Fitch Downgrades $145.6MM Lenox Hill Hospitals (New York) Bonds to 'BBB-'; Outlook Negative.

NEW YORK -- Fitch Ratings downgrades the rating to 'BBB-' from 'BBB+' on approximately $145.6 million of outstanding Dormitory Authority of the State of New York revenue bonds (Lenox Hill Hospital Obligated Group), series 2001. The Rating Outlook is Negative.

The rating downgrade is due to a sizable operating loss in fiscal 2004 at Lenox Hill Hospital and its subsidiary Manhattan Eye, Ear, and Throat Hospital (MEETH), the projected operating loss in 2005, and weak liquidity measures. LHH posted a $65.1 million loss in 2004 or negative 11.7% operating margin (excluding investment income and contributions included in other revenue). The 2004 operating loss was largely attributed to a $42.5 million writedown of accounts receivable that resulted from a 'look back' process to determine the net realizable value of accounts receivable at Dec. 31, 2004. The writedown consisted of $30 million of prior-year adjustments and $12.5 million of fiscal 2004 adjustments. Management indicated that they have addressed the issues that caused the writedown and do not expect adjustments going forward.

Excluding the $42.5 million writedown, LHH lost $22.6 million from operations in 2004 versus a breakeven budget. A portion of the operating losses was attributed to volume declines at both LHH and MEETH in interventional cardiology, plastic surgery, and ophthalmology, the impact of drug-eluting stents, and the closure of eight of MEETH's operating rooms for periods of time during 2004. Additionally, declines in Medicare outlier reimbursement and increases in malpractice, pension, and patient care supplies expenses contributed to the losses. Despite the sizable losses, LHH has complied with all of its financial covenants for fiscal 2004. Debt service coverage, excluding the accounts receivable writedown and MEETH's performance as allowed under the bond documents was 1.26 times (x) in 2004 versus a 1.25x covenant requirement.

Management is now projecting an operating loss of approximately $20 million for the year ending Dec. 31, 2005. Through the five months ended May 31, 2005, LHH posted a $6.9 million operating loss (negative 2.9% operating margin). Debt service coverage through the same period was 1.6x. Management has attributed the five months' results to lower-than-expected case mix intensity and lack of revenue realization from a strategic pricing initiative.

Unrestricted cash and investments declined to $91.4 million at 2004 from $102.9 million at fiscal year-end 2003. Days cash on hand and cash-to-debt ratios weakened to 46.9 days and 50.3%, respectively (factoring the use of an outstanding line of credit in the amount of $18.2 million). However, LHH will not be in violation of liquidity covenants as per the bond documents, which exclude the impact of MEETH and do not require adjustments for short-term debt outstanding. Days cash on hand as allowed under the bond documents is 53.5 days at fiscal year-end 2004.

Offsetting the current credit concerns are LHH's strong clinical reputation and market share in key clinical specialties and management's initiative to return the system to profitability. LHH maintains a leading market share in cardiovascular and orthopedic services, and MEETH currently holds a leading market share in plastic surgery, ear, nose and throat services, and ophthalmology. Several initiatives are currently under way to return LHH to profitability, including physician recruitment in key areas and managed care contract renegotiations. Also, management has engaged Navigant Consulting to assist in improving throughput and case management. Lastly, management is considering FTE reductions and is negotiating a lease agreement with another hospital for space at MEETH, which could result in additional revenue.

Fitch's Negative Outlook reflects the significant challenges management faces in returning the system to profitability over the short term. Inability to show measured improvement in profitability and balance sheet indicators over the next two years will result in downward rating pressure.

Located in New York City, LHH operates 682 beds (including MEETH) on two campuses. The consolidated system (including MEETH) had total revenue of $557.7 million in 2004. LHH covenants to provide only annual audited information to bondholders but voluntarily provides disclosure to bondholders through the nationally recognized municipal securities information repositories.

Fitch's rating definitions are available on the agency's public web site, www.fitchratings.com. Published ratings, criteria and methodologies, and relevant policies and procedures are also available from this site, at all times. This document will remain on the public site for seven days.