Fitch Downgrades Anna Jaques Hospital's $9.6MM Bonds to 'BB+'; Stable Outlook.

NEW YORK -- Fitch Ratings has downgraded to 'BB+' from 'BBB-' the rating on the outstanding $9.6 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 rating downgrade is due to AJH's continued operating losses, recent turnover in management, and future capital needs. AJH posted an operating loss of $2.4 million in fiscal 2005 (negative 2.6%; draft audited) and a bottom-line loss of $1.7 million (negative 1.8%), versus an operating loss of $352,000 (negative 0.4%) and a breakeven bottom line in fiscal 2004. The greater losses in 2005 were due to lower than expected volume, and rising labor and supplies expenses. The decline in profitability was also attributed to growing losses on employed physicians, the main component of which was the conversion of AJH's five-physician obstetrical/gynecological practice from an independent to employed practice in order to preserve obstetrics in the local market. In addition, management identified approximately $1.2 million in one-time costs in 2005 including severance for the former CEO and recruitment costs associated with finding a replacement. AJH experienced turnover in management of the CEO and CFO in fiscal 2005. While a new CEO is expected to start on Dec. 12, this instability could lead to further volatility in operating results over the short term. AJH's capital spending has remained well below depreciation expense for the last five fiscal years and was only 68.2% of depreciation expense in fiscal 2005. An increase in capital spending to levels exceeding depreciation will be necessary over the short term for AJH to remain competitive. Ongoing credit concerns include vulnerability to physician departures, and declines in days cash on hand to 51.9 days in fiscal 2005 from 68.3 days in fiscal 2004, well below 'BBB' levels.

Credit positives include AJH's low debt burden and a leading market position. Maximum annual debt service (MADS) as a percent of revenue, and debt to earnings before interest, depreciation, and amortization (EBITDA) were 2.2% and 3.0 times (x) at fiscal 2005, indicating a low leverage position. MADS coverage by EBITDA, while good in fiscal 2004 at 2.4 times (x) declined to 1.6 x in concert with the declining operating performance. AJH expects to borrow $3 million in the short term for a fixed MRI at the hospital, but has no other immediate debt plans. AJH maintains a leading market share in its service area and captured 32.5% of admissions versus Hale Hospital, part of Merrimack Valley Health System, its next closest competitor, which had an 18.4% market share.

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+'. A downgrade in the rating to a level below 'BB+' may result in a termination payment to Morgan Stanley and could cause the bonds to revert to their original coupon. However, in the event of a downgrade below 'BB+', AJH has the option to post collateral equal to the fair market value of the swaps to prevent a termination. The net mark-to-market valuation for both swaps, was negative $101,973 at Sept. 30, 2005, 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.

Fitch believes a return to profitable operations is possible over the next two years and the Stable Outlook reflects a belief that opportunities to improve revenue and control expenses do exist. Reaching stabilized profitability in the short term will be paramount to the organization's success and ability to fund necessary capital investments to remain competitive.

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 2005, SRHS reported total revenues of $89.8 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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