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Fitch Affirms West Penn Allegheny Health (Pennsylvania) at 'BB-'; Outlook Negative

NEW YORK - (BUSINESS WIRE) - Fitch Ratings affirms the $753,000,000 series 2007A health system revenue bonds issued by Allegheny County Hospital Development Authority for the benefit of West Penn Allegheny Health System (WPAHS) at 'BB-' and removes them from Rating Watch Negative. The Rating Outlook is Negative.

The affirmation reflects WPAHS's solid market position as the secondary provider in the extremely competitive market of Western Pennsylvania, an excellent reputation for quality and clinical excellence at its flagship facilities, and management's ongoing efforts to sustain operational improvement over the long term.

The Negative Outlook reflects further deterioration in the system's financial metrics for the fiscal year (FY) 2008 and continuing into third quarter 2009. Management has deemed FY 2009 to be a transitional year and profitability is not expected for the system until FY 2010. WPAHS's ongoing operational issues include the system's continuing lack of profitability, weak liquidity ratios, poor debt ratios, and an unfunded pension liability of $124 million at the end of FY 2008. In addition, average age of plant for the system is 16 years, well above the median for the category; however, all but the most critical capital needs for the system will be driven by financial performance and strategic direction. Management has no specific plans for any major capital projects at this time.

Fitch believes that WPAHS's solid market position as secondary provider to UPMC (rated 'AA-/F1+', Negative Outlook by Fitch) will continue. While there are other facilities in the service area, these two systems account for 75% of the inpatient market share in Allegheny County. This is a highly concentrated payor market dominated by Highmark, the regional insurance provider. While there have been some defections of surgeons, the majority of physicians are aligned with WPAHS support management's efforts, but referrals from community hospitals have declined.

WPAHS has a strong reputation for quality. West Penn has achieved Magnet status recognition from the American Nurses Credentialing Center. Both Allegheny General and West Penn were named in the Thomson Healthcare Top 100 Hospitals for cardiovascular care. Health Grades named West Penn the No. 1 hospital in Pennsylvania for bariatric surgery for the third consecutive year.

In FY 2008, WPAHS lost $89 million from operations, including a $73 million adjustment related to impaired accounts receivable, producing a negative operating margin of 5.9%. Bottom-line losses are reduced to $57.8 million (negative 3.8% excess margin) after including $30 million of investment income. Other income ratios were also negatively affected. WPAHS produced an operating EBITDA margin of 1.2%, EBITDA margin of 3.1% and a cash flow margin of 1.2%, all of which compare unfavorably to Fitch's rating medians for the non-investment grade category. Maximum annual debt service (MADS) coverage fell to 0.96 times (x) at the end of FY 2008 from 2.5x coverage in 2007. The system engaged Wellspring Partners to review system operations. In addition, the SEC notified WPAHS that it had initiated a formal inquiry into the $73 million of balance sheet adjustments. WPAHS is fully cooperating with the inquiry.

Interim results for the nine-month period ending March 2009 show evidence of the beginnings of operational improvement, though financial medians continue to be well below Fitch's medians for the non-investment grade category. Management budgeted an operating loss of $48 million and a bottom-line loss of $31.1 million. WPAHS actually reduced its operating loss to $34.7 million (negative 2.8% operating margin) and reduced the system's bottom-line loss to $20.1 million (negative 1.6% bottom-line margin) with an operating EBITDA margin of 4.1%, and an EBITDA margin of 5.2%. Both medians compare unfavorably to Fitch's rating medians for the non-investment grade category of 4.9%, and 6.4%, but indicate financial improvement compared to year-end 2008.

Of primary concern was the decline in liquidity between 2007 and 2008. For year-end FY 2008, WPAHS had $232.2 million in unrestricted cash and investments. Pursuant to WPAHS's conservative investment policies, approximately 10% of investments were in marketable equity securities with 20% in fixed income securities. The balance (70%) was limited to cash and cash equivalents consisting of U.S. treasury investments and repurchase agreements. The system does not invest in alternative investments or hedge funds. Days cash on hand (DCOH) declined to 55.7 days in 2008 from 72.2 days in 2007. The cash to debt ratio, already exceedingly weak from historically poor performance, declined further to 28.4% from 37.3%. Fitch category medians for cash to debt and debt to cap ratios are 40.2% and 72.9%, respectively, indicating a system that is very highly leveraged with weak liquidity reserves, and very limited debt capacity. Liquidity continued to decline for the nine-month period ending March 2009, albeit at a slower pace. WPAHS had 53.3 DCOH compared to 54.9 days for the nine-month period ending March 2008. Long-term financial viability is critical in order for WPAHS to compete effectively in its market. This will be difficult to achieve without sufficient cash flow to support service line expansion, quality initiatives and physician alignment strategies, despite its strong reputation for quality care. Balancing expense growth with service line development will continue to be a challenge.

An additional area of concern is WPAHS's large future pension liabilities. WPAHS maintains a defined benefit retirement plan for its employees that was redesigned in January 2009 to reduce liability growth. At March 31, 2009, WPAHS recognized an accrued pension liability of $149.4 million. The system has contributed approximately $4 million toward this liability for the nine-month period ending March 31, 2009. In accordance with Internal Revenue Service funding rules and in conjunction with special relief obtained under The Pension Protection Act of 2006, no additional funding is required to be made until April 15, 2010. WPAHS's fiscal 2010 pension contribution is estimated at $10 million. Current estimates for future pension contributions are estimated to be considerably higher but may change.

Approximately $98.7 million of recurring operational benefits have been implemented versus a target of $60 million, including $48.8 million of non-labor savings ($25 million of labor savings), primarily as a result of reduction in force of 364 FTEs, $22.9 million of revenue cycle enhancements, and $2. million of non-clinical integration savings. In addition, WPAHS has started the process of clinical and hospital consolidation leading to further rationalization of services by creating a committee to restructure the system's hospital campuses. Certain services have already been consolidated. For example, certain cardiothoracic surgeries are now performed exclusively at the Allegheny General Hospital campus. Senior management is on track to meet its goal of $100 million of operational improvement in 2009, with physician integration to be achieved by 2010, followed by clinical hospital integration by 2011.

Fitch has met with the new management team several times and is impressed by senior management's commitment to full system integration, a key component for long-term viability of the system. Stability and improved financial metrics should occur over time assuming successful and full implementation of the transformative cultural change that management is expecting to occur, but Fitch will continue to monitor the credit on a periodic basis and may take rating action as appropriate.

In April 2009, WPAHS filed suit against UPMC and Highmark claiming that 'both have conspired to reduce competition and raise prices at the expense of the community's employers, consumers and patients.' While the final outcome may be favorable to WPAHS over the long term, Fitch believes that the suit will have little beneficial effect for system performance in the near term and the legal costs associated with the suit may affect future profitability, leading to further negative rating pressure.

Headquartered in Pittsburgh, WPAHS is a large, integrated health system with six hospitals and other related entities that primarily serve Allegheny County and its five surrounding counties. WPAHS's flagships are the 720-licensed bed Allegheny General Hospital and the 500-licensed bed Western Pennsylvania Hospital. Total revenues in FY 2008 were approximately $1.5 billion. Disclosure to Fitch and to bondholders has been provided on a quarterly basis through the nationally recognized municipal securities information repositories and consists of an in-depth management discussion and analysis, income statement, balance sheet, cash flow statement, and utilization statistics.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 'www.fitchratings.com'. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Fitch Ratings, New York
Carolyn Tain, +1-212-908-0259
Media Relations:
Cindy Stoller, +1-212-908-0526
cindy.stoller@fitchratings.com