OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB' rating on \$14 million of series 2001 bonds issued by the Hospital Facility Authority of Hillsboro, Oregon on behalf of Tuality Healthcare (Tuality).

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross receivables of Tuality, mortgages on certain property, and a security interest in pledged equipment. A fully funded debt service reserve fund provides additional security for the bond issue.

KEY RATING DRIVERS

IMPROVED 2014 PROFITABILITY: Tuality posted an operating gain of \$827,000 (0.5% operating margin) in the fiscal year ended Sep. 30, 2014, exceeding the budgeted operating margin of negative 2.6%. Management attributes the improvement to better payor mix from Medicaid expansion and controlled expense growth.

ELEVATED COMPETITIVE PRESSURES: Market share weakening continues to negatively impact both inpatient and outpatient volumes. Kaiser Permanente (revenue bonds rated 'A+'; Stable Outlook) opened a new hospital in 2013 and gained considerable market share in Tuality's primary service area (PSA) since its opening. While somewhat offset by Medicaid expansion, the pressured competitive environment continues to challenge Tuality's volume trends and will likely impact future profitability.

LOW DEBT BURDEN: Despite market share and volume declines, Tuality's very low debt burden continues to support the rating. MADS was a low 1.1% of revenues in 2014 compared to the median of 3.6%, and coverage of maximum annual debt service (MADS) was a solid 5.6x versus the median of 2.6x.

STRONG LIQUIDITY: Certain liquidity metrics have consistently improved through a combination of debt retirement and limited capital spending (well below 1x annual depreciation expense) over the last several years. Although capital expenditures are expected to increase in 2015, lowered debt service payments should offset impact to liquidity.

RATING SENSITIVITIES

LOW DEBT BURDEN PROVIDES CUSHION: Tuality's solid balance sheet provides some financial flexibility in managing negative variance in operating results despite profitability being considerably weaker than 'BBB' medians. While not expected, material weakening in liquidity or debt metrics may lead to negative rating pressure. Positive rating movement is precluded at this time due to the continuous pressure on core operating performance.

CREDIT PROFILE

Tuality Healthcare is located in Hillsboro, Oregon and operates a total of 215 licensed beds at Tuality Community Hospital and Tuality Forest Grove Hospital. In fiscal 2014, Tuality had approximately \$174.7 million in total operating revenues.

Improved 2014 Profitability

Operating and operating EBITDA margins of 0.5% and 5.4% were significantly higher than expected (negative 2.6% operating margin budgeted), due to an improved payor mix and controlled expense growth but continued to lag the respective medians of 1.1% and 7.9%. As a result of Oregon's Medicaid expansion, Medicaid increased to 21.1% of gross revenues in 2014 from 14% in 2013, and self-pay declined to 3.4% in 2014 from 5.7% in 2013. Correspondingly, bad debt declined to \$11.6 million in 2014 from \$16.3 million in 2013. Overall, net patient revenues grew nearly \$10 million, reversing a four year trend of flat to declining revenues.

For fiscal 2015, management is budgeting an operating margin of 1%, which incorporates anticipated improvements in physician productivity. Fitch views this target as optimistic given Tuality's recent profitability trends and continued competitive pressures. Hospital stays (inpatient admission plus observations) have declined for over five years, affected by both regional trends and eroding market share. Kaiser Westside Medical Center opened in August 2013 now holds over 12% market share in Tuality's PSA. However, Fitch believes there are opportunities to capitalize on Tuality's relatively low cost structure and improve efficiency and productivity in existing operations to manage overall financial performance.

Low Debt Burden

One key credit strength continues to be Tuality's low debt burden. Total long-term debt declined significantly over the last five years and totaled \$16.1 million at FYE 2014 versus \$29 million at FYE 2010. MADS also decreased to \$1.9 million from \$6.3 million in 2012. As a result, MADS coverage is very strong at 5.6x in 2014 and 4.5x in 2012, compared to the 'BBB' median of 2.6x.

Solid Liquidity

At Sept. 30, 2014, unrestricted cash and investments totaled \$60.7 million, representing a modest growth from the prior year. Liquidity growth was likely driven by lower debt service payments (down to \$2.4 million in 2014 from over \$6 million), improved cash flows, and manageable capital spending. While days cash of hand of 133 days remains slightly behind the median of 145 days, 31.5x cushion ratio and 377% cash to debt are significantly stronger than the respective medians 10.5x, and 93.6%.

Manageable Capital 2015 Spending

Capital expenditures are budgeted at \$9 million for fiscal 2015, which is slightly above historical depreciation levels and higher than \$6.3 million spent in 2014. Management plans to fund the projects with internal cash flow and equity. Fitch does not expect the increased spending to materially impact liquidity.

DEBT PROFILE

At Sept. 30, 2014, long-term debt totaled \$16.1 million, generating a MADS of \$1.9 million. Debt service is expected to steadily decline until leveling out around \$1.3 million in 2017. All debt is fixed and Tuality does not have any swaps outstanding.

DISCLOSURE

Tuality provides annual disclosure within 180 days of year-end and provides quarterly disclosure voluntarily through the Municipal Rule Making Board's EMMA system.