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Rating Action:

Moody's assigns Aa3 to University of Pittsburgh Medical Center (PA)'s aggregate $400.0M Ser. 2014; Outlook stable

08 Sep 2014

System will have $2.9B of rated debt

New York, September 08, 2014 --

Moody's Rating

Issue: UPMC Revenue Bonds, Series 2014A; Rating: Aa3; Sale Amount: $350,000,000; Expected Sale Date: 9/15/2014; Rating Description: Revenue: Other

Issue: UPMC Revenue Bonds, Series 2014B; Rating: Aa3; Sale Amount: $50,000,000; Expected Sale Date: 9/15/2014; Rating Description: Revenue: Other

Opinion

Moody's Investors Service has assigned Aa3 ratings to the University of Pittsburgh Medical Center's (UPMC) $350.0 million of Series 2014A fixed rate bonds to be issued through the Pennsylvania Economic Development Financing Authority and to $50.0 million of Series 2014B fixed rate bonds to be issued through the Monroeville Finance Authority. The rating outlook is stable. At the same time, we are affirming the Aa3 ratings assigned to UPMC's outstanding rated debt that carries a pledge of the Obligated Group, including the Aa3 and stable outlook on the outstanding obligations of UPMC-Hamot (as parity obligations to UPMC's). This action affects approximately $2.9 billion of rated debt.

SUMMARY RATINGS RATIONALE: The Aa3 rating continues to reflect UPMC's leading and growing market position in Western Pennsylvania, strong patient demand, preeminent clinical reputation rooted in tertiary and quaternary clinical campuses throughout the greater Pittsburgh area and a large network of well-positioned community hospitals throughout western Pennsylvania which provides some cash-flow diversity, and a long track record of effectively addressing operating challenges. These strengths compensate for a weak regional economy, two years of weaker than historic operating margins, which are well below Aa3 rated peers, higher leverage than is typical for the rating category and an unusually acrimonious environment which carries near term uncertainty regarding future demand from Highmark Inc.'s commercial subscribers after December 31, 2014.

The stable rating outlook is supported by the system's investments in financial improvement initiatives and efficiencies as well as continued focus on service line growth, physician engagement, and care management which should support improved operating levels. However, the System's inability to improve and sustain improvement in margins from FY's 2013 and 2014 levels will likely result in an outlook revision or rating pressure.

STRENGTHS

*Preeminent clinical reputation and wide patient draw regionally and nationally, supporting future growth and compensating for stagnant population trends in the Pittsburgh area; unrivaled business platform in 29-county service area capturing 41% market share and a dominant 60% market share of Allegheny County; revenue was nearly $11.5 billion in FY 2014. UPMC is both the largest non-governmental employer and largest healthcare system in the Commonwealth;

*UPMC's tightly managed and integrated network of 21 hospitals, insurance services and physicians is the platform for substantial patient demand with almost 215,000 inpatient admissions and 72,500 observation visits system wide in FY 2014; a business position that remains well secured by the geographic diversity of its venues. Addition of the Altoona market on July 1, 2013 broadened and strengthened UPMC's geographic reach;

*Unrestricted cash and investments have grown measurably to nearly $4.0 billion, as of June 30, 2014, with unrestricted investments providing better cushion of absolute debt (123% cash to debt). Investments are more liquid then historic allocations and are highly diversified across asset classes and managers;

*Debt structure risks are very manageable; pro-forma debt is approximately 84% fixed rate and swap exposure is modest; monthly liquidity provides an improved 3.6 times coverage of demand debt (up from 1.7 times coverage at FYE 2012). Unfunded pension liability is de-minimis;

*Pennsylvania's recent decision to expand Medicaid (under the 2010 healthcare law) should be a financial benefit to UPMC Health Plan;

*Sound relationship with Aa1-rated University of Pittsburgh;

*Strong management capabilities evidenced by the organization's historic ability to absorb operating challenges; management is actively implementing initiatives to improve the System's current financial performance;

*Financial rigor and accountability provides for transparent and timely financial reporting. UPMC has voluntarily complied with all relevant provisions of the Sarbanes-Oxley Act since 2006.

CHALLENGES

*Soft operating performance in FY's 2013 and 2014 with System reporting operating margins of 0.5% in both years (reclassifying interest expense from non operating expenses in both fiscal years). Operating performance also excludes a non cash expense related to Pittsburgh Promise in FY 2013 ($54.5 million). The operating cash-flow margin has been tempered, too, with System reporting 6.0% and 5.6%, respectively. Margins are very thin relative to Aa3 medians and reflective of UPMC's sizable health plan, as well as cuts in government reimbursement, the effects of the economy on volumes and the continual shift to lower cost settings;

*Acrimonious operating environment that has been unusually litigious, divisive and distracting. The market's adversity is heightened by the near term certainty that UPMC's commercial contract with Highmark, the now dominant insurer in Western Pennsylvania, will expire as of December 31, 2014. We view the uncertainty and potential for disruption in demand as a key credit challenge for UPMC in the second half of its current fiscal year;

*Higher than average leverage as compared with unrestricted resources, exacerbated by concerns regarding a multi-year trend of softened margins and cash-flow. Based on FY 2014, pro-forma maximum annual debt service coverage is a modest 3.2 times while debt to cash-flow is a well above average (unfavorable) 4.3 times; indirect debt (operating leases) are material adding an additional $666 million of comprehensive liabilities, diluting all cushions for leverage;

*Long standing concern that UPMC's investments are riskier and less liquid than most comparably rated peers, however, recent increases in liquidity of the portfolio and material reduction of the pension liability temper this concern. With softer cash-flow, greater liquidity of the investments is viewed favorably. Approximately $2.1 billion of the $3.9 billion of unrestricted cash and investments at FYE 2014 was available monthly and slightly more than 65% of total investments was available within one year up from less than 50% a few years ago. Recent changes in target asset allocation were designed to address this issue;

*Weak demographics in Pittsburgh and the majority of the Western portion of Pennsylvania which are more pronounced given Commonwealth's budgetary challenges;

*Exposure to the cyclical nature of the insurance business, through the UPMC Health Plan, a key component of the System's integrated delivery model.

Outlook:

The stable rating outlook is supported by the system's investments in financial improvement initiatives and efficiencies as well as continued focus on service line growth, physician engagement, and care management which should support improved operating levels. However, the System's inability to improve and sustain improvement in margins from FY's 2013 and 2014 levels will likely result in an outlook revision or rating pressure.

What could change the rating--UP

Following two years of suppressed performance and uncertainty regarding the impact of UPMC's transition out of the Highmark Health Plan, an upgrade is unlikely in the near-term. Over the longer term, a measurable and sustained improvement in operating margins and strengthening of liquidity and relative measures of leverage in addition to the ability to withstand the expiration of the Highmark contract without material degradation of the System's historic footprint and market capture could result in upward rating movement.

What could change the rating--DOWN

Greatest risks remains a significant increase in debt beyond current issuance or a prolonged decline in operating performance that results in further deterioration of operating metrics. In addition rating pressure could follow marked disruption in demand, particularly if the expiration of the Highmark contract translates to a material market share loss.

METHODOLOGY

The principal methodology used in this rating was Not-for-Profit Healthcare Rating Methodology published in March 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Beth I. Wexler
VP - Senior Credit Officer
Public Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Lisa Martin
Senior Vice President
Public Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's assigns Aa3 to University of Pittsburgh Medical Center (PA)'s aggregate $400.0M Ser. 2014; Outlook stable
No Related Data.
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