Fitch Dwngrs Lutheran Social Services of the South, TX $12MM Bds to 'B-'.

Business Editors

NEW YORK--(BUSINESS WIRE)--Aug. 28, 2003

Fitch Ratings downgrades to 'B-' from 'BB' issued on behalf of Lutheran Social Services of the South (LSSS) as follows:

-- approximately $3.2 million Denton County Health Facilities

Development Corp. revenue bonds, series 1995;

-- approximately $2.1 million Louisiana Public Facilities

Authority revenue bonds, series 1994; and

-- approximately $6.4 million Washington County Health Facilities

Development Corp. revenue bonds, series 1994.

The Rating Outlook is Negative. Fitch's 'B' rating category indicates that significant credit risk is present, but a limited margin of safety remains.

The downgrade is based on recently poor operating performance and significantly reduced liquidity. Although one-time events such as flood damage at one of LSSS's facilities and mold problems at another facility explain part of recent poor operating performance, occupancy challenges at two start-up assisted living facilities have also contributed to declining profitability. Excess margins have declined from 5.1% in fiscal 2001 (ended March 31) to 0.7% at the end of fiscal 2003 to an unaudited negative 1% through three months of fiscal 2004 ended June 30. Despite the receipt of approximately $3.9 million, net of related debt, from the sale of two nursing homes in fiscal 2003, unrestricted cash and investments declined by more than $2 million. Cash was used to fund operating losses, capital costs, and an increase in insurance premiums. LSSS now provides self-insurance and expects claims experience, which has equaled approximately $1 million per year in the past, to be reduced with the elimination of two nursing homes.

LSSS, the largest provider of children services in the State of Texas, could lose up to $1 million in annual revenue related to its children programs due to a state rate cut that is expected to go into effect

Sept. 1. Although management expects to offset the revenue reduction by gaining additional cases at marginal costs as other providers discontinue operation, reimbursement cuts are expected to pressure operations.

Fitch does note certain positive organizational changes that have been made and are being contemplated. LSSS's plan to largely exit the nursing home business is viewed favorably since reimbursement is poor and insurance liability is high. LSSS may also diversify revenue streams as it looks at the possibility of operating a charter school for approximately 250 children it houses in its treatment centers, treating refugee children through a federal refugee settlement program, and maintaining strong occupancy at its assisted living facility. In addition, LSSS has instituted rate increases, ranging from 3%-10%, at its long-term care facilities that should lead to improved profitability by the end of fiscal 2004.

The Negative Rating Outlook reflects Fitch's belief that profitability improvement will remain challenging given expected cuts to reimbursement from the state and ongoing expense pressure. With LSSS' limited liquidity, failure to improve profitability and increase cash balances could create further rating pressure.

LSSS is a social service organization that provides care through three nursing homes (391 beds), three assisted living facilities (180 beds), five residential treatment centers (290 beds), two independent living facilities (164 units), two adult day care centers, as well as programs in child welfare, adoption, and foster care. LSSS is headquartered in Austin, Texas and services are offered throughout Texas and in New Orleans. Annual revenue in fiscal 2003 equaled $62 million. Disclosure to Fitch has been excellent with timely receipt of quarterly and annual financial information.