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Fitch Rates Anne Arundel Health System Series 2012 Bonds 'A-'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings assigns a long-term rating of 'A-' to approximately $72.970 million of series 2012 revenue bonds expected to be issued by the Maryland Health and Higher Educational Facilities Authority (MHHEFA) on behalf of Anne Arundel Health System (AAHS).

In addition, Fitch affirms its 'A-' rating on the following outstanding debt issued through MHHEFA:

--$82,830,000 fixed rate revenue bonds series 2010

--$120,000,000 fixed rate revenue bonds series 2009A

--$60,000,000 variable rate revenue bonds series 2009B

--$21,880,000 fixed rate revenue bonds series 2004A

--$58,980,000 fixed rate revenue bonds series 1998

The Rating Outlook is Stable.

The series 2012 bonds are expected to be fixed rate, and bond proceeds will be used to refund the series 1998 and 2004A bonds. The bonds are expected to price the week of Oct. 15, 2012.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group and a mortgage on certain property.

KEY RATING DRIVERS

STRONG OPERATING CASH FLOW: While operating margin has been negatively impacted by the effects of its heavy capital spending, AAHS' operating EBITDA margin remained robust at 11.2% in fiscal 2012 (June 30 year-end) which is improved from the prior year's 10.7% operating EBITDA and above Fitch's 'A' category median of 9.8%.

SOLID MARKET SHARE IN FAVORABLE SERVICE AREA: AAHS captured additional market share in 2012 and maintains a leading market share of 69% (as of December 2011) in its primary service area (PSA) of Anne Arundel County (rated 'AA+'). Upon opening of the new acute care tower in 2011, the system experienced a surge in volume with gains of 11.1% in inpatient admissions and 10.7% in net patient service revenues in fiscal 2012.

JOHNS HOPKINS AFFILIATION: AAHS' ongoing strategic alliance with Johns Hopkins is an additional positive credit factor which yields benefits related to physician recruitment, development of clinical programs, and cost containment initiatives. Entered into in 2007, this affiliation agreement has been extended an additional five years.

BALANCE SHEET IMPROVEMENT EXPECTED: With its major capital projects complete, AAHS plans to rebuild its cash reserves. At June 30, 2012, unrestricted cash and investments totalled $228.3 million which equates to 163.9 days cash on hand, 8.0x cushion ratio and 53.4% cash to debt; all of which are weak relative to 'A' category medians. Furthermore, a $78.5 million collateral posting requirement on AAHS' $320 million swap portfolio depressed liquidity metrics. Capital spending as a percentage of depreciation dropped significantly to 64.8% in fiscal 2012 from 286.1% in fiscal 2011 and 353.9% in fiscal 2010. Balance sheet metrics are expected to return to levels more consistent with the rating category.

HIGH DEBT BURDEN: Despite strong operating cash flow, debt service coverage is weak for the rating level due to its high debt burden. Debt service coverage by EBITDA was 2.4x in fiscal 2012 and 2.0x in fiscal 2011 which is weak compared to the 'A' category median of 4.1x. MADS accounted for a high 5.0% of total 2012 revenues. However, no additional debt is anticipated over the next five years.

WHAT COULD TRIGGER A RATING ACTION

WEAKER PERFORMANCE THAN PROJECTED: Given AAHS's high debt burden and light liquidity position, sustaining historical operating cash flow margins is key in maintenance of the rating. AAHS is projecting fiscal 2013 and 2014 operating performance to be slightly lower than fiscal 2012 given weak rate increases from the state rate setting commission, with improvement expected in fiscal 2015 and beyond. A negative variance to these projections could result in downward rating pressure.

CREDIT PROFILE

The 'A-' rating is supported by AAHS' realized benefits from the facility expansion, market position as the leading provider in an attractive service area, continuing affiliation with Johns Hopkins, and modest future capital plans. Fitch expects that AAHS will grow into its debt burden over time as it continues to benefit from solid volume growth due to the increased capacity.

AAHS is the main provider in its PSA with a leading inpatient market share of 69.4% as of December 2011, which has grown in the past two years from 65.2% in fiscal year (FY) 2010. However, increasing competition is a concern given its favorable service area characteristics. The next closest competitor is Baltimore Washington Medical Center (part of University of Maryland Medical System, rated A by Fitch).

After opening its new acute care tower in April 2011 that added 50 beds, AAHS opened up an additional 30 beds in August 2012 to accommodate strong volume growth as a result of the additional capacity. In addition, AAHS filed for a certificate of need earlier this year to build out another 30 new inpatient beds (shelled space) to meet the demand. In FY 2012, AAHS saw increases of 11.1% inpatient admissions, 19.4% in total emergency department visits and 10.7% in net patient service revenues. The system's primary service area of Anne Arundel County (rated 'AA+') has had and expects stable population growth, supporting continued growth in hospital volume.

AAHS has been affiliated with Johns Hopkins Health System (rated 'AA-') since 2007, and recently renewed the affiliation for another five years. The two entities collaborate on clinical and educational programs, research, and other initiatives. The system and Johns Hopkins Medicine are expanding health services in western Anne Arundel County by jointly opening a multi-use ambulatory service building in Odenton, Maryland. The building is scheduled to open in December 2012 and will augment primary care and specialty services already provided by both institutions in the Odenton and Fort Meade area.

AAHS has maintained strong operating cash flow but operating margins have gradually declined since FY 2010, reflecting the increased operating costs associated with its capital investments. Operating margin declined in FY 2012 to 1.9% while operating EBITDA margin remained strong at 11.2% compared to 10.7% in the prior year. AAHS is projecting operating EBITDA margin to be 10.2% in fiscal 2013 and 2014.

In Maryland, the reimbursement for essentially all Medicare and Medicaid inpatient services is determined by the Health Services Cost Review Commission (HSCRC) under an agreement with the Centers for Medicare and Medicaid Services (CMS). This agreement includes meeting a Medicare waiver test, which demonstrates that the rate of increase for cost per hospital inpatient admission is below the national average. Given certain payment reform initiatives that the HSCRC implemented in addition to funding a Medicaid assessment on hospitals, the waiver test is at risk of not being met. Fitch believes this will continue to pressure the level of rate increases to hospitals until a new methodology is agreed to by HSCRC and CMS. A new waiver test is under development but it is unclear how future reimbursement will be determined and when this will be finalized.

At June 30, 2012, unrestricted cash and investments totalled $228.3 million which equates to 163.9 days cash on hand, 8.0x cushion ratio and 53.4% cash to debt; all of which are weak relative to 'A' category medians. Cash has been negatively impacted by a $46.3 million increase in collateral posting requirement since FYE 2011 to $78.5 million (roughly 55 days cash on hand) which has depressed liquidity metrics at June 30, 2012. Capital spending as a percentage of depreciation dropped significantly to 64.8% in fiscal 2012 from 286.1% in fiscal 2011 and 353.9% in fiscal 2010. Balance sheet metrics are expected to return to levels more consistent with the rating category. The collateral requirement dropped to $72.7 million as of Sept. 24, 2012.

At FYE 2012, AAHS had $427.8 million in total debt outstanding, of which $343.7 million were revenue bonds and the remaining are non-obligated group, non-recourse bank loans. Of the bonds, $60 million are variable rate demand bonds supported by a letter of credit that expires in May 2016. Approximately 65% of AAHS' debt is in fixed rate mode. Fitch used MADS of $29.2 million, which incorporates the fixed swap rate on the variable rate debt.

AAHS has three interest rate swap agreements with a total notional value of approximately $320 million. At June 30 2012, the swaps had a combined marked to market value of negative $81.9 million, compared to $45.5 million at June 30 2011. Citigroup Inc serves as swap counterparty. Two of the swaps, executed in 2003 and 2004, mature in 2013. The third swap with a notional value of $180 million matures in 2048.

The stable rating outlook reflects Fitch's expectation that AAHS will continue to benefit from its sizeable capital investments and produce solid operating cash flow, which should lead to a strengthening of the balance sheet. A deterioration in liquidity metrics or weaker than projected operating performance could result in negative rating pressure.

Anne Arundel Health System, headquartered in Annapolis, MD, operates a 380 licensed bed acute care general hospital and several outpatient facilities in its primary service area of Anne Arundel County. Total operating income was $579 million in FY2012. AAHS discloses annual financial statements within 120 days and quarter unaudited financial statements within 45 days after the end of the first three quarters and no later than 60 days after the end of the fourth fiscal quarter through the MSRB EMMA website. Financial statements include an income statement, balance sheet, flow of funds, utilization data and management discussion and analysis.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in Fitch's Rating Criteria, this action was additionally informed by information from Citi.

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria' (June 12, 2012);

--'Non-Profit Hospital and Health System Rating Criteria' (July 23, 2012).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=683418

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Fitch, Inc.
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Jennifer Kim, +1-212-908-0740
Associate Director
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Source: Fitch Ratings