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Rating Update:

MOODY'S UPGRADES METHODIST HOSPITALS OF DALLAS' (TX) BOND RATING TO Aa3 FROM A1; OUTLOOK IS STABLE

09 Dec 2010

METHODIST HOSPITALS OF DALLAS HAS A TOTAL OF $342 MILLION OF RATED DEBT OUTSTANDING; $150 MILLION HELD INTERNALLY

Tarrant Co. Cultural Ed. Facs.Fin. Corp., TX
Health Care-Hospital
TX

Opinion

NEW YORK, Dec 9, 2010 -- Moody's Investors Service has upgraded to Aa3 from A1 the unenhanced rating assigned to Methodist Hospitals of Dallas (MHD) doing business as Methodist Health System (MHS) $342 million of outstanding bonds issued by Tarrant County Cultural Education Facilities Finance Corporation and North Central Texas Health Development Facilities Corporation (see debt list in Rated Debt section below). The outlook is stable at the higher rating category.

RATINGRATIONALE: The upgrade in the rating to Aa3 from A1 is attributable to sizable growth in the organization over the past five years that generates sizable mass for leveraging in a regional market, maintenance of strong double digit operating cash flow margins, growth in liquidity with a goal to maintain no less than 200 days cash on hand and with expectations for limited debt in the near-term, and anticipated reduced capital spending with major capital projects completed.

LEGAL SECURITY: Under the MTI, the obligated group consists of Methodist Hospitals of Dallas (which is the operating company for the three hospitals directly owned by the system, and Pavilion Properties. The bonds are a joint and several obligation of the obligated group and are secured by an interest in Gross Revenues, as defined in the MTI. The Series 1998 bonds are further secured by a springing debt service reserve fund which is currently not funded.

INTEREST RATE DERIVATIVES: MHD has six interest rate swap agreements for total initial notional amount of $200 million and a current notional amount of $192.4 million Under the agreements MHD pays a fixed rate (3.7048% on $100 million and 3.792% on $100 million) and receives a variable rate equal to 64% of one month LIBOR plus 0.196%. The counterparties to the swaps are Merrill Lynch, Goldman Sachs, and SBS Financial Products Company, LLC. The mark to market value of the swaps as of September 30, 2010 was a net liability of $40 million. MHD did not have to post collateral.at September 30, 2010 and none is required unless the mark to market net liability to an individual counter party exceeds $25 million.

STRENGTHS

*Strong market presence operating two acute care hospitals in its primary market in the southwest quadrant of Dallas County which is geographically separated from other Dallas providers by Interstate 30 and the Trinity River, along with a newly opened hospital in Tarrant County and expansion to the north of Dallas through a hospital lease and two joint venture arrangements, growing the revenue base to $890 million in fiscal year (FY) 2010 (unaudited)

*Absolute liquidity growing 32% in FY 2010 to generate a good 203 days cash on hand at fiscal yearend (FYE) 2010 (unaudited) with cash-to-debt ratio of 180%

*Consistently stable operating cash flow margin of over 10% across the past decade with strong Moody's-adjusted maximum annual debt service (MADS) coverage of 8.7 times on unaudited FY 2010 performance

CHALLENGES

*Hospitals operate in the highly competitive Dallas/Fort Worth region, home to several larger multi-hospital systems including Baylor Health Care System (rated Aa2/stable), Texas Health Resources (rated Aa3/stable) and for-profit HCA; absence of certificate of need (CON) regulation in Texas

*Rapid expansion outside of the primary service area into the cities of McKinney and Addison north of Dallas through joint venture hospital arrangements adds risks to support potential unfavorable cash flow generation during start-up; also represents a new service area for the system

*Anticipated reductions in supplemental payments (disproportionate share and upper payment limit funds), increases in indigent care, and the beginnings of healthcare reform expected to negatively impact operating performance slightly in FY 2011

RECENT DEVELOPMENTS/RESULTS

MHD continues to undergo expansion strategies that have driven sizable revenue growth since FY 2006, with total operating revenues increasing 85% over the four year period to $ 890 million in FY 2010 (unaudited) from $480 million in FY 2006. In recent years (2008-2010), total operating revenues increased 35%, driven by expansion that has included the opening of 36 additional beds at the Methodist Mansfield hospital in February 2009 followed by expansions of the ICU and emergency department in November 2009; the June 2009 lease of the Methodist Richardson Medical Center (MRMC); the opening of the new 72-bed patient tower at the Charlton hospital in September 2009; and the opening of a new joint venture hospital in McKinney in February 2010. Since FYE 2010, MHD opened a second joint venture hospital in Addison in November 2010.

At the Methodist Mansfield hospital, management added 36 additional acute care beds to shelled in space from the original construction project, doubled the number of ICU beds to16 and expanded the emergency department to 34 bays from 18 bays. These expansions followed the original opening of this facility in December 2006. The City of Mansfield (general obligation bonds rated Aa2) has historically served as a bedroom community to Ft. Worth and the mid-cities. Over the last decade, the city has enjoyed a boom in single family residential construction that has resulted in rapid population growth, increasing 107% between 2000 and 2009, with a current population estimate of 58,069 and average wealth levels above the national norm. Residential expansion has spurred substantial commercial and retail developments. Although growth has slowed significantly in fiscals 2010 and 2011, Moody's believes the City of Mansfield is well-positioned for ongoing economic development but anticipates the pace of growth to be slower than the historical trend.

The June 2009 lease of Richardson Regional Hospital from the Richardson Hospital Authority (The Authority) added a 209 licensed bed acute care facility in the City of Richardson (general obligation bonds rated Aaa), a suburb of Dallas located north along highway 75 approximately 15 miles from downtown Dallas. Under the terms of the lease, base rental payments are $8.72 million per annum In addition, MRMC is required to make certain capital investments within the first six years of the lease. The lease is for a 20 year term with renewal options as well as special termination rights whereby the lease can be terminated within the first six years. In addition, there exists an Indigent Care Agreement whereby Richardson Hospital Authority is liable for payments to MHS should certain operating measures not be reached. Under a separate master agreement with MHS, MHS must purchase the facility if certain conditions are met. The conditions include: the facility experiencing two consecutive audit years of operating margins of 4% or better (before any indigent care payments to/from The Authority), and the net debt of The Authority (measured as debt outstanding less investments) is equal to or less than a calculated threshold amount. To purchase the facility, MHS must either (1) pay to The Authority an amount that, along with The Authority's investments, would enable The Authority to redeem the bonds, or (2) assume the outstanding bonds from The Authority if such action is approved by the Trustee or a majority of the bondholders. (for more detailed information on the lease agreements, please refer to our report for Richardson Hospital Authority, TX dated October 27, 2009). MHD management have implemented revenue enhancement and cost control initiatives to improve the operating performance of this facility.

MHD management has entered into two hospital joint ventures with physicians. The first, a 23-bed facility located in McKinney, 35 miles north of Dallas along the highway 75 corridor, with local physicians and Nueterra Healthcare opened in February 2010; MHD holds a 50.5% interest. The second, a 32-bed specialty surgical hospital (neurosurgery, orthopedics, and ENT) in Addison, a Dallas suburb approximately 15 miles northwest of downtown Dallas. with local physicians and Nueterra Healthcare opened in November 2010 and MHD holds a 50.5% interest. Management views these joint venture arrangements, along with the hospital in Richardson, as ways to enhance its provision of healthcare north of downtown Dallas and increase its visibility in the Dallas Metroplex.

With these enhancements, admissions grew 12% in FY 2010 to 42,534 after increasing 7% in FY 2009 and 11% in FY 2008. Other volume measures grew across the three year period as well, including emergency room visits (37%), total surgeries (2%) , and observation stays (26%). Volume growth and successful contract renegotiations continue to drive favorable double digit operating cash flow margins, including 14.9% on unaudited results for FY 2010. Moody's notes that these results include $6 million in additional disproportionate share/upper payment limit funds over the prior year. Without these additional benefits to revenues, the operating cash flow margin is still a strong 14.2%. Operating performance is budgeted to decline in FY 2011 from FY 2010's higher level with a budgeted decline in supplemental payments, a budgeted increase in charity care and bad debt expense, and initial impact from healthcare reform, but operating cash flow is projected to remain above peers.

Total debt increased $40 million (20%) in FY 2010 with the construction of the McKinney hospital. We note that 100% of MHD's bond debt currently trading in the open market (Series 2008) is in a variable rate mode, and is synthetically converted to a fixed rate through the use of swap agreements. Management has acquired all of its $150 million of outstanding Series 1998 insured variable rate bonds in the open market and continues to hold this debt; management is contemplating reissuing some of this debt, using the cash proceeds for capital projects. Because the Series 1998 bonds have not been defeased, total debt outstanding is $342 million (net debt outstanding is $192 million). With the full $150 million included in debt outstanding, debt-to-cash flow increases to over 2 times from 1.46 times on unaudited FY 2010 results, and Moody's-adjusted MADS coverage remains stable at a strong 8.70 times with maximum debt service in 2041.

Since the initial repurchase of bonds in FY 2008 when cash declined to $301 million at FYE 2008, unrestricted liquidity (excluding the holding of MHD's own bonds) has continued to grow, increasing to $426 million unaudited at September 30, 2010 (a good 203 days cash) from $322 million at FYE 2009 (180 days cash). Strong operating cash flow, a reduction in capital spending, and a decline of days in accounts receivable were contributing factors to the cash growth in FY 2010. Despite the increase in total debt outstanding, growth in liquidity improved the cash-to-debt ratio to 180% at FYE 2010 from 164% at FYE 2009. MHD's investment allocation is conservative, with 20% held as fixed income, 71% held as cash, and 9% invested in equity securities (as of last audited FYE 2009). MHD's entire investment portfolio can be liquidated in one month or less, indicating that unrestricted cash and investments are highly liquid.

Outlook

The stable outlook reflects our belief that MHD will continue to generate good operating cash flow to support the existing debt load while maintaining strong liquidity. Potential increase in debt load from the reissuance of a portion of the Series 1998 bonds manageable given the strong cash flow generation with double digit margins.

What could change the rating--UP

Increase in market share; increased diversification of cash flows; continued growth in revenues and operating cash flow; no material new debt issuance

What could change the rating--DOWN

Loss of market share through increased competitive pressures; increase in debt load without commensurate increase in operating cash flow; operating challenges at the new joint venture facilities requiring capital contributions

KEY INDICATORS

Assumptions & Adjustments:

-Based on financial statements for Methodist Health System

-First number reflects audit year ended September 30, 2009

-Second number reflects unaudited full year September 30, 2010

Debt and liquidity exclude the $150 million of Series 1998 bonds bought back by the system but available to reissue

-Interest expense reclassified to operating expenses

-Investment returns normalized at 5% unless otherwise noted

-Interest expense "grossed up" to include capitalized interest, both historical and pro-forma

*Inpatient admissions: 38,101; 42,534

*Total operating revenues: $747.5 million; $889.5 million

*Moody's-adjusted net revenue available for debt service: $113.6 million; $168.6 million

*Total debt outstanding: $196.2 million; $236.3 million

*Maximum annual debt service (MADS): $19.4 million; $19.4 million

*MADS Coverage with reported investment income: 5.20 times; 7.49 times

*Moody's-adjusted MADS Coverage with normalized investment income: 5.86 times; 8.70 times

*Debt-to-cash flow: 1.84 times; 1.46 times

*Days cash on hand: 180 days; 203 days

*Cash-to-debt: 164%; 180%

*Operating margin: 7.1%; 8.7%

*Operating cash flow margin: 13.7%; 14.9%

RATED DEBT (debt outstanding as of September 30, 2010)

-Series 1998 ($150.0 million outstanding), Aa3 unenhanced rating; Ambac insured

-Series 2008A and 2008B variable rate revenue bonds ($192.4 million outstanding), rated Aa1/VMIG 1 under the joint support methodology, supported by a letter of credit from JPMorgan Chase Bank, N.A. expiring October 31, 2012; Aa3 unenhanced rating

CONTACTS

Obligor: Michael Schaefer, Chief Financial Officer, MHD (214) 947-4510

LAST RATING ACTION

The last rating action with respect to Methodist Hospitals of Dallas was on August 26, 2008, when a municipal finance scale rating of A1 was assigned and the outlook was stable. That rating was subsequently recalibrated to A1 on May 7, 2010.

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.

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

Kay Sifferman
Analyst
Public Finance Group
Moody's Investors Service

Sarah A. Vennekotter
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 UPGRADES METHODIST HOSPITALS OF DALLAS' (TX) BOND RATING TO Aa3 FROM A1; OUTLOOK IS STABLE
No Related Data.
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