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Rating Update:

MOODY'S AFFIRMS RIVERSIDE HEALTH SYSTEM'S (VA) A1 AND A1/VMIG 1 RATINGS; OUTLOOK REMAINS STABLE

08 Jun 2011

ACTIONS AFFECT TOTAL OF $126.3 MILLION RATED DEBT OUTSTANDING

Peninsula Ports Authority of Virginia
Health Care-Hospital
VA

Opinion

NEW YORK, Jun 8, 2011 -- Moody's Investors Service has affirmed the A1 and A1/VMIG 1 ratings assigned to Riverside Health System's (RHS) bonds issued by the Peninsula Ports Authority of Virginia and the IDA of the County of James City. The rating outlook remains stable. The ratings apply to $126.3 million of rated debt listed at the conclusion of this report.

SUMMARY RATINGS RATIONALE: The A1 rating is based on RHS's stable market position, solid debt coverage, very recent operating performance which evidences a marked improvement and lack of additional borrowing plans offset by a multi-year trend of thin cash-flow and weak operations. RHS's key credit challenge is maintaining current operating momentum while subsidizing a growing physician operation

STRENGTHS

*Still leading market share of the Newport News area and communities north, a service area that exhibits good demographics and some growth

*Robust liquidity position of $456.4 million as of FYE 2010 (Dec 31) equated to a healthy 199 days cash and provided an ample cushion of a modest debt load (330% cash to debt), both measures comparing favorably to A1 rated peers (medians are 182 days and 130%); however the cash cushion of comprehensive debt, which includes leases and pension liability, is more average for the rating category at 138%

*Relatively conservative asset allocation with approximately 23% invested in equities, 7% in private equity and hedge funds and 70% invested in cash and fixed income

*VMIG 1 short-term rating reflects RHS' ability to liquidate a portfolio of Aaa rated money markets on a timely basis to repay short term bondholders. RHS has limited demands on cash beyond the self liquidity supported debt (no other demand debt, manageable capital plans and pension liability was a modest $49.5 million at FYE 2010)

*While still moderate for the rating category, system operating performance through April 30, 2011 (2.3% operating margin and 7.9% operating cash-flow margin) has strengthened, running above budget and reflecting a $12.6 million turn from the prior year's comparable period

CHALLENGES

*Same store inpatient volume declines at the three legacy acute care campuses (Riverside Regional Medical Center, Walter Reed and Tappahannock) in each of the last several years; though System-wide demand has grown through facility acquisition

*Inability to generate a consolidated operating profit since FYE 2006; though performance through April 30, 2011 (4 months of FY 2011) is materially better then recent years and suggests better then break-even performance for the FYE 2011

*Though a tool to protect market share and ensure clinical coverage, continued expansion of the System's employed physician group, now at 350, markedly dilutes operating profitability

*Market expansion into Williamsburg, VA carries financial risk with planned capital investments for an inpatient health campus as competition from Aa2-rated Sentara Healthcare will be strong

*Highly competitive and dynamic market requires attention to physician development and continuous investment in clinical operations outside of the system's historic market area

DETAILED CREDIT DISCUSSION:

LEGAL SECURITY: All bonds are unsecured obligations of the Obligated Group with a negative mortgage lien. With the exception of small ancillary entities, all members of RHS are part of the Obligated Group.

INTEREST RATE DERIVATIVES: Floating-to-fixed rate swap on a notional amount of $63.7 million, related to the Series 2004 bonds. The counterparty is Deutsche Bank. The system's intention is to limit its variable rate debt exposure to 50% of total debt, giving effect to the swap.

RECENT DEVELOPMENTS/RESULTS

Riverside continues to control a leading 33.8% of the peninsula region (Newport News market). We do feel that market conditions have been altered as a result of the trends in healthcare toward outpatient delivery and ongoing physician alignment activity most notably seen in a decline in market share and Riverside's "same store" inpatient admissions, Riverside Regional has incurred a 10% decline in admissions since FY 2008. Though RHS management is confident that further admission decline will be mitigated as approximately 90% of admissions now originate from employed physicians. However, Riverside's physician employment/alignment strategy has come at an immediate cost to Riverside. Riverside, which owns a 350-member physician group (Riverside Medical Group or RMG), incurred a $42.4 million loss in FY 2010 following a $49 million loss in 2009; though management reports that performance in 2011 is improved by approximately $1.0 million per month (FY 2011 budget includes a $32.1 million loss at RMG). Outpatient volumes have grown with the system's investment in physicians, translating into revenue growth in spite of inpatient volume contraction. In fact, outpatient revenue equated to a growing 54% of total operating revenue in FY 2011. RHS has aligned with smaller rural hospitals to ensure referral flow, most recently adding Shore Memorial. The volumes from these facilities masks system-wide decline on a same store basis. We do view potential capital investments and historic financial challenges at these rural facilities as challenges to RHS's ability to restore and sustain healthier margins.

These market dynamics have pressured operations at RHS since FYE 2006. FY 2010 is the fourth consecutive year that RHS has generated an operating loss. The operating loss of $11.9 million (-1.4% margin) was measurably off budget which management had targeted at an operating profit of $16.4 million for FY 2010. Three non-recurring items totaling $18 million were large contributors to the deficit. In spite of thin operating cash-flow ($41 million or 4.7% operating cash-flow margin), debt measures remain healthy at 4.6 times maximum annual debt service coverage and a low (favorable) 2.2 times debt to cash-flow. However, as noted above, when including comprehensive debt obligations, these measures moderate to less favorable 2.4 times maximum annual debt service coverage and 4.2 times debt to cash-flow. We view performance through four months of FY 2011 as suggestive of a turning point, with the FY 2011 budget of $15.4 million appearing achievable given operating profit of $7.2 million as of April 30, 2011. Performance has turned as a result of a consultant engagement which has included operational interventions at RMG as well as productivity, supply chain, clinical documentation and revenue cycle initiatives throughout the system. Nevertheless, we view Riverside's operating performance in each of the last four years not consistent with the A1 rating category, underscoring the risk that rating pressure may follow if performance is not at least sustained at current levels. We do view RHS's flush balance sheet resources as a cornerstone of the A1 rating.

Riverside's balance sheet remains a primary credit strength. The system's cash position remained a robust $456.4 million as of FYE 2010 (Dec 31) equating to a healthy 199 days cash and providing an ample cushion of a modest debt load (330% cash to debt), both measures comparing favorably to A1 rated peers (medians are 182 days and 130%). However the cash cushion of comprehensive debt, which includes leases and pension liability, is more average for the rating category at 138%. Cash is highly liquid (70% fixed income and cash) and provides 5 times coverage of demand debt. Capital is manageable at $88 million in FY 2011 and $107 million in FY 2012, which includes the building of a 40-bed acute care hospital in Williamsburg, expected to cost a total of $45 million between now and 2013.

SHORT-TERM RATING RATIONALE: RHS SUPPORTS VARIABLE RATE DEMAND OBLIGATIONS WITH SELF-LIQUIDITY

RHS has a total of $91.2 million in variable rate debt, all of which is in weekly mode. Moody's is affirming the A1/VMIG 1 rating on the outstanding Series 1997 and 2004 variable rate demand bonds based on RHS's self-liquidity. As of April 30, 2011, RHS held approximately $108.2 million of investments with same-day liquidity, chiefly in money market funds, another $139 million in exchange traded equities and fixed income securities that can be accessed within one week. Currently, coverage of self liquidity debt by same day investments is more modest than our average self liquidity borrower at just 1.1 times while the investments are highly concentrated in one Aaa-rated money market fund.

Going forward management intends to maintain a balance in same-day-liquidity at a level of 1.3 times the balance of the VRDO (1.3 x $91,155,000 = $118,501,500); diversified amongst six Aaa rated money market investments. Additionally, management has stated intention to maintain a minimum balance of 1.1 times the balance of the VRDO in next-day-liquidity fixed-income funds (1.1 x $91,155,000 = $100,270,500).

Outlook

The stable rating outlook reflects our belief that RHS will continue to improve operating performance, meeting 2011 budget, while maintaining current balance sheet strength

What could change the rating--UP

Substantially improved cash flow generation that is sustained and translates into measurable margin improvement; increasing acute care demand at the hospitals that translates into market share gains

What could change the rating--DOWN

Inability to sustain current financial turn; balance sheet dilution or additional debt borrowings; weakened market position

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for Riverside Healthcare Association, Inc. & Subsidiaries

-First number reflects audit year ended December 31, 2009

-Second number reflects audit year ended December 31, 2010

-Investment returns smoothed at 6% unless otherwise noted

*Inpatient admissions: 27,308 ; 28,653

*Total operating revenues: $788.3 million; $872.3 million

*Moody's-adjusted net revenue available for debt service: $69.0 million; $68.6 million

*Total debt outstanding: $145.6 million; $138.3 million

*Maximum annual debt service (MADS): $14.8 million; $14.8 million

*MADS Coverage with reported investment income: 6.6 times; 3.8 times

*Moody's-adjusted MADS Coverage with normalized investment income: 4.7 times; 4.6 times

*Debt-to-cash flow: 2.3 times; 2.2 times

*Days cash on hand: 223 days; 199 days

*Cash-to-debt: 315%; 330%

*Operating margin: -1.1%; -1.4%

*Operating cash flow margin: 5.3%; 4.7%

*Comprehensive cash-to-debt: 140%; 138%

RATED DEBT

Series 1998, fixed rate, A1

Series 1997, variable rate demand bonds supported by issuers own liquidity, A1/VMIG 1 Series 2004, variable rate demand bonds supported by issuers own liquidity, A1/VMIG 1

CONTACTS

Obligor: Wade Broughman, Chief Financial Officer, (757) 534-7019

Underwriter: Jim Cain, Principal, Cain Brothers, (212) 869-5600

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 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

Lisa Martin
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 RIVERSIDE HEALTH SYSTEM'S (VA) A1 AND A1/VMIG 1 RATINGS; OUTLOOK REMAINS STABLE
No Related Data.
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