OREANDA-NEWS. Fitch Ratings has affirmed the 'A' rating on approximately \$1.1 billion of revenue bonds issued by the Maryland Health and Higher Educational Facilities Authority on behalf of University of Maryland Medical System (UMMS).

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group.

KEY RATING DRIVERS

ESSENTIAL PROVIDER: Once a state owned institution, UMMS occupies a unique position within the State of Maryland as a provider of certain essential services. Fitch views UMMS' strong relationships with the State and University of Maryland's School of Medicine (SOM) as a key differentiating factor compared to competitors that mitigates a financial profile that compares unfavorably to Fitch's 'A' category medians.

EVOLVING OPERATING ENVIRONMENT: UMMS joined Maryland's Global Budget Revenue (GBR) program effective Jan. 1, 2014 which provides revenue predictability as the system repositions itself to meet evolving models of care delivery. Fitch believes Maryland's highly regulated healthcare environment provides for operating stability albeit at a lower profitability level than 'A' category peers.

2014 RESULTS ON TARGET: UMMS generated operating and operating EBITDA margins of 1.6% and 9%, respectively, in the fiscal year ended June 30, 2014. While 2014 results exceeded budget and was improved over fiscal 2013 results, the 'A' rating incorporates Fitch's expectation that profitability would recover over time as the system absorbs the dilutive impact of the 232 bed St. Joseph Medical Center (SJMC) acquired in 2012.

WEAK LIQUIDITY: At Sept 30, 2014, 106 days cash on hand, 8.2x cushion ratio and 57.8 cash-to-debt trailed the respective 'A' category medians of 199, 17x and 131%. While liquidity is weak for the rating category and are not expected to improve given the system's future capital needs, metrics have remained stable over last five years.

ELEVATED DEBT BURDEN: UMMS leverage metrics are elevated but unchanged from historical levels. Maximum annual debt service of \$109 million equated to 3.6% of fiscal 2014, which is higher than 'A' category median of 3.1%. Historical coverage of MADS by EBITDA is light at 2.6x and 1.7x in fiscal 2014 and 2013, respectively.

RATING SENSITIVITIES

STEADY IMPROVEMENT EXPECTED: While operating results have been weak through the six month interim period ended Dec. 31, 2014, the negative variance was mostly attributable to revenue timing issues arising from the relative newness of the GBR program. Fitch expects UMMS's to meet its 2015 budget of 1.4% operating margin and remain on track to return to a 2-3% operating margin in the medium term.

ROBUST CAPITAL PLANS: Management has projected \$738 million of routine capital expenditures and \$957 million in strategic capital expenditures in 2015-2019 which may require issuance of additional debt over the next two to three years. While issuance of additional debt could pressure the rating, management has historically flexed capital expenditures based on debt capacity. Fitch will evaluate the impact of any longer term capital needs against UMMS's financial profile once plans are solidified.

CREDIT PROFILE

UMMS is comprised of the flagship facility, University of Maryland Medical Center (UMMC) located in Baltimore, Maryland, and several community and specialty hospitals. Over the last two years, UMMS added two new hospitals to its obligated group, and as such, fiscal 2014 incorporates seven months of Upper Chesapeake Health System (UCHS) and fiscal 2013 includes seven months of St. Joseph Medical Center (SJMC). Fitch reviews the consolidated system, which generated total operating revenues of \$3 billion in fiscal 2014.

Essential Provider in Maryland

Once a state-owned institution, UMMS continues to benefit from its close ties to the State of Maryland (general obligation bonds rated 'AAA') as an essential provider of certain high-end services, including the state's largest trauma center. Over the next five years, UMMS expects to receive \$70 million from the state for capital projects in addition to ongoing operating support for certain programs that are deemed to be 'essential' (about \$3 million annually for trauma services).

UMMS' strong relationship with the University of Maryland's (rated 'AA+') SOM enhances its ability to reduce costs and increase revenue as the faculty at SOM (approximately 1,000 physicians) is the medical staff at UMMC. A key relationship going forward will be between the community physicians and the academic physicians as the system continues to grow. Further, UMMC's ability to provide high end services is evidenced by a Medicare case mix index of 2.38 that results in a large volume of referrals throughout the state.

Maryland Global Budget Revenue Program

Effective Jan. 1, 2014, UMMS signed onto the Maryland GBR program, which now accounts for over 95% of total system revenues. Currently under a five-year pilot period, the GBR program offers participants a fixed revenue stream designed to incent hospitals to avoid unnecessary care and provide care in the most appropriate cost setting. The amount of hospital revenue is known before the start of the fiscal year and is adjusted annually. The per capita growth rate of total GBR payments is capped at 3.58% annually for the first three years.

For UMMS and most other Maryland hospitals rated by Fitch, the overall impact of the GBR program has been financially accretive in the first year (2014). However, there exist some challenges with revenue recognition for growing services due to the structure of capping annual revenues. With continued implementation, less complex services are expected to migrate to more cost effective outpatient settings from the main campus. Strategies are under development to improve physician alignment, which will be one of the key drivers of success in managing populations.

Continued Profitability Recovery Expected

UMMS revenue base continues to diversify and grow, with operating revenues totaling over \$3 billion in fiscal 2014 compared to \$2.4 billion in fiscal 2012. Due in part to challenges at SJMC, UMMS posted an operating loss of \$13.8 million in fiscal 2013 (negative 0.5% operating margin). In fiscal 2014, profitability improved with operating income of \$48.2 million (positive 1.6% operating margin), supported by good volumes, the addition of UCHS, and GBR program participation. While fiscal 2014 operating margin exceeded the budgeted operating margin of 1%, losses at SJMC continues to pressure profitability, which has historically been closer to 2-3%.

Profitability through the six months ended Dec. 31, 2014 was about breakeven, lagging a budget of \$12.7 million in operating income largely due to higher volumes than anticipated at SJMC and UMMC resulting in higher expenditures against GBR revenues. Management reported that the State has approved an additional \$28.5 million in annual revenues related to services provided at SJMC and UMMC, which essentially makes up below budgeted performance. The majority of the remaining hospitals in the system have been performing close to or above targeted profitability. Taking into account the additional revenues and other financial performance improvement plans in place, management expects to meet the budgeted operating margin of 1.4% in fiscal 2015, which Fitch also believes is achievable.

Update on Dimensions Health System

UMMS is a key participant in an ongoing discussion with the state, University of Maryland, Prince George's County, and Dimensions Health System in developing a financially feasible healthcare delivery system in Prince George's County. Management indicates that discussions are ongoing and Dimensions' long-term capital needs will have significant outside financial support, but UMMS does not expect to commit capital outside of support costs related to the financial viability study process.

Weak but Stable Liquidity

At Sept. 30, 2014, unrestricted cash and investments totaled \$893.9 million, which reflects an adjustment to deduct \$120 million in line of credit draws used primarily to fund UMMS's collateral posting under its swap contracts. Days cash on hand of 106, 8.2x cushion ratio, and 57.8% cash to debt are weak against the 'A' medians of 199 days, 17x and 131.2%, respectively. Fitch notes that unrestricted cash and investments have grown steadily over time, but the ability to grow liquidity is partly limited within Maryland's rate setting system. Balance sheet weakness is somewhat offset by the relative revenue stability. Given capital plans in the horizon, liquidity is likely to remain stressed, but expected to remain stable in line with historical levels.

Robust Capital Plans

Projected capital expenditures are robust, consisting of \$738 million budgeted for routine spending and \$957 million for strategic projects/priorities for 2015-2019. Management notes that a large portion of strategic spending has not yet been solidified, and will be flexed based on capacity. UMMS may issue additional debt in the next two to three years to fund certain projects. Fitch will review its potential impact once plans are finalized.

High Debt Burden

Debt burden is relatively high, with MADS equating to 3.6% of 2014 revenues and 54.2% debt to capitalization compared to the respective medians of 3.1% and 36.3%. Due to the relatively high debt burden and pressured profitability, MADS coverage was a low 2.6x in fiscal 2014 and 1.7x in fiscal 2013. While the pressure on coverage is a credit concern, Fitch also recognizes the limited profitability is offset by general revenue stability afforded by the operating environment under the Maryland rate setting system. However, Fitch expects coverage to return closer to 3x in the medium term as the system meets its financial improvement plan targets.

DEBT PROFILE

At Sept. 30, 2014, UMMS's outstanding long-term debt and capital leases totaled \$1.5 billion, of which approximately 61% was fixed rate and the remaining variable (swapped to fixed). Debt service is mostly level generating a MADS of \$109 million. There is an additional \$150 million drawn on an unsecured line of credit, the proceeds of which were used to fund the legacy funding corporation for UCHS for future expansion and renovation. The funds are held by a separate entity controlled by UMMS and are not included in the system's consolidated financials. Fitch excluded this debt given the nature of the obligation and the corresponding asset, and will incorporate it into the analysis once a more permanent structure is put in place.

Given market conditions, swap collateral posting requirements have been sizeable and volatile. As of Sept. 30, 2014, UMMS was counter-party to 11 swap contracts with a total notional value of \$801 million. The aggregate market value of UMMS' swap portfolio was negative \$179.6 million which required collateral posting of \$98.8 million. UMMS drew on its line of credit for these requirements which Fitch deducted from the corporation's unrestricted cash and investments.

DISCLOSURE

UMMS discloses annual financial statements within 120 days and quarter unaudited financial statements within 45 days for the first three quarters and within 90 days for the last quarter through the MSRB EMMA website.