Fitch Affirms Anna Jaques Hospital (Massachusetts) $9.0MM Bonds at 'BB+'; Stable Outlook.

NEW YORK -- Fitch Ratings affirms the 'BB+' rating on the outstanding $9.0 million Massachusetts Health and Educational Facilities Authority revenue bonds (Anna Jaques Hospital Issue), series 1993B. Seacoast Regional Health System (SRHS) is the parent and sole corporate member of Anna Jaques Hospital (AJH). The Rating Outlook is Stable.

The affirmation of the 'BB+' rating and the Stable Outlook are supported by AJH's improving operations, low debt burden, and solid market position. The hospital recruited a new CEO and CFO in early part of calendar 2006. Since management began operations have improved. AJH posted a small operating loss of $692,000 (negative 0.7% operating margin) in fiscal 2006, a significant improvement from the $2.4 million loss in fiscal 2005 (negative 2.6% operating margin). The three months interim fiscal 2007 data (December 2006) show an operating gain of $407,000 (operating margin 1.8%). Management's efforts have focused primarily on improving patient, employee, and physician satisfaction and physician recruitment which resulted in outpatient and inpatient volume growth. Additionally, the management was able to successfully curtail expenses by renegotiating contracts with its physician group's hospitalists and anesthesiologists, obtaining savings on supplies by joining a partnership, and reducing nurse agency reliance through recruiting full time floater nurses. AJH's low debt burden is evidenced by debt service coverage of maximum annual debt service (MADS), and MADS as a percent of revenues of 3.5 times (x) and 2.3%, respectively, through the three months ended Dec. 31, 2006. AJH maintains a leading market share in its service area capturing approximately 32.5% of admissions versus Hale Hospital, part of Merrimack Valley Health System, its next closest competitor, which had a market share of approximately 18.4%.

Primary credit concerns include AJH's historically weak profitability, low cash levels relative to expenses, and historically low capital spending. Since fiscal 1998, AJH's capital investment has been well below depreciation expense indicating mounting capital needs. However, Fitch notes that over the last few years, AJH has used operating leases to finance necessary investments in equipment, which management indicated will be used on a more limited basis going forward. In 2006 AJH issued $5 million in privately placed bonds to fund a much needed emergency room expansion, general information technology improvements, and other general upgrades and renovations. AJH is planning to spend approximately $3.5 million annually on capital improvements in the near term which equates to 91.2% of the AJH's depreciation expense in budgeted fiscal 2007 ($3.8 million). At 2006 fiscal year-end AJH had $11.5 million of unrestricted cash and investments equating to 47.8 days cash on hand (DCOH) and 5.3x cushion ratio. Both ratios are well below Fitch's 'BBB' medians of 130.5 DCOH and 8.5x cushion ratio.

AJH entered into two interest rate swaps with Morgan Stanley (rated 'AA-/F1+' by Fitch) as counterparty on Oct. 1, 2004. The first swap converted the bonds from a fixed to variable rate and the second swap converted the interest rates back to a fixed rate. Neither swap is on parity with existing debt. Termination events are credit related and include a downgrade provision if the rating falls below 'BB+'. The net mark-to-market valuation for both swaps was only negative $146 at Sept. 30, 2006, which is the amount AJH would pay to Morgan Stanley if the swap terminated at that time. Fitch believes any potential termination payment would have an immaterial impact on AJH's financial profile. However, a termination would cause the bonds to revert to their original coupon, which could negatively impact operations.

The Stable Outlook is supported by Fitch's expectation that AJH will maintain the current level of profitability. Fitch believes that raising liquidity in concert with making adequate capital outlays will be challenging for AJH in near-to-mid term but achievable in the long term if profitability can be maintained at or above 2%.

Located in Newburyport, MA (approximately 35 miles north of Boston), AJH is a 160-staffed bed community hospital providing primary and secondary care services. In 2006, SRHS reported total revenues of $95.1 million. AJH only covenants to provide annual disclosure to bondholders in the form of audited financial statements, which Fitch views negatively. However, Fitch notes that annual disclosure was standard industry practice when the series 1993 bonds were issued. Fitch was unable to find all of AJH's audits since the bonds were issued on the nationally recognized municipal securities information repositories.

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