Fitch Affirms Rex Healthcare (North Carolina) At 'A+'; Outlook Stable.

NEW YORK -- Fitch affirms the 'A+' underlying rating on the North Carolina Medical Care Commission's outstanding $124 million hospital revenue bonds (Rex Healthcare, Inc.), series 1998. The bonds are insured by Ambac Assurance Corp.(insurer financial strength is rated 'AAA' by Fitch). The Rating Outlook is Stable.

Primary credit strengths for Rex Healthcare, Inc. (Rex) include recent improvement in operating performance, improving utilization indicators, and a favorable environment for nursing. Rex reported an operating margin of 3.3% ($13.35 million operating income) for fiscal-year (FY) 2006 (unaudited), an improvement from 1.8% ($6.45 million) for FY2005. Maximum annual debt service (MADS) coverage by earnings before interest, taxes, depreciation, and amortization (EBITDA) improved to 2.7 times (x) in FY2006 (unaudited), up from 2.4x in FY2005, despite a short-term capital lease (excluding the lease, 4.3x in FY2006 (unaudited), from 3.9x in FY2005). All of Rex's utilization indicators improved in FY2006.

Comparing FY2006 to FY2005, discharges excluding newborn births increased 20.1%, outpatient surgeries increased 8.6%, and newborn births increased 7.1%. The increase in discharges occurred concurrently with a reduction in average length of stay to 3.1 days from 3.5 days.

Utilization improvements are largely attributable to 100 new physicians joining Rex in FY2006, as well as Rex's hospitalist program and expansion of its oncology, obstetrics, and surgery programs. In FY2006, Rex absorbed the physicians and patients from the closure of Duke University Health System's (DUHS; rated 'AA' by Fitch with a Stable Outlook) obstetrics program in Rex's service area, opened a surgery center with 12 new, digitally equipped operating suites, opened a hematology oncology practice, and formed a partnership expanding radiation oncology services to a new market. Rex received nursing magnet status in FY2006, which reflects a strong management practice relating to quality and clinical care.

Another credit strength is Rex's status as a controlled affiliate of University of North Carolina Health Care System (UNCHCS), which is owned by the State of North Carolina. Since the 2000 merger, Rex continues to operate as a separate, private, not-for-profit entity and retains its separate identity. Additionally, Rex remains independently obligated on its debt. UNCHCS controls the majority of seats on the Rex board of trustees, approves the annual operating budget, and approves any debt plans. The most significant benefit of the affiliation over the last six years has been UNCHCS' assistance in negotiating rates for Rex's managed care contracts and improved supply chain management through joint purchasing. Rex's management believes that the affiliation will provide selective future clinical programmatic enhancements. Although UNCHCS has not provided any financial assistance since its acquisition of Rex in 2000, Rex and UNCHCS are currently in discussions about support for future capital expenditures, which, Fitch would view favorably.

Primary credit concerns are Rex's increasingly competitive marketplace, continued light liquidity position, delayed execution of a suburban growth plan, and future capital plans. Rex competes with two large systems, WakeMed Health & Hospitals (WakeMed; 44% market share) and DUHS (8% market share). While Rex's inpatient share based upon discharges has returned to the same level at the beginning of calendar 2006 as it was at the beginning of calendar 2001, at 34%, WakeMed's share increased to 44% from 41% during the same period through continued expansion of services into the fast-growing suburban areas of the market. As of June 30, 2006 on an unaudited basis, Rex's $138 million of unrestricted cash and investments represented 139.7 days of operating expenses, which is below Fitch's 'A' category median of 188.6 days.

However, pro forma debt of 122.2% is above Fitch's 'A' category median of 111.1%. Rex's investment in PP&E averaged 95% of depreciation expense from fiscal 2001-2005, causing its average age of plant to increase to a high 12.4 years. Having received the necessary certificates of need, Rex plans to add 45 acute beds, and renovate and relocate its birth center with 30 postpartum beds and an expanded 15-bed Level III special care nursery at its main campus. Rex plans to spend approximately $12 million from operations in FY2007-2008, which represents the majority of the costs for the bed project. Fitch believes Rex's recent level of capital spending and delayed suburban expansion have weakened its position in an increasingly competitive market. Although plans are preliminary and still being finalized, capital projects for strategic expansions off of the main campus may cost more than $25 million in calendar 2007, which excludes the costs of the bed additions and relocation described above.

The Stable Outlook reflects Fitch's expectation that Rex will continue to perform at recent levels of profitability (operating income is budgeted at $12.4 million (3.0% operating margin) for FY2007). However, liquidity growth may be hindered by capital expenditures over the near term, until Rex is able to restructure its capital lease, which has short maturities. Fitch fully expects UNCHCS to assist with strategic and capital planning, financial support as needed for capital expenditures and expansion plans, and branding which should all help to improve Rex's operating and financial profile. Failure of Rex to maintain operating profitability at or above Fitch's 'A' category median or failure to improve and maintain liquidity levels and MADS coverage to levels at or above Fitch's 'A' category medians is likely to result in downward rating pressure.

Rex operates a 394-licensed bed acute care tertiary hospital (with 45 additional beds in development) and two nursing care facilities with a total of 227 beds. Rex is a controlled affiliated of UNCHCS, which operates a 684-bed academic medical center located in Chapel Hill, NC. The obligated group accounted for approximately 98% of Rex's total assets and total revenue in FY2006. Rex's total operating revenue in FY2006 was $406.8 million. Rex has no interest rate swaps outstanding.

Rex covenants to provide only annual disclosure to the Nationally Recognized Municipal Securities Information Repositories (NRMSIRs). Lack of a covenant to provide for quarterly disclosure is viewed negatively. However, Rex's disclosure covenant was typical of standard practice at time of bond issuance. The practice of reporting only annually to the NRMSIRs is indicative of a weak management practice and Fitch believes that investors should and will impose stricter disclosure requirements on hospitals that only covenant to provide annual disclosure. Management indicates that it will begin disclosure on a quarterly basis to the NRMSIRs.

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.