BRADENTON, Fla. - Moody's Investors Service downgraded Wake Forest Baptist and North Carolina Baptist Hospital bonds to A2 from A1, citing financial setbacks at Wake Forest.

The lower rating affects $603.8 million of parity debt. The outlook is stable, Moody's said July 25.

The downgrade reflects the financial setbacks Wake Forest Baptist incurred over the last several years and Moody's assessment that the organization's financial flexibility has been reduced, said analyst Daniel Steingart. The most recent financial challenge is the large accounts receivable write off that impacted fiscal 2014.

"Despite projected improvement in the coming year, we expect financial performance to remain suppressed and well below that of peer organizations through fiscal year 2015," Steingart said. "The outlook is stable at the lower rating level reflecting the organization's strong balance sheet and fundamental strengths, including a strong market position and clinical reputation."

Wake Forest Baptist is the borrowing name for Wake Forest Baptist Medical Center, North Carolina Baptist Hospital, Wake Forest University Health Sciences, and their affiliates. The integrated system is located in Winston-Salem, and operates 1,004 acute care, rehabilitation and psychiatric care beds, as well as outpatient services and community health/information centers.

Fiscal 2014, which ended June 30, "was another challenging year and represents the third consecutive year of deteriorating margins," Steingart said.

Wake Forest is expected to meet its rate covenant, Moody's said.

In the spring of 2014, a new senior management team was hired, including a chief operating officer and a chief financial officer.

The 2015 budget includes detailed patient volume forecasts and expense reduction goals, a 5.8% operating cash flow margin with effectively $57 million of operating improvement, according to Moody's. The budget anticipates gradual improvement and generation of operating income in the fourth quarter.

"In our opinion, the budget is achievable especially given that there is $36 million of contingency between the operating and capital budgets, but there remains downside risk given the prolonged nature of financial underperformance over the last three years," said Steingart. "However, if [Wake Forest] reports variance to budget through mid fiscal year 2015, the rating outlook may be revised to negative."

Although the organization added a line of credit to finance the large increase in accounts receivable over the last few years, leverage is manageable with approximately 119% cash-to-debt as of March 31, Moody's said. Capital spending is projected at $57 million.

The defined benefit pension plan was only $14 million underfunded at the end of fiscal 2013, according to Moody's.

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