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New Issue:

MOODY'S ASSIGNS A2 RATINGS TO SWEDISH HEALTH SERVICES (WA) SERIES 2010 BONDS; A2 RATINGS ON PARITY DEBT AFFIRMED; OUTLOOK IS STABLE

11 Nov 2010

TOTAL OF $635 MILLION OF DEBT TO BE OUTSTANDING

Washington Health Care Facilities Auth
Health Care-Hospital
WA

Moody's Rating

ISSUE

RATING

Series 2010 Fixed Rate Revenue Bonds

A2

  Sale Amount

$250,360,000

  Expected Sale Date

11/16/10

  Rating Description

Healthcare Revenue Bonds

 

 
Moody's Outlook   Stable
 

Opinion

NEW YORK, Nov 11, 2010 -- Moody's Investors Service has assigned A2 ratings to Swedish Health Services Series 2010 revenue bonds, and has affirmed the A2 ratings on Swedish's outstanding parity debt (listed at the end of this report). Bonds are issued by the Washington Health Care Facilities Authority. The outlook is stable.

RATINGS RATIONALE

USE OF PROCEEDS: Bond proceeds will be used to: (1) refund the Series 1998 fixed rate bonds for savings (approximately $197 million); (2) reimburse Swedish for various qualifying capital expenditures ($60 million); and (3) pay certain costs of issuance. The series 2010 bonds will increase Swedish's total debt liability by approximately $60 million.

LEGAL SECURITY: Bonds are secured by a gross receivables pledge of Swedish Health Services. Swedish Medical Center Foundation is not obligated on the bonds. Swedish may not incur liens except for certain permitted liens. Substitution of notes is not permitted.

INTEREST RATE DERIVATIVES: None

STRENGTHS

*Largest healthcare provider in Seattle metropolitan region with net patient revenue in excess of $1.3 billion, three established acute care hospitals totaling 832 staffed beds, and 27 primary and specialty care clinics; system generates over 41,000 admissions annually; in September, Swedish closed a transaction to lease Steven's hospital in Edmonds, WA on a long term basis, which will further increase the size and reach of the organization.

*Leading position in the competitive Seattle market with approximately 22% market share in King County; next largest competitor is University of Washington / Harborview with a combined 18% of the market; with the acquisition of Steven's hospital, and the planned opening of a new hospital in Issaquah in 2011 and 2012, Swedish expects to gain market share over the next several years.

*Improved operating performance after a setback in fiscal year (FY) 2008; in FY 2009 operating income improved to $42.8 million (3.1% margin) from $16.7 million (1.3% margin) in FY 2008; operating cashflow improved to $154.4 million (11.2% margin) from $113.4 million (9.0% margin); year to date (through 8 months ended August 31, 2010, based on unaudited interim financial statements) Swedish is on track to match FY 2009's strong performance

*Improved cash balances; due to strong cashflow generation, favorable investment markets, and reduced capital spending, cash on hand improved to 167 days as fiscal year end (FYE) 2009, from a much weaker 105 days at FYE 2008; as of August 31, 2010 (per unaudited interim financial statement), cash balances remain strong at 166 days; due to reimbursement provided by the series 2010 bonds, cash balances improve on a proforma basis to 177 days.

CHALLENGES

*High leverage producing somewhat weak debt ratios; proforma FY 2009 measures (including the issuance of the Series 2010 bonds) are fair to somewhat weak for the A2 category, with cash to debt of 99% (A2 median is 132%), adjusted maximum annual debt service coverage of 5.0 (A2 median is 5.0), debt to operating revenue of 45.9% (A2 median in 33.8%), and debt to cashflow of 3.7 (A2 median is 3.2); possible debt issuance as early as Q1 2011 could increase debt by as much as an additional $190 million, placing significant further stress on balance sheet measures

*Exposure to large amount of indirect debt; Swedish's pension liability stands at approximately $200 million as of FYE 2009 (producing a funded ratio of 66%); the debt equivalent of Swedish's non-cancellable operating lease obligations is $175 million (based on a multiplier of 6 times current lease expense); due to a number of 3rd party financed projects currently in process, Swedish's lease obligations are expected to further increase in FY 2010 and 2011; exposure to indirect debt further increases balance sheet measures

*Strong competition from numerous district, academic, and not-for-profit hospitals including University of Washington Medical Center (part of University of Washington, rated Aaa), A3-rated Overlake Hospital Medical Center, A3-rated Evergreen Healthcare, Aa3-rated Seattle Children's Hospital, and Baa2-rated Virginia Mason Medical Center

*High exposure to construction, execution and operating risk associated with large number of new projects; projects include: the construction of a new $443 million, acute care hospital in Issaquah; construction of two, 3rd-party financed, stand-alone emergency departments (in Redmond and Millcreek); and the acquisition (through a lease arrangement) of Steven's Hospital in Edmonds

MARKET POSITION/COMPETITIVE STRATEGY: DOMINANT PROVIDER OF HEALTHCARE SERVICES IN THE VERY COMPETITIVE SEATTLE MARKET; UNDERGOING RAPID EXPANSION OF SERVICE SITES

Swedish Health Services is the Seattle region's largest health system. In 2009, Swedish was comprised of two large downtown facilities (697-bed First Hill Campus and 385-bed Cherry Hill Campus) and one smaller community hospital (the 163-bed Ballard Hospital), and generated nearly 41,000 admissions in 2009, and produced nearly $1.4 billion of net patient revenue. Swedish uses a mixed staff model, with approximately 800 employed physicians, and a strong open staff. Swedish has benefited from a large footprint throughout the Seattle region, operating 12 primary care clinics in the city and throughout its suburbs in 2009. The system offers a wide array of community, tertiary, and quaternary services, including a recently completed, stand-alone orthopedic institute, a neuroscience institute, a heart & vascular institute, a cancer institute, and a women and infants center.

Swedish is currently in the process of rapidly expanding its organizational footprint, and is undertaking a number of projects concurrently. Of largest significance is the construction of a new, green-field hospital in the town of Issaquah, located approximately 20 miles from down town Seattle. Construction of the hospital began in 2009, and is expected to cost a total of $443 million. The hospital is licensed for 175 beds, and the project will include an ambulatory care center, and a medical office building. The project will be completed in phases, with the medical office building scheduled to open in mid 2011, and the first 80 inpatient beds operational in early 2012. Approximately $77 million has been spent on the project to date. Swedish already has a standalone emergency department in this market, which it opened in 2005, and which has reportedly experienced strong volumes. Nevertheless, we believe a full acute care hospital in this market represents a significant investment, and entails significant construction, execution, and operating risk.

Other current projects include: the construction of a freestanding emergency department in Redmond, to be completed in December 2010; the construction of a freestanding emergency department in Mill Creek, to be completed in February 2011; and the acquisition of Stevens Hospital in Edmonds through a long-term lease with Snohomish County Public Hospital District 2 for a period of 30 years. The freestanding emergency departments cost approximately $40 million each, and are being financed by 3rd party vendors. Nevertheless, Swedish will be subject to long-term non cancellable operating leases, which we treat as the equivalent of debt, and Swedish will retain the risk entailed in operating the new facilities, which are located in competitive communities traditionally served by other hospitals.

Stevens Hospital (which prior to the lease agreement had a revenue bond rating of Ba2, and a general obligation bond rating of A2) is an existing, 217-licended bed facility receiving approximately 7,800 admissions annually, and in 2009, generated over $190 million in operating revenues. While the facility has a history of poor operating performance, the organization has achieved a significant operational turn around and in 2009, achieved 10.3% operating cashflow margins and produced nearly $20 million of operating cashflow. Swedish has agreed to lease the hospital for the cost of $7.2 million a year (subject to inflation), and has agreed to commit $90 million of capital to the facility over the next 10 years dependent upon operating margins of the facility. The transaction closed in September. Overall, while we believe these projects have the potential of being highly accretive to Swedish, they represent a significant expansion of operations over a short period of time, and may compete with one another for senior management's attention. Given Swedish's leveraged balance sheet, it will be important for the organization to maintain strong, consistent operating cashflow in support of its debt service in order to remain stable at the current rating level.

Swedish's well established community presence and large medical staff (1,410 active physicians) are important positive credit factors. Washington state exercises strict Certificate of Need, and though some consolidation has taken place, Seattle remains a very competitive market, with a number of prestigious, and clinically important organizations operating in a tight market. Swedish has a significant lead over its competitors with respect to market share, with a 22% market share in King county, which is likely to increase in the coming years with the addition of two hospitals. Swedish's competitors include University of Washington Medical Center / Harborview, with 18% of the market, Valley Hospital with 11% of the Market, Overlake Hospital (rated Baa2) with 12% of the market, and Virginia Mason Medical Center (rated Baa2) with 6%. Other significant competitors include Seattle's Children's Hospital (rated Aa3), and the Seattle Cancer Care Alliance (rated A3), both of which have national reputations. Swedish's long term strategic plan includes substantial growth, which may involve opportunistic and accretive strategic alliances.

OPERATING PERFORMANCE: IMPROVED MARGINS AFTER SETBACK IN FY2008

Swedish has a history of relatively stable and favorable operating performance. Between 2003 and 2007, operating revenues grew annually by an average of 6.6%, and Swedish's operating margin swung within a relatively narrow ban between 2.1% and 3.3%. Operating cashflow for the period averaged 9.8%. FY 2009 was a departure from this trend. Despite strong performance the first three quarters of FY 2008 (during which Swedish achieved nearly an 11% operating cashflow margin), overall performance for the year was down, driven by weak operating results in each of the last three months of the year. Most significantly, Swedish experienced very material operating losses in December, cutting its total operating income for the year nearly in half. The primary driver of poor performance in December was the occurrence of unusually severe weather. Due to snow and storm conditions, overall retail performance in the region was down significantly. At Swedish, volumes were impacted for approximately ten days, and payer mix shifted somewhat towards self pay, Medicaid, and Medicare. Despite reduced volumes, expenses were actually up due to emergency staffing requirements, exceptional overtime use, and utilization of temporary labor.

Performance in FY 2009 improved significantly and beat the historical averages, despite initial modest expectations. Operating income improved to $42.8 million (3.1% margin) from $16.7 million (1.3% margin) in FY 2008 and operating cashflow improved to $154.4 million (11.2% margin) from $113.4 million (9.0% margin). The improvement was achieved despite a drop in inpatient admissions, and despite increased overhead relating to the newly opened orthopedic facility, increased pension expense, and increased labor costs. Profitability enhancements included a reduction in force equal to 200 non-clinical FTEs (implemented in early February), the rationalization of consulting costs, and the reduction of leased space. Also, while inpatient admission dropped, adjusted admissions remained flat, indicating a partial migration of the business model toward increased outpatient activity. We view favorably management's ability to quickly address operating problems, and consider this to be a strong credit positive.

Year to date (through 8 months ended August 3, 2010, based on unaudited interim financial statements) Swedish is on track to match FY 2009's strong performance, with operating cashflow forecasted to reach levels similar to last year. Looking forward, in addition to the challenges cited above associated with operating a large number of new facilities, there is a significant labor contract to be renewed in 2011 which will have material bearing on the organization's future performance. Over 50% of Swedish's workforce is unionized, and while negotiations may be extensive, there is no history of work stoppages or strikes at Swedish.

BALANCE SHEET POSITION: CASH POSITION HAS IMPROVED; POSSIBLE FUTURE DEBT, AND CURRENT INDIRECT DEBT, STRESS BALANCE SHEET RATIOS

Swedish's cash balances have improved significantly since FYE 2008. Due to strong cashflow generation, favorable investment markets, and reduced capital spending, cash on hand improved to 167 days as FYE 2009, from a much weaker 105 days at FYE 2008. Year to date, cash balances remain strong. As of August 31, 2010 (per unaudited interim financial statement), liquidity remained at 166 days. The Series 2010 bonds will include $60 million of new money, a portion of which will refinance $21.2 million drawn on a line of credit, with remainder going back on Swedish's balance sheet as reimbursement. Proforma post financing, Swedish's balance of cash on hand is 177 days. Approximately 60% of Swedish's assets are allocated to equities, with the remaining 40% allocated to highly rated fixed income instruments and cash. Swedish's investments are highly liquid, with essentially all of its assets available within 30 days. While approximately 40% of Swedish debt is demand debt, Swedish's ratio of monthly cash to demand debt is good at 231%.

With the issuance of the Series 2010 bonds, Swedish remains fairly leveraged, with debt measures that are fair to somewhat weak for the A2 category. Based on FY 2009 results, and incorporating the Series 2010 bonds, Swedish measures cash to debt of 99% (A2 median is 132%), adjusted maximum annual debt service coverage of 5.0 (A2 median is 5.0), debt to operating revenue of 45.9% (A2 median in 33.8%), and debt to cashflow of 3.7 (A2 median is 3.2). Significantly, a possible debt issuance as early as first quarter 2011 in support of the Issaquah project could increase debt by as much as an additional $190 million. This would place material additional stress on Swedish's balance sheet measures. Timing of the issuance, structure of the issuance, the ultimate size of the issuance, and the state of Swedish's balance sheet and operating performance at that time, will all have influence on the ultimate credit implications of additional debt.

Perhaps most significantly, Swedish also has significant exposure to a large amount of indirect debt. Swedish currently has a large pension liability, which stands at approximately $200 million as of FYE 2009, and equates to a funded ratio of 66%. The organization plans to contribute approximately $40 million to the pension in FY 2011. Currently, the pension plan is frozen for all but unionized employees. Additionally, Swedish is party to a large number of non-cancellable operating leases. As of FYE 2009, the debt equivalent of Swedish's non-cancellable operating lease obligations was $175 million (based on a multiplier of 6 times current lease expense). Including the operating leases as debt, debt measures become significantly more stressed, with cash to debt dropping to 78%, and debt to cashflow jumping to 4.3 times. Due to a number of 3rd party financed projects currently in process, Swedish's lease obligations are expected to further increase in FY 2010 and 2011.

Outlook

The stable outlook reflects our belief that Swedish will continue to produce strong operating cashflow, and grow its current market position, without taking on more debt than is supportable by current level of operations

What could change the rating--UP

Significant organizational growth; sustained operating improvement; improved balance sheet measures

What could change the rating--DOWN

Deterioration of cash balances; increase in debt beyond what is compatible with the current rating level; increase in put risk or exposure to unfavorable LOC covenants; inability to sustain operating improvements

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for Swedish Health Services

-First number reflects Audit year ended December 31, 2009

-Second number reflects proforma on 8-month unaudited, management-prepared financial statements ended August 31, 2010, annualized; includes impact of the issuance of the Series 2010 bonds, including $38.8 million of net additional debt, and $38.8 million of reimbursement, net of repayment of a $21.2 million borrowing under a short term line of credit

-Investment returns normalized at 6% unless otherwise noted

*Inpatient admissions: 40,734; 40,285

*Total operating revenues: $1.38 billion; $1.43 billion

*Moody's-adjusted net revenue available for debt service: $190 million; $193 million

*Total debt outstanding: $564 million; $635 million

*Maximum annual debt service (MADS): $36.6 million; $38.9 million

*MADS Coverage with reported investment income: 4.5 times; 3.9 times

*Moody's-adjusted MADS Coverage with normalized investment income: 5.2 times; 4.9 times

*Debt-to-cash flow: 3.3 times; 3.8 times

*Days cash on hand: 167 days; 172 days

*Cash-to-debt: 101.3%; 95.0%

*Operating margin: 3.1%; 3.0%

*Operating cash flow margin: 11.2%; 10.8%

RATED DEBT

-Series 1998 Fixed Rate Revenue Bonds ($204 million outstanding); rated A2; insured by Ambac - to be refunded by current offering

-Series 2006 Variable Rate Demand Bonds ($100 million outstanding), supported by a direct pay letter of credit from Citibank N.A.; rated A1/VMIG1; A2 underlying rating

-Series 2009A Fixed Rate Revenue Bonds ($100 million outstanding), rated A2

-Series 2009B variable Rate Demand Bonds ($75 million outstanding), supported by a direct pay letter of credit from US Bank N.A., rated Aa1/VMIG1; A2 underlying rating

-Series 2009C variable Rate Demand Bonds ($75 million outstanding), supported by a direct pay letter of credit from US Bank N.A., rated Aa1/VMIG1; A2 underlying rating. Swedish expects to diversify this exposure with another commercial bank beginning December 1, 2010

CONTACTS

Obligor: Jeff Veilleux, Chief Financial Officer, Swedish Health Services, (206) 386-6321

Underwriter: Citigroup Global Markets Inc.; Michael Brown (312) 876-3557

Advisor: Ponder & Co.; Jennifer Daugherty, (206) 331-2364; Glenn Wagner (615) 690-5541

The last rating action with respect to Swedish Health Services was on March 2, 2009, when an initial municipal finance scale rating of A2 was assigned and the outlook was stable. That rating was subsequently recalibrated to A2 on May 7, 2010.

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, public information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of assigning 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

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

Daniel Steingart
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 ASSIGNS A2 RATINGS TO SWEDISH HEALTH SERVICES (WA) SERIES 2010 BONDS; A2 RATINGS ON PARITY DEBT AFFIRMED; OUTLOOK IS STABLE
No Related Data.
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