Fitch Rates Stanford Hospital & Clinics (California) Bonds 'A+'.

SAN FRANCISCO -- Fitch Ratings assigns an underlying 'A+' rating to the California Health Facilities Financing Authority revenue bonds (Stanford Hospital and Clinics) series 2006A and series 2006B. Each series is expected to be insured at a later date. In addition, Fitch assigns an underlying 'A+' rating to the approximately $427.4 million outstanding debt, listed below. The Rating Outlook is Stable.

The approximately $260.3 million series 2006A and $168.2 million series 2006B bonds are expected to be issued as insured auction-rate securities and will price sometime in February 2006 through negotiation led by Bear, Stearns & Co. Inc. Bond proceeds will fund various renovation and expansion projects, capitalized interest, and costs of issuance. The security on the outstanding bonds is a pledge of gross revenues. Legal documents related to the series 2006 bonds are not yet available. The rating assumes no weakening of the legal covenants, security, and/or changes to the bond sizing.

The series 2006 bonds have been swapped to a fixed rate through the use of four forward starting swaps with Bear Stearns Capital Markets Inc. and one forward starting swap with Morgan Stanley Capital Services Inc. as the counterparties. Stanford Hospital and Clinics (SHC) pays fixed rates ranging from 3.63%-3.73% and receives 70% of one-month LIBOR on the swaps. Fitch believes that the swaps pose limited credit risk to SHC due to its good liquidity position.

The rating is supported by SHC's strong operating trend, solid liquidity relative to expenses, and excellent clinical reputation with ties to Stanford University. SHC achieved robust operating margins in each of the past three fiscal years following large operating losses in fiscal years 2000 and 2001. Operating income was $122 million in fiscal 2005, which equated to a very high 9.1% operating margin, up from $42 million (4.3% operating margin) and $92 million (8.0% operating margin) in fiscal years 2003 and 2004, respectively. The operating improvement is attributed largely to rate increases, high-acuity volume growth, and increased stability following the SHC/University of California at San Francisco Medical Center demerger. In addition, academic grant transfers, which historically had been recorded as operating expenses, were recorded as reductions to net assets in 2004 and 2005 ($13.9 million and $21.1 million, respectively). Sizable rate increases were implemented in fiscal years 2004 and 2005 to bring SHC's charges more in line with its peer group, and inpatient admissions increased 9.9% and 2.1% in each of the same fiscal years. Moreover, SHC exited most of its commercial capitated contracts in fiscal 2002, and the majority of its managed care contracts have stop loss coverage. Pro forma maximum annual debt service (MADS) coverage was a healthy 4.5 times (x) in fiscal 2005.

SHC's solid liquidity position has been bolstered by its strong operating performance and cash flow. At Aug. 31, 2005, unrestricted cash and investments were $641.9 million, which translated into 206.6 days cash on hand and 150.5% cash-to-debt. However, when including the additional debt, pro forma cash-to-debt at Aug. 31, 2005 falls to a below-average 75.1%.

Fitch views as a strong credit factor SHC's reputation as a leading tertiary and quaternary provider of acute-care services and close affiliation with the Stanford University School of Medicine (SOM). U.S. News and World Report ranked SHC as the 16th best hospital in the nation in 2005, and SHC has a leading market position for most high acuity services in its primary service area.

Primary credit concerns include SHC's extensive capital plan and high pro forma debt burden. SHC has a five-year, approximately $1.1 billion capital plan that is driven by facility renovation and expansion, as well as investment technology and seismic upgrades. Included in the capital plan is $250 million for the acquisition and construction of an off-campus ambulatory surgery center that will house orthopedics and other outpatient services to be completed in fiscal 2008. The location is highly accessible and will free up needed capacity at the main facility, which is viewed positively. Capital plan sources include series 2006 bond proceeds and cash and ongoing cash flow. Fitch believes the capital plan is achievable; however, the additional debt will nearly double SHC's existing debt load, which is a concern. Pro forma debt-to-capitalization increases to a high 66.2% in fiscal 2005, although this concern is mitigated somewhat by a still relatively low 3.3% pro forma MADS as a percentage of revenue and a moderate 4.3x pro forma debt-to-EBITDA in fiscal 2005.

Other concerns include SHC's competitive service area and labor, pension, and other expense pressures. SHC has two bargaining units, one of which (the SEIU) recently participated in a one-day strike after contract bargaining meetings ended in a stalemate. Negotiations resumed but have yet to be resolved and, although participating employees make up only 17% of SHC's workforce, a prolonged stalemate and/or additional strikes could disrupt operations. In addition, SHC plans to increase its pension contribution to $10.1 million in fiscal 2006 from $1.7 million in 2005.

The Stable Rating Outlook is based on Fitch's belief that SHC will continue to achieve positive margins and good MADS debt service coverage given its recent operating and cash flow trend, clinical reputation, and growth in services. SHC has a 5.8% operating margin budget for fiscal 2006, which Fitch believes is achievable. Fitch also believes, however, that future operating margins could be tempered somewhat by lower anticipated rate increases than those implemented in recent years and increased labor, pension, and other expense pressures. In addition, effective fiscal 2006, academic grant transfers will once again be recorded as operating expenses and the potential for construction delays and other inherent capital plan related risks could constrain profitability and limit liquidity growth.

SHC is a 566 licensed-bed hospital located in Palo Alto, California on the Stanford University campus. Total revenue in fiscal 2005 was $1.4 billion. SHC covenants to provide annual and quarterly disclosure to bondholders, which Fitch views positively. Quarterly disclosure includes balance sheet, income statement, and statement of cash flows.

Outstanding debt:

--$177,430,000 California Health Facilities Financing Authority revenue bonds (Stanford Hospital and Clinics) series 1998B, insured by both Ambac Assurance Corporation and Financial Security Assurance;

--$100,000,000 California Health Facilities Financing Authority revenue bonds (Stanford Hospital and Clinics) 2003 series A;

--$48,800,000 California Health Facilities Financing Authority revenue bonds (Stanford Hospital and Clinics) 2003 series B, insured by Financial Security Assurance;

--$48,700,000 California Health Facilities Financing Authority revenue bonds (Stanford Hospital and Clinics) 2003 series C, insured by Financial Security Assurance;

--$52,500,000 California Health Facilities Financing Authority revenue bonds (Stanford Hospital and Clinics) 2003 series D, insured by Financial Security Assurance.

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