Fitch Upgrades Los Angeles (CA) Orthopaedic Hospital Foundation to 'A-'.

NEW YORK -- Fitch Ratings has upgraded the underlying rating on California Statewide Communities Development Authority (Los Angeles Orthopaedic Hospital Foundation and Orthopaedic Hospital, or the foundation and LAOH) revenue bonds, series 2000 to 'A-' from 'BBB+'. Approximately $55 million of debt is affected. The Rating Outlook is Stable.

The upgrade is based on the material improvement in the combined organization's balance sheet and improved operating performance following a significant asset sale and transfer of inpatient hospital operations to Santa Monica-UCLA Medical Center and Orthopaedic Hospital (the new licensed name is effective Nov. 1, 2006). In March 2005, the Hospital Board of Directors and the Foundation Board of Trustees approved a plan to sell its North Campus property, consisting of its closed inpatient hospital, a power plant, and medical office buildings. The transaction sale closed July 2006, approximately six months later than anticipated, and yielded $70.5 million of cash and a net book profit of $62.3 million. Unrestricted cash and investments, including board designated funds for research, increased to $165.9 million and equates to 300% of outstanding debt and more than 2000 annualized days' cash on hand. These liquidity ratios far exceed Ambac's revised business covenants of a cash-to-debt ratio of 1.5:1.0, and 500 days' cash on hand. The foundation holds approximately 60% of its investments in equities and the balance in fixed income securities.

The combined foundation and hospital balance sheet's net asset position was materially strengthened following the booked gain on the property sale. Unrestricted net assets increased by 58% to approximately $197.9 million, and the ratio of debt to unrestricted fund balance declined to 28%, well below the 45% debt to unrestricted fund balance covenant. Enhanced liquidity is expected to be augmented by the capital campaign which was temporarily in hiatus. Of the $100 million original capital campaign goal, $62.5 million has been raised and $55.2 million has been collected to date.

LAOH is still feeling the effects of a significant transition in its business. During the fiscal year ended Oct. 31, 2005, LAOH opened a new 36,000 square foot outpatient medical center, closed its unprofitable 112-bed acute care hospital, and temporarily transferred inpatient hospital operations to Santa Monica-UCLA Medical Center, its strategic affiliate since 1998. LAOH also converted its standby emergency room department to an urgent care center, and operates it as a joint venture with a physician group. The transfer of inpatient services is a temporary step pending the delayed (currently until 2009) opening of the new Santa Monica Medical Center. Under the terms of the Alliance agreement with UCLA, LAOH is not obligated for any project overruns associated with further delays in opening the planned new Santa Monica hospital.

The LAOH/UCLA research facility, owned entirely by the Regents of the University of California, and partially financed with proceeds from the series 2000 bonds, is on schedule to open January 2007, two years later than planned (LAOH does not bear the risk of cost overruns). LAOH will occupy the building without paying rent. The project contribution is recorded as prepaid rent under other assets. Following these changes, LAOH's healthcare operations are now primarily focused on outpatient orthopedic pediatric services and urgent care services to adult and pediatric patients. LAOH continues to conduct research activity both independently and jointly with UCLA. LAOH reports that outpatient volumes were negatively affected by the transfer of inpatient activity, the need to renegotiate contracts with MediCal and other third party payers, and the elimination of the standby emergency room.

Through nine months ended July 31, 2006, the operating loss excluding interest and dividend income, and including the benefit of capitalized interest, improved to a negative $4.9 million from negative $10.5 million in the prior year. Based on this improvement, LAOH is poised to generate a positive excess margin with realized investment gains. The improvement reflects large cost reductions related to exiting inpatient activities and the standby emergency room. Fitch notes that the interim operating loss is about 3.5% above budget. Operated results were negatively affected by the delayed sale of north campus property. Management's revised projections reflect growth in outpatient volumes, reduced operating losses, and a 7% investment return. Fitch considers these projections somewhat optimistic; however, based on interim fiscal 2006 results a material improvement from historical performance is feasible. Health care cost pressures and a challenging business and payer mix, typical of children's hospitals, will require continued foundation subsidies and solid investment performance. Fitch notes that there has also been turnover in the chief financial officer position. The current chief financial officer previously served as the controller, and has been with LAOH for about 25 years.

The hospital was started in 1911 as a clinic for crippled children. It is the most advanced treatment and teaching center in the western United States for children with disorders that strike bones, joints, muscles, nerves and connective issue. In June 1998, the hospital formed a strategic alliance with UCLA and the Board of Regents of the University of California. The alliance was formed to eliminate the financial risk to the hospital associated with operating an inpatient hospital facility, to improve the hospital's ability to manage revenues and expenditures, to enable the hospital to increase its patient visit capacity, and to expand its research and education efforts.

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