NMFF's Illinois Health Facility Authority revenue bonds upgraded to 'A+'

Fitch Ratings takes the following rating action on Northwestern Medical Faculty Foundation, IL as part of its continuous surveillance effort:

--Approximately $75 million Illinois Health Facility Authority revenue bonds, series 1998, upgraded to 'A+' from 'A'.

The Rating Outlook is revised to Stable from Positive.

RATING RATIONALE:

--The upgrade reflects Northwestern Medical Faculty Foundation's (NMFF) sustained operating profitability and positive volume trends.

--Strong nationwide clinical reputation, and affiliation with Northwestern University Feinberg School of Medicine (FSM), a part of Northwestern University (revenue bonds rated 'AAA' by Fitch) and Northwestern Memorial Hospital (the hospital).

--Satisfactory liquidity position.

--The main offsetting rating factor is the uncertainty surrounding proposed physician payment reductions that are currently being debated in the U.S. Congress that are part of the Obama Administration's health reform efforts.

--The Stable Rating Outlook is based on Fitch's expectation that operating margins remain in positive territory despite potential Center for Medicare and Medicaid Services (CMS) payment reductions and consistent balance sheet measures.

KEY RATING DRIVER(S):

--Continuation of healthy earnings trends despite potential CMS reimbursement modifications.

--Maintenance of adequate liquidity balances and modest leverage indicators.

SECURITY:

The bonds secured by a security interest in unrestricted receivables, a mortgage on certain real property, and a debt service reserve fund.

CREDIT SUMMARY:

Since Fitch assigned a Positive Rating Outlook in September 2007, NMMF continues to produce healthy operating margins. Although not as strong as the fiscal year (FY) 2005-2007's average of 8%, NMMF produced a 6.5% operating margin in FY08 and a 6.1% operating margin in FY09. FY09 numbers are preliminary and based on draft audited financial statements. Utilization trends continue to be robust with total physician encounters increasing 8% in FY08 and 5.6% in FY09. NMMF has been able to maintain performance despite decreases in reimbursement from governmental programs. This is due to NMFF's ability to leverage its size and clinical reputation to garner favorable commercial health plan contracts, improve physician productivity, enhance organizational efficiencies, and control practice expenses. Cash flow flexibility is also supported by NMFF's ability to suspend certain payments to FSM. Outside of the dean's tax, certain transfers to FSM are discretionary and may be deferred, which NMFF has done in the past.

NMFF's main credit strength is the caliber of its multi-specialty group that is highly regarded nationwide for its clinical and research excellence. The physician group has grown significantly to 670 doctors in FY09 from 537 in FY05. Although NMFF, FSM, and the hospital are separate corporations that issue their own debt, Fitch believes the success of the three entities is interdependent. NMFF is the teaching faculty for FSM, and NMFF's physicians account for about 60% of the hospital's admissions. Fitch views this interdependent relationship favorably. Further demonstrating the close working relationship of the three organizations, the hospital and FSM typically jointly support practice development and recruitment for NMFF.

In addition to the healthy profitability, financial strength is demonstrated by good debt service coverage, adequate liquidity, and a low debt burden. EBITDA debt service coverage is very solid at 3.7 times (x) in FY08 and 4.5x for FY09. Moreover, adjusted EBITDA debt service coverage after adding back in the contributions to FSM is healthy at 7.4x in FY08 and 5.9x in FY09. As of Aug. 31, 2009, $109 million of unrestricted cash and investments amounts to 88 days operating expenses or 148% of long-term debt. The debt burden is light with maximum annual debt service representing only 1.3% of revenues. NMFF indicates that it does not have any significant capital plans or long-term debt plans over the next several years.

Fitch's main credit concern is the uncertainty surrounding proposed physician payment reductions from CMS that are supposed to cut Medicare reimbursement by about 21% on March 1, 2010. However, the U.S. Congress is currently debating a modification to the proposed CMS reductions as part of the Obama Administration's health reform efforts with the potential of moderating and extending the reimbursement cuts. With Medicare representing 30% of its gross revenues, a significant decline in revenues could have a negative impact on NMFF's earnings and cash flow. Nonetheless, NMMF maintains budgetary flexibility as about 10%-15% of its compensation expenses are based on incentives for revenue performance and achievement of NMFF's clinical, research and educational mission.