Fitch Rates Wellmont Health (Tennessee) $200MM Revs 'BBB+'; Upgrades Outstanding Revs.

NEW YORK -- Fitch Ratings has assigned an 'BBB+' rating to the $200 million The Health, Educational, and Housing Facilities Board of the County of Sullivan, Tennessee hospital revenue bonds (Wellmont Health System Project), series 2006 C. In addition, Fitch has upgraded to 'BBB+' from 'BBB' Wellmont's outstanding debt listed below, and also assigned the 'BBB+' rating to the series 2006A and 2006B bonds which were not rated by Fitch at time of issuance. Bond proceeds will fund construction projects at three facilities; fund routine capital needs, fund a debt service reserve fund, and pay costs of issuance. The bonds are expected to sell the week of October 23 via negotiation by Ziegler Capital Markets and Citigroup Capital Markets.

The rating upgrade is primarily supported by Wellmont's improved operating performance and strategic plan. In fiscal 2006, Wellmont reported its best operating performance since Fitch initially rated the credit, with a second straight year of strong operating profitability. Wellmont finished fiscal 2006 with an operating margin of 2.6% (operating income of $14.8 million), up from an operating margin of 2.2% (operating income of $11.5 million) for fiscal 2005 and above Fitch's 'BBB' medians of 2.2%. This improved operating performance is a result of enhanced patient volumes coming from Wellmont's new hub-and-spoke model, as well as revenue cycle improvements. Wellmont is expanding its draw from, its secondary service area, which consists of the surrounding 22 counties, through outreach programs as well as clinical affiliations and partnerships.

Wellmont's additional credit strengths include its liquidity and leading market position in its service area. At June 30, 2006 (fiscal 2006) Wellmont had 166.6 days cash on hand (DCOH), down from the 178.4 DCOH at fiscal 2005 but still above Fitch's 'BBB' median of 130.5 DCOH. With this issue, Wellmont intends to reimburse itself approximately $14 million for prior capital expenditures and will also pay of approximately $20 million in short term debt. As a result, unrestricted cash on hand should improve by about 25 days. Wellmont's primary service area market share remains strong at 56%, compared to 22% for the closest competitor; Mountain States Health Alliance (rated 'BBB' with a positive outlook by Fitch).

Credit concerns include a significantly increased debt burden, future capital plans and unfavorable service area characteristics. Following this transaction, both cash-to-debt and debt service as a percentage of revenues will be below Fitch's 'BBB' medians, on a pro forma historical basis. Cash-to-debt drops to 62.7% compared to the Fitch median of 76.1%, and maximum annual debt service amounts to 5% of revenues, compared to a Fitch median of 3.5%. Wellmont's proforma debt service coverage of 2.4 times (x) compares to a Fitch 'BBB' median of 2.8x. Wellmont has embarked on a $200 million capital project with construction and renovation projects at three of its campuses including its two main hospital facilities at Bristol Regional Medical Center and Holston Valley Medical Center. The majority of the construction is at the Holston Valley campus. Fitch is concerned with the typical risks associated with construction projects including interruption to patient volume, delays and cost overruns. In fiscal 2006, Wellmont's payor mix included a high 11.9% Medicaid and 6.9% self pay. Bad debt as a percent of revenues for fiscal 2006 has declined to 6.0%, from 7.6% for fiscal 2005 but still above Fitch's 'BBB' median of 5.6%.

The Stable Rating Outlook is based on Wellmont's improved operating performance and the expectation that Wellmont will meet its projected increasing operating margins of 2.4% to 4.8% through FYs 2007-2011. Wellmont is budgeting an operating income of $14.8 million in FY 2007 (operating margin of 2.4%), which Fitch believes is achievable.

Wellmont currently has seven derivative instruments in place with a total notional amount of approximately $587 million including basis swaps, floating-to-fixed swaps, fixed-to-floating swaps, and total return swaps. Lehman Brothers Special Financing Inc. (rated 'A+/F1+' by Fitch) is the counterparty on all but one of these swaps. For the Lehman swaps, Wellmont is required to post collateral if their ratings were to fall below 'BBB', which Fitch views as a concern given Wellmont's current rating and debt plans. In addition to the Lehman swaps, Wellmont has entered into a forward starting swap for a notional amount of $150 million with Morgan Stanley Capital Services, Inc. (Morgan) with an effective date of December 15, 2006 (extended from September 1, 2006). Fitch does not rate Morgan Stanley Capital Services but does rate the parent company, Morgan Stanley, at 'AA-/F1+'. The purpose of the swap with Morgan is to hedge Wellmont's series 2006C bond issue. Swap payments and termination payments for all of Wellmont's swaps are subordinate to outstanding debt. As of June 30, 2006, the mark-to-market value for all swaps was $5.147 million. Wellmont has a board-approved swap policy and receives monthly reports on the mark-to-market values for the swaps which are presented to the board on a quarterly. Fitch believes the risks posed by the swaps are offset by their financial advantages and management's oversight of their swap program.

Wellmont Health System is a large health care system with five hospitals (857 staffed beds) and other related entities located in northeastern TN and southwestern VA. Wellmont had $573 million in total revenue in FY 2006. Wellmont covenants to provide only annual disclosure to the Nationally Recognized Municipal Securities Information Repositories (NRMSIRs), which Fitch views as a weak legal covenant. Although Wellmont has historically provided both annual financial statements and unaudited quarterly financial statements to the NRMSIRs, management has discontinued the practice of disclosing quarterly information to the NRMSIRs following its September 30, 2005 disclosure, which Fitch views negatively. Management indicates that, due to strategic and competitive considerations, Wellmont only discloses on a quarterly basis to bondholders of record and requesting bondholders. Fitch notes that Wellmont's continuing disclosure practices are indicative of a poor management practice and believes that investors should impose stricter disclosure requirements on hospitals that only covenant to provide annual disclosure.

The following is the list of outstanding debt:

--$76,595,000 The Health, Educational and Housing Facilities Board of the County of Sullivan, TN Hospital Revenue Refunding Bonds, Series 2006A (Wellmont Health System Project) 'BBB+';

--$21,880,000 The Health, Educational and Housing Facilities Board of the County of Sullivan, TN Hospital Revenue Refunding Taxable Bonds, Series 2006B (Wellmont Health System Project) 'BBB+'

--$70,165,000 The Health, Educational and Housing Facilities Board of the County of Sullivan, TN Hospital Revenue Refunding Bonds, Series 2005 (Wellmont Health System Project)** 'BBB+';

Series 2005 bonds were issued to advance refund the series 2002 bonds.

--$49,845,000 The Health, Educational and Housing Facilities Board of the County of Sullivan, TN Hospital Revenue Refunding Bonds, Series 2003 (Wellmont Health System Project)*** 'BBB+'.

**Underlying rating. The bonds are backed by a letter of credit provided by Bank of America, whose long- and short-term debt is rated 'AA-/F1+' by Fitch Ratings.

***Underlying rating. All but $5 million of the series 2003 bonds are insured by Radian Asset Assurance Inc., whose insurer financial strength is rated 'AA' by Fitch.

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