NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has downgraded the underlying rating on approximately $1 billion outstanding bonds issued on behalf of Bon Secours Health System, Inc. (BSHSI) to 'A-'. The Outlook is Stable.

The downgrade is due primarily to BSHSI's reduced liquidity, with fiscal 2009 investment losses further eroding a liquidity position that Fitch had already considered weak relative to rating category medians. While the divestiture of unprofitable assets and more recent operational improvements in troubled divisions have stabilized the enterprise, BSHSI's substantial exposure to demand debt, interest-rate swaps, and equity investments calls for a higher level of compensating, market-stable financial resources than presently exists.

BSHSI's liquidity metrics, which have been drifting downward for the past few years due to capital investment coupled with profitability declines in a few market areas, reflect a 20.4% investment loss for the nine months ended May 31, 2009 (the interim period). Days cash on hand (DCOH) dropped to 94.8 days from 126.7 days as of Aug. 31, 2008, and cash to debt at the end of the interim period was 60.2%, compared to Fitch 'A' category medians of 171.2 days and 113.3%, respectively.

The light liquidity position underscores the potential risk and volatility of the system's debt structure (consisting of 52% variable-rate demand debt), interest rate swaps exposure that limits debt remediation options, and a somewhat aggressive 53% allocation to equity investments. While management's overall effectiveness and recent success in improving operating performance partially offsets this potential risk, Fitch does not anticipate recovery of sufficient balance sheet strength over the near term to maintain the rating at its prior level.

The Stable Outlook reflects BSHSI's successful completion of its portfolio assessment and asset disinvestments in Michigan and New Jersey, proven ability to successfully employ joint ventures, strengthened management and governance practices and significant investment in facilities, with presence in several high growth, good payor markets, such as Virginia and South Carolina. Management was highly responsive to losses which developed in the New York, Baltimore (MD) and Hampton Roads (VA) markets, and was able to reverse a 2008 operating loss of $12 million to a $17.1 million operating profit in the Hampton Roads market, bringing the New York loss close to breakeven performance and reducing the Baltimore loss to a manageable level. Fitch believes that the operational improvements implemented during this fiscal year are sustainable and will return system profitability closer to historical levels, enabling BSHSI to stem the liquidity decline in the absence of further market deterioration.

Steps taken to conserve cash included deferring certain capital projects, freezing executive compensation, and expense reduction throughout the system and particularly in the underperforming markets. Capital spending, which has historically been robust, resulting in a very low average age of plant of 7.4 years, has been curtailed to a target of approximately 60% of operating cash flow with focus on strategic projects and those with a high rate of return. BSHSI has committed $185 million to an electronic health record, of which $75 million has been spent to date. Pro forma coverage of maximum annual debt services (MADS) was a solid 3.4 times (x) in fiscal 2008, but decreased to 1.7x for the May 2009 interim period as a result of investment losses (Fitch excludes the effect of unrealized investment and derivative losses).

As a result of the unfavorable market conditions, BSHSI recorded both realized and unrealized investment losses during 2009, resulting in cash and unrestricted investments declining to $640.7 million on May 31, 2009 (days cash relative to expenses of 94.8 days) from $790 million (126.7 days cash on hand) as of the end of fiscal 2008. BSHSI investment portfolio includes 53% equities, 38% fixed income and cash, and 9% of hedge fund and real estate investments. At the present time, 52% of BSHSI's debt is variable, which Fitch considers to be fairly high in light of the system's liquidity position. BSHSI has 14 fixed-payer and/or basis swaps with a notional amount of $1.4 billion, diversified among a number of counterparties. The majority of the swaps (approximately $1.1 billion) are either insured or do not have collateral posting requirements. As of June 30, BSHSI was posting only $3.8 million in collateral. It is management's intention to continue to evaluate strategies to reduce risk in its debt and swap portfolio.

All but one of BSHSI's pension plans are church plans and as such are exempt from meeting ERISA and PPA pension funding requirements. BSHSI is planning to fund only the service costs associated with the church plans, estimated at $21 million for 2009 and $25 million for 2010. BSHSI expects to record a pension liability adjustment related to its defined benefit plans for fiscal 2009, which is determined based on actuarial assumptions and asset values on Aug. 31, 2009. As of May 31, 2009, BSHSI's debt to capitalization was 63.8% and, depending on the amount of the adjustment, BSHSI may exceed a 65% debt to capitalization covenant in certain of its insurer and bank documents. In anticipation of the pension adjustment, BSHSI has secured verbal prospective amendments from all interested parties.

BSHSI, headquartered in Marriottsville, MD, with facilities in seven eastern states, consists of 18 owned and joint-ventured hospitals, as well as several other non-acute entities. BSHSI reported total revenues of $2.6 billion and unrestricted cash and investments of $790 million for fiscal 2008. BSHSI covenants to supply both audited annual and unaudited quarterly financial data to bondholders through the nationally recognized municipal securities information repositories. BSHSI has been disclosing annual and quarterly financial statements through Digital Assurance Certification LLC (DAC) at 'www.dacbond.com'. Financial disclosure to bondholders has been excellent in terms of content and timeliness and includes detailed management discussion and analysis, a balance sheet, an income statement, utilization statistics, and consolidating statements.

An error was found in the rating on Fitch's web site for the bonds listed below:

-- Hanover County Industrial Development Authority (VA) (Memorial Regional Medical Center) hospital revenue bonds series 1995;

-- Hanover County (VA) (Bon Secours Health System, Inc.) hospital revenue bonds series 1995.

These bonds were incorrectly removed from Fitch's database. The correct rating history for all the above bonds is now reflected on Fitch's web site at 'www.fitchratings.com'.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, '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.





Fitch Ratings, New York

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Source: Fitch Ratings