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Fitch Affirms Mountain States Health Alliance (Tennessee) Revs at 'BBB+'; Outlook Stable.

NEW YORK -- Fitch Ratings affirms the 'BBB+' rating on Mountain States Health Alliance's (MSHA) outstanding debt, which is listed below.

The Rating Outlook is Stable.

SECURITY:

Pledged assets and a mortgage on Johnson City Medical Center and Sycamore Shoals Hospital. In addition, there is a debt service reserve fund on certain debt.

KEY RATING DRIVERS:

STRONG MARKET FOOTPRINT: MSHA is a 14-hospital system that covers a 29-county service area with a leading market position.

CONSISTENT STRONG OPERATING CASH FLOW: MSHA maintains excellent operating cash flow margins, which well exceed the median ratio for its rating level.

HIGH DEBT BURDEN: MSHA's high debt burden remains Fitch's main credit concern. Despite strong operating performance, debt service coverage is adequate for the rating level.

MODERATED CAPITAL SPENDING: After several years of heavy capital investment, a moderation in capital spending is expected beginning in fiscal 2013, which should facilitate further liquidity growth.

CREDIT PROFILE:

The rating affirmation reflects MSHA's continued solid financial performance. Good financial performance has been driven by MSHA's strong market position and focus on cost efficiencies. Upward movement of the rating is limited by its heavy debt burden.

MSHA was formed in 1998 from the acquisition of five hospitals in Tennessee from Columbia/HCA. Since that time, MSHA has grown to a 14-hospital system through several acquisitions from 2005-2009, which has extended MSHA's service area to Virginia. Management indicated that there are no future hospital acquisitions planned, especially since there are limited sole providers remaining in the service area. MSHA's acute inpatient market share in its 29-county service area was 36.8% in 2010, which compares favorably to MSHA's only major competitor's (Wellmont Health System; rated 'BBB+' by Fitch) 30.1% market share.

MSHA's operating performance in fiscal 2011 was in line with last year with an operating margin of 1.9% compared to 1.7% the prior year. Operating cash flow has consistently been outstanding and is one of the highest in Fitch's portfolio with a 15.7% operating EBITDA margin in fiscal 2011 compared to the 'BBB' category median of 8.5%. For the interim period (three months ended Sept. 30, 2011), operating performance is ahead of the prior year and the fiscal 2012 budget includes a 2.1% operating margin.

Solid operating performance has been driven by good volume and management's continued focus on cost initiatives, which include Lean practices. Management has been diligent in eliminating duplicative services and consolidating activities with the growth of the system. Management expects more opportunities for cost reductions as the Virginia facilities are further integrated into the system and brought onto a common information technology platform over the next several years.

As of Sept. 30, 2011 MSHA had $514 million of unrestricted cash and investments, equating to a solid 208 days cash on hand, which compares very favorably to Fitch's 'BBB' category median of 128.6 days, although this is down from historical levels due to investment performance. Through the three months ended Sept. 30, 2011, MSHA had $14 million of unrealized losses on investments.

MSHA's investment policy was revised in June 2010 and is conservative. The revised policy has allocated at least 110 days cash on hand in highly liquid fixed-income securities, and investments over the 110-day threshold would be invested in no more than 50% equities.

Cash-to-debt of 50% at Sept. 30, 2011 compares unfavorably to the 'BBB' category median of 79.8% and is reflective of MSHA's sizeable debt load. Management's target is to maintain approximately 250 days cash on hand and any excess cash flow generated will be used to reduce its debt.

Liquidity growth should be aided by a moderation of capital spending. MSHA has been investing significantly in its plant, which totaled approximately 2 times (x) depreciation expense the last three fiscal years. Major capital projects include three new replacement hospitals and an expansion of surgical space at the flagship facility.

Johnston Memorial Hospital's replacement facility opened in July 2011 and was completed within budget. The replacement facility for Smyth County Community Hospital is expected to open in spring 2012. The remaining major capital project is the expansion of surgical space (16 new surgery suites) at MSHA's flagship facility, Johnson City Medical Center. This project is expected to cost $69 million and a portion will be funded by approximately $45 million of additional debt sometime in calendar year 2012.

The high intensity of capital spending is expected to drop after fiscal 2012 with capital commitments of $133 million in fiscal 2012, $114 million in fiscal 2013 and $70 million-$80 million a year thereafter, compared to $173 million in fiscal 2011 and $172 million in fiscal 2010.

Fitch's main credit concern is MSHA's sizeable debt load and fairly aggressive capital structure. Despite MSHA's strong operating cash flow, maximum annual debt service (MADS) coverage is adequate at 2x by operating EBITDA for fiscal 2011 compared to 1.8x in fiscal 2010 and Fitch's 'BBB' median of 2.3x. The only future new money debt plans include $45 million in fiscal 2013, which should not impact MSHA's current rating level.

Fitch expects MSHA to grow into its debt burden due to limited near-term acquisition activity, moderation of capital spending, and continued strong operating cash flow that should allow for liquidity growth and subsequently the paydown of some debt.

MSHA's total outstanding debt is approximately $1.1 billion with $631.7 million underlying fixed-rate and $484.2 million underlying variable-rate debt. Of the $484.2 million of variable-rate debt, $434.7 million are letter of credit (LOC) backed variable-rate demand obligations (VRDOs). The remaining variable-rate exposure is a five-year direct bank loan with SunTrust Bank.

Fitch views MSHA's debt profile as aggressive for its rating level due to its exposure to interest rate, put, remarketing, and renewal risk. All the LOCs (US Bank, PNC Bank, Mizuho Bank) expire on Oct. 19, 2014 and the term-out provision under the agreements is three years. However, unrestricted cash and investments to putable debt was 1.2x as of Sept. 30, 2011 and the investments are liquid with 96% available within three days.

MSHA reduced its swap exposure with the termination of a swaption in October 2011 and also converted all of its fixed payor swaps to basis swaps, which should result in less mark-to-market volatility. As of Sept. 30, 2011, MSHA posted $5.8 million of collateral.

One of MSHA's strategies includes being an accountable care organization (ACO) to improve the delivery of care. MSHA's ACO contracting entity, Integrated Solutions Health Network, is in place and will be ready to begin contracting with the federal government in July 2012. Management expects the ACO to facilitate the transformation of care, which should lead to lower costs and improved quality. Mountain States Medical Group is a key part of the strategy and the number of employed physicians currently totals 400 and is expected to increase further.

The Stable Outlook is based on Fitch's expectation that MSHA will continue to generate strong operating cash flow to service its debt load and capital needs. Fitch expects that over time MSHA will continue to grow its liquidity due to a moderation of capital spending, which should allow MSHA to reduce its leverage. Positive rating movement would be dependent on an improvement in debt metrics.

Headquartered in Johnson City, Tennessee, MSHA is a large regional health care system with 14 hospitals (1,789 licensed beds) and other related entities, primarily serving northeast Tennessee and southwest Virginia. MSHA has a ranging membership interest (50.1%-80%) in three of the hospitals in the system (Smyth County Community Hospital, Norton Community Hospital, Johnston Memorial Hospital). In fiscal 2011, MSHA had total operating revenue of $976 million. MSHA covenants to provide annual and quarterly financial and operational disclosure to the nationally recognized municipal information securities repositories (NRMSIRS).

Outstanding debt:

--$30,358,000 The Health and Educational Facilities Board of the City of Johnson City, Tennessee, hospital first mortgage revenue refunding bonds, series 2000A;

--$34,325,000 The Health and Educational Facilities Board of the City of Johnson City, Tennessee, hospital first mortgage revenue bonds, series 2000C;

--$14,790,000 Mountain States Health Alliance taxable note, series 2000D;

--$23,100,000 The Health and Educational Facilities Board of the City of Johnson City, Tennessee, hospital first mortgage revenue bonds, series 2001A;

--$169,630,000 The Health and Educational Facilities Board of the City of Johnson City, Tennessee, hospital first mortgage revenue bonds, series 2006A;

--$5,560,000 The Health and Educational Facilities Board of the City of Johnson City, Tennessee, hospital revenue bonds, series 2009A;

--$5,535,000 Industrial Development Authority of Smyth County hospital revenue bonds, series 2009B;

--$115,955,000 Industrial Development Authority of Washington County Virginia, hospital revenue bonds, series 2009C.

Fitch Ratings has withdrawn its rating on the following bonds due to prerefunding activity:

--Johnson City Health & Educational Facilities Board (TN) (Mountain States Health Alliance) Hospital first mortgage revenue refunding bonds, series 2000B (insured: MBIA Insurance Corp.) (all maturities).

The correct rating history for the prerefunded CUSIPs is now reflected on Fitch's web site at 'www.fitchratings.com'.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', dated June 20, 2011;

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Aug. 12, 2011.

For information on Build America Bonds, visit www.fitchratings.com/BABs.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648836

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE '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.
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