[March 12, 2013]

Fitch Affirms Nanticoke Health Services, DE's Bonds at 'BBB-'; Outlook Stable

Fitch Ratings has affirmed the rating on approximately $38.3 million Delaware Health Facilities Authority (Nanticoke Health Services Project) series 2002 bonds at 'BBB-'.

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of gross revenues, a mortgage on the Obligated Group's facilities in Seaford, and a debt service reserve account.

For rating purposes, Fitch's analysis is based on the performance of the consolidated system, which includes the physician group that is not part of the obligated group.

KEY RATING DRIVERS

POSITIVE FISCAL 2012 PERFORMANCE: Due to the added benefit of the designation as a Medicare Dependent Hospital (MDH) ($4 million) as well as funds from meaningful use ($2.6 million), Nanticoke reported operating gain of $2.6 million, the first after several years of operating losses, equal to operating margin of 2.1% and operating EBITDA margin of 9.4%. Nanticoke also had strong volume trends, however, net patient revenue was flat at $119 million fiscal 2012 (June 30 year-end) compared to $118 million in fiscal 2011.

SUPPLEMENTAL FUNDING TO BE TERMINATED: Nanticoke only qualified for the MDH program in 2012, which was then terminated effective October 2012. However, the federal government has extended the program through September 2013, which will result in $4-6 million of funds for the current fiscal year. Due to the lag in the receipt of the MDH funds for the current year, Nanticoke reported an operating loss of $0.3 million through the six-month interim period ended Dec. 31, 2012. Despite the loss of the supplemental funding, the sustained improved profitability is expected as Nanticoke is committed to reducing overall expenses by $4 million.

ELEVATED DEBT BURDEN: Nanticoke's coverage of maximum annual debt service (MADS) is somewhat elevated, partially due to new capitalized leases entered into in fiscal 2012. MADS coverage by EBITDA was 2.2x in fiscal 2012 and is reported at 1.7x through the interim period. MADS represents an elevated 4.6% of consolidated system revenues.

IMPROVED LIQUIDITY: Nanticoke's liquidity improved due to higher cash-flow generation in 2012 and the $8.5 million of proceeds from the sale of the Lifecare at Lofland Park. Days cash on hand (DCOH) rose to 133.1 days at Dec. 31, 2012 and cash to debt was 77.5%, both close to the 'BBB' category rating medians.

RATING SENSITIVITIES

NEED TO SUSTAIN IMPROVEMENT: Failure to sustain the improved operating performance for the remainder of the 2013 fiscal year or a significant departure from the budgeted $3.5 million operating profit for the consolidated system may lead to downward rating pressure.

CREDIT PROFILE

The affirmation of the 'BBB-' rating and Stable Outlook is based on improved profitability and liquidity metrics in fiscal 2012 and the expectation that Nanticoke will be able to sustain its improved operations in the current fiscal year. Profitability will be aided by the delayed funds pursuant to the Medicare Dependent Hospital (MDH) program as well as its cost reduction initiative. In 2012 (year-end June 30), the consolidated system generated operating income of $2.6 million, translating to an operating and operating EBITDA margins of 2.5% and 9.4%, respectively, exceeding Fitch's 'BBB' category medians of 1.9% and 8.3%. The positive gain from operations was the first since 2005 and the hospital nly performance exceeded the budgeted operating income of $4 million. For the interim period ended Dec. 31, 2012, the system reported operating loss of $0.3 million for a negative 0.5% operating margin.

Nanticoke's designation as MDH resulted in a $4 million benefit in the 2012 fiscal year. Effective Oct. 1, 2012, CMS terminated the program. The program was subsequently reinstated for one more year, to run to Sept. 30, 2013. However, no monies have been received under the program to date and while management fully expects to receive the funds this fiscal year, estimated between $4-6 million, none have been accrued through Dec. 31, 2012. Management is budgeting $3.5 million operating income for the system for fiscal 2013.

Management is implementing a number of expense reductions with a potential goal of reducing expenses by $4 million this year. These include a redesign of the employee benefits, which brings benefit expenses more in line with industry standards, elimination of unprofitable service lines, such as occupational therapy, and renegotiation of certain vendor contracts. Nanticoke continues to focus on physician recruitment and was able to add several specialists, and is also adding primary care physicians at its five outpatient clinics. The recruitment efforts have resulted in a strong growth in utilization in fiscal 2012, with admissions exceeding the prior year by a robust 10.7%. Inpatient volumes have slowed in the current fiscal year and admissions are reported at 1.1% below the prior year through Jan.31, 2013. The system continues to subsidize the Nanticoke Physician Group which currently employs 27 physicians. The physician network lost $4.6 million in 2012 and the loss of $2.1 million through Dec. 31, 2012 was slightly lower than for a comparable period in the prior year due to improved physician productivity. Management expects to reduce the subsidy of the physician group to approximately $3.5 million in fiscal 2013.

The system's liquidity position improved due to positive operating cash flow in 2012 and was also boosted by the $8.5 million of proceeds from the sale of the Lifecare at Lofland facility to Genesis Healthcare effective June 29, 2012. The system reported cash and unrestricted investments of $42.5 million at Dec. 31, 2012, an increase from $30.5 million at the end of fiscal 2011. Nanticoke's liquidity metrics with 133.1 DCOH, 7.5x cushion ratio and 77.5% cash to debt are only slightly below Fitch's 'BBB' medians of 138.9 days, 9.4x and 82.7%, respectively.

The system debt load is somewhat elevated compared to the 'BBB' medians. Coverage of MADS by EBITDA was 2.2x in fiscal 2012, including debt service on $4 million of capitalized leases, as compared to the 'BBB' category median of 2.8x, and only 1.7x through the interim period. MADS as 4.6% of revenues is higher than the 'BBB' category median of 3.3%. Somewhat offsetting the higher debt load is the system's all fixed rate debt composition and limited capital needs in the near term.

The chief credit concerns remain the limited size of the hospital's staff and the exposure to changes in reimbursement given the institution's dependence on governmental sources of revenue (67% of gross revenues for Medicare and Medicaid combined). A mitigating factor is the sole provider status of the hospital in its primary service area generating a solid 45% market share.

Located in Seaford, DE, Nanticoke Health Services operates 99 acute care beds at Nanticoke Memorial Hospital. The system posted $124.7 million in operating revenue in fiscal 2012. Nanticoke covenants to disclose annual audited financial statements and quarterly disclosure to bondholders. Disclosure has been timely and includes a balance sheet, income statement, statement of cash flows and utilization data.

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:

--'Nonprofit Hospitals and Health Systems Rating Criteria', July 23, 2012;

--'Revenue-Supported Rating Criteria', June 112, 2012.

Applicable Criteria and Related Research

Nonprofit Hospitals and Health Systems Rating Criteria

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

Revenue-Supported Rating Criteria

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

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