Fitch Revises Jefferson Health System, PA's Outlook to Positive; Affirmed at 'AA-'.

NEW YORK -- Fitch Ratings has affirmed the 'AA-' rating on approximately $622 million (original par amount) of hospital revenue bonds issued on behalf of Jefferson Health System, PA. The outstanding bonds are listed at the end of the press release. Fitch has also revised the Rating Outlook on Jefferson Health System (JHS) to Positive from Stable.

Fitch has also affirmed the short-term rating on $27 million of series 1999B variable-rate demand bonds at 'F1+', which is based on Jefferson Health System's (JHS) own internal liquidity. The bonds are remarketed annually, which provides JHS substantial time to prepare for any potential unremarketed put. Coverage of these bonds with cash and cash equivalents at fiscal 2005 is in excess of 12 times (x).

The Rating Outlook revision to Positive reflects JHS' improved profitability trends over the last two and a half years. Through the first six months of fiscal 2006 ended Dec. 31, 2005, JHS posted a solid 4% operating margin (income of $62.8 million). This compares favorably to the 1.7% and 3.2% operating margins generated in fiscal years 2004 and 2005, respectively. Fiscal 2005 operating income of $96.1 million includes a one-time charge of $37.6 million related to a prior insurance claim. For fiscal 2006, JHS management expects an operating margin in excess of 4%, which Fitch believes is attainable. In addition, management has indicated potential acquisition targets in the Philadelphia market, plans to build two new hospitals in Montgomery County and Delaware County, and a tower expansion at the Paoli hospital facility. The total scope of these projects along with their associated costs and sources of funding have not all been determined. A positive rating action will depend upon sustained operating profitability over the next two years along with no significant deterioration in balance sheet indicators given JHS' capital and acquisition plans.

Primary credit strengths supporting the 'AA-' rating include JHS' leading market position, strong balance sheet, low debt burden, good profit dispersion among its various affiliates, and nurse magnet status at Main Line's four hospitals. JHS had a leading 25% market share in the five-county Philadelphia region ahead of the University of Pennsylvania Health System's approximate 12% to 13% (the next largest health system).

Although there are some major credit concerns for organizations operating in Pennsylvania, especially in Philadelphia, JHS' size and relative diversity within the Philadelphia market allows the system to operate and compete effectively. The balance sheet remains a key financial strength with over $1.7 billion of unrestricted cash and investments, which includes about $200 million of board designated, self insurance funds in excess of actuarially determined amounts and $400 million in foundation funds that are not fully consolidated on JHS' balance sheet. This translates into 229 days' cash on hand and cash to debt of 293% at Dec. 31, 2005. JHS' debt burden remains low for the 'AA' category with MADS at 1.5% of revenues and debt to capitalization of 27.1% at fiscal 2005. As a result, MADS coverage is very strong at 6.6x in fiscal 2005 and 7.6x through the six months ended Dec. 31, 2005. Additionally, all five of JHS' hospital divisions generated positive operating gains in fiscal 2005, which reflects good profit dispersion in the system.

Fitch's primary concerns remain JHS' competitive market, the dominance of two large managed care organizations in the market, future capital needs and acquisitions, historically difficult professional liability insurance environment, a sizeable unfunded pension liability (accumulated benefit obligation is 69% funded), and the weak legal structure governing the bonds. JHS competes with several large multi-site hospital systems that have between 7%-12% market share. In addition, the managed care market is dominated by Independence Blue Cross (IBC) and Aetna. JHS has been successful in achieving favorable reimbursement rates with these insurers through 2008 when these contracts are up for renegotiation. Nonetheless, the influence IBC and Aetna could have over reimbursement rates in the long term remains a concern.

Capital spending historically has been below Fitch's 'AA' category medians. As a result JHS' average age of plant is high at 12.7 years, which indicates the need for future capital spending. JHS is expected to issue around $110 million in debt over the next one-to-two years to fund the construction of a new patient tower at Paoli Hospital. JHS also has plans to build two new hospitals, one in Montgomery County and another in Delaware County, however, plans for both are preliminary at this stage. Just recently, JHS' Albert Einstein division and Montgomery County Hospital formed a partnership to build a new 200 bed replacement hospital in the county. The replacement hospital will cost around $200 million, which will be financed through a FHA loan. While the FHA loan will be non-recourse to JHS, the new hospital will be a wholly-owned subsidiary of Albert Einstein and the debt will also be consolidated into JHS' balance sheet. Market consolidation in the greater Philadelphia market is also expected to continue with the potential exit of Tenet from the market. JHS has indicated the possibility of growing through future acquisitions; however, no transactions are currently in process.

On Nov. 8, 2005, JHS entered into a forward starting floating- to fixed-rate swap with a total notional amount of $100 million. The swaps have an effective date of Nov. 1, 2007 and the counterparties are UBS and Wachovia.

Headquartered in Radnor, PA, JHS is a large health care system operating nine acute-care hospitals (3,168 staffed beds), three physical rehabilitation hospitals, two skilled nursing facilities, one psychiatric hospital, and multiple clinical delivery sites throughout the Philadelphia/Delaware Valley area. JHS' total revenues in fiscal 2005 were $3 billion. JHS only covenants to provide bondholders with annual disclosure, which is viewed negatively by Fitch. However, JHS has started to post, voluntarily, quarterly disclosure material on the NRMSIRs and DAC www.dac-ey.com. Quarterly disclosure to date includes a balance sheet and income statement, however, lacks management discussion and analysis, a cash flow statement, and utilization statistics.

Fitch has affirmed the following health systems revenue bonds on behalf of Jefferson Health System and revised the Rating Outlook to Positive from Stable:

Pennsylvania Economic Development Financing Authority (PA)

-- $55,000,000 revenue bonds, series 2005A and series 2005B (1).

Chester County Health and Education Facilities Authority

-- $41,600,000 revenue bonds, series 2004A (2);

-- $27,425,000 revenue bonds, series 2004B (2);

-- $185,400,000 revenue bonds, series 1997B (5).

The Hospitals and Higher Education Facilities Authority of Philadelphia, PA

-- $52,200,000 revenue bonds, series 1999A;

-- $26,900,000 revenue bonds, series 1999B (3);

-- $123,900,000 revenue bonds, series 1998A (4);

-- $108,700,000 revenue bonds, series 1997A (5).

(1) These bonds have a short-term rating of F1+ based on a standby bond purchase agreement provided by Fleet National Bank.

(2) These bonds have a short-term rating of F1+ based on a standby bond purchase agreement provided by JP Morgan Chase.

(3) These bonds have a short-term rating of 'F1+' based on the internal liquidity of Jefferson Health System;

(4) Insured by MBIA (rated 'AAA' by Fitch);

(5) Certain portions of the series 1997A and 1997B bonds are insured by Ambac (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.