[March 18, 2014]

Fitch Affirms Children's Specialized Hospital (NJ) at 'BBB'; Outlook Revised to Positive

Fitch Ratings has affirmed its 'BBB' rating on the approximately $30 million outstanding New Jersey Health Care Facilities Financing Authority fixed-rate revenue bonds, series 2005A issued on behalf of Children's Specialized Hospital (Children's) as part of its continuing surveillance effort.

The Rating Outlook is revised to Positive from Stable.

SECURITY

Children's is the sole obligor on the debt, and the Children's Specialized Hospital Foundation (the foundation) provides a guarantee of long-term indebtedness. Security includes a gross revenue pledge and a mortgage on the Children's hospital facility in New Brunswick. Bond covenant ratios are based on the combined operations of Children's and the foundation.

KEY RATING DRIVERS

IMPROVED 2013 FINANCIAL RESULTS: Children's finished fiscal 2013 (year-end Dec. 31, unaudited), with a stronger operating gain, resulting in a reduction of the foundation subsidy. On a combined basis Children's and the foundation reported operating gain of $6.3 million. Fitch includes funds provided by the Foundation in support of Children's programs in operating revenues.

COMBINED LIQUIDITY METRICS EXCEED MEDIANS: At Dec. 31, 2013 unrestricted cash on a combined basis was reported at $88 million, equating to 297 DCOH, 22.1x cushion ratio and cash equal to 180% of debt.

FOUNDATION GUARANTEE: Children's benefits from the presence of the foundation, which guarantees Children's debt and provides a subsidy to Children's to offset any operating losses.

MEDICAID REIMBURSEMENT CUTBACKS DELAYED: The conversion of Medicaid reimbursement for long-term care to managed care has been delayed for an additional year. Children's is responding to Medicaid cutbacks by reducing the cost per unit through expense management and expansion of services. In 2013 Children's opened a new outpatient facility near Newark Beth Israel Hospital.

RATING SENSITIVITIES

RELIANCE ON (News - Alert) FOUNDATION SUBSIDY: Children's ability to meet its obligations, historically dependent on the foundation's support and the foundation's ability to raise philanthropic support, is a key factor in Fitch's rating. Sustained maintenance of profitability, when factoring the likely conversion of long-term care Medicaid to managed care reimbursement, and liquidity at current levels could lead to positive rating pressure.

CREDIT PROFILE:

The rating affirmation and the revision of the Outlook to Positive is based on the continued strong demand for both inpatient and outpatient services provided at Children's facilities, management's efforts resulting in improved profitability and the consistent growth of liquidity position,

IMPROVED 2013 FINANCIAL RESULTS

For 2013 fiscal year ending Dec. 31 (unaudited), based on solid volumes and expansion of services Children's reported better than historical operating performance, with operating income of $2.4 million, resulting in a reduction of the subsidy from the foundation. The combined Children's and foundation reported operating gain of $6.3 million, equal to an operating margin of 5.1% and operating EBITDA margin of 13.7. The anticipated conversion by New Jersey Medicaid of reimbursement for long-term care to a managed care basis, which was expected to take effect in 2014, has been delayed by an additional year (state's fiscal year 2015).

Fitch's main concern is the impact of potential unfavorable changes in reimbursement. Children's is heavily reliant on Medicaid (35% of gross revenues) and the organization remains vulnerable to potetial cutbacks. New Jersey Medicaid transitioned reimbursement for most outpatient services to a managed care basis in mid-2012. In order to absorb what is likely to be the eventual reduction in Medicaid rates for long-term care, Children's management has continuously been working on both reducing the costs per unit and expanding services. A new outpatient site was opened in September 2013 near Newark Beth Israel Hospital and the organization's cost per unit has been reduced by 7.5% since 2011.

STRONG DEMAND FOR SERVICES

Volumes continue to be solid, given very limited competition in the state and high demand for services. In September 2013 Children's opened an additional outpatient facility near Newark Beth Israel Hospital and is considering two additional sites in New Jersey counties where it currently does not have presence. The foundation provided $2 million of the $3.5 million costs of the Newark facility. The addition of the Newark facility and the Egg Harbor Township site opened in 2012 are part of Children's strategic plan based on creating a network of geographically dispersed outpatient facilities throughout the state, so that follow up care can be provided closer to children's homes once they are released from inpatient care.

COMBINED LIQUIDITY METRICS EXCEED MEDIANS

Children's and foundation's combined unrestricted cash increased to $88 million at Dec. 31, 2013, up from $64.7 million at 2012 fiscal year-end. The improved cash position translates to 297 DCOH, cash equal to 180% of debt and cushion ratio of 22.1x, better than the 'BBB' category medians of 144.7 DCOH, 91.7% and 10.2, respectively. The improvement in operating results of Children's in 2013 resulted in a reduction of what was the planned total support by the foundation to $2.5 million from the budgeted $3.5 million. The foundation raised a total of $7.8 million in 2013, a level similar to the prior year.

REFINANCING OF THE SERIES 2005B BONDS

The organization executed the refinancing of the series 2005B variable rate bonds (not rated by Fitch) via a private placement with TDBank in August 2013. The loan has a 10-year term and the debt amortizes at the same schedule as the 2005B bonds schedule with final maturity in 2036 and the transaction eliminates bank renewal risk. Of the new issuance, $10 million was fixed rate and the remaining approximately $5 million was issued as variable rate based on one month LIBOR plus a spread. On combined basis coverage of maximum annual debt service (MADS) by EBITDA was 5.1x in fiscal 2013, better than the category median, and MADS represents 3.2% of revenues. Children's alone had 2.1x MADS coverage and MADS represents 3.4% of revenues.

Children's Specialized Hospital is a free-standing pediatric rehabilitation hospital located in New Brunswick, NJ. Children's also has several other locations which provide inpatient and outpatient care throughout New Jersey with a total operating capacity of 60 rehabilitation beds and 68 licensed long-term care beds. In fiscal 2013 (unaudited, ended Dec. 31), total operating revenue was $116 million. Children's covenants to provide audited year-end financials, as well as quarterly unaudited financial statements for both the hospital and the foundation to the authority, trustee, and to the Municipal Securities Rulemaking Board's EMMA system and provides Independent Accounts' Report on applying Agreed upon Procedures for the combined Children's and foundation.

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

Applicable Criteria and Related Research:

--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', May 20, 2013;

--'Revenue-Supported Rating Criteria', June 3, 2013.

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=824191

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