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Rating Update:

MOODY'S AFFIRMS SOUTHWEST WASHINGTON MEDICAL CENTER'S (WA) A2 REVENUE BOND RATING; OUTLOOK REVISED TO STABLE FROM NEGATIVE

25 Jul 2011

RATING ACTION AFFECTS UNDERLYING AND LONG-TERM RATINGS ON APPROXIMATELY $160 MILLION OF DEBT

Washington Health Care Facilities Auth
Health Care-Hospital
WA

Opinion

NEW YORK, Jul 25, 2011 -- Moody's Investors Service has affirmed the A2 underlying and long term ratings on Southwest Washington Medical Center's (SWMC) $160 million of variable rate and fixed rate revenue bonds. The rating has been revised to stable from negative.

RATINGS RATIONALE: The affirmation of the A2 rating and the revision of the outlook to stable from negative reflects the good credit fundamentals of SWMC and SWMC's recent affiliation with PeaceHealth, a regional multistate system headquartered in Washington State with significant operations in Alaska, Washington and Oregon. SWMC maintains good marketshare in the quickly growing and demographically attractive Vancouver, WA market, has a new facility with strong service offerings, and is experiencing strong revenue and admissions growth. While operating performance and balance sheet measures have been maintained at a lower level for the last several years, five-month year-to-date unaudited results indicate that a turnaround is underway.

STRENGTHS

*Affiliation with PeaceHealth, a sizable regional multistate health system with significant operations in Alaska, Washington State and Oregon; affiliation was concluded January 1, 2011; PeaceHealth is now the sole corporate member of Southwest Washington Health System, the parent of SWMC. SWMC's income statement and balance sheet will be consolidated on PeaceHealth's financial statements; obligated groups will remain distinct for the time being, and SWMC will continue to produce independent financial statements as supplemental disclosure

*Dominant and growing market position (55%) in Vancouver, WA, a demographically attractive and rapidly growing suburb of Portland, Oregon

*Sizable operations, with over $650 million of total revenues, and nearly 24,000 admissions in fiscal year (FY) 2010; offers broad array of tertiary and quaternary services, with a relatively high Medicare case mix index of 1.59 in FY 2010

*Good revenue and admissions growth, with admissions growing an average 4.3% in 2009 and 2010, and with revenues growing an average10.8% over the same time horizon

*Improved debt measures despite poor operating performance; debt measures are adequate for the rating category, with maximum annual debt service (MADS) coverage of 5.0 times, cash to debt of 140%, debt to cashflow of 3.8 times, and debt to operating revenue of 26%

CHALLENGES

*Increased competitive pressures following the opening of Legacy Health System's Salmon Creek Hospital in 2006, eight miles north of SWMC' main facility in Vancouver; previously SWMC had been the only acute care hospital in this portion of Washington State; also, a large local multispecialty physician group (the Vancouver clinic) provides referrals but also competes for outpatient services

*Somewhat modest cash balances for the rating category; cash on hand dropped from 183 days at fiscal year end (FYE) 2008 to 132 days at FYE 2009 and to 139 days at FYE 2010

*The continuation of poor operating performance in FY 2009 and 2010 despite the hiring of consultants and the implantation of a comprehensive turn around plan in 2008; from FY 2007 through FY 2010, operating margin averaged -0.7% and operating cashflow margin averaged 6.4%, which is fairly modest for the rating category; unaudited interim results for five-months year-to-date 2011 show significant improvements versus the same period last year

*Somewhat aggressive balance sheet structure for the rating category with approximately two-thirds of bonds held as variable rate debt and swapped to fixed rate with LIBOR-based swaps, and with approximately 60% of unrestricted cash and investments allocated to equities, hedge funds, commodities and real estate

DETAILED CREDIT DISCUSSION

LEGAL SECURITY: The bonds are a general obligation of the medical center, which is the only member of the obligated group. We note that a substitution of notes is allowed, and the bond documents do not limit additional debt, though the letters of credit backing the variable rate demand bonds require the letter of credit providers to consent to additional debt greater than $1 million. SWMC represents 86% of Southwest Washington Health System's (SWHS) assets and 82% of the SWHS' total revenues. The letters of credit carry a number of covenants including a minimum liquidity requirement of 100 days cash on hand, a debt service coverage requirement of 1.25 times, a maximum debt to capitalization of 45%, and a minimum bond ratting requirement of Baa3. PeaceHealth is not obligated on the bonds.

INTEREST RATE DERIVATIVES: SWMC is counterparty to two fixed-payer, LIBOR-based swap contracts with a total notional of approximately $110 million. As of FYE 2010, the aggregate mark-to-market on the swap portfolio was approximately negative $12 million. There are no collateral posting requirements. The swaps may be terminated at any time (at market) at SWMC's option with 20 days notice, or at the counterparties' option upon downgrade of SWMC to below Baa3.

RECENT RESULTS / DEVELOPMENTS

On January 1, 2011, SWMC formally affiliated with PeaceHealth. Prior to the affiliation, SWMC was the largest remaining independent hospital in the Pacific Northwest. PeaceHealth is a sizable regional multistate health system with significant operations in Alaska, Washington State and Oregon; and with total annual net revenues of $1.4 billion (prior to the affiliation). The affiliation increases PeaceHealth's revenue base by 45%. Prior to the affiliation, PeaceHealth's primary operations were centered in three regions: central Oregon, anchored by the recently completed Sacred Heart Medical Center at the RiverBend Campus in Springfield (which, together with the University District Campus in neighboring Eugene, and a critical access hospital in Cottage Grove, operates 456 beds); southern Washington State, in Longview, with 163-bed St. John Medical Center (which is located 43 miles from SWMC); and northern Washington State, which is served by the 253-bed St. Joseph Medical Center in Bellingham. PeaceHealth also operates a 25-bed critical access hospital in Ketchikan, Alaska, and another 21 bed critical access hospital in Florence, Oregon. Each of PeaceHealth's hospitals has the dominant marketshare in its region (ranging from 70% to more than 90%), and together they constitute a strong and diverse revenue base for the Bellevue-based organization.

PeaceHealth is now the sole corporate member of SWHS (the parent of SWMC), and SWHS's income statement and balance sheet will be consolidated on PeaceHealth's financial statements. PeaceHealth and SWMC's original obligated groups securing the organizations' respective bond offerings will remain distinct for the time being and SWMC will continue to produce independent audited financial statements. SWMC's bond holders do not have legal recourse to PeaceHealth, and PeaceHealth is not obligated on SWMC's bonds. Nevertheless, we believe PeaceHealth has a strong and fundamental interest in SWMC, and we believe the affiliation has value to SWMC's bond holders. PeaceHealth's commitment to SWMC is evidenced, among other things, by PeaceHealth's decision to move its corporate headquarters from Bellevue to Vancouver. A major factor contributing to the maintenance of SWMC's A2 rating, and to the revision of the outlook to stable from negative, is indeed the affiliation.

Aside from the relationship with PeaceHealth, an additional fundamental credit strength of SWMC is its leading market share in an attractive service area in suburban Portland, Oregon. Located in Vancouver, Washington, SWMC has long maintained a dominant market position in Clark County despite its close proximity to Portland, OR (which is adjacent to - and just south of - Vancouver). Competition in the Portland market is significant with a number of large systems, including Providence Health System (rated Aa2) with 4 hospitals in the Portland metropolitan area, and Legacy Health System (rated A1) also with 4 hospitals. Up until 2006 SWMC operated the only acute care hospital in Vancouver and commanded a dominant 70% market share (with the remaining volume out-migrating to Portland). In 2006, Legacy opened 220-bed Legacy Salmon Creek eight miles north of SWMC's main campus. In a relatively short amount of time, SWMC lost a full 20% market share in its primary service area, depressing volumes, operations, and outpatient services.

Concurrent with these developments, SWMC underwent its own physical transformation with the construction of a new $150 million patient tower. The new facility, which was completed in 2007 (one year after the completion of LSC), added 82 net beds, increased targeted procedural space, expanded the emergency department, increased parking, and constructed new common areas. Approximately $50 million in donations was raised from the community, which we believe is an impressive number for a community of this size, and demonstrates ongoing commitment to the organization from its historical service area.

The Vancouver market is served by a mix of independent community physicians, and a single, dominant, multi-specialty physician group called the Vancouver Clinic consisting of over 100 doctors. The Vancouver Clinic currently occupies four medical office buildings (MOBs) in the Vancouver region, including MOBs adjacent to both SWMC and LSC's primary Vancouver facilities. We believe maintaining positive relations with the Vancouver Clinic is critical to SWMC's ability to improve profitability and volumes. In recognition, however, of their potential vulnerability, SWMC has pursued increased direct physician employment, increasing the total number of employed physicians from 30 in 2008 to 59 in 2010.

Following the opening of LSC in 2006, SWMC entered into a period of depressed operating performance which has continued through FY 2010. During this period, operating margin has averaged -0.7%, and operating cashflow has averaged 6.4%. (SWMC changed its fiscal year end from September 30 to December 31 beginning with FY 2009. Operating performance during the last three months of calendar year 2008 was not publically disclosed). Despite the hiring of consultants in 2008, and the implementation of a comprehensive improvement plan, operations have continued to underperform in 2009 and 2010, with the operating margin measuring -0.3% and -1.2% in 2009 and 2010 respectively, and with the operating cashflow margin measuring 6.4% and 5.8%, respectively. Interestingly, admissions and revenue growth has been strong during this period of time, averaging annual growth of 4.3% and 10.8%, respectively. Drivers of the poorer performance include: an increase in charity care from $26 million in 2008 to $40 million in 2009 and $42 million in 2010; an increase in bad debt expense from $30 million in 2008 to $35 million in 2009 and $49 million in 2010; and increased subsidies to SWMC's employed physician group, which saw significant growth during this period.

SWMC has an aggressive budget for FY 2011 which assumes a significant improvement in profitability. SWMC's unaudited results year to date (through five months ended May 31) are better than budget, and show very significant gains over the same period last year. Drivers of the improvement include systematic expense reductions, labor optimization, patient flow improvements, better contracting, and improved collections and clinical documentation. As PeaceHealth and SWMC move to consolidate back offices and other shared functions, and to further leverage the relationship between SWMC and PeaceHealth's St. John Medical Center in Longview, we would expect the profitability of SWMC to further improve.

Despite poor profitability, SWMC has improved it debt coverage levels over the last several years due in part to the absence of additional debt, and to the healthy growth of SWMC's revenue base. SWMC's debt measures are adequate for the A2 rating category with maximum annual debt service (MADS) coverage of 5.0, cash to debt of 140%, debt to cashflow of 3.8 times, and debt to operating revenue of 26%. SWMC's debt structure is somewhat aggressive with approximately 69% of all bond debt held as variable rate demand bonds. The variable rate demand bonds are backed by direct pay letters of credit (LOC). The Series 2008A bonds have an LOC from Union Bank which expires on 12/27/2013. The Series 2008B bonds are backed by an LOC from Bank of America, N.A which expires on 05/25/2014. Covenants relating to the LOCs include a minimum liquidity requirement of 100 days cash on hand, a debt service coverage requirement of 1.25 times, a maximum debt to capitalization of 45%, and a minimum bond ratting requirement of Baa3. SWMC is counterparty to two LIBOR-based fixed payer swaps with a total notional approximately equivalent to the outstanding par of the variable rate bonds.

SWMC bolstered its balance sheet in 2008 through the monetization of several medical office buildings, which was largely responsible for an increase in SWMC's liquidity to 183 days cash on hand at FYE 2008, from 146 days at FYE 2007. Following 2008 however, liquidity balances returned to lower levels, measuring 132 days at FYE 2009, and 139 days at FYE 2010. This drop in liquidity was due to a number of factors, including poor cashflow in 2009 and 2010, and the continued spending on capital projects. Capital expenditures totaled $71 million in FY 2009 (equal to 2.2 times depreciation), and included the fit out of several floors originally constructed as shelled space as part of the new patient tower. In FY 2010 capital expenditures dropped to $18 million (equal to 0.5 times depreciation) and spending over the next several years is expected to continue at a moderate level. SWMC's investment allocation is somewhat aggressive, with approximately 60% of unrestricted cash and investments allocated to equities, hedge funds, commodities and real estate.

Outlook

The stable outlook reflects SWMC's good credit fundamentals, and its recent affiliation with PeaceHealth. SWMC maintains good marketshare in the quickly growing and demographically attractive Vancouver, WA market, has a new facility with strong service offerings, and is experiencing strong revenue and admissions growth.

WHAT COULD MAKE THE RATING GO UP

Growth in liquidity and improved debt measures; significantly improved performance measures

WHAT COULD MAKE THE RATING GO DOWN

Material increase in debt without a commensurate increase in cash and cashflow; significant loss of marketshare; further decrease in operating performance; deterioration of cash balances

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for Southwest Washington Health System and Affiliates

-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: 22,060; 23,932

*Total operating revenues: $602 million; $652 million

*Moody's-adjusted net revenue available for debt service: $53.5 million; $54.4 million

*Total debt outstanding: $181 million; $171 million

*Maximum annual debt service (MADS): $10.8 million; $10.8 million

*MADS coverage based on reported investment income: 3.2 times; 7.1 times

*Moody's-adjusted MADS coverage: 4.9 times; 5.0 times

*Debt-to-cash flow: 4.0 times; 3.8 times

*Days cash on hand: 132 days; 139 days

*Cash-to-debt: 114%; 140%

*Operating margin: -0.3%; -1.2%

*Operating cash flow margin: 6.4%; 5.8%

RATED DEBT

- Series 1999 Fixed Rate Revenue Bonds ($49.7 million outstanding); insured by Ambac; rated A2

- Series 2008A Variable Rate Demand Bonds ($55.5 million outstanding); rated Aa3/VMIG1 based on joint default including a direct pay letter of credit from Union Bank (expires 127/27/2013)

- Series 2008B Variable Rate Demand Bonds ($54.0 million outstanding); rated Aa1/VMIG1 based on joint default including a direct pay letter of credit from Bank of America (expires 05/25/2014)

CONTACTS

Issuer: Southwest Washington Medical Center: David Willie, Chief Financial Officer, (360) 514-3103

Corporate parent: PeaceHealth: Roshan Parikh, Treasury Director, (425) 649-3843

Underwriter: Goldman Sachs, Patrick McCarthy, Managing Director, (212) 902-9956.

PRINCIPAL METHODOLOGY USED

The principal methodology used in this rating was Not-for-Profit Hospitals and Health Systems published in January 2008. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Information sources used to prepare the 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, and confidential and proprietary Moody's Analytics information.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a 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

Brad E. Spielman
Analyst
Public Finance Group
Moody's Investors Service

Lisa Goldstein
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 SOUTHWEST WASHINGTON MEDICAL CENTER'S (WA) A2 REVENUE BOND RATING; OUTLOOK REVISED TO STABLE FROM NEGATIVE
No Related Data.
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