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Rating Update:

MOODY'S DOWNGRADES TO Baa3 FROM Baa2 THE RATINGS ON ST. VINCENT HEALTH CENTER'S (PA) BONDS; RATINGS REMOVED FROM WATCHLIST; OUTLOOK IS NEGATIVE

14 Mar 2011

HOSPITAL HAS $90.1 MILLION OF OUTSTANDING RATED DEBT

Erie County Hospital Authority, PA
Health Care-Hospital
PA

Opinion

NEW YORK, Mar 14, 2011 -- Moody's Investors Service has downgraded to Baa3 from Baa2 the long-term and underlying ratings assigned to St. Vincent Hospital d/b/a St. Vincent Health Center (SVHC), the primary operating entity of St. Vincent Health System (SVHS), affecting $90.1 million of outstanding rated debt issued by the Erie County Hospital Authority, Pennsylvania (see RATED DEBT section at end of report). At this time we are removing the rating from Watchlist. The rating outlook remains negative at the lower rating level.

RATINGS RATIONALE:

The downgrade of the rating to Baa3 from Baa2 assigned to St. Vincent Health Center's outstanding debt reflects a decline in operating performance resulting in weakened leverage, thin balance sheet measures, and limited headroom to the 80 days cash on hand covenant. This departure in performance occurs at a time of increased competition from Hamot Health, which has become a member of University of Pittsburgh Medical Center's Health System (UPMC), and following significant changes to senior management. The negative rating outlook reflects our belief that SVHS' pension underfunding, increased bad debt expense, and significant capital plans further stress cash flow and balance sheet liquidity, heightening letter of credit (LOC) bank risk, which is concentrated with M&T Bank (currently rated A2 / P-1 on Watchlist for downgrade), as SVHS has limited flexibility to repay a material amount of debt if M&T Bank's rating is lowered and if the bonds backed by M&T letters of credit are tendered resulting in accelerated amortization of the debt.

LEGAL SECURITY: SVHC is the primary entity of SVHS, representing approximately 83% of consolidated system assets. SVHC is presently the only member of the Obligated Group. The obligated group covenants under the LOC agreement are: (a) minimum 80 days cash on hand measured semi-annually; (b) 66% debt to capitalization measured at fiscal yearend (FYE); and (c) 1.15 debt service coverage measured each fiscal quarter.

INTEREST RATE DERIVATIVES: SVHC currently has two swaps in place. The first swap is a cash flow swap (variable to fixed) in the notional amount of $29.3 million with Morgan Stanley as the counterparty. SVHC pays a fixed rate of 3.725% and receives a variable rate of 67% of one month LIBOR plus fifty basis points. The second swap dated as of November 1, 2010 is a forward starting swap effective May 1, 2011 in the notional amount of $17.0 million with PNC Bank as the counterparty. SVHC pays a fixed rate of 2.135% and receives variable rate of 67% of one month LIBOR.

CHALLENGES

*Weakened operating performance, following over five years of inconsistent results, with a $6.5 million operating loss (-2.0% margin) and nominal $10.8 million operating cash flow margin (3.3% operating cash flow margin) in fiscal year (FY) 2010 compared with a $2.0 million operating profit (0.6% margin) and already weak $17.5 million operating cash flow (5.6% operating cash flow margin) in FY 2009; losses continue through six months of FY 2011

*Vulnerability to variable rate demand debt; with thin balance sheet measures of 88 days cash on hand (Baa2 median is 102 days cash on hand) and 59.6% cash to debt (Baa2 median is 59.6%) at FYE 2010 based on the system audited financials and 74 days cash on hand and 55% cash to debt at December 31, 2010 based on unaudited system financials; management reports days cash on hand ratio is in compliance to the minimum 80 days cash on hand covenant required under the LOC agreement measured semi-annually at SVHC (99 days cash on hand at FYE 2010 based on SVHC audited financials and 91 days cash on hand calculated at December 31, 2010 based on SVHC unaudited financials); however, exposure to M&T Bank, in light of SVHS' key credit weaknesses of modest balance sheet resources and an above average debt load, is a primary driver of the maintenance of a negative rating outlook at the lower rating level as the repayment of a material amount of debt could be accelerated if M&T's rating is lowered and if the bonds backed by M&T letters of credit are tendered and cannot be remarketed

*Leveraged debt profile with 11.5 times debt-to-cash flow (Baa2 median is 4.8 times) and 60% cash to debt (Baa2 median is 60%); increased credit risk due to SVHS' 62% VRDB debt structure and swap exposure

*Investments in physicians continues to dilute operating performance given losses in the physician practices

*Escalating competition in the Erie, PA market following the acquisition of Hamot Health (Baa1 on watchlist for upgrade) by Aa3-rated UPMC; UPMC Hamot's 2011 opening of a new Women's Hospital as well as the transition of two of SVHS' obstetrics/gynecology group practices to UPMC Hamot as of January 2011 further indicates the increased level of competition in the market

*Modest service area demographics as indicated by SVHS' high 14% reliance on Medicaid (national median is 11%) and 4% self pay; aging population with expectations of stable to declining population growth

*High average age of plant (14 years) and 1.0 times capital spending (for the last five years) indicate that capital needs could be imminent; although SVHS is undertaking an infill project that will materially increase capital spending in FY 2012 funded from cash flow and existing debt proceeds, resulting in further pressure on performance results

STRENGTHS

*SVHS maintains substantial market position with 46% market share in a fifteen county primary service area (PSA), although UPMC Hamot Health maintains near equal market share in the PSA in FY 2010; SVHS maintains leading market share in cardiovascular and surgical oncology; acquisition of a 12 cardiologist practice in December 2010 and exclusive arrangement with neurosurgery practice in November 2010 is expected to improve cardiology and neurosurgery market share in the PSA

*Sizeable organization with over 17,000 admissions, wide breadth of clinical services (Medicare Case Mix Index of 1.73) and year-over-year volume growth with 3% inpatient admissions growth and outpatient surgeries growth 4% in FY 2010; although management estimates the transition of its obstetrics/gynecology groups to UPMC Hamot to result in a loss of 5,600 inpatient and outpatient cases annually

*SVHS maintains a large employed physician group with 103 physicians, including 35 primary care physicians and 68 specialists, and family medicine, sports medicine and colo-rectal residency program

*Defined benefit pension plan frozen as of FYE 2010 and replaced with a cash balance plan; although pension was only 56% funded ($55.2 million underfunded on a projected benefit obligation basis) following the decrease of the discount rate to 5.4% at FYE 2010 from 6.2% at FYE 2009

*A new management team has presented actionable steps to effectuate a turnaround plan in the short-term and implement longer-term strategies to grow strategic service lines and further align with physicians

*The new medical assistance modernization reimbursements in PA in FY 2011 will begin to be distributed in April, prior to the collection of any Quality Assessment payments from the hospitals, and the additional reimbursement amounts will be retroactive back to July 1, 2010; the net impact for SVHS is estimated to be over $5 million, the recognition of these funds should afford the system the ability to meet reforecasted FY 2011 performance

RECENT DEVELOPMENTS/RESULTS

The downgrade to Baa3 from Baa2 reflects a downturn in the SVHS' operating performance following several years of inconsistent and weak results. In FY 2010, SVHS' operating income declined to a material $6.5 million operating loss (-2.0% margin) down from a $2.0 million operating gain (0.6% margin). Operating cash flow weakened to $10.8 million (3.3% operating cash flow margin) from a higher, but still modest, $17.5 million (5.6% operating cash flow margin) in FY 2009. The weakened performance in FY 2010 is driven, in part, by increased employed physician group losses, increased pension funding, and increased bad debt expense (29% growth in FY 2010). SVHS maintains a compliment of 363 active physicians, employing 35 primary care physicians and 68 specialists. Management estimates its physician losses to average approximately $183,000 per employed physician. Furthermore, SVHS' pension expense grew to $9.8 million in FY 2010 from $5.1 million in FY 2009 resulting in an unexpected $4.7 million expense in FY 2010. As of June 30, 2010, SVHS implemented a soft freeze of its defined benefit pension plan and converted to a cash balance plan which will reduce pension funding concerns over time. Management expects to fund the pension plan over the next fifteen years. The weakened performance in FY 2010 is also due in part to SVHS' bad debt expense increase of $5.1 million due to overall economic conditions within the PSA.

Through six months of FY 2011, performance continues to be challenged as indicated by a $4.2 million operating loss (-2.5% operating margin) and just $4.3 million operating cash flow (2.6% operating cash flow margin) compared with the same period the prior year which reported a $2.8 million operating loss (-1.8% operating margin) and $5.2 million operating cash flow (3.3% operating cash flow margin).

As of January 2011, SVHS management has implemented a turnaround action plan in an effort to improve performance and reduce the impact of the transitioning physician groups by focusing on reducing losses and undertaking revenue cycle initiatives. Management estimates these efforts to have a $12.3 million impact on performance annually and a $52.3 million impact on performance over five years. SVHS' reforecasted FY 2011 performance projects reflects improved performance resulting in an operating gain of $1.3 million (0.4% margin) and operating cash flow to increase to $17.8 million (5.3% operating cash flow margin) driven by the execution of the turnaround action plan and the expectation of the receipt of net $5.8 million annually over the next three years from Pennsylvania's Medicaid Provider Tax program beginning in FY 2011.

Despite weakened performance, 425-bed SVHS maintains a solid 46% market share in its PSA of Erie County and fifteen surrounding counties in Northwestern Pennsylvania and Western New York largely due to its regional referral center status and tertiary service offerings. SVHS holds near equal market share to competitor 351-bed UPMC Hamot Health. It is our observation that the recent acquisition of Hamot by UPMC has increased the competitive landscape in SVHS' PSA and will likely intensify as UPMC Hamot opens its Women's Hospital offering a broad range of women's health services including heart health, orthopedics, neuroscience and psychology.

Despite financial challenges, admissions growth over the last three years has been healthy relative to national experience, supporting solid market share. In FY 2010, inpatient admissions grew 3% to 17,856 from 17,259 in FY 2009 driven by increased medical, surgical and behavioral health cases. Also, observation stays grew 12% to 4,191 from 3,727 over the same period. Outpatient surgeries also grew 4% in FY 2010 increasing to 11,642 from 11,235 in FY 2009. Through six months of FY 2011, admissions grew another 3% to 8,538 from 8,304. SVHS does cede outmigration to larger quaternary care providers in Cleveland, Pittsburgh and Buffalo for complex services and is challenged to retain medical staff due to the draw to the larger metropolitan areas. We have observed a great amount of physician fluidity in this market with recent pressure owing to two of SVHS' obstetrics and gynecology group practices transitioning over to UPMC Hamot in January 2011; this transition is not reflected in SVHS' six month FY 2011 volume results.

During first quarter of FY 2011, SVHS experienced significant changes to senior management following the departure of the Chief Financial Officer (CFO) in October 2010 and the subsequent retirement of the Chief Executive Officer (CEO). SVHS has appointed a new CEO, who came to the system in August 2010. There is an interim CFO for the system and there is an executive search underway for a new permanent CFO. In addition, SVHS has a new Chief Operating Officer (COO) as of January 2011 who came from within the system.

Absolute unrestricted cash and investments at the system level declined to a weak $70.6 million (74 days cash on hand) at December 31, 2010 from an already modest $75.9 million (88 days cash on hand) at FYE 2010. As a result, cash-to-debt declined to 55.4% at December 31, 2010 from 59.6% at FYE 2010. The cash decline at December 31, 2010 is largely due to increased days in accounts receivable and ongoing operating losses; although 100% of cash is available within one month. SVHS' decline in cash stresses already thin headroom to its 80 days cash on hand covenant measured based on the SVHC's unrestricted cash semi-annually (days cash on hand for SVHC was 91 days at December 31, 2010 down from 99 days cash on hand at FYE 2010 both calculated per the covenant which excludes bad debt expense). The limited headroom under covenants is exacerbated by bank risk related to SVHS' LOC provider, M&T bank, (see discussion above). Further pressuring liquidity, management projects to spend $11.0 million on capital in FY 2011 and for that number to increase to $32.0 million in FY 2012 during the construction of the infill project, $15.0 million in FY 2013 and $18.8 million in FY 2014. Completion of the infill project, expected in fall of calendar year 2013, will result in increased operating room and emergency department capacity and improved throughput at the hospital. The infill project is anticipated to be funded from SVHS cashflows and existing bond proceeds and is estimated to have a $2.4 million positive impact on margins once completed. Following the infill project, management has no further major capital plans or plans to issue additional debt in the future at this time.

Moody's views the 62% variable rate debt structure as a credit risk; cash to demand debt is 81.4% while monthly liquidity to demand debt is 81.4%. Furthermore, leverage measures have also weakened as indicated by 11.5 times debt-to-cash flow, 60% cash to debt and 1.8 times Moody's adjusted maximum annual debt service (MADS) coverage in FY 2010.

Outlook

The negative rating outlook reflects our belief that SVHS' pension underfunding, increased bad debt expense, and significant capital plans further stress cash flow and balance sheet liquidity heightening letter of credit (LOC) bank risk, which is concentrated with M&T Bank (currently rated A2 / P-1 on Watchlist for downgrade), as SVHS has limited flexibility to repay a material amount of debt if M&T Bank's rating is lowered and if the bonds backed by M&T letters of credit are tendered resulting in accelerated amortization of the debt.

What could change the rating--UP

Sustained and material operating improvement resulting in strengthened liquidity and debt measures; ability to address capital needs without diluting already thin balance sheet measures

What could change the rating--DOWN

A weaker financial trajectory or further cash decline; additional debt without commensurate increase in cash flow and liquidity growth; material market share and volume loss

KEY INDICATORS

Assumptions & Adjustments:

-Based on audited financial statements for Saint Vincent Health System and Subsidiaries

-First number reflects audit year ended June 30, 2009

- Second number reflects audit year ended June 30, 2010

-Investment returns normalized at 6% unless otherwise noted

*Inpatient admissions: 17,259; 17,856

*Total operating revenues: $312.6 million; $322.8 million

*Moody's-adjusted net revenue available for debt service: $22.0 million; $15.3 million

*Total debt outstanding: $99.1 million; $127.4 million

*Maximum annual debt service (MADS): $6.9 million; $8.6 million

*MADS Coverage based on reported investment income: 2.7 times; 1.6 times

*Moody's-adjusted MADS Coverage: 3.2 times; 1.8 times

*Debt-to-cash flow: 5.3 times; 11.5 times

*Days cash on hand: 92 days; 88 days

*Cash-to-debt: 75.8%; 59.6%

*Operating margin: 0.6%; -2.0%

*Operating cash flow margin: 5.6%; 3.3%

RATED DEBT (as of June 30, 2010)

- Series 2009 fixed rate ($12.9 million), Baa2 rated

- Series 2010A fixed rate ($21.0 million), Baa2 rated

- Series 2010B variable rate demand bonds ($56.1 million), Baa2 underlying; Letter of Credit from M&T bank (expiring 1/13/2013)

CONTACTS

Obligor: Mr. Ray Snead, interim Chief Financial Officer, SVHS (814) 452-5132

Financial Advisor: Ms. Terri Wareham, Managing Director, Kaufman, Hall & Associates, (847) 441-8780

The last rating action with respect to SVHS was on December 7, 2010, when the Baa2 rating was placed on watchlist for a potential downgrade.

RATING METHODOLOGY:

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

Nyisha Hohn
Analyst
Public Finance Group
Moody's Investors Service

Beth I. Wexler
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 DOWNGRADES TO Baa3 FROM Baa2 THE RATINGS ON ST. VINCENT HEALTH CENTER'S (PA) BONDS; RATINGS REMOVED FROM WATCHLIST; OUTLOOK IS NEGATIVE
No Related Data.
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