Fitch Assigns Underlying 'A' Rating to OSF Healthcare System's Series 2005 Bonds

Business Wire, Sept 14, 2005

NEW YORK -- Fitch Ratings has assigned an underlying 'A' rating to OSF Healthcare System's approximately $122.8 million revenue refunding bonds. The series 2005 bonds are expected to be insured by FSA, whose insurer financial strength is rated 'AAA' by Fitch. A total of $107.7 million of series A and B bonds will be issued through the Illinois Finance Authority while $15.1 million series C bonds will be issued through the Michigan State Hospital Finance Authority. The series A and B bonds are expected to be issued in the auction-rate mode while the series C are expected to be issued in Merrill Lynch's R-FLOATS mode. In addition, Fitch has affirmed the 'A' rating on the approximately $327.5 million of outstanding debt listed below. The Rating Outlook is Stable.

Proceeds of the 2005 bonds will be used to partially refund OSF's outstanding series 1999 bonds maturing after Nov. 15, 2009 to the first call date, fund a debt service reserve funds on each series of bonds, and pay costs of issuance. The bonds are expected to price the week of Sept. 26 through negotiation by Merrill Lynch Capital Markets, Inc.

OSF's credit strengths include improved financial performance, solid position in the majority of its markets, and the benefits of vertical integration. OSF's recent financial performance is consistent with Fitch's 'A' rated medians, with an operating margin of 2.4% in fiscal 2004 and 2.7% through the nine months ended June 30, 2005. In addition, the system's cash relative to expenses improved to 140 days in 2004. The system's results in 2004 and through the nine-month interim period have materially improved from the recent operating losses posted in 2002-2003. OSF met its fiscal 2004 budget without the benefit of a one-time gain on a sale of a joint venture that added $9.4 million (after-tax) to the system's net bottom line. Excluding the gain from the sale, operating margin and pro forma debt service coverage in fiscal 2004 were 1.2% and 3.3 times (x), respectively. The improved financial performance is due in part to volume growth and better performance of the health plan.

While the health plan has negatively affected OSF's financial performance, historically, Fitch believes it has been a strategic asset system. Under new leadership, the health plan's performance improved to a $1.1 million loss in 2004 from an $8.1 million loss in 2003. Through the nine-month period ended June 30, 2005, management reported that the health plan posted an operating gain of $4.2 million. OSF maintains stable market positions in each of its service areas, although the markets are competitive. OSF's flagship facility, Saint Francis Medical Center in Peoria, had over a 50% market share in 2004 compared with its closest competitor, Methodist Medical Center. OSF has created a vertically integrated health system in central Illinois, which provides distinct advantages in managed care contracting and patient referral patterns. Fitch believes this integration benefits the system in securing employer contracts and in negotiations with the various managed care plans.

Credit concerns include future capital plans, a weakened economic environment in two of OSF's smaller service areas, and the operating losses on its employed physicians. A major capital plan is being considered that would add capacity and alleviate current capacity constraints at OSF's flagship facility in Peoria. Management is addressing current capacity issues through reconfiguration of existing space through renovation projects. A significant campus reconfiguration on the Saint Francis Medical Center campus may be pursued over the mid term. Despite this, ongoing investment in its plant has been solid and averaged 156% of depreciation expense over the past three years. OSF's Galesburg and Pontiac markets have been more challenging due to their smaller population bases and weakened employment environments. Losses of the OSF Medical Group (which do not take into account system revenues attributable to hospital admissions or the ancillary revenue arising from the operations of OSF Medical Group) were $19.9 million in fiscal 2004. According to management, employed physicians are a key strategy for the system.

The Rating Outlook is Stable and reflects the expectation that OSF maintains the level of operating improvement achieved since fiscal year-end 2003. Based on year-to-date results, Fitch expects the system to exceed its fiscal 2005 budgeted operating income of $34 million. Fitch believes that operating profitability will continue due to the organizational leadership changes in the past few years, rising volume, and favorable terms from its managed care renegotiations. Fitch will evaluate the effect of any capital expansion plans at the Saint Francis campus once the board makes any final approvals.

In connection with the series 2005 bonds, OSF has entered into three floating- to fixed-rate swaps effective Sept. 29, 2005 with Merrill Lynch Capital Services (rated 'AA-/ F-1 ' by Fitch) in notional amounts that match the series A, B, and C bonds. The swaps are coterminous with the series 2005 bonds. OSF's swap obligations are on parity with the bonds and will be insured by FSA; however, termination payments are not insured.