OREANDA-NEWS. Fitch Ratings has upgraded to 'BBB+' from 'BBB' the rating on the approximately \$29.4 million outstanding New Jersey Health Care Facilities Financing Authority fixed-rate revenue bonds, series 2005A issued on behalf of Children's Specialized Hospital (Children's) as part of its continuing surveillance effort.

Simultaneously, Fitch has assigned its 'BBB+' to Children's Specialized Hospital implied general revenue obligations.

The Rating Outlook is Positive.

SECURITY

Children's is the sole obligor on the debt, and the Children's Specialized Hospital Foundation (the foundation) provides a guarantee of long-term indebtedness. Security includes a gross revenue pledge and a mortgage on the Children's hospital facility in New Brunswick. Bond covenant ratios are based on the combined operations of Children's and the foundation and include a 1.25x debt service coverage ratio and a 75 days cash on hand (DCOH) liquidity covenant calculated on a combined basis with the foundation.

KEY RATING DRIVERS

COMBINED CREDIT PROFILE EXCEEDS CATEGORY MEDIAN: The upgrade to 'BBB+' and maintenance of the Positive Outlook is supported by the combined profitability and balance sheet metrics of Children's and the foundation exceeding Fitch's 'BBB' category medians. Coverage of maximum annual debt service (MADS) on a combined basis was a very strong 6.9x in fiscal 2014.

FOUNDATION GUARANTEE: Children's benefits from the presence of the foundation, which guarantees Children's debt and provides a subsidy to Children's to offset any operating losses.

MAINTAINING IMPROVED FINANCIAL RESULTS: Children's finished fiscal 2014 (year-end Dec. 31, unaudited), with an operating gain of \$2.2 million, resulting in a planned return of the \$1 million foundation subsidy in the current fiscal year. On a combined basis, Children's and the foundation reported operating gain of \$11.6 million, which is adjusted for the subsidy reduction. Fitch includes funds provided by the foundation in support of Children's programs in operating revenues.

COMBINED LIQUIDITY METRICS EXCEED MEDIANS: At Dec. 31, 2014, unrestricted cash on a combined basis was reported at \$113.2 million, a \$31 million increase in two years, equating to 347.3 DCOH, 28.5x cushion ratio and cash equal to 238% of debt.

IMPACT OF MEDICAID REIMBURSEMENT CUTBACKS DELAYED: The conversion of Medicaid reimbursement for long-term inpatient care to managed care took effect July 2014, but Children's rates have been frozen at the then current levels to July 2016. Children's has been preparing for the Medicaid cutbacks by reducing the cost per unit through expenses management and expansion of services. In 2014, Children's opened a new outpatient facility in Warren, in Somerset County and another is planned to open in the fall of 2015.

PLANNED REFINANCING OF THE SERIES 2005A BONDS
Children's is planning to refinance the fixed rate series 2005A bonds with a private placement with Siemens Public Inc., in April 2015, which will not be rated by Fitch.

RATING SENSITIVITIES

RELIANCE ON FOUNDATION SUBSIDY: Children's ability to meet its obligations, historically dependent on the foundation's support and the foundation's ability to raise philanthropic support, is a key factor in Fitch's rating.

MAINTENANCE OF IMPROVED PROFTIABILITY: Sustained maintenance of profitability and liquidity at the current levels, and more clarity regarding the impact of conversion of long term care Medicaid to managed care reimbursement, could lead to positive rating pressure.

CONTINUED STRONG DEMAND FOR SERVICES: Given Children's unique and highly specialized profile, Fitch expects the strong demand for both inpatient and outpatient services and programs to continue.

CREDIT PROFILE

Children's Specialized Hospital is a free-standing pediatric rehabilitation hospital located in New Brunswick, NJ. Children's also has several other locations which provide inpatient and outpatient care throughout New Jersey with a total operating capacity of 60 rehabilitation beds and 68 licensed long-term care beds. In fiscal 2014 (unaudited, ended Dec. 31), total operating revenue was \$126 million.

MAINTAINING IMPROVED FINANCIAL RESULTS
Children's finished fiscal 2014 (unaudited) with operating income of \$2.2 million, exceeding the budgeted \$1.1 million. As in the last fiscal year, which had operating income of \$2.4 million, the foundation subsidy of \$1 million will be returned to the foundation, resulting in a like reduction in operating income. The financial results were driven both by continued strong demand for services, management's investment in efficiency initiatives to improve throughout, allowing for higher number of patient encounters and the delayed impact of the shift of New Jersey Medicaid long term care to managed care.

Fitch's main concern is the impact of potential unfavorable changes in reimbursement. Children's is heavily reliant on Medicaid (37% of gross revenues) and the organization remains vulnerable to potential cutbacks. New Jersey Medicaid transitioned reimbursement for most outpatient services to a managed care basis in mid-2012. The conversion of inpatient Medicaid rates for long term care was effective July 2014, but Children's rates were frozen to remain at the 2014 levels to July 2016 and children then under care had rates grandfathered for three to five years (the average length of stay for patients is five years).

In order to absorb what is likely to be the eventual reduction in Medicaid rates for long-term care, Children's management has continuously been working on both reducing the costs per unit and expanding services. A new outpatient site was opened in Warren in Somerset County, increasing the outpatient locations to 13. An additional outpatient location is planned to be opened in Monmouth County in the fall of 2015. The expansion of outpatient locations is part of Children's strategic plan based on creating a network of geographically dispersed outpatient facilities throughout the state, so that follow up care can be provided closer to children's homes once they are released from inpatient care.

COMBINED LIQUIDITY METRICS EXCEED MEDIANS
Children's and foundation's combined unrestricted cash and investments have grown consistently year-over-year and were reported at \$113.2 million at Dec. 31, 2014, compared to \$65 million in 2010. The improved cash position translated to 347 DCOH and cash equal to 238% of debt. The foundation raised a total of \$15 million last year, ahead of budgeted \$9 million due to a significant \$6 million gift.

PLANNED REFINANCING OF THE SERIES 2005A BONDS
Children's is planning to refinance the fixed rate series 2005A bonds with a private placement with Siemens Public Inc., which will not be rated by Fitch. The fixed rate \$28 million transaction is expected to close April 2, 2015 with amortization shortened to 14 years from the current 21 years. Based on interest rate anticipated to be below 3%, the annual savings are estimated at \$700,000, with net present value savings potentially at \$7 million. The foundation will serve as guarantor of the debt and security and covenants will be identical to those in place for the series 2005A bonds and the TDBank private placement. Given the expected debt service savings, Fitch views the planned refinancing as a credit positive.

DEBT PROFILE
The current debt profile includes 10% of Children's debt in variable rate. The organization executed a refinancing of the series 2005B variable rate bonds (not rated by Fitch) via a private placement with TDBank in August 2013. The loan has a 10-year term and the debt amortizes at the same schedule as the 2005B bonds schedule with final maturity in 2036. Ten million of the private placement was fixed rate and the remaining approximately \$5 million was issued as variable rate based on one month LIBOR plus a spread.

DISLOSURE
Children's covenants to provide audited year-end financials, as well as quarterly unaudited financial statements for both the hospital and the foundation to the authority, trustee, and to the Municipal Securities Rulemaking Board's EMMA system and provides Independent Accounts' Report on applying Agreed upon Procedures for the combined Children's and foundation.