WASHINGTON - The District of Columbiain the coming weeks plans to convert $283.9 million of auction-rate securities on behalf of MedStar HealthInc., which garnered upgrades from Standard & Poor'sand Fitch Ratings ahead of the deal.

Working through the district, MedStar is scheduled to join an ever-growing list of issuers on May 15 when it is scheduled to convert $142.2 million of auction-rate securities to fixed-rate debt. Shortly after the conversion, the district will convert the remaining ARS - about $142 million - to another mode, possibly variable-rate demand obligations, but that decision has yet to be made, said William Liggins, director of the district's revenue bond program.

Kaufman Hall & Associates Inc. is financial adviser. Citi is underwriter on the negotiated sale.

Venable LLP is bond counsel.

The bonds are insured by Financial Security Assurance Inc., which has managed to keep its triple-A rating, as it has had limited exposure to securities backed by subprime mortgages.

Both Standard & Poor's and Fitch upgraded MedStar Health to A-minus from BBB-plus, but Fitch's rating does not apply to the second portion of auction-rate debt that will be converted later. Fitch said it will issue a rating on those bonds closer to the conversion date. Both agencies have a stable outlook on the credit. Moody's Investors Service rates it A3 with a stable outlook.

Moody's analyst Beth Wexler said the agency may put out a new report on MedStar closer to the conversion.

The health group joins a big list of issuers getting out of the auction-rate market.

"We knew we had to do something, because the ARS market is killing us," Liggins said.

"It's interesting going through this process - everybody is in uncharted waters," he said. "We're asking 'is this is what we want to do? Do we want to lock in at a fixed rate? Should we refund?' The question mark of how we do this is still out there."

Auction-rate securities are essentially variable-rate bonds the interest on which is reset via a periodic Dutch auction. However, because ARS do not carry a put feature like VRDOs to guarantee liquidity, the debt is highly sensitive to changes in the issuer's credit ratings and normally requires the highest ratings to make them marketable.

Most ARS deals achieved this with bond insurance. An auction failure results when there are not enough orders from investors to purchase all the bonds being sold. When failures occur, most auctions reset to above-market rates.

Matt Fabian, managing director at Municipal Market Advisors, said in an earlier interview that hospitals have been hit hardest by the collapse of the auction-rate market. He said hospitals generally have a steeper fixed-rate curve and more credit risk, so that when the auction-rate market emerged they used it to get bigger savings because they typically do not have a huge cash pot. When the auctions began to fail, hospitals, among many other issuers, were stuck holding the debt with drastically higher interest rates.

MedStar has about $883.3 million of outstanding debt, which is issued by the District of Columbia and the Maryland Health and Higher Education Facilities Authority.

MedStar is a large, integrated health care system made up of eight hospitals, with four in the Washington- area, and four in the Baltimore area, with a total of 2,674 operated beds and several other health care-related organizations. MedStar had total operating revenues of $3.1 billion in fiscal 2007.

The upgrade reflects MedStar's sustained improvement in operations, driven mainly by improved performance in the district market for the past three fiscal years, a Fitch report said.

After multiple years of losses, MedStar Health broke even in fiscal 2004 and continued with positive operating margins since then. It earned $39.7 million, an operating margin of about 1.3%, from operations in fiscal 2007, and $35.1 million, a 1.5% margin, through the first eight-months of fiscal 2008, ending Feb. 29, the report said.

Fitch cited MedStar's large, diversified revenue base, maturity as a system, recognized clinical quality, and modest debt burden as other reasons for the upgrade.

"With over 140,000 admissions in fiscal 2007 and combined 2,647 staffed beds, MedStar is the market share leader in its combined D.C. and Baltimore service area," the report said. It added that the system has 18.1% of market share compared to its closest competitor, John Hopkins Health System with 10.2%.

Five out of eight hospitals owned and operated by MedStar are recognized in the U.S. News & World Report for being in top 50 in the nation in certain specialties, including the 854-bed Washington Hospital Center, which ranks 17th in cardiac care, according to Fitch.

Standard & Poor's said its upgrade reflects continued positive patient utilization trends, a strong and improving business position, and improving financial performance, adding that the financial profile overall remains below expectations for the rating level.

Both Fitch and Standard & Poor's say the credit is boosted by the addition of Montgomery General Hospital to the health group in the beginning of February. Standard & Poor's also notes strong 4.4 to 4.5 times maximum annual debt service coverage in fiscal 2007 and the first eight months of fiscal 2008 and a low 1.7% debt burden.

Standard & Poor's revised MedStar's rating to positive in January 2007, and "since then, the system has continued to improve patient volumes, which have generally grown faster than the market as a whole; kept its largest capital project, at Franklin Square Hospital, on track and on budget; successfully added [Montgomery General Hospital] to the system after MGH conducted a competitive search for a partner; and continued to improve operating results, with positive contributions from each of its markets," the rating report said.

MedStar may issue new money for MGH during 2008 and 2009, which is factored into debt ratios and debt service, but the health group currently has no additional debt plans, but may have additional debt in two to three years, according to Standard & Poor's.

Factors that could threaten the rating over the next two years include continued depressed liquidity levels and issuance of unexpectedly large additional debt without commensurate financial improvement, according to the report.

 

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