Fitch Rates Univ Health System of Eastern Carolina's (North Carolina) $246MM VRDBs 'AA-'/Underlying

Fitch Ratings has assigned an underlying 'AA-' rating on approximately $246 million of North Carolina Medical Care Commission (University Health System of Eastern Carolina's (UHSEC) f/k/a Pitt County Memorial Hospital) series 2008 A-1, A-2, B-1 and B-2 variable rate demand bonds (VRDBs). In addition, Fitch affirms UHSEC's outstanding debt at 'AA-'. The Rating Outlook is Stable.

The affirmations are based on UHSEC' dominant market position as a Level I trauma center in Eastern North Carolina, solid operating performance, and manageable pro forma debt burden relative to operations. UHSEC had a dominant 78.8% market share in its primary service area (PSA) in fiscal 2007, up from 74.1% in fiscal 2005. In fiscal 2007, UHSEC generated a 3.9% operating margin ($42.0 million gain), increasing from 2.3% in fiscal 2004, and in line with Fitch's 'AA' median of 4.1%. UHSEC operating profitability has been supported by positive utilization trends, successful negotiation of managed care contracts, and reduced losses associated with the employment of physicians. Two of the System's hospitals have received critical access hospital status (Chowan Hospital in 2004 and Outer Banks Hospital in 2006) which should support revenue growth going forward. Although days in accounts receivables remained somewhat high at 61.6 days at fiscal year-end 2007, it declined from 61.8 days at fiscal year-end 2006 due to favorable revenue cycle initiatives.

In fiscal 2007, UHSEC's pro forma debt burden was manageable with debt to EBITDA of 3.4 times (x), in line with Fitch's 'AA' median. Pro forma MADS coverage by EBITDA was 3.8x in fiscal 2005. Fitch expects UHSEC's debt measures to improve over the medium term as there are no major capital projects expected.

Primary credit concerns center on UHSEC's light liquidity position relative to debt, high Medicaid load, and rising bad debt expense. At Sept. 30, 2007, UHSEC' unrestricted cash of $371 million equated to 157 days cash on hand and 74.8% cash to debt, compared with 161.2 days and 91.9%, respectively, at fiscal year-end 2005. However, Fitch notes that UHSEC's overall unrestricted cash position has grown by nearly $83 million over the same time frame, lending strength to it's overall cash position relative to MADS, reflected in an improved cushion ratio of 13.0x in fiscal 2007, up from 10.1x in FY2005. Fitch had noted that UHSEC's exposure to Medicaid load was high relative to other credits, equating to 17.0% of gross revenues, which results in significant exposure to changes in government reimbursement. However, Fitch notes that UHSEC does receive cost-based reimbursement under the NC Medicaid program for its flagship facility, Pitt County Memorial, due to its affiliation with the Brody School of Medicine at East Carolina University. Medicaid disproportionate share payments have been stable at $12.3 million over the past three years. UHSEC's bad debt expense as a percentage of revenues was high at 10.2% of revenues in fiscal 2007, increasing from 8.5% in fiscal 2004, which management attributes to a rising uninsured population, deductibles, and co-pays.

The Stable Rating Outlook reflects the expectation that UHSEC will continue to benefit from its dominant market position and post strong operating margins, which should be enhanced with the opening of 168-bed patient tower, scheduled to open in January 2009. Growth of UHSEC's liquidity position has been good over the past two fiscal years and should continue to improve as there are no significant capital plans over the next several years. Going forward, Fitch expects UHSEC' strong operating performance to support growth of cash reserves at a moderate rate.

UHSEC is a 1,116-bed hospital system operating six hospitals and several other related health care entities throughout Eastern North Carolina. UHSEC had total operating revenues of $1,065.9 million in fiscal 2007. UHSEC has covenanted to disclose annual audited financial statements to the NRMSIRs and provides Fitch with timely quarterly disclosure (including a balance sheet, income statement, statement of cash flows, and utilization statistics).

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