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Rating Action:

Moody's upgrades Catholic Health East's to Aa2; outlook is negative

03 Oct 2013

$687 million of rated debt affected

New York, October 03, 2013 -- Moody's Investors Services has upgraded to Aa2 from A2 the ratings assigned to Catholic Health East's (CHE) $687 million of outstanding long-term rated debt issued through various authorities. The outlook is negative. CHE is now part of CHE Trinity, Inc. (referred to as CHE Trinity) and the rating upgrade and negative outlook are based on our analysis of CHE Trinity. The rating upgrade is attributable to a proposed substitution of notes that is scheduled to take place the week of October 1, 2013. At this time we are assigning Aa2/VMIG 1 ratings to the previously issued Series 2012B bonds issued through the Saint Mary Hospital Authority and the Series 2008 bonds issued through the North Carolina Medical Care Commission. These bonds are expected to be remarketed at the time that CHE Trinity issues its 2013 bonds. The long-term and short-term ratings are based on the credit quality of CHE Trinity, CHE Trinity's self liquidity program established originally by Trinity Health, and the proposed new debt security structure. Please see the CHE Trinity and Trinity Health reports issued concurrent with this report for a discussion of the analysis supporting the short term rating.

CHE Trinity became the new sole corporate member of Catholic Health East (CHE) and Trinity Health on May 1, 2013. CHE and Trinity Health currently maintain separate obligated groups in support of their respective organization's secured debt. As part of the merger, a new debt structure is being established whereby Trinity Health's Master Trust Indenture (MTI) will be amended to expand the Obligated Group to include CHE Trinity, CHE and Trinity Health. Trinity Health's debt will continue to be secured under the amended MTI and CHE's debt that is not refunded or refinanced will become secured under the new MTI through a proposed substitution of notes for the existing outstanding bonds, scheduled to occur on October 2, 2013. CHE Trinity is issuing $305 million of Series 2013 bonds. Concurrent with this bond sale, CHE's debt is being upgraded to Aa2 from A2 to reflect the new security and Trinity Health's bond ratings are being affirmed (see separate rating reports issued concurrently for CHE Trinity and Trinity Health).

Should the proposed substitution of notes not take place as outlined, CHE's rating will be revisited and could be downgraded.

SUMMARY RATING RATIONALE:

The Aa2 rating is attributable to CHE Trinity's position as one of the nation's largest multi-state health systems that has expanded into 21 states, with anticipated operating revenues to be just shy of $14 billion in fiscal year (FY) 2014 following the May 1, 2013 consolidation of Trinity Health and CHE. This geographic diversification generates cash flow diversification, with only three ministry organizations generating greater than 10% of system operating cash flow, and reducing the exposure to unfavorable fluctuations in any one state to only 25% of system revenues. Trinity Health's margins softened at the end of the last decade but have remained stable at 9.6% for the past three years (FY 2013 excludes net rural floor settlement of $50 million). While CHE experienced operational improvement in FY 2012 (ended December 31), the operating cash flow margin of 7.8% remains below that of Trinity Health (excludes net rural floor settlement of $24 million). On a pro forma basis as of June 30, 2013 including Trinity Health's audited financial performance and twelve months of CHE ended June 30, 2013, the combined group shows a adequate pro forma 9.0% operating cash flow margin and good debt service coverage of over 5 times on a moderate debt load. Cash on hand is adequate at just over 200 days, yet cash to direct debt is well below average for a Aa at 137% (Aa2 median is 222%).

The negative outlook speaks to the absence of a permanent top executive management team at this time, the weakened combined pro forma performance prior to the realization of annualized $302 million of cost control improvements and $100 million of anticipated revenue enhancements over the next three years, and the potential for the addition of organizations with weaker credit profiles that will place pressure on the rating.

STRENGTHS

*CHE Trinity has material geographic diversification across 21 states that reduces risk to any healthcare changes in an individual state. Only three markets comprise greater than 10% individually of system operating cash flow in FY 2013 (Columbus, OH, Ann Arbor, MI, and Chicago, IL), yet these regional systems hold strong market positions.

* CHE Trinity is now the second largest system in our portfolio with operating revenues projected to near $14 billion in FY 2014. Trinity Health, the stronger of the two combining systems, represents about 67% of the newly formed system's revenues and brings a history of strong centralized services.

*The organizations undertook separate cultural surveys prior to the merger that evidenced two highly aligned corporate cultures. A lack of geographic overlap will help mitigate conflicts of clinical integration on a market-by-market basis that can sometimes impair mergers over the short term. Concomitantly, however, it limits large scale clinical cost avoidance savings.

*Trinity Health has experienced a stable operating cash flow margin across the past three years (June yearend) and CHE reported improved performance in FY 2012 (December yearend). The combined operating performance is below average for a Aa2 rating (pro forma 9.0% operating cash flow margin for FY 2013), but remains good compared to peers with comparably large revenues bases. Operational improvement is anticipated across the next three years with annualized $302 million targeted in cost controls as the system's functions are consolidated and $100 million of anticipated revenue enhancements.

*Pro forma Moody's adjusted maximum annual debt service (MADS) coverage remains good at over 5 times on an average debt load of 37% debt to revenues.

*Growth in absolute liquidity has maintained cash on hand at or above 200 days with a strong treasury management function. CHE's assets have been consolidated with Trinity Health's treasury function and an anticipated rebalancing of the portfolio will occur over the next six months.

*Both organizations maintain a history of strategic mergers/acquisitions and divestitures to improve system operating performance. Trinity Health demonstrated a highly successful turnaround at Loyola University Health System in Chicago. CHE has pending divestitures of unprofitable markets that are expected to close in the near term.

*A sizable unrestricted liquidity portfolio along with a dedicated syndicated line of credit, solid treasury management, and appropriate liquidation procedures support the tender features on variable rate demand debt supported by internal liquidity.

CHALLENGES

*CHE Trinity is without a permanent top executive management team, currently functioning with an interim chief executive officer (the CEO from CHE), an interim COO from the Trinity Health Board, and an interim chief financial officer (the CFO from CHE). The longstanding CEO of Trinity Health was slated to be the CEO of CHE Trinity, but an unexpected departure from the organization mandated a change in plans. A new CEO is expected by the end of the calendar year.

*Trinity Health experienced slow decline of the operating cash flow margin in the last decade, followed by stability at a lower level in 2011-2013. The operating performance and balance sheet profile of Aa2 rated Trinity Health Credit Group was further weakened with the merger of CHE. CHE Trinity has signed a letter of intent with Ba1 rated St. Joseph's Hospital Health Center in NY, whose projected $600 million in revenues could cause additional pressure on ratios.

*CHE Trinity expects to issue debt annually to fund capital projects and strategic growth, though management has proven an ability and willingness to pull back on capital spending when either operations or liquidity are stressed.

*Current liquidity is strained relative to the Aa2 level with ratios below the Aa2 median: pro forma cash on hand of 201 days versus median of 290 days and pro forma cash to direct debt low at 137% versus median of 222%. Additionally, CHE Trinity has underfunded pension plans and a sizable swap program.

*Many of the system's hospitals operate in highly competitive markets, with some not holding leading market share positions.

*Protracted efforts to complete various planned divestitures of CHE underperforming assets is a credit risk and continued consumption of time and resources.

OUTLOOK

The negative outlook reflects the absence of a permanent senior leadership team, a lengthy effort to complete the divestiture of some distressed CHE facilities, recent tempering of pro forma operating performance and balance sheet metrics, and potential future acquisitions that could stymie near-term improvement.

WHAT COULD MOVE THE RATNG UP

A rating upgrade would be considered with material and sustained improvement in operating and operating cash flow margins that generate improved debt coverage metrics on a sustained basis. Establishment of a permanent top executive team is a must. Growth in liquidity and an overall strengthening of the balance sheet, including higher coverage under the self-liquidity program would need to be reached. Successful integration of the two merged organizations with a track record at higher performance levels would be an additional factor.

WHAT COULD MOVE THE RATING DOWN

A rating downgrade would be considered if CHE Trinity is unable to improve operating performance due to challenges with the integration of the two systems or acquisitions/ mergers that further dilute operations or the balance sheet. Continued protracted effort to divest of two distressed CHE markets will also pressure the rating. The inability to establish a permanent and effective new executive management team for this complex organization will create rating pressure. Any tempering of the balance sheet, in particular a weakening of liquidity balances, could place stress on the long term rating.

The principal methodology used in the long term rating was Not-for-Profit Healthcare Rating Methodology published in March 2012. An additional methodology used in rating the short term rating was Variable Rate Instruments Supported by Conditional Liquidity Facilities published in May 2013. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

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

Beth I. Wexler
VP - Senior Credit Officer
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 upgrades Catholic Health East's to Aa2; outlook is negative
No Related Data.
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