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Fitch Affirms WellSpan Health's (PA) Revenue Bonds at 'AA-'; Outlook Stable
[January 10, 2013]

Fitch Affirms WellSpan Health's (PA) Revenue Bonds at 'AA-'; Outlook Stable

NEW YORK --(Business Wire)--

Fitch Ratings affirms the 'AA-' long-term rating on the following General Authority of Southcentral Pennsylvania and York County Hospital Authority bonds issued on behalf of WellSpan Health:

--$174,780,000 fixed rate revenue bonds, series 2008A;

--$24,570,000 auction rate bonds, series 1993B (York Hospital).

WellSpan also has $211.7 million of series 2008B-D direct bank loans outstanding, which Fitch does not rate.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a pledge of gross receipts.

KEY RATING DRIVERS

BUSINESS PLATFORM PREPARES FOR PAYMENT REFORM: Fitch views WellSpan's integrated delivery model with high physician alignment favorably, which allows for changes in care management. The ability to leverage its integrated platform with its information technology capabilities will prepare WellSpan for a declining reimbursement environment. WellSpan has begun to collaborate with payers on new payment models, including bundled payments and patient centered medical homes.

SOLID MARKET POSITION: WellSpan has maintained a leading market position despite declining volume across the region. Market share was strong in the 2011 calendar year with 59% of inpatient admissions and 42% of ambulatory surgery procedures compared to 10% and 12%, respectively, for the closest competitor.

IMPROVED PROFITABILITY: Given WellSpan's high percentage of employed physicians, profitability has historically lagged the 'AA' category medians. Operating profitability improved in fiscal 2012 due to strong revenue growth and expense management with a 4.2% operating margin compared to 2.4% in fiscal 2011 and 1.6% in fiscal 2010. Although year to date profitability is lower than the same prior year period, operating margin in fiscal 2013 is projected to return closer to historical levels of around 3%.

PENSION FUNDING IMPACTS LIQUIDITY: WellSpan's defined benefit plan, which was partially frozen in 2007, was only 61% funded as of fiscal year end 2012 (June 30). This necessitated a pension contribution of $41 million in the first quarter of fiscal 2013 and led to a decline in liquidity metrics. Unrestricted cash and investments of $657.3 million as of Sept. 30, 2012 equated to 217.9 days cash on hand and 17.4x cushion ratio, which are only slightly below Fitch's AA category medians.

HIGH DEBT BURDEN: Debt load metrics compare unfavorably to Fitch's 'AA' category medians with debt to capitalization of 50.3%, MADS as a percentage of revenues of 3.2%, and debt service coverage of 3.9x through the interim period. However, the debt burden should improve as amortizing principal is paid down and future capital needs are funded by cash flow with no additional debt plans.

CREDIT PROFILE

The rating affirmation reflects WellSpan's integrated business model including a highly aligned physician network facilitating a considerable level of penetration in its primary service area (PSA), improved operating performance, adequate liquidity, and modest future capital needs. Primary credit concerns include its high debt burden and erosion in funded status of its pension plan.

WellSpan's main credit strength remains its integrated business model including a high level of physician alignment, with over 75% of active physicians in the market affiliated with the health system. Of these physicians (766), 411 are employed and 259 are sole admitters to WellSpan. WellSpan has a strong primary care base with 49.7% of the PSA population having visited a WellSpan employed or loyal primary care physician in 2010 or 2011. Leveraging this position, WellSpan's inpatient market share increased from 56% in 2010 to 59% in 2011, compared to the next competitor, Hanover Hospital, with only 10%.

In October 2012, WellSpan and Ephrata Community Hospital (Ephrata), located i Lancaster County about 40 miles northeast of WellSpan's York Hospital, announced plans to explore a potential affiliation. Management expects the transaction to finalize in early 2013. Management believes that the affiliation will allow WellSpan to expand its population health management efforts in the service area. Each entity will remain separately obligated on its respective debt although it is expected that Ephrata will be consolidated into WellSpan's financials. Fitch believes the financial impact of the transaction will be minimal to WellSpan due to Ephrata's relatively small size.

WellSpan has begun to collaborate with payers on new payment models, including bundled payments and patient centered medical homes. This was a result of its PRICE (Payment Reform Involving Corporate Engagement) initiative which focuses on increasing value. WellSpan tailored strategies to different segments of the population with varying healthcare utilization rates. WellSpan has started a bundled payment initiative with regional employers, other providers and payors, which will initially cover a limited number of conditions. The portion of revenues derived from new payment models will initially be very small, but may expand depending on the initial results.

Profitability rebounded to historical levels in fiscal 2012, producing a robust operating margin of 4.2% ($48.9 million operating income) due to various expense reduction initiatives including supply chain and lean management tools compared to 2.4% in fiscal 2011 and 1.6% in fiscal 2010. Operating EBITDA margin was 10.6% in fiscal 2012 compared to 9.3% in fiscal 2011, respectively. Fitch notes that WellSpan's overall profitability is somewhat depressed by its large employed physician base. The physician group generated losses of $21.4 million in fiscal 2012 and $19.6 million fiscal 2011. Through the three months ended Sept. 30, 2012, operating margin of 2.7% is closer to historical performance. Although year to date performance is below the same prior year period, WellSpan is on target to meet its budgeted operating margin of 3.3% in fiscal 2013. In the next several years, management is preparing for continued revenue pressure, which will necessitate ongoing expense reductions to sustain operating profitability. WellSpan is projecting to maintain an operating EBITDA margin of approximately 10%.


Liquidity grew steadily from 2009 to 2012 but dropped in the quarter ended Sept. 30, 2012 due to cash contribution to the pension plan of $41 million (about 14 days cash on hand). Unrestricted cash and investments totaled $657.3 million producing 217.9 days cash on hand and 17.4x cushion ratio, down from 240.1 days and 18.0x from June 30, 2012. Slightly below Fitch's 'AA' category medians, liquidity is adequate for its rating.

Long-term debt totaled $430.8 million at Sept. 30, 2012, producing debt metrics that are unfavorable to rating category medians. Through the interim period, MADS coverage by EBITDA of 3.9x, MADS as a percentage of revenue of 3.2%, and debt to capitalization of 50.3% were weak compared to respective medians of 4.8x, 2.5%, and 33.9%. Debt to capitalization is particularly high, and increased from fiscal 2011 due to a decline in unrestricted net assets affected by an increase in pension liability. Concerns with the debt load are mitigated by WellSpan's plans to reduce its debt burden by paying down maturing principal and funding capital expenditures using internally generated cash flow. Modest capital plans are supported by a low average age of plant of 8.1 years. WellSpan continues to restructure its debt portfolio with 39% fixed rate bonds, 49% direct bank loans, 6% auction rate bonds, and 6% notes payable and capital leases. Although there is no near-term put and remarketing risk with the direct bank loans (refinanced outstanding VRDBs), the loans do face renewal risk with initial terms of five to 10 years. WellSpan does not currently have any new debt plans.

Another key credit concern is the erosion in pension funding status that has declined from 98.2% in 2008 to 61.3% in 2012 driven by a combination of investment losses and decline in the discount rate. The unfunded liability could pressure future liquidity growth. However, the pension was partially frozen in 2007.

The Stable Outlook reflects Fitch's expectation that WellSpan will continue to produce consistent results due to its market position and integrated delivery model. A significant variance from projections could lead to negative rating pressure.

Headquartered in York, Pennsylvania, WellSpan consists of two acute care hospitals (York Hospital, with 550 staffed beds, and Gettysburg Hospital, with 95 staffed beds) located about 31 miles apart, Surgical & Rehab hospital (73 beds), 34 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'. 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, June 12, 2012;

--Non-Profit Hospital and Health System Rating Criteria, July 23, 2012.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm rpt_id=681015

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm rpt_id=683418

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 (News - Alert) 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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