Methodist Hospitals' Indiana Health Facilities Financing Authority revenue bonds rated 'BB+'

Fitch Ratings assigns a 'BB+' rating to the following Indiana Health Facilities Financing Authority revenue bonds issued on behalf of Methodist Hospitals (Methodist):

-- $14.6 million series 1996 Indiana Health Facilities Financing Authority revenue bonds;
-- $60.6 million series 2001 Indiana Health Facilities Financing Authority revenue bonds.

The Rating Outlook is Stable.

RATING RATIONALE:

-- Methodist is one of only 12 disproportionate share designate hospitals in Indiana, which results in substantial additional Medicaid revenue.
-- Strong and consistent liquidity measures through 2008 and the interim period have enabled Methodist to subsidize poor operations while maintaining an adequate cash position.
-- Improving operational performance in the interim 2009 periods and a demonstrated ability to manage expenses within a more efficient operating base has led to a more stable credit profile.
-- The Stable Outlook results from the recent appointment of a permanent leadership team, which has contributed to improved operational performance in the six month interim period ended Sept. 30, 2009.

KEY RATING DRIVERS:

-- Successful implementation of the medical staff development plan to stem the losses of active physicians generating clinical volume, and the development of a loyal physician base going forward.
-- Achievement of strategic initiatives that are focused on continued cost controls and patient revenue growth, while maintaining a consistent level of strong liquidity.
-- The potential impact to reimbursement at a state level from changes to the disproportionate share (DSH) program, and potential impact at a national level as a result of health care reform.

SECURITY:

The series 2001 and series 1996 bonds are secured by the gross revenues of the obligated group (The Methodist Hospitals).

CREDIT SUMMARY:

Methodist's solid balance sheet has been a key credit strength for some time, serving as a mitigant that has allowed it to weather various operational challenges in recent years. Specifically, the challenging economic indicators in the Gary service area coupled with a consent decree that mandates parity services offered on both hospital campuses has limited management's ability and agility to properly respond to the changing economic realities within the industry and the service area. With 203 days of cash on hand (DCOH) at the nine month period ending Sept. 30 2009, Methodist has strengthened the balance sheet from 149.6 DCOH as of fiscal year end 2008. This is due in large part to improved operations and cash flow generation in the interim period. Methodist operates two acute care hospitals in Indiana; a 302-bed hospital in Gary and a 313-bed hospital in Merriville. While Merriville generally has favorable economic indicators, the Gary market is challenged by higher self pay and Medicaid populations, a declining growth rate, and a poor economy. Methodist has been restricted in its operations by a consent decree, issued in 1979 by the U.S. Office of Civil Rights that requires Methodist to offer the same scope and scale of services at both hospital campuses. While Methodist has been able to find some flexibility within the decree, its restrictive mandates have muted management's ability to respond in an effective and efficient manner to address the market pressures extant in its service area and within the industry.

Methodist has undergone a significant organizational overhaul since 2006, which led to a stressed relationship between the medical staff and hospital leadership. A sharp decline in the number of active medical staff in fiscal 2008 was demonstrative of that tenuous relationship. A large exodus of the medical staff culminated in a loss of $22.7 million from operations in fiscal 2008. However, in late 2008 and into early 2009, the Methodist Board installed a new permanent leadership team that was amenable to many of the departed medical staff. The new management team has gained significant traction deploying new strategic imperatives focused on maintaining a vibrant and engaged medical staff who are committed to Methodist going forward. Strategic efforts also include scaling and programming service offerings in an efficient manner that will decrease costs and enable revenue enhancement efforts to take hold. These combined efforts have produced positive results in the interim period, as Methodist generated $4.9 million from operations (2.1% operating margin and 12.4% EBITDA margin).

Credit concerns include Methodist's inconsistent operating performance, its reliance on the Indiana DSH program, and the restrictions associated with the consent decree. Since 2005, Methodist has had varied operating performance, generating operating margins of -5.6%, -1.1%, 7.9%, and -7.7% in the fiscal years ending 2005, 2006, 2007, and 2008 respectively. This is due in part to Methodist's reliance on state subsidies to supplement operations, which have been paid in periods subsequent to the booking of the operating expenses. Methodist received approximately $33.5 million (14% of total revenue) in the nine month period ending Sept. 30 2009, and $21.8 million (7.4% of total revenue) in fiscal 2008 from the DSH program. Some of the 2009 payments contained amounts that should have been paid in 2008. While Fitch believes that the State of Indiana will continue to support providers that serve a high level of Medicaid patients, the timing, amount and funding sources for such payments and the net impact to Methodist cannot be determined beyond 2010 and present a fundamental credit risk going forward.

(The) Methodist Hospitals Inc. (Methodist) operates a 302-bed acute care facility in Gary, Indiana and a 313-bed acute care facility in Merriville, Indiana. The obligated group is comprised of Methodist Hospitals Inc. Methodist covenants to disclose audited financial statements within 150 days of fiscal year end. Annual disclosure is posted to the Municipal Securities Rulemaking Board's EMMA system and includes audited financial statements and utilization statistics. Total revenues for fiscal 2008 were $294.7 million.

Source Methodist Hospitals Inc.