Elkhart General Hospital, IN -- Moody's affirms Elkhart General Hospital's (IN) A2 bond rating; Outlook revised to positive from stable

New York, November 09, 2012 -- Moody's Investors Service has affirmed Elkhart General Hospital's (EGH) A2 bond rating on $84.5 million outstanding bonds issued by the Elkhart County Hospital Authority. The rating outlook is revised to positive from stable.

SUMMARY RATING RATIONALE

The affirmation of the A2 bond rating reflects EGH's improved financial performance in interim fiscal year (FY) 2012, low leverage position, and growth in already strong balance sheet metrics. EGH entered into an affiliation with Memorial Health System of South Bend, IN (MHS) at the end of FY 2011 and financial performance has improved as a new senior management team quickly implemented expense saving initiatives at the hospital. EGH continues to be challenged by a trend of flat or declining volume statistics and a service area with flat population growth and a high unemployment rate. The positive rating outlook reflects EGH's expected merger into MHS's obligated group, which will secure outstanding bonds with the combined pledged revenues of both systems. Pro forma financial performance, debt coverage ratios and balance sheet metrics for the combined systems (named Beacon Health System) indicate upward pressure on the rating. The success of the merger depends on the organization's ability to continue to gain efficiencies through integration and maintain relationships with aligned and employed physicians.

STRENGTHS

*Leading market share of 62% in EGH's primary service area (PSA) of Elkhart County; combined market share for EGH and MHS (aka Beacon Health System or Beacon) is 59% in the larger two county PSA; the new combined systems' employed and aligned physicians are expected to help maintain and grow this market share

*Improved financial performance at EGH with a 3.9% operating margin (when normalizing for the expected annual Indiana Medicaid provider tax benefit) and 10.6% operating cash flow margin through nine months FY 2012 compared a 0.2% operating margin and 7.9% operating cash flow margin during the same period in the prior year; improvement driven by cost saving measures quickly initiated by a new senior management

*Planned merger of EGH into MHS's obligated group increases the pledged revenues securing bonds for both organizations; very good pro forma debt service coverage ratios when annualizing nine months of FY 2012 for Beacon with Moody's adjusted maximum annual debt services (MADS) coverage of 9.4 times, adjusted debt-to-cash flow of 1.5 times and debt-to-operating revenue of 25%

*Continued growth in unrestricted cash and investments at EGH to $218 million or 307 days cash on hand at September 30, 2012 and cash-to-debt of 267% compared to A2 median of 195 days and 143% cash to debt; combined unrestricted cash and investments for Beacon is $592 million or 291 days and cash-to-debt is 275%

CHALLENGES

*Location in the economically challenged Elkhart, IN which has been plagued by very high unemployment, a slowdown in population growth and a decline in the median household income; the unemployment rate has improved over the last three years to 9.1% from a high of 18%, however it is still above the state and national rates; South Bend is also demographically challenged with slow population growth and sustained high unemployment (according to Moody's Analytics)

*Continued trend of declining utilization trends in inpatient admission, outpatient surgeries and total surgeries; we note outpatient visits and combined inpatient admissions and observation stays show growth

*Competitive market with a number of acute care providers in the PSA including St. Joseph Regional Medical Center (part of Aa2 rated Trinity Health System) which has a new facility located between EGH and MHS and Indiana Health Goshen Hospital (part of A1 rated Indiana University Health); the merger between MHS and EGH reduces some of the competitive pressure in the market

*Merger with MSB brings integration challenges including achieving efficiencies and savings, consolidating some staff, and maintaining alliances with physicians; thus far, progress with achieving savings has been positive, however, there is still more to be done

*Large capital plans over the next two years totally $89 million with a capital budget in FY 2014 that is greater than current cash flow which will place some pressure on strong cash position; management may issue new debt in FY 2014 to finance part of the capital plans at EGH; combined capital plans over the next two years are more manageable given the current cash flow of the combined organization

OUTLOOK

The positive outlook reflects our expectation that EGH will join MHS's obligated group securing both organizations' bonds with combined pledged revenues. Furthermore, pro forma financial performance, debt service coverage ratios and balance sheet metrics indicate upward pressure on the rating. At this time we are not indicating a rating on the new Beacon Health System.

WHAT COULD MAKE THE RATING GO UP

Successful execution of the merger and integration between EGH and MHS; defined strategy which affords the combined organization the ability to sustain favorable operating performance and strong financial profile as the combined Beacon Health System

WHAT COULD MAKE THE RATING GO DOWN

Unlikely given the positive outlook, however a downgrade would be a function of material decline in financial performance at EGH leading to stressed debt ratios; material decline in EGH's balance sheet position; sizable additional debt at EGH without commensurate increase in cash flow; disintegration of merger with MHS

PRINCIPAL METHODOLOGY USED

The principal methodology used in this rating was Not-For-Profit Healthcare Rating Methodology published in March 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

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Jennifer Ewing Associate Analyst Public Finance Group Moody'sInvestors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653Beth I. Wexler VP - Senior Credit Officer Public Finance Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Releasing Office: Moody's Investors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653(C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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