Fitch Upgr Mountain States Health Alliance -- Tennessee -- Bonds to 'BBB'; Positive Outlook.

NEW YORK -- Fitch Ratings today has upgraded to 'BBB' from 'BBB-' the rating on Mountain States Health Alliance's (MSHA) $493,489,671 of outstanding bonds, listed below. The Rating Outlook remains Positive.

The rating upgrade is supported by MSHA's sustained improvement in operating performance, liquidity gains, and positive volume trends, which have allowed MSHA to maintain its leading market position. MSHA has steadily improved its overall operating performance every year since fiscal 1999. MSHA surpassed its budget in fiscal 2004 with $10.3 million in operating income (2.1% operating margin) and $36.4 million in excess income (a 7.2% excess margin). Revenue growth has been fueled by higher volumes and more favorable reimbursement rates, while expense growth has declined in each of the past three years due to effective cost containment initiatives.

These operating improvements, combined with steady investment returns, have led to improvements in debt service coverage and liquidity. Through the three months ended Sept. 30, 2004, MSHA's operating and earnings, before, interest, taxes, depreciation, and amortization margins were 2.2% and 20.0%, respectively, and its maximum annual debt service (MADS) coverage was 2.2 times (x), a solid improvement from negative 7.5%, 11.3%, and 0.8x, respectively, in fiscal 1999. MADS was adjusted from $41.3 million to $47.2 million in fiscal 2005. MSHA's days cash on hand increased to 227.5 days at June 30, 2004, compared with 178.7 days at fiscal 2003. The growing population in MSHA's service area combined with positive volume trends has enabled MSHA to maintain its leading market share in the PSA.

Credit concerns revolve around MSHA's heavy debt burden, its high dependence on governmental payors, and dependence on its flagship facility and a complex and aggressive swap program. Although leverage ratios at June 30, 2004 continue to improve, MSHA's cash to debt continues to be low at 49.9% and MADS as a percentage of revenues is high at 9.8%; both are weaker than Fitch's 'BBB' median of 69.4% and 3.7%, respectively. Fitch views MSHA's payor mix as a negative credit factor, reflecting the high concentration of TennCare (Tennessee's Medicaid program), which is highly unprofitable for the system and constitutes more than 20% of MSHA's gross revenue.

Additionally, the State of Tennessee indicates it may eliminate its TennCare Medicaid program, which could have a more negative impact on MSHA's flagship hospital, Johnson City Medical Center (JCMC), a level I trauma center that is generally considered a 'safety net' hospital. MSHA continues to rely heavily on its flagship hospital, JCMC, for positive operations, while most of the other hospitals continue to be a financial drain on the system. In fiscal 2004, JCMC reported net income of $33.4 million, while at the same time MSHA as a whole reported net income of $37.5 million. However, MSHA's five other hospitals, although still unprofitable, have stabilized their operations and have demonstrated steady improvements. Fitch acknowledges that this system is structured around tertiary and quaternary referrals from the supporting hospitals to JCMC and that JCMC is meant to be and will likely always be the dominant driver of the system. MSHA's swap program synthetically lowers its annual debt service payments and provides annual positive cash flow to the system. However, Fitch notes the inherent credit risks associated with the swap program, which include termination risk and interest rate movements. Fitch believes that management's daily monitoring of its swap program is essential and should be maintained.

The Rating Outlook remains Positive due to Fitch's belief that the strong cash flow generated by MSHA in the past several years will be sustained. If the financial performance continues on its current trend and MSHA's debt ratios improve, and if Tennessee's proposed, new Medicaid program has a minimal affect on MSHA, upward movement of the rating is possible.

Headquartered in Johnson City, Tennessee, MSHA is a large, integrated health care system with six hospitals (1,100 staffed beds) and other related entities, primarily serving the northeast portion of Tennessee. In fiscal 2004, MSHA had total operating income of $481.8 million. MSHA's annual and quarterly financial disclosure has been good in terms of content, balance sheet, income statement, statement of cash flows and utilization data, and timeliness.

Outstanding issues:

--$26,000,000 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue bonds, series 2001A;

--$60,175,000 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue bonds, series 2001B;

--$203,289,671 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue and refunding bonds, series 2000A (Certain maturities are insured by MBIA, whose insurer financial strength is rated 'AAA' by Fitch);

--$113,155,000 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage revenue and refunding bonds, series 2000B (Certain maturities are insured by MBIA, whose insurer financial strength is rated 'AAA' by Fitch);

--$39,330,000 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage (taxable) revenue bonds, series 2000C (Insured by MBIA, whose insurer financial strength is rated 'AAA' by Fitch);

--$16,950,000 Health and Educational Facilities Board of the City of Johnson City, TN hospital first mortgage (taxable) revenue bonds, series 2000D (Insured by MBIA, whose insurer financial strength is rated 'AAA' by Fitch);

--$34,590,000 Health and Educational Facilities Board of the City of Johnson City, TN hospital revenue bonds, series 1994 (Insured by MBIA, whose insurer financial strength is rated 'AAA' by Fitch Ratings).