OREANDA-NEWS. Fitch Ratings has affirmed its 'BB+' rating on the following series of bonds issued by the Hospital and Higher Education Facilities Authority of Philadelphia on behalf of Temple University Health System (TUHS):

--$307.8 million series 2012A and B;
--$205.8 million series 2007 A and B.

The Rating Outlook is revised to Positive from Stable.

SECURITY
The bonds are secured by a pledge of gross revenues of the obligated group, mortgages on certain properties of the obligated group, and a debt service reserve fund. The obligated group represented approximately 94% of the assets and 100% of the revenues of the consolidated system in fiscal 2015 Fitch reports on the performance of the consolidated system.

KEY RATING DRIVERS
IMPROVING OPERATING PERFORMANCE TREND: The revision in the Outlook to Positive reflects TUHS's continued trend in operating improvement. The system ended fiscal 2015 (year-end June 30) with operating income of $3.9 million, reversing the declining but still sizeable losses in the prior two years. Management budgets to end the fiscal 2016 with a $2.6 million operating income.

ESSENTIALITY AND HIGH DEPENDENCE ON SUPPLEMENTAL PAYMENTS: TUHS's flagship facility - Temple University Hospital (TUH) - serves both as a provider of high-end specialty services and as a de facto safety net hospital for North Philadelphia. As such, its continued viability is of critical importance to the greater Philadelphia market, which has been reflected in the significant support the institution has been receiving in the form of supplementary revenues, which in the current fiscal year are expected to remain significant and level with the prior year. However, due to issues surrounding the Commonwealth of Pennsylvania (the Commonwealth) 2015-2016 budget approval process, a portion may be delayed, which could potentially affect Temple's liquidity in the 2016 fiscal year.

LOWER VOLUMES, HIGHER ACUITY: While overall volumes have declined reflecting the general decreasing volume trend in the greater Philadelphia market, a major driver for the improved operating performance, in addition to better results at Jeanes and Fox-Chase division, was the system's ability to attract higher acuity, more highly reimbursed cases. TUH's case mix index was 1.79 in 2015, as compared to 1.69 in the prior year and the system has actually increased its share of the high-end cases to 6% from 4.9% since 2011.

MODERATE LEVERAGE: The system's coverage of maximum annual debt service (MADS) of $38.9 million by EBITDA was a stronger 2.5x in fiscal 2015, close to the 'BBB' median of 2.7x and the system has a still modest leverage with MADS equal 2.6% of revenues, an all fixed rate debt structure and no swap exposure. There are no additional debt plans.

MODEST LIQUIDITY: While liquidity remains light, cash and unrestricted investments increased to $374.3 million at 2015 year-end from $318.8 million in 2012, translating to 94 days cash on hand (DCOH), cushion ratio of 9.6x and cash equal to 70.5% of debt. Liquidity metrics are slightly higher than Fitch's NIG medians but still materially lower than Fitch's 'BBB' category medians of 161.5 DCOH, 11.1x cushion ratio and 93.6% cash to debt. Liquidity is projected to decline slightly by 2016 fiscal year-end to $357 million due to a Medicare overpayment and could potentially be temporarily impacted by a delay in the receipt of the supplementary payments.

RATING SENSITIVITIES
NEED TO MAINTAIN OPERATING PERFORMANCE: The Positive Rating Outlook reflects Fitch's expectation that Temple University Health System will maintain profitable operations, which should produce solid debt service coverage due to its moderate debt load. A return to the investment grade rating category would require maintaining operating performance in line with fiscal 2015 results over the next 12-24 months, leading to strengthened coverage and balance sheet metrics.

CREDIT PROFILE
TUHS is a Philadelphia based health care system, whose flagship is TUH, a 722-bed teaching hospital located on the campus of Temple University (University) in North Philadelphia. TUH sits on the University's health science campus, along with the University's School of Medicine and its other research and educational facilities. TUHS also owns and operates Jeanes Hospital (Jeanes), a 176-licensed bed community hospital located in a residential area in Northeast Philadelphia and the adjoining 100-bed American Oncologic Hospital d/b/a Fox Chase Cancer Center (Fox Chase), one of only 41 National Cancer Institute designated Comprehensive Cancer Centers in the nation. TUHS reported $1.6 billion revenues in fiscal 2015.

IMPROVING OPERATING PERFORMANCE TREND
Operations continued to improve in fiscal 2015, with TUHS recording operating income of $3.9 million, equal to a slim, but positive 0.3% operating margin and 5.4% operating EBITDA margin compared to sizeable operating losses of $15.8 million (2014) and $24.8 million in fiscal 2013. The improved performance had several components including a rather significant turnaround at the Fox-Chase and Jeanes divisions. The Fox-Chase improvement included both more robust outpatient volumes as management continued to recruit physicians and develop programs, including launching the Access Service, which offers new patients a guaranteed next-business-day appointment with the relevant specialist, as well as expense management and revenue cycle improvement and better managed care contracts. Jeanes results also improved materially from a focus on cost reductions and improved physician relations under a new CEO, who also serves as the head of Temple Physicians Inc. While the improvement at Fox-Chase is sustainable, management will have to find a more optimal operating platform for Jeanes, whose operations will need to be more closely integrated into one of TUHSs system components.

Profitability improvement was somewhat hampered by lower results at TUH compared to the prior year, which included the planned reduced level of University support, increased pharma expenses, while carrying a higher portion of IT implementation costs. Although TUHS's performance through the three months ended Sept. 30, 2015, is behind budget with a $3.9 million operating loss (but favorable compared to same prior year period), management expects to meet its budgeted operating income of $2.6 million for fiscal 2016.

LOWER VOLUMES, HIGHER ACUITY
The Philadelphia market has seen a continuing decline in inpatient volumes, but the decline for TUHS has been lower than the market in general. TUHS's discharges were 2.9% lower in 2015 and volumes are slightly softer than budgeted through the first quarter of fiscal 2016. However, TUHS has been able to gain a higher market share of the better reimbursed high acuity cases, which increased to 6% from 4.9% four years ago. Between 2011 and 2015 TUH had a 17.4% increase in high acuity cases, and most notably, that increase came from referrals outside of the PSA. TUH's transplant program increased 38% in 2014 and a further 29% in 2015.

SUPPLEMENTARY PAYMENTS RECEIPT TIMING CONCERN
The supplementary payments are essential to supporting the organization's position as a 'safety net provider' to inner city Philadelphia. Management has historically worked closely with the Commonwealth for the critically needed supplemental payments. TUHS's management was requested by the new Commonwealth administration to formulate a proposal, which would help to permanently stabilize the supplemental support, replacing the need for protracted annual negotiations. The proposal would have TUH serve as the anchor for the plan to address the needs of the North Philadelphia indigent and underinsured population that is the major determinant of the level of the supplemental funding it receives. However, the discussion over a new funding mechanism is ongoing and there continues to remain a concern about the level and timing of the supplemental funding. TUH's payor mix includes close to 46% of revenues from Medicaid.

The supplemental payments for fiscal 2016 are expected to be level with the prior year. However, given the issues surrounding the timing of the approval of the 2015-2016 Commonwealth budget, there is a possibility that the receipt of a portion of the support may be delayed past the end of Temple's fiscal year, which could negatively affect liquidity. At this time, there is no certainty as to the ultimate timing of the Commonwealth budget decision and whether the receipt of any of the supplemental funds will be delayed. While there is a concern that liquidity may be temporarily impacted, in management's estimate the Temple obligated group would need to maintain unrestricted cash and investments at approximately $250 million in order to meet its 60 DCOH covenant, a level which appears manageable even given some delay in receipts of the funds.

DEBT PROFILE
TUHS had $530.6 million of long-term debt at 2015 fiscal year-end, all of which is fixed rate and the system has no swaps. Coverage of MADS of $38.9 million was 2.5x in fiscal 2015, close to the 'BBB' category median of 2.7x, and MADS is a manageable 2.6% of system revenues, which is lighter than the 'BBB' median of 3.6%. Fitch's calculation of TUHS's metrics excludes the non-preferred appropriations ($6.2 million in 2015), for which TUHS only serves as a conduit for Temple University.

DISCLOSURE
TUHS covenants to provide timely annual quarterly financial and operating data to MSRB's EMMA system.