[February 14, 2014]

Fitch Upgrades Virginia Hospital Center, VA Revs to 'AA-'; Outlook Stable

Fitch Ratings has upgraded to 'AA-' from 'A+' the rating on the following Industrial Development Authority of Arlington County, Virginia hospital revenue bonds issued on behalf of Virginia Hospital Center (VHC):

-- $127.5 million series 2010.

The Rating Outlook is Stable.

SECURITY:

Debt payments are secured by a pledge of the gross revenues of the VHC obligated group, which consists solely of Virginia Hospital Center. Fitch reports on the performance of the consolidated Virginia Hospital Center Arlington Health System (VHC), which includes the Virginia Hospital Center Physician Group as well as several other affiliates.

KEY RATING DRIVERS:

METRICS CONSISTENT WITH 'AA' MEDIANS: The upgrade to 'AA-' is based on VHC's profitability, coverage and liquidity metrics which are now consistent or better than Fitch's 'AA' medians, location in a demographically attractive market and modest capital needs.

EXCELLENT LIQUIDITY: Strong operating cash flow has enabled VHC to further strengthen its robust liquidity position. At year-end 2013, VHC reported unrestricted cash and investments of $643 million, equal to 704 days cash on hand (DCOH), 55.9x cushion ratio, and cash equal to 504.5% of long-term debt, all significantly higher than the 'AA' category medians. VHC's investment allocation is aggressive, but in Fitch's view acceptable given the liquidity levels.

STRONG PROFITABILITY MAINTAINED: VHC continues to produce strong operating results based on robust utilization, to a large part due to higher than originally anticipated volume of Kaiser Permanente (Kaiser) patients pursuant to a contract that was extended to November 2016. VHC produced operating and operating EBITDA margins in 2012 (fiscal year end Dec. 31) of 5.1% and 13.3%, respectively, and 6.3% and 15% in fiscal 2013 (unaudited), exceeding the 'AA' category medians.

MODEST CAPITAL NEEDS: VHC has a new patient tower erected in 2004 and faces no significant capital needs other than routine capital investments roughly equal to depreciation in the near- to medium-term. Debt load is manageable with maximum annual debt service (MADS) equal to 3% of revenues, and MADS coverage by EBITDA was a robust 6.9x for fiscal 2013.

COMPETITIVE SERVICE AREA: VHC's market share has steadily been increasing over the last decade and is now the highest in its service area at 34.2%, but the area remains competitive with Inova's (News - Alert) two facilities in Fairfax and Alexandria and an HCA hospital under construction.

RATING SENSITIVITIES

MAINTAIN STRONG OPERATING PROFILE: While the budget for fiscal 2014 calls for a slightly lower operating EBITDA margin of 11.5%, Fitch expects VHC to maintain its robust liquidity metrics while sustaining coverage metrics consistent with the rating category. Fitch views VHC's strong liquidity position as a mitigant against the potential operating volatility associated with VHC's smaller revenue base relative to the rating category. Fitch views VHC's strong liquidity position as a mitigant against the potential operating volatility associated with VHC's smaller revenue base relative to the rating category.

CREDIT PROFILE:

EXCELLENT LIQUIDITY

Because of good cash flow and strong investment returns, VHC cash and unrestricted investments increased to $643.1 million at 2013 year-end, equal to 704 DCOH from $417.9 million two years ago (503 DCOH), well exceeding the 'AA' category medians of 254 DCOH, and VHC now has cash-to-debt of 504%, as compared to the 'AA' median of 174%. Fitch notes that VHC's investment allocation is aggressive, with close to 60% in equity and 15% in alternative investments, but in Fitch's view this is acceptable given the liquidity levels and given all of VHC's long-term debt in fixed-rate mode and no swap exposre. Additionally, the investment policy requires that the market value of fixed income investments be at all times not less than 75% of outstanding long-term debt. Fitch views VHC's strong liquidity position as a mitigant against the potential operating volatility associated with VHC's smaller revenue base relative to the rating category.

SOLID PROFITABILITY MAINTAINED

VHC reported operating income of $19.9 million for the year ended Dec. 31, 2012, equal to an operating margin of 5.1% and operating EBITDA margin of 13.3%, and for fiscal 2013 (unaudited) operating gain of $24.3 million, equal to operating margin of 6.3% and operating EBITDA margin of 15%. Fitch's 'AA' medians for operating and operating EBITDA margins are 4.2% and 11.8%, which VHC exceeded consistently for the last five years. As had been planned, Kaiser added obstetrics to the services which are provided for their subscribers at VHC and births increased by over 1,000 last year, a 16% increase. Similarly, admission grew by 7.6% last year. The partnership agreement with Kaiser, which designates VHC as the hospital of choice for Kaiser subscribers, runs to 2017 and management does not anticipate that the contract would not be extended. Kaiser patients accounted for 24% of VHC's managed care revenues in 2013, up from 18% two years ago, and their census has significantly exceeded expectations with approximately 80-90 Kaiser patients in the hospital on any given day.

MODEST CAPITAL NEEDS

As VHC has a patient tower housing most patient care areas constructed in 2004, the organization has no major capital needs over the near- to medium-term. The capital budget for the current fiscal year is $30 million, roughly mirroring depreciation expense and primarily focused on infrastructure needs and IT investment. While VHC may face some capacity issues in the future if inpatient volumes continue to grow, these can be accommodated using space in the older hospital facility, which is currently primarily used for non-patient care. Fitch views the relatively light debt burden as a credit positive. MADS coverage by EBITDA of 6.3x is better than the 'AA' category median of 4.2x and MADS as a percent of revenues is moderate at 3%. Debt-to-capitalization is a very low 15%.

COMPETITIVE SERVICE AREA

VHC operates in an affluent (Arlington County rated 'AAA', Stable Outlook by Fitch) but relatively competitive service area. Market share has increased over the last decade and was most recently reported at 34.2%, compared to Inova's 32.2% for their Fairfax facility and 23.1% for the Inova Alexandria facility. VHC's market share has steadily increased every year since 2004; in 2009 it was under 30% while Inova Fairfax's was 40%. VHC is bolstering its presence on the fringes of its service area through the location of a half-dozen outpatient clinics. The contract with Kaiser is a major driver behind the strong inpatient volumes and management is working closely with Kaiser to accommodate the needs of their subscribers. Proposed construction of an HCA facility approximately 20 miles from VHC, to be completed in late 2015, is not seen as a serious risk because of difficult traffic patterns in this area. Physician recruitment, given the attractiveness of the service area, has not been an issue for this organization in the past. A recent launching of a joint insurance product between Aetna and Inova has not had an impact on VHC, but could present some risk in the future.

Virginia Hospital Center Arlington Health System (VHC) is a 342-bed tertiary teaching hospital located in Arlington, VA, which is across the Potomac River from Washington DC. VHC generated total revenues of $385 million in unaudited fiscal 2013. VHC covenants to provide audited financial statements within 180 days of fiscal year end, and quarterly disclosure within 45 days of quarter's end. Disclosure is reported to the Municipal Security Rulemaking Board's EMMA system.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', dated June 23, 2013.

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2013 .

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=820669

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