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Rating Update:

MOODY'S DOWNGRADES MEMORIAL HEALTH UNIVERSITY MEDICAL CENTER'S (GA) LONG-TERM BOND RATING TO Baa3 FROM Baa2; OUTLOOK STABLE AT THE LOWER RATING LEVEL

09 Sep 2010

AFFECTS APPROXIMATELY $194 MILLION OF RATED DEBT OUTSTANDING

Chatham County Hospital Authority, GA
Health Care-Hospital
GA

Opinion

NEW YORK, Sep 9, 2010 -- Moody's Investors Service has downgraded Memorial Health University Medical Center's (MHUMC) long-term bond ratings to Baa3 from Baa2. The downgrade reflects MHUMC's weaker operating performance in fiscal year (FY) 2009 and through six months FY 2010, after Moody's had expected improved results when we affirmed MHUMC's Baa2 rating and revised the outlook to stable in February 2009. The action affects approximately $194 million of rated debt issued through the Chatham County Hospital Authority (see Rated Debt section at the end of this report). The outlook remains stable at the lower rating level. This analysis reflects the financial performance of Memorial Health, Inc. and Affiliates (System). MHUMC represents approximately 90% of System assets and 87% of System operating revenues.

RATINGS RATIONALE

LEGAL SECURITY: The bonds are secured by a revenue pledge of Memorial Health Inc. (parent) and Memorial Health University Medical Center (the hospital), the latter of which cannot exit the obligated group so long as bonds are outstanding.

INTEREST RATE DERIVATIVES: None.

CHALLENGES

*Reversion to weaker operating performance in FY 2009 (2.7% operating cash flow margin); challenges continue through six months FY 2010 (2.1% operating cash flow margin)

*Weak Moody's adjusted debt ratios at the Baa3 rating level (17.4 times debt-to-cash flow, 1.2 times peak debt service coverage)

*According to management, Medicaid represents a high 18.6% of gross revenues and management notes that MHUMC's payer mix has deteriorated due to the economic recession

*Continued modest liquidity ratios with 81 days cash on hand at fiscal year end (FYE) 2009

*Very modest capital spending in recent years as MHUMC's capital spending ratio averaged below 0.4 times between FY 2007 and FY 2009

*Significant reliance on special funding sources such as Indigent Care Trust Fund (ICTF, Georgia's disproportionate share program) and Upper Payment Limit (UPL); while these funding sources indicate significant public policy support for MHUMC, we consider these revenues to be at-risk

*Recent management turnover in the past three years, including the CEO and multiple changes in the CFO post; we note that this indicates the board is willing and able to execute senior management changes in the face of challenging operating performance

STRENGTHS

*Large academic medical center (AMC) with a broad 12 county total service area covering two states

*Generally good demographic characteristics in the broad service area

*Virtually all debt is in fixed rate mode and MHUMC has a defined contribution pension plan, collectively which help to minimize balance sheet risk

RECENT DEVELOPMENTS/RESULTS

The downgrade of MHUMC's rating to Baa3 reflects the System's reversion to weaker operating performance in FY 2009 and through six months FY 2010, after we had expected performance to improve in FY 2009 and beyond. In audited FY 2009 (December 31 year end), the System recorded an operating loss of $24.4 million (-4.3% operating margin) and operating cash flow of $15.2 million (2.7% operating cash flow margin). In audited FY 2008, the System recorded an operating loss of $21.3 million (-3.7% margin) and operating cash flow of $21.0 million (3.7% margin). The System's operating margins have been challenged and consistently weaker than Baa2 medians Since FY 2006. In fact, the affirmation of the Baa2 rating and change in outlook to stable from negative in February 2009 factored the System's materially improved, although still modest, performance in FY 2008 over FY 2007 (when the System recorded and operating margin of -11.1% and -2.7% operating cash flow margin) and our expectation of continued improvement in FY 2009. Challenges continue in interim FY 2010. Through six months FY 2010, the System has recorded -4.7% operating margin and 2.1% operating cash flow margin, compared to -2.9% and 4.0%, respectively, for the same period FY 2009.

Management attributes the weak operating margins to a number of factors, including: (a) increased losses by the System's employed physician practice that helped to offset improved bottom line results at the hospital (between FY 2008 and FY 2009, MHUMC's operating income improved from a loss of $6.6 million to a gain of $3.7 million); payer mix challenges due to the economic recession; and a 0.9% decrease in total surgical volumes through six months FY 2010. To this latter point, we note that MHUMC generally is not facing declining volumes, as surgical volumes increased 3.1% in FY 2009 and inpatient admissions increased 5.3% in FY 2009 (and are up a modest 0.3% through six months FY 2010). Management notes that MHUMC met its financial covenants in FY 2009.

Looking forward, Memorial management has projected a baseline operating margin for the System of -3.8% for full year FY 2010 and -1.8% for full year FY 2011 (adjusted to reclassify philanthropy from operating to non-operating revenue). We note, however, that management has identified $12.9 million of 2010 cost savings and has projected a revised operating margin of -2.9% for FY 2010. Key improvement initiatives that have been implemented or identified include: (a) better flexing of staffing levels to volumes; (b) staff reductions, largely through attrition; (c) improved physician practice collect efforts; (d) reduced average length of stay; (e) supply expense savings, including a joint-contracting effort with MHUMC's in-town competitor Baa1-rated St. Joseph's/Candler Health System (SJ/C); and (f) updated contracts with the System's employed physicians that are expected to result in significant savings. Additionally, management is working to improve the System's payer mix, specifically by expanding profitable service lines (such as cancer and neurosurgery) and broadening beyond the City of Savannah MHUMC's already extensive service area where the payer mix tends to be more favorable.

The System's liquidity position is somewhat modest although adequate at the Baa3 rating level. At audited FYE 2009 absolute unrestricted cash and investments measured $124 million, translating to 81 days cash on hand (Baa3 median is 92 days) and 59% cash-to-debt (Baa3 median is 76%). At June 30, 2010, absolute unrestricted liquidity increased modestly to $127 million, translating to 82 days cash on hand and 61% cash-to-debt. According to management, at FYE 2009 the System's unrestricted liquidity is invested among approximately 54% cash and fixed income securities, 27% equities, and 19% alternative and other investments, and approximately 87% of liquidity can be liquidated within one month.

The System's Moody's-adjusted debt ratios remain stressed, which is a key credit concern. Based on FY 2009 results, the system's adjusted debt-to-cash flow measured a very high 17.4 times (Baa3 median is 5.5 times) and adjusted maximum annual debt service (MADS) coverage measured a thin 1.2 times (Baa3 median is 2.4 times). Debt-to-total operating revenue is manageable at 38% (Baa3 median is 36%).

The Savannah market remains competitive between Memorial and SJ/C. The primary service area (PSA) covers Chatham, Bryan, and Effingham counties in Georgia. Based on data previously provided by Memorial System management, SJ/C had been increasing its market share of the PSA, and as recently as 2007 SJ/C captured approximately 49% share compared to MHUMC's 46%. According to Memorial management, market share trends have started to stabilize, and as of the first quarter of 2010 MHUMC captured a 47.2% share of the PSA compared to SJ/C's 47.5%. Despite the competitive nature of the market, Moody's believes the Savannah area can sustain two viable acute care healthcare systems. According to the US Census Bureau, population growth in all three PSA counties exceeds the national average (and has been particularly strong in Bryan and Effingham counties), and the median household income levels in Bryan and Effingham counties exceed the state and national averages.

The Memorial System's capital spending has been modest in recent years as management has focused on improving operating performance (the capital spending ratio averaged less than 0.4 times between FY 2007 and FY 2009). Management is considering the construction of a new children's hospital, to be built in existing shelled space. The project is estimated to cost approximately $25 million and management hopes to fund through fundraising. Management has applied for a certificate of need (CON) for the project. Upon completion of the children's hospital, management expects to reconfigure existing pediatric space for adult operating room capacity. Management does not have new money debt plans in the coming years.

Outlook

The stable outlook at the lower rating level reflects our expectation that the System will maintain its adequate liquidity position and begin to stabilize operating performance - albeit at potentially more modest margins than what the System had recorded prior to FY 2006.

What could change the rating -- UP

Sustained material operating improvement leading to significantly stronger debt ratios; material market share gain; improved liquidity ratios

What could change the rating -- DOWN

Continued weakening of operating performance leading to maintenance of weak debt ratios; declining patient volumes and market share loss; weaker liquidity ratios; unexpected increase in debt without commensurate increase in cash and cash flow generation

KEY INDICATORS

Assumptions & Adjustments:

-Based on Memorial Health, Inc. and Affiliates consolidated financial statements

-First number reflects audited FY 2008 for the year ended December 31, 2008

-Second number reflects audited FY 2009 for the year ended December 31, 2009

-Investment returns smoothed at 6%

*Inpatient admissions: 24,501; 25,793

*Total operating revenues: $572 million; $563 million (management notes that the decline in absolute operating revenue is due to reclassifying approximately $21 million of bad debt expense to self-pay contractual)

*Moody's-adjusted net revenues available for debt service: $30.1 million; $24.1 million

*Total debt outstanding: $220 million; $212 million

*Maximum annual debt service (MADS): $20.1 million; $20.2 million

*MADS Coverage with reported investment income: 0.30 times; 1.07 times

*Moody's-adjusted MADS Coverage with normalized investment income: 1.50 times; 1.19 times

*Debt-to-cash flow: 12.48 times; 17.42 times

*Days cash on hand: 78.3 days; 80.9 days

*Cash-to-debt: 55.0%; 58.5%

*Operating margin: -3.7%; -4.3%

*Operating cash flow margin: 3.7%; 2.7%

RATED DEBT

Issued by the Chatham County Hospital Authority, GA (debt outstanding as of December 31, 2009):

-Series 1996A Fixed Rate Hospital Revenue Bonds ($100.6 million outstanding), insured by Ambac, rated Baa3

-Series 2001A Fixed Rate Hospital Revenue Bonds ($44.0 million outstanding), rated Baa3

-Series 2004A Fixed Rate Hospital Revenue Bonds ($49.7 million outstanding), rated Baa3

CONTACTS

Obligor: Darcy Davis, Senior Vice President and CFO, (912) 350-8443

The last rating action with respect to MHUMC was on February 10, 2009, when a Baa2 municipal finance scale rating was affirmed and the outlook was revised to stable from negative. That rating was subsequently recalibrated to Baa2 on May 7, 2010.

The principal methodology used in rating MHUMC was Moody's Rating Methodology: Not-For-Profit Hospitals and Health Systems, published in January 2008, and available on www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not 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

Mark Pascaris
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


Moody's Investors Service
250 Greenwich Street
New York, NY 10007
USA

MOODY'S DOWNGRADES MEMORIAL HEALTH UNIVERSITY MEDICAL CENTER'S (GA) LONG-TERM BOND RATING TO Baa3 FROM Baa2; OUTLOOK STABLE AT THE LOWER RATING LEVEL
No Related Data.
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