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Rating Update:

MOODY'S DOWNGRADES THE RATINGS ASSIGNED TO LOMA LINDA UNIVERSITY MEDICAL CENTER'S (CA) REVENUE BONDS TO Baa3 FROM Baa2; OUTLOOK IS STABLE AT THE NEW RATING LEVEL

25 May 2011

ACTION AFFECTS APPROXIMATELY $362 MILLION OF RATED DEBT

Loma Linda (City of) CA
Health Care-Hospital
CA

Opinion

NEW YORK, May 25, 2011 -- Moody's Investors Service has downgraded the ratings assigned to Loma Linda University Medical Center's (LLUMC) revenue bonds to Baa3 from Baa2, affecting approximately $362 million of rated debt (see list at the conclusion of this report). The outlook is stable at the new rating level.

SUMMARY RATING RATIONALE: The downgrade of the rating to Baa3 from Baa2 reflects: the return to poor operating performance in fiscal year (FY) 2010; ongoing economic pressures in the Inland Empire; and the failure of the organization to improve cash balances despite an unbudgeted gain under the California State provider fee program in FY 2010. The assignment of the stable outlook at the new rating level reflects the medical center's strong ties to Loma Linda University, the medical center's strong market position within San Bernardino county, and the stability that we believe is achieved through the organization's size, breadth of clinical offerings, and reputation.

CHALLENGES

*Variable operating performance; results in FY 2010 (per unaudited statements) show significant stress, with operating margins (excluding the California State provider fee) dropping to -2.7% from 2.1% in FY 2009, and operating cashflow margins dropping to 3.9% from 8.6%; results for the last quarter of FY 2010 and the first four-months of FY 2011 show significant improvement

*Significant leverage; direct debt is high totaling $521 million at fiscal year end (FYE) 2010; in FY 2010, debt to cash flow was an unfavorably high 14.7 times; maximum annual debt service coverage was a weak 1.2 times, and cash to debt was 45%; inclusive of very significant non-cancelable operating leases equal to $253 million on a net present value basis, cash to debt drops further to a very low 31% at fiscal FYE 2010

*Modest liquidity despite an unbudgeted gain under the California State provider tax program in FY 2010, with unrestricted cash and investments of $236 million at FYE 2010, equal to 82 days cash on hand; an unusually high percentage of investments are invested in alternative vehicles, including trust deeds and triple net leases; altogether, a total of 29% of unrestricted cash and investments is invested in illiquid non-marketable securities (however, LLUMC's interest in the these investment pools is unitized and is believed to be accessible in a relatively short amount of time)

*Unfavorable payer mix, with high exposure to Medi-Cal (34.5% of gross revenues) related to LLUMC's children's hospital; strong reliance on supplemental funds

*Ambitious strategic agenda with a large number of projects rolling out simultaneously; new initiatives include an ambulatory surgery center in Beaumont, opened in early 2010; and a new 106-bed hospital in Murrieta, opened less than one month ago

*Routine, sizable transfers to affiliates (to support the academic physician group, among other purposes) perpetuates slow liquidity growth and dilutes MADS coverage

STRENGTHS

*High level of integration with A2-rated Loma Linda University

*Provider of clinical excellence with a focus on high-end services; LLUMC is the only academic medical center and the only Children's Hospital in the Inland Empire; exclusive services include Level I trauma, Level 3 NICU, proton treatment for cancer, and certain specialized transplant services; rated highest quality provider in its primary and secondary service areas

*Significant beneficiary under the California State provider fee program, resulting in a net benefit of $85 million in FY 2010; program has been extended for an additional six months, which will net LLUMC another $44 million through June 30, 2011; a proposed additional extension for State Fiscal Year 2012 (starting July 1, 2011) may result in additional revenues for LLUMC in FY 2011 and FY 2012 estimated at $82 million

DETAILED CREDIT DISCUSSION

LEGAL SECURITY: The bonds are secured by a security interest in the gross revenues of the Medical Center (the sole member of the Obligated Group), and by a deed of trust on mortgaged premises, including the Medical Center's leasehold interest in the leased land and the hospital buildings as well as certain owned land and facilities. There is an additional bonds test, with coverage including existing and proposed indebtedness of greater than 1.1 times or actual coverage of 1.2 times for the most recent fiscal year. (The calculation of revenues available for debt service under the bond documents excludes transfers to affiliates.) Additionally, there is a rate covenant that requires 1.1 times debt service coverage, a minimum liquidity requirement of 60 days cash on hand (measured biannually), and a limitation on disposition of assets and cash transfers.

Although LLUMC is independent of A2-rated Loma Linda University (LLU), an educational health-sciences institution with 3,000 students, and bondholders have no legal recourse to LLU's revenues and assets, we believe LLUMC and the University maintain very strong ties with closely aligned strategic goals. Both LLU and the Medical Center are separate and distinct entities under the common control of Loma Linda University Adventist Health Sciences Center (LLUAHSC - which is the sole corporate member of both LLU and LLUMC) and there is significant governance and management overlap. The three boards have many members in common, and the president and CFO of LLUAHSC also serve as president and CFO of LLU and LLUMC. We believe ties are particularly strong given the organizations' association with the Seventh-day Adventist Church, whose mission permeates the culture of both institutions.

INTEREST RATE DERIVATIVES: LLUMC is counterparty on two LIBOR-indexed fixed payer swaps with a total notional of $100 million. The swap counterparty is Goldman Sachs Capital Markets. As of FYE 2010, net termination value of the swaps was negative $16.2 million, and LLUMC was posting collateral of approximately $10.9 million.

RECENT DEVELOPMENTS/RESULTS

Over the last several years, LLUMC's operating performance has been highly variable. After producing results in FY 2008 that were well below expectations, LLUMC achieved significant improvements in FY 2009, executing on a sizable turnaround. However, in FY 2010 (per unaudited financial statements), operating results again deteriorated, dropping to levels that were below those posted in 2008. Altogether, excluding expenses and revenues related to the California state provider fee, operating income dropped to a loss of $28.7 million (equal to an operating margin of -2.7%) in FY 2010, from a gain of $21.8 million in FY 2009 (2.1% margin), and operating cashflow dropped to $41.1 million (3.9% margin) from $90.8 million (8.6% margin). (Moody's makes a number of adjustments to operating income, including: the exclusion of the change in the value of interest rate swaps from operating expense; the inclusion of transfers to affiliates as an operating expense; and the exclusion of investment income from operating revenue).

Given LLUMC's high exposure to MediCal, the impact of the California state provider fee on LLUMC's financial statements is very significant. The program began to be implemented in Fall 2010, and was initially approved for a 21 month period beginning retroactively in April 2009, and ending in December 2010. The fee was imposed, in the last quarter of calendar year 2010. For LLUMC, revenues and expenses relating to the 21-month initial period of the program were booked in their entirety in FY 2010, and resulted in a net gain of $85 million ($35 million of which, however, was not received until the first quarter of FY 2011). Earlier this month, the program was extended for another six month period, through June 30, 2011. The extension is expected to produce an additional $44 million net benefit for LLUMC. Additionally, a further extension has been proposed, which would continue the program into the 2012 state fiscal year, and provide LLUMC with an additional $82 million. Moody's currently excludes both revenues and expenses relating to the program from the calculation of performance measures for all hospitals in the state. Nevertheless, the balance sheet impact of these funds can be material, and in the case of LLUMC, helped the organization avoid significant dilution of its cash balances as of FYE 2010. The six-month extension of the program is expected to further bolster cash balances.

There are a number of additional one-time items that LLUMC reported in FY 2010 which are not excluded from our calculation of operating income and cashflow. The most significant of these were: 1) an $18 million deferral of DSH supplemental funding which LLUMC will recover in FY 2011; and, 2) an additional $10 million transfer to the University on top of the $17 million it routinely transfers. Exclusion of these items from the calculation of operating income improve LLUMC's operating margin and operating cashflow margin to -0.1% and 6.4% respectively. Other drivers of poorer performance in FY 2010 include: a decrease of volumes from well-paying non-contract payers; lower census of elective cases; and reduced throughput in its Proton Treatment Center due to facility improvements and short-term staffing limitations. Additionally, as noted above, operating performance of both the heart and surgical hospital in Loma Linda and the Beaumont ambulatory surgery center were below expectations.

In response to these operating pressures, management contracted with Wellspring and Zero Space Solutions to identify cost saving initiatives, which altogether are expected to produce approximately $32 million of ongoing savings. Initiatives include improved productivity standards resulting in a reduction in worked hours equivalent to 220 FTEs, and improved materials and services costs. Operating performance in the last quarter of FY 2010 and the first quarter of FY 2011 show significant improvement. Also of significance is a reported steep increase in volumes. Through four months of 2011, inpatient volumes are up 10.5% versus the same period the prior year, and up 1.7% compared to the same period of 2009. Even excluding the ongoing positive impact of the provider fee program, management expects results in FY 2011 to show significant improvement, and to be on par with the results achieved in FY 2009, and prior to FY 2008.

Over the last several years, LLUMC has taken on a number of significant strategic initiatives simultaneously, including expansion outside the community of Loma Linda for the first time in its 100+ year history. In 2008, LLUMC took advantage of an opportunity to acquire a newly constructed, physician owned, 28-bed facility that was poised to begin operations in Loma Linda before year end. LLUMC paid $90 million for the facility, including $60 million for the hard capital assets, and approximately $30 million for goodwill. Although the facility had been completed, LLUMC took approximately six months to equip and modify the facility for its purposes and opened the facility in January 2009. The facility has thus far not performed to expectations, generating losses in both FY 2009 and FY 2010.

In early 2010, LLUMC opened a medical office building and ambulatory surgery center in Beaumont (a smaller community approximately 20 miles east of Loma Linda). LLUMC operates the facility jointly with Redlands Community Hospital-affiliated faculty practice plan physicians and the Beaver Medical Group, the largest unaffiliated physician group in the area, consisting of approximately 165 physicians. In FY 2010, LLUMC realized a loss of approximately $1 million on the venture.

Lastly, in Murrieta, California (located approximately 45 miles south of Loma Linda in Riverside County) LLUMC entered into a joint venture to build a 106-bed community hospital. The cost of the hospital was approximately $215 million. The project was built with third party financing and is backed by a non-cancelable operating lease from the joint venture, the majority of which is held by LLUMC. (In the last year, LLUMC's interest in the JV increased to 70% from 45%) As with all of LLUMC's non-cancelable operating leases, Moody's imputes this obligation as debt. The facility opened less than a month ago and has reportedly been very well received by the community. It is expected to generate an operating loss of approximately $20 million in its first 12 months of operation, and break-even over the next 12 months.

An ongoing challenge of the Medical Center is its sizable debt load. In addition to the $362 million of rated tax exempt bond issues, LLUMC is party to approximately $159 million of other miscellaneous debt obligations (comprised of over a dozen notes, and a private placement), for a total of $521 million of direct debt. Debt measures are currently very stressed, with cash to debt measuring 45% at FYE 2010, debt to cashflow measuring a very unfavorable 14.7 times, and Moody's adjusted maximum annual debt service coverage dropping to just 1.2 times.

In addition to the direct debt, LLUMC has a very high amount non-cancelable operating leases totaling nearly $400 million on a nominal basis, the net present value of which (discounted at 6%) is approximately $250 million. Inclusive of these obligations, cash to debt drops further to a very low 31% at fiscal FYE 2010. Year-to-date FY 2011, the nominal value of these leases has dropped by approximately $76 million due to the reduction of the cost of a ground lease with LLUAHSC.

An additional ongoing challenge of LLUMC is its cash position, which has consistently has been below the median for Baa-rated institutions. At FYE 2010 days cash on hand remained unchanged from FYE 2009, at 82 days. With respect to its investment strategy, LLUMC has a relatively aggressive strategy for an organization in its rating category. The majority of the Medical Center's cash is pooled with the University, and invested by the foundation, which invests in a wide variety of investment vehicles including REIT's, direct real estate holdings, trust deeds, private equity, hedge funds and venture capital investments. Inclusive of these fund and of cash held directly by LLUMC, LLUMC's total unrestricted cash and investments has an investment allocation consisting of approximately 39% cash and fixed income, 15% equities, 17% marketable alternatives, and 29% non marketable alternatives. LLUMC's interest in the foundation's investment pools is unitized and is believed to be accessible in a relatively short amount of time. Furthermore, $125 million of these investments is structured to maintain the fund's net asset value at $1 per share, and pays a fixed return.

Outlook

The assignment of the stable outlook at the lower rating level reflects the medical center's strong ties to Loma Linda University, the medical center's strong market position within San Bernardino county, and the stability that we believe is achieved through the organization's size, breadth of clinical offerings, and reputation.

WHAT COULD MAKE THE RATING GO UP

Material growth in liquidity and balance sheet measures; significant improvement in financial performance; successful implementation of its growth strategy, including profitable operation of the Murrieta hospital

WHAT COULD MAKE THE RATING GO DOWN

Ongoing significant operating challenges; further dilution of balance sheet; inability to support and manage capital projects; further increase in debt

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for Loma Linda University Medical Center and Affiliates,

-First number reflects audit year ended December 31, 2009

-Second number reflects unaudited financial statements for year ended December 31, 2010

-Investment returns normalized at 6% unless otherwise noted; transfers to affiliates reclassified as an operating expense; change in the value of interest rate swaps excluded from operating expense; investment income excluded from operating revenue; California State provider fee program excluded from both expenses and revenues

*Inpatient admissions: 31,282; 31,181

*Total operating revenues: $1.1 billion; $1.1 billion

*Moody's-adjusted net revenue available for debt service: $104.2 million; $55.1 million

*Total debt outstanding: $521 million; $521 million

*Maximum annual debt service (MADS): $39.7 million; $45.9 million

*MADS Coverage with reported investment income: 2.5 times; 1.1 times

*Moody's-adjusted MADS Coverage with normalized investment income: 2.6 times; 1.2 times

*Debt-to-cash flow: 6.1 times; 14.7 times

*Days cash on hand: 82 days; 82 days

*Cash-to-debt: 43%; 45%

*Operating margin: 2.1%; -2.7%

*Operating cash flow margin: 8.6%; 3.9%

RATED DEBT

Series 1999A Fixed Rate Bonds ($34.0 million outstanding), insured by Ambac, rated Baa3

Series 2005A Fixed Rate Bonds ($153.1 million outstanding); rated Baa3

Series 2007B1 Variable Rate Demand Bonds ($40 million outstanding); rated Aa3/VMIG1 based on two party pay analysis including a letter of credit from Union Bank of California (expires 12/20/2012); Baa3 underlying rating

Series 2007B2 Variable Rate Demand Bonds ($40 million outstanding); rated Aa1/VMIG1 based on two party pay analysis including a letter of credit from Bank of America, N.A. (expires 12/18/2012); Baa3 underlying rating

Series 2008A Fixed Rate Revenue Bonds ($70 million outstanding); rated Baa2

Series 2008B Variable Rate Demand Bonds ($25 million outstanding); rated Aa1/VMIG1 based on two party pay analysis including letter of credit from Bank of America N.A. (expires 11/13/2011); Baa3 underlying rating

CONTACTS

Issuer: Steven Mohr, Loma Linda University Medical Center, Senior Vice President, Finance, (909) 558-4728

PRINCIPAL METHODOLOGY USED

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, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and

confidential and proprietary Moody's Analytics information.

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

Kimberly S. Tuby
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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MOODY'S DOWNGRADES THE RATINGS ASSIGNED TO LOMA LINDA UNIVERSITY MEDICAL CENTER'S (CA) REVENUE BONDS TO Baa3 FROM Baa2; OUTLOOK IS STABLE AT THE NEW RATING LEVEL
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