Fitch Affirms Deaconess Hosp Obligated Group, Indiana, at 'A+'

Fitch Ratings affirms the ‘A+’ rating on approximately $101.7 million of bonds issued through the Indiana Health Facility Financing Authority on behalf of Deaconess Health System, as listed below. The Rating Outlook is Stable.

The affirmation of the ‘A+’ rating is supported by Deaconess Health System’s (DHS) strong operating profitability, increasing market share, growing utilization trends, and the benefit accruing from Deaconess Health Plan. From fiscal 2003-2005, DHS posted strong operating margins ranging from 5.0%-6.0%. In fiscal 2006, operating margin slipped to 3.1% due to increased operating expenses related to the opening of the new 116-bed Gateway Hospital in January 2006. As admitting patterns between Deaconess Hospital and the Gateway facility have become normalized, operating results have returned to historical levels with an operating margin of 5.0% through the first quarter ended Dec. 31, 2006. EBITDA margins in fiscal 2005 and 2006 of 14.2% and 12.4% resulted in maximum annual debt service coverage by EBITDA of 4.0 times(x) and 4.1(x), respectively. DHS has further increased its market share in the primary service area to 57.9% in 2005 from 48.8% in 2003. Not surprisingly, utilization growth has been robust. Inpatient admissions in 2006 of 20,503 represent a 31.7% increase over fiscal 2004 while outpatient surgeries and emergency room visits have increased 23.5% and 18.1%, respectively, over the same period. DHS’ increasing market share and positive utilization trends have been driven by its affiliation with multi-specialty group Welborn Clinic, the expansion of The Women’s Hospital in 2005, the opening of the Gateway Hospital, and the growth in employed physicians. Finally, DHS benefits from its ownership position in Deaconess Health Plan, with an estimated 175,000 covered lives.

Credit concerns include DHS’ relatively low liquidity position for the rating category, a well-capitalized competitor, and a somewhat high exposure to governmental payors. As of Sept. 30, 2006, DHS’ unrestricted cash and investments of $115.2 million represented 118.8 days cash on hand and 74.1% of total long-term debt, which are below Fitch’s 2006 ‘A’ medians of 188.6 and 86.4%, respectively. Liquidity was negatively impacted in fiscal 2006 due to the planned equity contribution to the completion of the Gateway project. Management has projected days cash on hand to grow to 131 by fiscal year-end 2007. DHS’ main competitor is St. Mary’s Medical Center (SMMC), which is part of Ascension Health (senior revenue bonds rated ‘AA+’ by Fitch). While SMMC has continued to lose market share to DHS, Ascension has the financial resources to make substantial investments to recoup market share. In fiscal 2006 Medicare and Medicaid payors represented 49.8% and 8.0% of gross revenues.

The Stable Outlook reflects DHS’ continued expansion in market share and growth in utilization volumes. Fitch believes management has implemented appropriate controls to generate historical financial performance while servicing increasing patient volumes. Continued cash flow generation at or near historical level should lead to improved balance sheet indicators. There are no plans for issuance of additional debt over the next three years.