Moody's Upgrades Texas Medical Center's Long-Term Rating To A1

Moody's Investors Service has upgraded Texas Medical Center's long-term rating to A1 from A2 and assigned an A1 rating to$178.7 million of Series 2008A, Series 2008B-1, and Series 2008B-2 Special Facilities Revenue Bonds. The upgrade reflects the Center's well-established role in providing important services to 47 member institutions with growing needs, consistently strong operating margins, and improved levels of liquidity despite concerns about potential demands on liquidity resulting from the use of letters of credit in the debt structure. The rating outlook is stable at the higher rating level.

The Series 2008A bonds will be issued as fixed rate debt, while the Series 2008B-1 and B-2 bonds will be issued as variable rate demand debt in the daily and weekly mode, respectively. The Series 2008B-1 bonds are expected to be supported by an irrevocable direct-pay letter of credit (LOC) from JPMorgan Chase Bank, N.A. (rated Aaa/P-1). The Series 2008B-2 bonds are expected to be supported by an irrevocable direct-pay letter of credit (LOC) from Compass Bank (rated Aa3/P-1). Full credit reports and ratings reflecting the joint obligations of the banks and TMC to make debt service payments will be released shortly. Following this transaction, the Center will have $240.5 million of debt outstanding, of which 52% is variable rate with a put feature.

USE OF PROCEEDS: Bond proceeds will be used to pay off a taxable bank loan used to refinance the Series 2001, Series 2006 bonds, and the Series 1999B bonds.

LEGAL SECURITY: Loan repayments are a general obligation of TMC, on parity with other outstanding debt. Under the Letters of Credit, TMC is required to meet a rate covenant of 1.20 times, a Capitalization Ratio capped at 0.72 times, and a liquidity test requiring Unrestricted Cash and Equivalents to be at least 0.45 times Funded Debt. In addition, TMC must maintain a rating of Baa2 or higher.

INTEREST RATE DERIVATIVES: TMC is party to two floating to fixed rate swaps totaling $76.3 million that hedge the interest rates on a portion of its existing Series 2001 and Series 2006 bonds and will be retained to hedge a portion of the Series 2008B-1 and 2008B-2 bonds. The counterparty for both swaps is JPMorgan Chase Bank (Aaa/P-1). Under the swap for the Series 2006 bonds, TMC pays 3.264% and receives 68% of LIBOR. The swap may be cancelled if BMA averages above 6% for six consecutive months. TMC also has a swap with JPMorgan for a portion of the Series 2001 bonds. TMC pays a fixed rate of 4.25% and receives payments based on the BMA index. TMC also sold an option to JPMorgan to void the agreement if the BMA index averages more than 7% for a six month period. With the current transaction, the Center is terminating insurance on the swaps and amending the Schedule to the ISDA Master Agreement and Credit Support Annex with JPMorgan to add provisions that could require TMC to post collateral depending on the current market value of the swaps and the Center's rating level. In addition, the counterparty could terminate the swaps if TMC's rating declines below A3 prior to December 1, 2008 or below Baa2 at any later date. Swap termination payments are subordinate to debt service payments on the bonds. Moody's is comfortable with the risks posed by these agreements at the current rating level.

STRENGTHS

*Established role providing essential services to a large and growing medical complex in Houston, serving 47 member institutions.

*Strong operating performance (13.0% three-year average operating margin) generating 2.3 times maximum annual debt service coverage, with slight increase in revenue diversity in recent years.

*Growing financial cushion, with expendable financial resources at December 31, 2007 as adjusted for a planned draw down of investments to pay down $11.5 million in debt obligations covering direct debt by 0.54 times and operations by 1.7 times.

CHALLENGES

*Relatively high debt levels at $240 million compared to an operating revenue base of $90 million. Approximately one-half of debt is variable rate, including nearly 20% of direct debt that is unhedged, resulting in exposure to fluctuating interest rates.

*Ongoing growth at medical center will likely result in further demand for TMC to provide additional services, with the Center considering a new $35 million building renovation project to add leasable space to the main campus, which could result in further leverage.

*Debt structure will employ letters of credit that carry renewal and termination risks with covenants that, if breached, could lead to a call on nearly all of TMC's debt, deplete its financial resources, and limit its financial flexibility.

MARKET/COMPETITIVE STRATEGY: TMC PROVIDES ESSENTIAL SERVICES TO LARGE AND GROWING MEDICAL COMPLEX IN HOUSTON

Moody's believes that the Texas Medical Center will maintain a strong and unique market niche providing essential services to a large and growing medical complex in Houston. Established in 1945, the Texas Medical Center is a major health services complex that spans approximately 1,000 acres on five campuses and hosts 47 member institutions, including 13 hospitals (6,300 licensed beds), two medical schools, four schools of nursing, and various other organizations involved in the provision of health care services and education. TMC has continued significant growth, both through expansion of existing organizations housed on the campus as well as the gradual additions of new member institutions. Among the member institutions that account for the largest share of TMC's revenue are the University of Texas MD Anderson Cancer Center (University of Texas Revenue Financing System debt rated Aaa), Texas Children's Hospital (Aa2), Baylor College of Medicine, the Methodist Hospital, and Memorial Hermann-Texas Medical Center (Memorial Hermann Healthcare System rated A2). An estimated 169,000 people travel to TMC each day, including 73,000 employees, 63,000 patients, and 33,000 students. In 2007, institutions located at TMC counted 5.5 million patient visits. Current construction on TMC campuses totals 10.6 million gross square feet and is estimated to cost $3.5 billion. TMC's 36-member governing board attracts prominent members of the Houston community. Moody's believes that the size, growth, and diversity of TMC will contribute to ongoing demand for services offered by TMC, leading to sound operating performance and favorable debt service coverage.

In addition to serving as a coordinating body for the member institutions, TMC operates various auxiliary services, such as parking (29,000 spaces), food service, a residence facility, and a 600,000 square foot research and office complex leased to various members. It will be closing a conference center on campus this year. TMC may renovate another existing building to expand its commercial leasing operation. Parking is by far the largest component of the Center's operations, accounting for nearly two-thirds of Moody's adjusted revenues. These figures differ from TMC's reported revenues, as Moody's includes a component of investment income and gains as operating revenues. TMC owns or operates approximately 60% of the parking spaces at the Medical Center, but does face some competition from member institutions with their own parking facilities. However, TMC currently owns a substantial portion of the land in the Medical Center upon which future parking could be constructed. The expansion of public transportation to the Medical Center does not appear to have dampened demand for parking.

OPERATING PERFORMANCE: CONTINUED POSITIVE OPERATING PERFORMANCE PROVIDES SOLID COVERAGE OF INCREASING DEBT SERVICE COSTS

Continued demand for parking services has contributed to the Center's consistently healthy annual operating performance. Through Fiscal Year (FY) 2007, which ended December 31, 2007, the average three-year operating margin was a strong 13%. Operating cash flow margin in FY 2007 was 42%, producing 2.3 times coverage of estimated maximum annual debt service coverage following the current transaction. The positive operating performance supports a high debt load, with debt service representing nearly 21% of expenses in 2007. In our opinion, the strength and consistency of the Medical Center's operations is a key credit factor supporting the Center's relatively high operating leverage.

Parking revenues have continued to increase, growing nearly 5% between 2005 and 2007 due to rate increases. In 2007, parking revenues totaled $58 million, of which nearly 60% was from contracts with member institutions and 38% was from visitors to TMC. With the most recent facility, Garage 19, TMC initiated a new model for building parking garages under which it will construct a facility only if it is able to enter into long-term use agreements with a specific member institution that would cover the costs of construction and operations. Moody's views this structure as an effective means of limiting the Center's financial risk.

While TMC faces the potential for lost parking revenue, any loss may be offset by increasing revenue diversity. TMC's agreements with members to manage two of 19 parking garages on the campuses expire within the next year, and the Center could face a loss of approximately $4 million in annual revenue in 2009 if those agreements are not renewed. Growing revenue diversity could help offset some of any loss. Next to parking, leasing operations are now TMC's second largest revenue stream (11% of Moody's adjusted total revenues), largely comprised of leases at the John P. McGovern Campus. Occupancy is currently at 91.5%. TMC continues to reconfigure its food service operations, which accounted for 6% of operating revenues in FY 2007, in order to generate breakeven results from that line of business. The Center is undertaking a cost restructuring exercise that is expected to reduce expenses by $2.5 million (approximately 3%) when fully implemented in 2010.

According to TMC management, the impact of Hurricane Ike is not likely to materially affect its financial position. The storm's greatest impact occurred during a weekend, when there are typically fewer visits to member institutions. While parking facilities were closed to visitors only through Monday, parking volume was initially lower than usual in the following days but grew somewhat as patients who usually visit suburban healthcare facilities, which remained closed, came to TMC for medical care.

BALANCE SHEET POSITION: GROWTH IN LIQUID RESOURCES, ALTHOUGH LOC EXPOSURE POTENTIALLY LIMITS FINANCIAL FLEXIBILITY

Moody's believes that the TMC will remain relatively leveraged for the A1 rating category, despite financial growth driven by operating surpluses. In recent years, TMC has increased its financial resources significantly, with unrestricted financial resources increasing nearly 50% to $139 million since fiscal 2003. During that same time period, TMC's direct debt held fairly steady at between $237 million and $254 million. In conjunction with the current transaction, TMC will utilize $11.5 million of reserves to redeem tax-exempt debt in order to allow more flexibility for commercial use in previously debt-financed buildings. As a result, unrestricted financial resources will drop slightly, to $127 million. Expendable financial resources will cover total pro-forma direct debt by 0.54 times and operations by 1.7 times. Moody's expects TMC will further strengthen its balance sheet with future retained operating surpluses. TMC receives minimal gift revenue. The Center is considering a $35 million debt-financed project to renovate the Bell Building on the main campus, but exact timing has not been determined.

TMC's investments are allocated conservatively. At June 30, 2008, fixed income represented 55% of assets (including 19% comprised of preferred stock), 43% equities, and 3% cash. Moody's notes a concentration of investments with three managers holding more than 10% of the total portfolio, including two equity managers (24% and 19%) and one fixed income manager (14%). For FY 2007, which ended December 31, 2007, TMC recorded an investment return of 0.4%. For the year ended June 30, 2008 the investment return was negative 3.9%.

The structure of the debt portfolio and letters of credit adds modest risk to TMC's credit profile. Of the Center's debt, 52% is variable rate with a put feature and the interest rate on 18% remains unhedged. The unhedged exposure leaves TMC vulnerable to fluctuations in interest rates. The $120 million of variable rate Series 2008B-1 and B-2 bonds are expected to be supported by irrevocable direct-pay letters of credit (LOC) from JPMorgan Chase Bank, N.A. (rated Aaa/P-1) and Compass Bank (rated Aa3/P-1), respectively, each for an initial three-year term. Under the terms of the LOC, the TMC would have five years to repay the bank for any drawings to pay the purchase price of unremarketed bonds as long as no event of default exists. Events of default include violations of financial covenants that require TMC to meet a rate covenant of 1.2 times (actual 2.5 times in 2007), a Capitalization Ratio of up to 0.72 times (actual 0.65 times in 2007), and a liquidity test requiring Unrestricted Cash and Equivalents to be at least 0.45 times Funded Debt (actual 0.65 times in 2007). In addition, TMC must maintain a rating of at Baa2 or higher. Following an event of default, each bank could choose to require that any outstanding obligations due to the bank be immediately due and payable or direct the trustee to cause a mandatory tender of all of TMC's outstanding bonds. In either case, TMC would be required to provide for immediate repayment and could be forced to deplete its financial resources.

While Moody's anticipates that TMC will continue to exceed the financial and rating covenants, we believe either of these remedies could reduce its financial flexibility.

OUTLOOK:

The stable outlook reflects Moody's expectation that TMC will continue to generate operating surpluses from providing services to member institutions with growing needs that will provide solid debt service coverage and increase financial resources over time.

What could change the rating-UP

Significant increase in financial resources with limited additional debt.

What could change the rating-DOWN

Reduced role as service provider to member institutions that results in decreased operating performance, significant decline in financial resources, borrowing in excess of amounts currently envisioned.

KEY INDICATORS (FY 2007 financial data)

Total Pro-Forma Direct Debt: $239 million

Unrestricted Financial Resources: $127 million

Expendable Financial Resources to Debt: 0.54 times

Expendable Financial Resources to Operations: 1.7 years

Three-Year Average Operating Margin: 13.0%

Three-Year Average Debt Service Coverage: 2.3 times

RATED DEBT

Series 1996: MBIA insured (MBIA's current financial strength rating is A2 under review for downgrade)

Series 1999A: A1 underlying, FSA insured (FSA's current financial strength rating is Aaa under review for downgrade)

Series 1999B: A1 underlying, Aaa/VMIG1 based on FSA insurance (FSA's current financial strength rating is Aaa under review for downgrade) and standby bond purchase agreement from JPMorgan Chase Bank, N.A. - expected to be refunded

Series 2001: A1, A2/VMIG3 based on MBIA insurance insured (MBIA's current financial strength rating is A2 under review for downgrade) and standby bond purchase agreement from JPMorgan Chase Bank, N.A. - expected to be refunded

Series 2006: A1, A2/VMIG3 based on MBIA insurance insured (MBIA's current financial strength rating is A2 under review for downgrade) and standby bond purchase agreement from JPMorgan Chase Bank, N.A.- expected to be refunded

Series 2008A: A1

Series 2008B-1: A1 underlying rating; letter of credit to be provided by JPMorgan Chase Bank, NA

Series 2008B-2: A1 underlying rating; letter of credit to be provided by Compass Bank

 

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