Fitch Rates MedStar's 2007 Bonds 'BBB+'; Outlook to Positive.

NEW YORK -- Fitch Ratings has assigned a 'BBB+' rating to the $149 million Maryland Health and Higher Education Facilities Authority revenue bonds MedStar Health Issue, series 2007. In addition Fitch affirms the 'BBB+' rating on approximately $750 million of MedStar Health Inc.'s (MedStar) outstanding bonds (listed below). The Rating Outlook is revised to Positive from Stable.

Bond proceeds will be used to finance construction projects at Franklin Square Hospital (FSH) and pay for costs of issuance. Final legal documents for the series 2007 transaction were not available to Fitch; the rating assumes no weakening of the legal structure for the existing bonds and that the series 2007 bonds will be on parity with existing debt. The bonds are expected to price the week of Jan. 15 through negotiation led by Citigroup Capital Markets.

The rating and Positive Outlook reflect MedStar's improving financial profile, improved performance of its Washington, D.C. facilities, and good management practices, offset mainly by the increased debt load and future capital plans.

Medstar's profitability has improved with an excess margin of 7.8%, in the fiscal year ended June 30, 2006, up from the 6.9% reported in fiscal 2005. MedStar's operating margin, after adjusting for investment income included as other operating income, was 1.4% in fiscal 2006, up from the 0.6% in fiscal 2006. All of MedStar's acute care hospitals had profitable operations, including its Washington, D.C. facilities, which have historically struggled. Balance sheet measures, including days cash on hand, cash to debt, and pro-forma cushion ratio, remain healthy and were 104.6 days, 94.1%, and 12.6 times (x), respectively, at fiscal 2006. Pro-forma debt service coverage by EBITDA was a strong 3.9x for the same period. Through the three months ended Sept. 30, 2006 MedStar had a 1.9% operating margin ($14.8 million).

Including the construction at FSH, MedStar is planning to spend 152%-194% of its depreciation expense over the next three years. The $175 million project at FSH will be funded by bond proceeds ($130 million), and operations and philanthropy ($45 million). Spending since fiscal 2001 has been somewhat light, and the average age of plant has increased to 11.8 years, which compares unfavorably with Fitch's 'BBB' median of 9.6 years. While MedStar's debt burden relative to operations is low, pro-forma debt-to-capitalization (60.6% at fiscal 2006) and pro-forma debt-to-EBITDA (4.1% at fiscal 2006) are somewhat high compared to Fitch's 'BBB' medians of 47.1% and 4.0%, respectively.

The Positive Outlook is based on Fitch's expectation that operating performance will continue to improve. Growing patient volumes and revenues should continue to support strong debt service coverage. MedStar is projecting operating margins of approximately 1% through fiscal 2009, which Fitch views as conservative. If MedStar is able to improve results over the next two fiscal years, an upgrade would be warranted.

MedStar entered into a floating- to fixed-rate swap related to its series 1998 District of Columbia bonds. The swap has a notional amount of $138.2 million and expires in 2027. The counterparty is Wachovia Bank, N.A. (whose long- and short-term debt is rated 'AA-/F1+' by Fitch). At Nov. 30, 2006, the mark to market valuation on the swap was negative $5.6 million, indicating the amount MedStar would have to pay if the swap were terminated. MedStar has a board-approved swap policy and is in the process of developing a summary report on outstanding swaps for the board. Swap and termination payments are on parity with outstanding debt, which Fitch views negatively. Despite this, Fitch believes the swap poses minimal risk to MedStar.

MedStar Health is a large, integrated health care system composed of seven hospitals (three in Washington, D.C. and four in Baltimore) with a total of 2,442 operated beds and several other health care-related organizations. MedStar had total operating revenues of $2.9 billion in fiscal 2006. MedStar covenants to provide annual and quarterly disclosure to the Nationally Recognized Municipal Securities Information Repositories (NRMSIRs). Quarterly disclosure is very good and includes a balance sheet, income statement, cash flow statement, utilization, and management discussion and analysis. Fitch notes that MedStar's fourth-quarter disclosure to bondholders is not similar to what is disclosed in the other quarters, which Fitch views negatively; however, management indicated that they are willing to provide information to bondholders supplemental to the audit upon request.

Fitch affirms the following outstanding debt at 'BBB+':

--$170,350,000 Maryland Health and Higher Education Facilities Authority (MedStar Health Issue) revenue refunding bonds, series 2004;

--$292,300,000 District of Columbia (Medlantic/Helix) multi-modal revenue bonds, series 1998A, 1998B, 1998C (insured by FSA);

--$166,605,000 Maryland Health and Higher Education Facilities Authority (Medlantic/Helix) revenue bonds, series 1998A (insured by FSA, whose insurer financial strength is rated 'AAA' by Fitch);

--$114,600,000 Maryland Health and Higher Education Facilities Authority (Medlantic/Helix) revenue bonds, series 1998B (insured by Ambac, whose insurer financial strength is rated 'AAA' by Fitch).

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.