds (see debt list at end of report). The outlook has been revised to positive from stable.

CareGroup, formed over fourteen years ago, is the parent corporation and sole corporate member of Beth Israel Deaconess Medical Center (formerly Beth Israel Hospital and New England Deaconess Hospital) (BIDMC), Mount Auburn Hospital, and New England Baptist Hospital (NEBH). BIDMC is now the parent corporation and sole corporate member of Beth Israel Deaconess Hospital-Needham (formerly Deaconess-Glover Hospital). The academic faculty practice group, associated with BIDMC, Harvard Medical Faculty Physicians (HMFP) was removed as an obligated group member in 2006, but continues to be incorporated into Moody's analysis of the consolidated system in our rating assessment of CareGroup.

RATINGS RATIONALE:

The affirmation of the A3 rating and revision in the outlook to positive from stable reflect CareGroup's stable operating performance and market share among each of its hospitals. The rating incorporates the increased volume at BIDMC in fiscal year (FY) 2010 and our expectation that balance sheet leverage will continue to improve over the near term.

LEGAL SECURITY: The bonds are a joint and several obligation of the CareGroup Obligated Group with revenue pledges provided by BIDMC and Mount Auburn, and broadened to include revenue pledges by New England Baptist Hospital and Beth Israel Deaconess Hospital - Needham. A first mortgage is provided on certain core properties of these four campuses and is excluded from the definition of permitted liens.

INTEREST RATE DERIVATIVES: none

STRENGTHS

*Sizeable growth in patient volume at BIDMC in FY 2010 due to a large physician group shifting a significant portion of its admissions to BIDMC from Brigham and Women's Hospital

*Good market share in Boston with second place market share behind Partners (rated Aa2 with a stable outlook) anchored by the system's academic medical center, Beth Israel Deaconess Medical Center

*Financial performance in FY 2010 improved substantially over the prior two years, largely as a result of the increased volume at BIDMC operating cash flow margin improved to 8.4% in FY 2010 from 7.0% and 7.6% in 2009 and 2008, respectively, and cash flow and investment returns grew the balance sheet to 143 days cash on hand and 129% cash to debt in FY 2010 from 128 days and 107% cash to debt in FY 2009

*Construction projects at Mount Auburn Hospital and New England Baptist Hospital funded with Series 2008 bonds have opened; no additional debt planned, although management previously has stated the need for a master facility plan review at BIDMC, which could lead to significant spending or additional debt

*All fixed rate debt structure with no derivatives; debt is amortizing quickly at approximately $25 million a year

CHALLENGES

*The system's two defined benefit pension plans that were underfunded by $127 million at FYE 2010 and will require contributions over the next several years; we note that CareGroup had maintained a funding ratio of over 100% for several years until changes in the discount rate and losses on plan assets reduced the funded status to 74% at FYE 2010 (funded status based on PBO)

*Sizeable operating lease expense of over $50 million annually; when converted to a debt equivalent, FY 2010 maximum annual debt service (MADS) coverage falls to 2.7 times from 4.2 times; we note that a significant portion of lease expense is for core research space

*Reliance on BIDMC, the clinical and financial flagship of the system, which represents over 70% of system revenues; any changes to performance at BIDMC disproportionately affects system results

*Long serving CEO of BIDMC unexpectedly announced his departure in January 2011; while the former CEO was instrumental in turning around BIDMC's financial performance over the last decade, we believe the system's current financial performance will be sustained in his absence. A national search for new CEO at BIDMC has begun

RECENT DEVELOPMENTS/RESULTS

CareGroup achieved stronger operating results in FY 2010 with operating cash flow reaching $193 million (8.4% margin), and reversed two years of declining performance where operating cash flow averaged $153 million and operating cash flow margins declined to 7.6% (2008) and 7.0% (2009). The improvement is driven largely by 2.7% growth in inpatient admissions at BIDMC, which contributed to consolidated 2.5% admission growth reaching 59,394 inpatient admissions system wide (39,533 at BIDMC). Volume growth at BIDMC is driven by the highly publicized decision of Harvard Vanguard Medical Associates (part of Atrius Health) to redirect a significant portion of their inpatient volume from Brigham and Women's Hospital (owned by Partners HealthCare, rated Aa2/Stable) to BIDMC. CareGroup is budgeting further volume gains in FY 2011.

Capital spending in FY 2010 slowed to 1.0 times depreciation expense, following several years of higher spending. Projects funded with the Series 2008 bonds, including expanded clinical facilities at the Mount Auburn campus and additional operating room and other renovations at NEBH have opened and contributed to volume gains at those campuses. System wide, budgeted capital spending in FY 2011 is $131 million (1.2 times capital spending ratio) a manageable amount that should allow CareGroup to strengthen its balance sheet modestly. NEBH plans to open three more operating rooms in FY 2011. CareGroup is paying approximately $25 million annually in debt service principal payments and currently has no new debt plans. At this rate, balance sheet leverage should continue to improve provided no debt is added and adequate financial performance is maintained.

Credit concerns at this time include the system's underfunded pension plans and ability to maintain good operating performance. The FY 2011 budget anticipates a weaker operating cash flow margin of 7.7%. Although nurses are not unionized, many other Boston hospitals and academic medical centers in particular, are unionized, limiting CareGroup's flexibility to control wage and benefit growth. The NEBH pension plan was frozen in 2010. The BIDMC's pension plan (the much larger of the two plans) is also a defined benefit plan and is not frozen. Although both plans were fully funded between FY 2005 - 2007, they are currently only 74% funded (compared to an aggregate PBO of $490 million), representing a sizeable $127 million underfunded status. In addition, CareGroup, has approximately $54 million in annual lease expense, a majority of which is for core research space. When converted to a debt equivalent, the leases reduce FY 2010 MADS coverage to 2.7 times from 4.2 times.

CareGroup maintains a large, diversified investment portfolio with a variety of equity, credit, and alternative investments. Although the portfolio is relatively illiquid compared to other rated hospitals (74% monthly liquidity to unrestricted cash), CareGroup has no demand debt or derivatives and over 100 days of monthly cash on hand, limiting the liquidity risk of the portfolio. Across the entire portfolio, CareGroup maintains an adequate 143 days cash on hand and 129% cash to debt.

Outlook

The revision in the outlook to positive from stable is attributable to CareGroup's good operating performance in FY 2010 and our expectation that the system will continue to maintain adequate margins and strengthen the balance sheet over the near term.

What could change the rating--UP

Further growth in balance sheet metrics; maintenance of good operating performance; maintenance of market share

What could change the rating--DOWN

Decline in operating performance or balance sheet strength; loss of market share; additional debt without commensurate growth in revenue

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for CareGroup, Inc. and Subsidiaries

-First number reflects audit year ended September 30, 2009

-Second number reflects audit year ended September 30, 2010

-Investment returns normalized at 6% unless otherwise noted

-Interest expense "grossed up" to account for capitalized interest by $3.6 million in FY 2009 and $519,000 in 2010

*Inpatient admissions: 57,918; 59,394

*Total operating revenues: $2.170 billion; $2.301 billion

*Moody's-adjusted net revenue available for debt service: $195.2 million; $244.3 million

*Total debt outstanding: $674.3 million; $651.6 million

*Maximum annual debt service (MADS): $58.4 million; $57.7 million

*MADS Coverage with reported investment income: 2.9 times; 3.7 times

*Moody's-adjusted MADS Coverage with normalized investment income: 3.3 times; 4.2 times

*Debt-to-cash flow: 4.2 times; 3.1 times

*Days cash on hand: 128 days; 143 days

*Cash-to-debt: 107%; 129%

*Operating margin: 0.8%; 2.4%

*Operating cash flow margin: 7.0%; 8.4%

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

-Series H (Beth Israel Hospital Issue); fixed rate ($5.8 million outstanding); rated A3

-Series A (CareGroup Issue); fixed rate ($177.4 million outstanding); rated A3

-Series B (CareGroup Issue); fixed rate ($74.1 million outstanding); rated A3

-Series D (CareGroup Issue); fixed rate ($42.8 million outstanding); rated A3

-Series E (CareGroup Issue); fixed rate ($350.0 million outstanding); rated A3

CONTACTS

Obligor: John T. Szum, EVP and Chief Financial Officer, CareGroup, 617-667-1881

Underwriter: Thomas H. Green, Citi, 617-346-9253

The last rating action with respect to CareGroup was on April 3, 2009, when the municipal finance scale rating of A3 was affirmed with a stable outlook. That rating was subsequently recalibrated to A3 on May 7, 2010.

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 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

Daniel Steingart
Analyst
Public Finance Group
Moody's Investors Service

Kimberly S. Tuby
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

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


Moody's Investors Service
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New York, NY 10007
USA

MOODY'S AFFIRMS CAREGROUP'S (MA) A3 DEBT RATING; OUTLOOK REVISED TO POSITIVE FROM STABLE
No Related Data.
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