Fitch Rates St Elizabeth Medical Center (KY) 2009 Bonds 'AA-' & Upgrades Outstanding; Outlook Stable

NEW YORK - (BUSINESS WIRE) - Fitch Ratings has assigned a 'AA-' rating to the expected issuance of approximately $140 million Kentucky Economic Development Finance Authority hospital facilities revenue refunding and improvement bonds (Saint Elizabeth Medical Center, Inc. Project). Fitch also upgrades the rating on St. Elizabeth Medical Center's (St. Elizabeth) outstanding debt to 'AA-' from 'A+'. The Rating Outlook is Stable.

The bonds will be issued in two series, approximately $101.9 million in fixed rate bonds and approximately $38.2 million in variable rate demand bonds (VRDBs) that will be supported by an irrevocable letter of credit (LOC) from JPMorgan Chase Bank. The rating on the LOC-supported bonds is an underlying rating, and Fitch will assign a long-term bank rating on the VRDBs closer to the date of issuance. Proceeds from the bonds will be used to refund all of St. Elizabeth's outstanding debt (series 2003A, 2003B, and 2003C auction rate debt, insured by Ambac Assurance Corporation), repay St. Elizabeth approximately $28 million for prior capital expenditures, fund the renovation and consolidation of St. Elizabeth's obstetrics department, and pay for the cost of issuance.

The 'AA-' rating is supported by the completion of St. Elizabeth's merger with St. Luke Hospital, formerly its main competitor in its primary service area of Northern Kentucky, the strength of St. Elizabeth's operating performance, its light debt burden, and solid liquidity. With the completion of the merger with The St. Luke Hospitals, Inc. (St. Luke) in October 2008, St. Elizabeth became the sole acute care provider in Northern Kentucky. The merger added two community hospitals (a total of 394 inpatient beds) and a substance abuse treatment center to the St. Elizabeth system. The merger establishes St. Elizabeth as the dominant regional provider of acute care services in Northern Kentucky and positions it well to continue to compete in the greater Cincinnati market, which includes a number of strong hospital systems. Before the merger, St. Elizabeth had an inpatient market share in Northern Kentucky of approximately 50% (St. Luke had approximately 30%) and an inpatient market share of approximately 18% in the greater Cincinnati area.

St. Elizabeth's exceptional operating performance further supports the 'AA-' rating. Over the last six audited years, St. Elizabeth has averaged a 4.5% operating margin and 9.8% operating EBITDA margin per year, solid for Fitch's 'AA' category. Through the first nine months of fiscal 2009, St. Elizabeth has a 3.9% operating margin and a 10.4% operating EBITDA margin, both above Fitch's 2008 'AA' category median. Fiscal 2009 is the first full year of results for the merged entity. At the point of the merger, the two St. Luke hospitals were losing money; however, St. Elizabeth has begun effectively integrating the hospitals, with each facility showing positive monthly operating margins in the last three months. Many of St. Luke's doctors had dual privileges with St. Elizabeth, which has helped smooth the integration of the medical staff. St Luke also had management contracts with the Health Alliance (the organization St. Luke left to merge with St. Elizabeth), and St. Elizabeth is unwinding those contracts, approximately $16 million in total, which is yielding cost savings as well as leading to further integration as St. Elizabeth puts in place its own management structure.

St. Elizabeth's other credit strengths include its light debt burden and solid liquidity. Days cash on hand for St. Elizabeth at year end 2008 was 149.5 days, a solid result but slightly below Fitch's 2008 'AA' category median. St. Elizabeth's cash and unrestricted investments has improved in the interim period, and St. Elizabeth will be putting $28 million back on the balance sheet with the debt issue, which will increase its DCOH.

A pro forma analysis of St. Elizabeth's total debt after the 2009 debt issuance -- $140 million in long-term debt and maximum annual debt service (MADS) of $9.3 million -- shows at year end 2008, a cushion ratio of 23.5 times (x), cash to debt of 156.6%, MADS coverage of 7.2x., debt to EBITDA of 2.1x and MADS as a percentage of revenue of 1.5%, all excellent figures for the 'AA' category. Additionally, after the debt issue St. Elizabeth will have a more conservative debt structure, with 75% fixed rate bonds and 25% variable rate bonds (the VRDBs will be synthetically fixed with an existing floating- to-fixed rate swap). All of St. Elizabeth's current outstanding debt is auction rate.

Key rating drivers include the continued successful integration of the St. Luke hospitals, the growth of St. Elizabeth's tertiary services and specialty physicians, and the maintenance of St. Elizabeth's current operational and debt profile. The integration of the hospitals over the last year has focused on consolidation and cost savings. St. Elizabeth has strategic plans for revenue enhancing initiatives, which it will be implementing over the next few years. With the 2009 bond funds, St. Elizabeth plans to consolidate its three obstetrics departments into one at its flagship tertiary hospital in Covington, as well as expand obstetrical services and add a level III neonatal intensive care unit at Covington to increase its ability to handle high risk pregnancies. St. Elizabeth has additional plans to expand tertiary services and add specialty physicians to build upon its strong primary care base (80% of Northern Kentucky's general practitioners were employed by St. Elizabeth before the merger) in an effort to reduce out migration to Cincinnati for certain specialty services. Fitch believes that the merger provides St. Elizabeth with the market strength and resources to execute on these plans.

Additionally, Fitch believes St. Elizabeth's operational and debt profile will remain stable over the medium term. St. Elizabeth's five facilities have no significant capital needs; St. Elizabeth added four floors to its flagship hospital and expanded the emergency department with proceeds from its 2003 bond issue, and St. Elizabeth recently opened a brand new ambulatory care center, which replaced its aging inpatient North campus facility and relocated the facility to a more accessible location off a major highway. The two St. Luke hospitals are in good shape, and St. Elizabeth has made about $12 million in upgrades to the facilities since the merger, including purchasing a 64-slice CT scanner. St. Elizabeth's largest capital expenditure in the next few years will be for implementation of EPIC and no major debt issuance is expected over this time period. The largest risk is the competition that exists for acute care services in the greater Cincinnati region, which includes a number of strong hospital systems.

St. Elizabeth has two floating-to-fixed rate swaps in place with a notional value of $76.3 million. The counterparty is Merrill Lynch Capital Services. The current mark to market for the swaps is ($5.5 million). St. Elizabeth has no collateral posting requirements at its current rating level.

Saint Elizabeth Medical Center's flagship hospital is located approximately seven miles south of Covington, KY, which is across the Ohio River from Cincinnati. In October 2008, The St. Luke Hospitals, Inc. with locations in Florence, Ft. Thomas and Falmouth, merged with St. Elizabeth Healthcare to form a large regional healthcare delivery system. The newly merged organization has approximately 1,200 beds, 6,000 employees, and 900 physicians on the medical staff. Total operating revenue in fiscal 2008 equaled $623.7 million.

With this debt issuance, St. Elizabeth has covenanted to disclose annual and quarterly results to bondholders through the Municipal Securities Rulemaking Board. Quarterly disclosure will include a balance sheet, income statement, statement of cash flows and operating statistics. Fitch notes this as a positive change as prior to this there was no disclosure covenant that included bondholders and disclosure was limited to annual audited financial information to the trustee and rating agencies.

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