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Rating Action:

Moody's downgrades to A2 Baptist Healthcare System Obligated Group (KY); outlook stable

16 Sep 2013

$614 million of outstanding rated debt affected

New York, September 16, 2013 -- Moody's Investors Service has downgraded to A2 from A1 the rating assigned to Baptist Healthcare System Obligated Group's $614 million of outstanding rated debt issued by the Kentucky Economic Development Authority. The outlook is stable at the lower rating level. The rating downgrade is attributable to a marked decline in operating cash flow generation for the system in FY 2013. The stable outlook reflects balance sheet strength that provides flexibility during a time of budgeted operational improvement.

SUMMARY RATING RATIONALE

The rating downgrade reflects continued weakening of operating cash flow generation to very low levels in interim FY 2013 performance partly driven by continued growth in losses in the physician employment strategy along with operating losses from recently acquired facilities. The operating losses are weaker than we anticipated and are likely to continue through the remainder of the fiscal year. Volumes are under pressure, with same store declines in several areas. The stable outlook is attributable to a good balance sheet with increasing liquidity, and our expectation of no erosion in liquidity, that provides flexibility during the operational turnaround. Debt levels are also manageable. Management is developing multiple strategic initiatives to improve operating performance in FY 2014, including revenue improvement through renegotiated contracts and cost reductions in the areas of labor and supplies controls, but has yet to fully execute the plan. Baptist Healthcare System (Baptist) also benefits from operating cash flow diversification across several markets in the state but is still vulnerable to statewide trends, including declining admissions.

CHALLENGES

*Baptist continues to experience declines in operating cash flow (6.9% margin in FY 2012 and 4.5% in interim FY 2013) that remain below peers (A2 median of 10.2%). Margins have remained low due to increased losses from an aggressive and rapid physician employment strategy.

*Same store volume declines across the system for admissions, emergency room visits and surgeries in FY 2012 and continuing in FY 2013.

*The two largest volume hospitals (Louisville and Lexington) operate in highly competitive markets where they do not hold leading market positions.

*Recent hospital acquisitions are generating operating losses and negatively impacting system operating performance, requiring management resources to address and stabilize.

STRENGTHS

*Baptist is a nearly $2 billion multi-hospital (seven owned and two managed facility) state-wide health system and the largest system in the State of Kentucky, operating in four distinct regions and generating over 69,000 acute care admissions. This wide geographic spread provides cash flow diversification.

*Baptist holds distinctly leading market shares in two markets (Paducah and Corbin) representing 20-25% of system operating cash flow, down from 36% in fiscal year 2010), yet the largest hospitals in the system are in highly competitive markets (Louisville and Lexington) and do not hold leading market shares. State certificate of need (CON) regulation limits future competitive pressures.

*Capital spending exceeding depreciation expense in each of the past nine years provides for continued investment in facilities and reduced capital needs in the future.

*Unrestricted cash and investments has exceeded 200 days cash on hand in each of the past audited nine years and in the first nine months of FY 2013 for a very good 222 days at fiscal yearend (FYE) 2012, and contributes to a good cash-to-debt ratio of 174% as of May 31, 2013, better than the A2 median of 140%. Absence of a defined benefit pension plan and minimal operating leases are also viewed favorably.

*Management has identified multiple strategic initiatives to improve operating performance, yet many have yet to be executed or show traction.

OUTLOOK

The stable outlook reflects our belief that operating performance will improve but remain low in FY 2014, continuing to improve in FY 2014 as growth in the physician employment base stabilizes and losses per physician decline. The good balance sheet and currently stronger liquidity position provides cushion to improve operations.

WHAT COULD MOVE THE RATING UP

A rating upgrade would be considered with growth in volumes and enhanced market position that markedly improves operating performance and cash flow generation and stabilizes at a much higher level. Stability or improvement in balance sheet metrics would need to be retained.

WHAT COULD MOVE THE RATING DOWN

A rating downgrade would be considered if the FY 2014 budget and detailed plan for operational improvement is not completed in the near term, or operating performance and cash flow generation do not improve during the course of FY 2014. A weakening of liquidity, which provides operating flexibility, could also drive a rating downgrade. Another factor considered in a rating downgrade is continued declines in same store volumes. Any non-accretive acquisition could result in a downgrade as well .

PRINCIPAL METHODOLOGY USED

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.

Kay M Sifferman
VP - Senior Credit Officer
Public Finance Group
Moody's Investors Service, Inc.
600 North Pearl Street
Suite 2165
Dallas, TX 75201
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Lisa Goldstein
Associate Managing Director
Public Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
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JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's downgrades to A2 Baptist Healthcare System Obligated Group (KY); outlook stable
No Related Data.
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