CHICAGO - Despite remaining largely insulated from the turmoil in the capital markets so far, the years-long strong operating performance across the nonprofit health care sector could be headed for a decline in 2009, particularly among smaller, lower-rated credits, Fitch Ratings analysts said in a report on median ratios on the industry released yesterday.

The industry turned in a stable performance in 2007, though the overall picture is mixed, with a host of negative fiscal pressures such as bad debt and increasing competition waiting in the wings.

As a result, Fitch predicted downgrades would outpace upgrades over the near term - they are tied at 11 each so far in 2008 - in contrast to recent years. In 2007, for example, Fitch assigned twice as many upgrades as downgrades.

Both Standard & Poor's and Moody's Investors Service have presented similarly weak outlooks for the nonprofit health care sector heading into 2009.

On the bright side, providers so far remain largely unaffected by the turmoil in the financial markets, Fitch analyst Jeff Schaub said in a conference call discussing the report yesterday.

"There's been relatively little exposure to Lehman [Brothers Inc.] or AIG, and where we did see it, with swaps or investments, it was limited and the downside risks are manageable," Schaub said. "The same is true with the spike in [variable-rate demand bond's interest rates] and puts; it's similar to the auction-rate problem. But we continue to closely monitor the situation and we're waiting for progress on the federal bailout program, which we feel will add some stability and liquidity to the debt markets."

And while many nonprofit health care issuers, like issuers across the municipal market, have opted to postpone bond issuances over the last two weeks, none so far have reduced the scope or scale of their debt plans, he added.

"Folks are waiting a few weeks for markets to settle down, but if it goes on longer than that, it could be a problem for people in the middle of construction projects that need financing," Schaub warned.

Debt refundings are expected to slow in 2008 and through 2009 as most providers have already spent the first half of the year refunding bonds that were tainted either by the collapsed auction-rate market or downgrades of bond insurers, said Fitch.

But new-money issuance could increase next year, as the 'construction pipeline' in 2009 totals around $45 billion. That compares to $43 billion in 2008 and $20 billion a few years ago, Schaub said.

Like analysts at other ratings agencies, Fitch analysts warned that the nonprofit health care sector would be increasingly affected by a widening credit gap between larger, higher-rated credits and smaller, lower-rated credits. One dramatic indication of the struggles of smaller, BBB rated credits was a 50% decline in the median operating margin in 2007 compared to 2006, said Fitch. As well, that ratings category saw a "significant decline" in capital spending in 2007, a key component to maintaining credit worthiness.

That decrease in capital spending lead directly to an increase in the average age of a plant for the BBB category, up to 10.1 years in 2007 from 9.5 years in 2006.

"There's some serious negative implications for [lower-rated credits'] competitiveness going forward," Schaub warned. "[Higher-rated credits'] ability to invest in their systems is the backbone of improvements we've seen for cost reduction and quality improvement."

Providers at both ends of the ratings scale face a slew of fiscal pressures, none of which are particularly new, Fitch said. Budgetary pressures, reimbursement constraints from governments and commercial payers, increase in capital costs, physician competition and rising bad debt amid a weak economy are all pressures that providers will have to tackle over the near-term, Fitch said.

"There's a lot of doom and gloom, but it's nothing new," Schaub said. "The outlook is more bifurcated. We expect stability overall but negative factors will disproportionately affect the weaker credits."

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