Fitch Affirms WellSpan Health's Outstanding Debt at 'AA-'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'AA-' rating on WellSpan Health's outstanding debt. The Rating Outlook is Stable.

Total outstanding debt is $436 million with approximately $209 million of variable-rate demand bonds (VRDBs), which are being restructured to direct bank loans. The tender for the conversion of the VRDBs is expected to occur on Feb. 2, 2011. Fitch views the restructuring favorably as it reduces put and renewal risk.

SECURITY:

The bonds are secured by a pledge of gross receipts.

RATING RATIONALE:

The 'AA-' rating reflects WellSpan Health's (WellSpan) integrated business model, strong market position and good liquidity. However, historical solid operating profitability has waned in the last few years and operating cash flow will need to return to historical levels within the next year to maintain the rating.

Debt metrics compare unfavorably to Fitch's 'AA' category medians; however, WellSpan's future capital needs are manageable.

Management's methodical and conservative planning processes and detailed financial reporting are among the best in Fitch's nonprofit hospital and health care system portfolio.

KEY RATING DRIVERS:

--Expectation of improved and sustained profitability exhibited in the first quarter of fiscal 2011. The failure to maintain solid cash flow could place negative pressure on the rating.

--Despite WellSpan's effective physician strategies, there has been increased competition in the service area.

CREDIT SUMMARY:

The underlying 'AA-' rating reflects WellSpan's considerable footprint in the service area through its two acute care hospitals, multiple outpatient centers, and a large multispecialty physician group, and a history of disciplined and conservative financial and strategic planning. WellSpan's main credit strength is its integrated business model, which includes a high level of physician alignment. Over 85% of the active physicians in the market are primary admitters to the health system and of those, 60% are employed by the system. WellSpan maintains a strong market position in its south central Pennsylvania service area (approximately 50 miles north of Baltimore, MD) with a market share of 56.6% in calendar year 2009, which increased from 55.7% in 2007. The health system has a history of methodically fortifying its presence in the service area through vertical and horizontal diversification and growth strategies and until recently, maintaining strong financial performance. Although WellSpan's liquidity position is good, its profitability and debt metrics compare unfavorably to Fitch's 'AA' category median ratios. WellSpan's liquidity ratios have remained relatively stable at 218.5 days at Sept. 30, 2010 compared to 200 days at fiscal year end 2010 (June 30), 193.9 days at June 30, 2009 and the 'AA' category median of 214.7 days.

Fitch's primary credit concerns include WellSpan's weakened profitability over the last two years, below-average debt metrics and increased competition in the service area. WellSpan ended fiscal 2010 and 2009 with operating margins of 1.5% and 1.7%, respectively, compared to historical levels in the range of 3%. The decline in profitability was attributable to several factors including increased charity care and salaries and pension expense. The fiscal 2011 operating income budget is $36.3 million or 3.2% operating margin. Through the first quarter of 2011, WellSpan is in line with the budget and ahead of prior year performance with a 2.5% operating margin. The improved performance is attributable to the implementation of lean and supply chain initiatives. Fitch expects WellSpan to sustain the first quarter's performance and meet its fiscal 2011 budgeted goals. WellSpan's debt metrics are below average with operating EBITDA maximum annual debt service (MADS) coverage of 2.5 times (x) for fiscal 2010 and 2.8x for first quarter 2011, compared to the 'AA' category median of 4.1x. Fitch expects debt service coverage to improve since future capital needs are manageable and approximate depreciation expense. WellSpan has several revenue-generating projects in process with capital spending totaling $111 million for fiscal 2011 but dropping to $84 million in fiscal 2012 and $70 million a year in fiscal 2013-2015.

Major capital investments include a new surgery and rehabilitation hospital (Apple Hill Campus), a neuroscience and pain center, new emergency room at Gettysburg, and additional primary care locations. The Apple Hill Campus will focus on orthopedics and inpatient rehabilitation and should open in March 2012. This facility was in response to a large orthopedic surgery center that some entrepreneurial physicians opened in the service area. Although WellSpan has already absorbed the impact of the loss of the outpatient business, the competing facility's inpatient capacity opened at the end of 2010, and management expects a drop in volume associated with this. Fitch will monitor the impact of the competing facility and if the impact is greater than expected and hampers WellSpan's return to historical profitability, negative rating pressure could occur.

WellSpan is in the process of converting all its letter of credit backed VRDBs (series 2008B-D) to direct bank loans. The bank loans will be with four different banks (M&T Bank, US Bank, TD Bank, PNC Bank) and will have varying initial terms (five to 10 years) at a floating rate based on LIBOR plus a spread. If the bank does not want to renew at the end of the initial term, WellSpan will have a minimum one-year put notice from the banks. Fitch views the restructuring favorably as it significantly reduces WellSpan's put and renewal exposure.

The Stable Rating Outlook reflects Fitch's expectation that WellSpan will sustain its operating performance exhibited in the first quarter of fiscal 2011. It is imperative that WellSpan meet its fiscal 2011 operating income budget given its weaker overall financial profile compared to other

'AA-' rated credits. A material negative variance from budget could lead to negative rating pressure.

Headquartered in York, Pennsylvania, WellSpan consists of two hospitals (York Hospital, with 550 staffed beds, and Gettysburg Hospital, with 95 staffed beds) located about 31 miles apart, 32 ambulatory and outpatient care locations, and various other health care-related entities. WellSpan covenants to provide quarterly and annual disclosure to bondholders.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

'Revenue-Supported Rating Criteria', dated Oct. 8, 2010

'Nonprofit Hospitals and Health Systems Rating Criteria', dated Dec. 29, 2009.

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=564565

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493186

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