Fitch Rates Adventist Health's (CA) Series 2005 Bonds 'A'; Outlook to Stable.

NEW YORK -- Fitch Ratings assigns an 'A' rating to the approximately $81.6 million California Statewide Communities Development Authority health facility revenue bonds (Adventist Health System/West) 2005 series A, and to the $93.4 million 2005 series B. Fitch also affirms the underlying 'A' rating to the $508.8 million outstanding bonds listed below. The Rating Outlook is revised to Stable from Negative.

Bond proceeds will be used to finance future capital expenditures, fund a debt service reserve, and pay costs of issuance. At this time, Adventist is evaluating the possibility of issuing the series B bonds in the form of insured auction bonds. Pricing of the fixed-rate bonds is expected the week of Sept. 26 through negotiation by Goldman, Sachs & Co. After the current issuance, Adventist Health's (Adventist) pro forma debt mix will be approximately 50% fixed-rate and 50% variable-rate, including the use of swaps. Adventist has two variable-to-fixed-rate interest rate swaps with a notional amount totaling $30 million (ending in 2012) with JP Morgan Chase Bank as the counterparty. Adventist also has a $124 million total return swap program, which essentially converts the mode on the series of bonds from a fixed to variable rate, with Morgan Stanley as the counterparty. Adventist can unwind the total return swap program upon three days notice. Lastly, Adventist has a $150 million BMA interest rate cap in place with JP Morgan Chase Bank as the counterparty.

The rating is supported by Adventist's improved operating performance through the six months ended June 30, 2005, solid maximum annual debt service (MADS) coverage, and system diversity. Operating income was $9.4 million (1.5% operating margin) through June 30, 2005, an improvement from $4.8 million (0.5% operating margin) over the same period in the prior year. At the time of Fitch's last review in November 2004, operating profitability had been declining due in large part to California-mandated nurse staffing ratios, increased nurse agency usage, insufficient governmental reimbursement, and a reduction to its Medicare outlier reimbursement payment. In response to these pressures, Adventist's management consolidated managed care contracting at the system level, hired new business development staff at eight hospitals to enhance market share and promote revenue growth, and engaged operational improvement consultants to help implement operational improvement plans at several of its hospitals. The result has been improved operating performance and solid debt service coverage with pro forma MADS coverage of 2.8 times (x) through June 30, 2005. In addition, Fitch views positively Adventist's geographic diversity, which provides some level of protection against negative market forces in any one region. Other strengths include Adventist's manageable debt burden and adequate liquidity. Pro forma MADS as a percentage of revenue was a low 2.7% in 2004, although this strength is offset somewhat by above-average pro forma debt-to-capitalization and debt-to-EBITDA ratios of 48.9% and 6.5x, respectively, in the same period. Liquidity relative to expenses is adequate as highlighted by 135 days cash on hand at June 30, 2005.

Credit concerns include Adventist's weak operating profitability in each of the last two years, high exposure to governmental funding, capital needs, and continued pressure on labor expense. In addition, some revenue concentration remains within the system, as the four largest hospitals accounted for approximately 46% of total revenue in 2004. Medicaid reimbursement, which is made up primarily of Medi-Cal, comprised approximately 20% of gross revenues in 2004 and Adventist receives substantial disproportionate share hospital funding, which leaves it vulnerable to governmental funding reductions. Adventist also has a substantial five-year $613 million capital plan, the majority of which will be funded from proceeds of the current issuance and cash flow from operations. Other sources are estimated to include some additional debt ($110 million), philanthropic support ($33 million), and FEMA grants ($15 million). Fitch believes the capital plan is manageable but that there is potential for cost overruns and construction delays and that liquidity growth will likely be limited. Fitch also believes labor expense will continue to pressure operations given state-mandated nurse staffing ratios combined with the statewide nurse shortage.

The Stable Rating Outlook is based on Adventist's improved operating performance through the six-month interim period and the expectation that Adventist will achieve stable operating margins going forward due to revenue growth and cost reduction initiatives, together with the opportunity to increase market share and volume growth as new facility renovations and expansions are completed. Moreover, Adventist's future debt issuance plans appear to be minimal so its debt burden should remain manageable. However, failure to maintain positive operating margins could result in negative rating pressure. Adventist controls or manages 20 hospitals, 15 of which are obligated group members, located throughout California, Oregon, Washington, and Hawaii. Total revenue was $1.8 billion in 2004. Adventist covenants to provide bondholders with quarterly and annual financial disclosure, which includes balance sheet, income statement, and statement of cash flows.

Outstanding debt:

--$2,600,000 Washington Health Care Facilities Authority variable rate demand revenue bonds, Series 1984 (Adventist Health System-West/Walla Walla General Hospital) (enhanced by Mellon Bank LOC);

--$6,593,000 Adventist Health System/West five-year extendable notes, 1987 series A;

--$9,425,000 Adventist Health System/West variable rate demand bonds due 2016 (enhanced by Wells Fargo LOC);

--$33,580,000 California Health Facilities Financing Authority insured hospital revenue refunding bonds (Adventist Health System/West) 1991 Series A (insured by MBIA whose insurer financial strength is rated 'AAA' by Fitch);

--$38,420,000 California Health Facilities Financing Authority insured hospital revenue refunding bonds (Adventist Health System/West) 1991 series B (insured by MBIA whose insurer financial strength is rated 'AAA' by Fitch);

--$28,015,000 City of Glendale, California insured hospital revenue refunding bonds (Adventist Health System/West) 1991 series A (insured by MBIA whose insurer financial strength is rated 'AAA' by Fitch);

--$28,417,482 California Health Facilities Financing Authority variable rate revenue bonds (Adventist Health System/West-Sutter Health Revolving Loan Pool) series 1991A and 1991B (enhanced by US Bank LOC);

--$8,290,000 Hospital Facility Authority of Clackamas County, Oregon, insured hospital revenue refunding bonds (Adventist Health System/West) series 1992A (insured by MBIA whose insurer financial strength is rated 'AAA' by Fitch);

--$15,750,000 City of Bakersfield, California, hospital revenue refunding bonds (Adventist Health System/West) series 1993 (insured by MBIA whose insurer financial strength is rated 'AAA' by Fitch);

--$3,400,000 Department of Budget and Finance of the State of Hawaii special purpose revenue bonds (Adventist Health System/West) series 1994 (enhanced by Wells Fargo LOC);

--$106,300,000 California Health Facilities Financing Authority insured variable-rate hospital revenue bonds (Adventist Health System/West) 1998 series A, B, and C (insured by MBIA whose insurer financial strength is rated 'AAA' by Fitch) (liquidity by CALSTRS (California State Teachers' Retirement System));

--$60,000,000 California Health Facilities Financing Authority variable-rate hospital revenue bonds (Adventist Health System/West) consisting of: $35,000,000 2002 series A and $25,000,000 2002 series B (enhanced by Wachovia LOC: $35 million; $25 million);

--$168,000,000 California Health Facilities Financing Authority variable-rate hospital revenue bonds (Adventist Health System/West) consisting of: $35,000,000 2002 series A and $25,000,000 2002 series B.

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