Fitch Affirms Stanly Hosp (NC) Bonds at 'BBB+'; Rating Outlook Stable.

NEW YORK -- Fitch has affirmed the outstanding rating of 'BBB+' on Stanly Health Services and Affiliates (Stanly) $13.97 million of North Carolina Medical Care Commission health care facilities revenue bonds (Stanly Memorial Hospital Project), series 1999, and has also affirmed the underlying rating of 'BBB+' on the $19.255 million of North Carolina Medical Care Commission health care facilities revenue bonds (Stanly Memorial Hospital Project), series 1996. The series 1996 bonds are insured by Ambac Assurance Corp, whose insurer financial strength is rated 'AAA' by Fitch. The Rating Outlook is Stable.

The 'BBB+' rating affirmation is based on Stanly's strong market position, improved operating performance, manageable debt burden, and reduced losses on employed physicians. Stanly operates the only hospital located in its primary service area and maintains a strong market share of 62.5% as of June 30, 2005, compared to 17.6% for Northeast Medical Center, its nearest competitor. In fiscal 2005, Stanly reported an operating margin of 1.3% (operating income of $1.5 million), up from the negative 1.5% operating margin (operating loss of $1.5 million) for fiscal 2004 and above Fitch's 'BBB' median of 1%. The primary drivers for this improved profitability were a reduction of losses from employed physicians, increased outpatient volume, cost controls and managed care payor rate increases. Maximum annual debt service (MADS) coverage and MADS as a percent of revenue for fiscal 2005 was 3.3 times (x) and 3.3%, respectively, which compares favorably to Fitch's 'BBB' medians of 2.8x and 3.6%, respectively. Losses on employed physicians dropped to approximately $2.1 million (loss of $87,500 per provider) in fiscal 2005, from approximately $3.0 million (loss of $136,360 per provider) in fiscal 2004. Management expects a further reduction in losses from employed physicians for fiscal 2006 due to restructuring of all physician agreements to performance-based contracts that became effective in October of 2005.

Credit concerns include Stanly's light liquidity, declining inpatient admissions, weak payor mix, and future capital needs. At fiscal 2005, Stanly had 93.4 days cash on hand and cash to debt of 75.3%, below Fitch's 'BBB' medians of 117.5 days and 82.1%, respectively. However, this liquidity has improved from fiscal 2004 and management intends to continue to build liquidity at or above Fitch 'BBB' medians. Inpatient admissions have declined by approximately 10.2% since fiscal 2003, and are down 4% through the first three months of fiscal 2006 when compared to fiscal 2005. The primary reasons for this declining volume are Stanly sponsored health and wellness programs for the community resulting in fewer hospital admissions and a decrease in hospital admissions from the emergency room. Offsetting this concern is outpatient volume and surgical cases, which are both profitable and continue to improve for the hospital. Stanly remains exposed to a weak payor mix due to its service area characteristics. Bad-debt expense for fiscal 2005 was 8.9% of total revenue and the percentage of Medicaid and self-pay payors are high at 13.5% and 7.3%, respectively.

Stanly has announced plans to begin construction on its West Campus located in Locust, NC, approximately 15 miles from the main hospital. Preliminary construction plans include a campus with primary and specialty care, urgent care, imaging services, and a pharmacy. Total cost for this project is estimated to be around $7 million and may include an additional debt issuance and outstanding debt restructuring. If current levels of profitability continue, Fitch would not expect the proposed financing to cause any rating pressure. Management does not expect to issue any new debt before fall 2006.

The Stable Rating Outlook is based on Stanly's return to profitability, reduced losses on physicians, and stable debt service coverage. Stanly is budgeting an operating income of $6.59 million from hospital operations for fiscal 2006, which Fitch believes is aggressive. Management is projecting an operating income of approximately $4.8 million (3% operating margin) for the hospital in fiscal 2006. Fitch expects the system operating margin for fiscal 2006 to meet or exceed fiscal 2005 performance.

Stanly Health Services and Affiliates is located in Albemarle, NC (approximately 40 miles east of Charlotte) and includes Stanly Memorial Hospital (119-bed acute care hospital), Stanly Manor (100-bed long-term care facility), Stanlex Inc. (home health agency), and Stanly Medical Services (13 physician practices -- not a member of the obligated group), and other related health care entities. In fiscal 2005, Stanly Health Services had $111.4 million in total revenue. Stanly covenants to provide only annual audited financial statements to the Nationally Recognized Municipal Securities Information Repositories (NRMSIRs) which Fitch views negatively. However, Fitch notes that Stanly's bond covenants date back to documents produced in 1999 and 1996, when the expectations for disclosure were not as thorough. Stanly does voluntarily disclose quarterly disclosure to the NRMSIRs including unaudited nonconsolidated balance sheet, income statement and utilization statistics but no cash flows or management discussion and analysis. Management has indicated that it will continue to voluntarily disclose quarterly information 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.