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Rating Update:

MOODY'S AFFIRMS FIRELANDS REGIONAL MEDICAL CENTER'S (OH) Baa2 BOND RATING; OUTLOOK IS STABLE

13 Sep 2010

RATING ACTION AFFECTS TOTAL OF $151 MILLION OF RATED DEBT OUTSTANDING

Erie (County of) OH
Health Care-Hospital
OH

Opinion

NEW YORK, Sep 13, 2010 -- Moody's Investors Service has affirmed the Baa2 bond rating on Firelands Regional Medical Center's (OH) outstanding bonds, affecting $151 million of debt as listed at the end of this report. The rating outlook is stable.

LEGAL SECURITY: The bonds are secured by a gross receipts pledge from the Obligated Group, which is comprised of Firelands Regional Medical Center. The Obligated Group does not include the Foundation for Firelands, the latter of which holds 13% of unrestricted investments; however, the purpose of the Foundation for Firelands is to support the medical center and the Foundation has demonstrated its support in the past.

INTEREST RATE DERIVATIVES: Firelands has a very large swap program with a total current notional amount of $411 million as of June 30, 2010, which we believe poses risks, especially at a Baa2 rating category. The total size of the program is unchanged since our last review; Firelands terminated a $40 million swap in 2009 and replaced it in early 2010. Firelands has entered into a $15 million total return swap with a termination date of 2011, whereby Firelands pays SIFMA and receives 5.35%. Firelands has also entered into a $200 million basis swap, which has a termination date of 2028, whereby Firelands pays SIFMA and receives 80% of 3-month LIBOR plus 0.5%. Additionally, Firelands has entered into a $40 million total return swap with a termination date of 2012, whereby the hospital pays SIFMA plus 0.25% and receives SIFMA plus 0.75%. Firelands also had three separate forward rate-lock swaps totaling $148 million with effective dates ranging from 2012 to 2016 and termination dates ranging from 2024 until 2040; one of these ($40 million) was terminated and replaced with a $40 million swap with a termination date of 2040 whereby Firelands receives a percentage of LIBOR and pays a fixed rate of 4.29%. Firelands faces termination risk if the rating falls to Baa3 or below and is required to post collateral above certain thresholds based on rating category. The thresholds were amended last year such that there is a $10 million threshold at Baa2 (amended from zero). The hospital had to post $2 million in collateral as of December 31, 2009 and $19.6 million as of September 10, 2010. As of September 10, 2010 the mark-to-market was a loss of $27.6 million. Merrill Lynch is the counterparty on the swaps.

STRENGTHS

*Operating cashflow improved in fiscal year 2009 and shows some further improvement through six months of fiscal year 2010

*Leading market position as a sole community provider with 74% market share in Erie County, Ohio

*Strong cash position of 239 days of cash on hand as of June 30, 2010, consistent with the level at the time of our last rating review

*Fixed rate debt structure and no plans for new debt; capital plans for the next several years are moderate since the hospital finished its master facility plan in 2008

CHALLENGES

*Despite operating improvement, the system reported an operating loss in fiscal year 2009 and through six months of fiscal year 2010 (including physician-related subsidies and excluding investment income); performance in 2010 is below budget in part due to low revenue growth of 1.8%

*Very high debt load and weak debt measures, resulting in very high debt-to-revenue of 89%, unfavorably high debt-to-cash flow of 8.9 times and modest Moody's adjusted peak debt service coverage of 2.3 times based on 2009 results

*Trend of flat or declining admissions due to competition and area declines; additionally, historical competition from physician groups has affected volumes and presence of a large multi-specialty group is a risk

*Concentration of payers with two large managed care payers accounting for 22% of revenues

*An investment allocation we believe is aggressive relative to the hospital's rating level because of the higher degree of variability in returns than a more conservative strategy and the need for more predictable returns to support operations and debt; the hospital's target allocation is 46% to equities and 29% to alternatives

*Large swap program with total notional amount of swaps of $411 million currently, equivalent to a very high 226% of debt; large swap collateral postings in late 2008 resulted in the realization of investment losses to meet collateral posting requirements

RECENT DEVELOPMENTS/RESULTS

Firelands continues to maintain a leading market share of 74% in the service area as the sole community provider in Erie County. Although there are some smaller hospitals in the secondary service area, historically the most competition has come from local physician groups. The largest group is a 34-physician multi-specialty group that opened a three-story tower in July 2009, which offers diagnostic radiology and lab services as well as therapies. Given the size and independence of this group, it remains influential in directing patient referrals in the area. In the last year, Firelands recruited two new medical oncologists and one radiation oncologist under its joint venture with University Hospitals' Ireland Cancer Center; this venture is a strategy to compete with the primary group of oncologists in the area that opened their own cancer center in 2007. The venture, which requires sharing income, is expected to be profitable by 2011 with the recovery of previously lost volume.

In 2009 admissions were flat while area-wide admissions were down. Through six months of 2010, admissions were down 5%; including observation cases, volumes were down 1.8% primarily reflecting lower volumes in the region. Outpatient surgeries grew 2% in 2009 and 12% through six months of 2010 as a result of the recruitment of new surgeons.

Since our last report in August 2009, operating performance in the latter half of 2009 continued to improve and exceeded the forecast, although the system is still generating an operating loss. In fiscal year 2009 Firelands Regional Health System (which includes the Foundation and its employed physicians) had an operating loss (excluding investment income) of $3.5 million (-1.8% margin), compared with a $5.3 million (-2.8% margin) operating loss in 2008. Operating cash flow in 2009 was $18.7 million (9.5% margin), compared with $15.3 million (8.2% margin) in 2008. The improvement in 2009 was due to 5% revenue growth from growth in inpatient and outpatient surgeries and other outpatient services, partially offset by higher charity care. Additionally, salaries and wages were flat. Operating subsidies related to employed physicians (as part of an entity under the Foundation for Firelands) increased about $1 million, reflecting the hospital's strategy to recruit physicians, some of which are employed.

Through six months of fiscal year 2010, there is some further operating improvement, although performance is below budget due to revenue pressures. Revenue growth is low at 1.8% through the six months, reflecting inpatient admission declines and higher charity care. Including physician losses, the system had an operating loss of $2.3 million (-2.5% margin), compared with an operating loss of $2.7 million (-2.9% margin) in the prior year period. Operating cashflow is $8.9 million (9.4% margin), compared with $7.7 million (8.3% margin) in the prior year period. Operating challenges include softer and uncertain volumes related to the economy, increasing charity care and Medicaid, and the state's Medicaid fee assessment program (which Firelands is already accruing for in the interims).

Firelands is highly leveraged both relative to operations and balance sheet measures, even with some improvement in operations. Debt measures are weak with a very high debt-to-revenue of 89%. Cash-to-debt (based on June 2010 cash levels) remains weak at 64%. Based on fiscal year 2009, debt-to-cash flow is unfavorably high at 8.9 times. Peak debt service coverage (based on Moody's 6% investment return adjustment) is low at 2.3 times in 2009. Short-term debt increased by $10 million in 2010 as a result of the draw on a short-term note to fund swap collateral requirements. No new debt is anticipated.

Firelands maintains a strong unrestricted cash position relative to its rating category, but we believe the hospital's asset allocation is aggressive and introduces a higher degree of variability than is typical for the credit profile. As of June 30, 2010, excluding swap collateral, Firelands had $117 million in unrestricted cash (including cash available at the Foundation for Firelands, which is dedicated to the hospital) representing a very strong 239 days of cash on hand (annualized). Cash is consistent with our last rating review, which was based on June 30, 2009 results. Unrestricted cash as of fiscal year end 2009 increased about $35 million from fiscal year end 2008 as a result of a reduction in swap collateral and low capital spending; unrestricted cash declined by about $10 million between fiscal year end 2009 and June 30, 2010 due to investment losses. Firelands target allocation is 17% to hedge funds, 6% to real estate, 6% to private equity, 16% to international equities and 30% to U.S. equities. Based on a liquidity analysis provided by the hospital, approximately 78% of the hospital's cash is invested in assets that can be liquidated within 30 days.

Capital needs are modest since the hospital just finished a master facility plan. Fiscal year 2010 includes approximately $7 million in capital spending. The hospital's pension is only 67% funded as of fiscal year end 2009, although at this time management is not budgeting to fund the pension plan at an amount greater than the expense level.

Outlook

The stable outlook reflects the system's ability to sustain a better level of operating performance and our expectations that future performance will be maintained; no new debt is anticipated

What could change the rating--UP

A significant and sustained increase in cash flow, notable increase in unrestricted cash and/or large pay down in debt

What could change the rating-DOWN

Decline in operating performance and/or volumes, any incremental debt, decline in unrestricted cash

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for Firelands Regional Health System

-First number reflects audit year ended December 31, 2008

-Second number reflects audit year ended December 31, 2009

-Investment returns smoothed at 6% unless otherwise noted

-Capitalized interest added back to interest expense

*Inpatient admissions: 10,212; 10,134

*Total operating revenues: $187.0 million; $196.4 million

*Moody's-adjusted net revenue available for debt service: $20.8 million; $26.4 million

*Total debt outstanding: $178.9 million; $173.8 million

*Maximum annual debt service (MADS): $11.3 million; $11.3 million

*MADS coverage with reported investment income: -0.6 times; 1.9 times

*Moody's-adjusted MADS coverage with normalized investment income: 1.8 times; 2.3 times

*Debt-to-cash flow: 13.1 times; 8.9 times

*Days cash on hand: 186 days; 252 days

*Cash-to-debt: 51%; 73%

*Operating margin (excluding investment income): -2.8%; -1.8%

*Operating cash flow margin: 8.2%; 9.5%

RATED DEBT

-Series 2002 Revenue Bonds ($71 million outstanding), Series 2006A ($65 million), Series 2006B ($15 million): Baa2

CONTACT

Issuer: Daniel Moncher, Chief Financial Officer, Firelands Regional Health System, (419) 557-7793

The last rating action was on August 17, 2009 when the rating for Firelands Regional Medical Center was downgraded to Baa2 from Baa1 and the outlook was revised to stable from negative.

The principal methodology used in rating this issuer was Rating Methodology: Not-For-Profit Hospitals and Health Systems, which can be found at www.moodys.com in the Credit Policy & Methodologies directory, in the Ratings Methodologies subdirectory. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Credit Policy & Methodologies directory.

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 FIRELANDS REGIONAL MEDICAL CENTER'S (OH) Baa2 BOND RATING; OUTLOOK IS STABLE
No Related Data.
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