Kennet h T. Gacka Associate Director U.S. Public Finance – Health Care July 29, 2013

1. Western PA HFMA Summer Education EventU.S. NFP Health Care Sector Trends and Outlook: Providers Prove Adaptable but Face a Test as Reform Looms Kenneth T. Gacka Associate Director U.S. Public Finance – Health Care July 29, 2013

2. Outline • Rating Criteria: key areas of analytic focus • Recent credit trends in not-for-profit healthcare • Credit outlook for 2013 and longer term • How does health reform impact ratings • Medicaid expansions impact • Overview of ratings and ratings process • Additional questions?

3. What Credit Ratings Are and Are Not Credit ratings are: Opinions about relative credit risk Opinions of the bond issuer’s willingness and ability to meet its financial obligations in full and on time Intended to be a forward looking opinion Credit ratings are not: Investment advice Buy, hold, or sell recommendations Guarantees of credit quality or of future credit risk An indication of absolute default probability

4. S&P Rating Scale: www.standardandpoors.com

5. Rating Outlook Definition • Outlook can be: • Stable • Positive • Negative • Developing • Assesses the potential direction of a long-term credit rating over two years • One year outlook for speculative grade credits • Expresses our view that the rating could change in indicated direction • One in three chance of change • Not necessarily a precursor of a rating change

6. U.S. Not-for-Profit Hospital Rating Criteria Enterprise & Financial Profiles Combine to Indicate Rating Enterprise Profile – S&P’s view of: • Industry Risk – standard risk measure shared by all U.S. hospitals – reason for no `AAA’s • Economic Fundamentals – population growth, wealth & income, employment market, etc. • Market Position & Strategy • Competition, market share, demand • Medical staff characteristics • Strategic vision • Management/Governance

7. U.S. Not-for-Profit Hospital Rating Criteria Enterprise & Financial Profiles Combine to Indicate Rating Financial Profile – S&P’s view of: • Financial Policies • Transparency/disclosure, capital spending, debt management, investment management • Financial Performance • Absolute level, trend, and volatility of recent and projected earnings and cash flow • Liquidity and Financial Flexibility • Unrestricted cash and investments, age of plant, capital expenditure forecasts, contingent liabilities • Debt/Liability Profile • Current, proposed, contingent, and off-balance sheet liabilities • Balance of fixed/variable/direct purchase versus credit characteristics

8. U.S. Not-For-Profit Health Care: Our View Of Sector Outlook – 2013 • We believe rating trends are likely to be broadly stable in 2013 • However, we project less favorable trends than in 2010-2012 • Many incremental challenges remain and health care reform implementation will continue • Providers have done well managing costs despite soft volumes and a tighter revenue environment • Many metrics approached or achieved pre-recession peaks • Bright spots: meaningful use, provider taxes • Heavy investment in IT, physicians, and integration to continue • Rapid pace of consolidation likely to continue • Credit stability will depend in part on finding next level of cost savings

9. Ongoing Incremental Pressures Continue Despite strong performance, we see incremental credit pressures • Relatively high unemployment, reduced health insurance benefits • Medicaid funding pressures – ARRA funding expired in 2012; enrollment still growing • Medicare: weak update factors, VBP, HAC penalties, re-admit penalties, fiscal cliff deal, looming sequestration / negotiated cuts • Commercial plans offering smaller rate increases, seeking value-based contracts • Many of the “easier” cost cutting tactics already deployed • Utilization trends remain generally weak • Cost of employing physicians raises fixed costs • Ongoing competition from physician offices and privately owned treatment centers • Rising average age of plant ARRA = American Recovery and Reinvestment Act. VBP = Value-based purchasing. HAC =Hospital-acquired condition.

10. Incremental Pressures: Growth of High-Deductible Plan Membership Members (millions) Source: America’s Health Insurance Plans - Center for Policy Research.

11. Incremental Pressures: Medicare $ At Risk – Quality Provisions of ACA ACA = Patient Protection and Affordable Care Act of 2010. VBP = Value Based Purchasing. Source: Standard & Poor’s Ratings Services, Patient Protection & Affordable Care Act.

12. Bright Spots: Some Measures Approaching Pre-Recession Levels Days’ Cash on Hand EBIDA Margin (%) Capital Exp./ Depreciation (%) Debt Service Coverage (x) Source: Standard & Poor’s Ratings Services.

13. Bright Spots: Meaningful Use Dollars Are Flowing to Providers (Program period is 2011-2016) Professionals include physicians, dentists, optometrists, podiatrists, and chiropractors. Approximately 90% are physicians. 2012 active registration data is as of November. Source: Centers for Medicare and Medicaid Services.

14. Bright Spots: Hospital Fee Programs • Hospitals are assessed a fee or tax, which is then used to draw down additional matching funds from the federal government • Additional money to the state and to hospitals according to each state’s funding structure • Many states have some sort of hospital fee program implemented • Significant support for operations in fiscal 2011 for certain states (i.e. California, Pennsylvania), 2012 for North Carolina • Term of programs and redistribution of increased federal match varies by state • Finite term of program vs. programs with no sunset date • California, Illinois vs. Colorado, Arkansas • Discrete supplemental payment to hospitals, and/or • Used by state to supplement Medicaid program in another way

15. Health Care Reform – ACA And Organic Change • Supreme Court ruling gave hospital leadership more confidence to accelerate reform preparation activities • Reform efforts likely to continue down the path they are on • Lower costs – pressure to lower costs continues unabated • More value-based reimbursement • Continued development of shared risk models • Physician employment trends continue • Focus on improved quality remains • Continued consolidation • Still ample uncertainty • Political opposition • Which states will opt out of or delay Medicaid expansion? • Decision will impact the envisioned reduction in uninsured • Could lead to greater variability in state Medicaid programs and cost structures • Variability in Medicaid from state to state has typically been a factor

16. S&P’s View: Transition Risk – Living In Two Worlds At Once • Value-based orientation replacing fee-for-service. A slow process. • Emerging delivery system: incentivize better care coordination, reduction in practice variation, better quality of care, higher patient satisfaction in lieu of volume-based production • Incentives of current system still support higher volume, market share, key service line growth; are turned upside down in value-oriented system • Can you back-fill lost volume through market share growth? Does volume move to high quality, transparent provider or to lower cost provider? • Moving too quickly to value-based approach costs revenue and pressures margins. Can providers lower costs fast enough to offset revenue loss? • Moving too slowly to value-based approach may leave you vulnerable when delivery system finally reaches ‘tipping’ point

17. S&P’s Non-Profit Acute Care Hospital Rating Trends 10 year totals: Upgrades: 346 Downgrades: 450 Source: Standard & Poor’s Ratings Services.

18. U.S. Not-For-Profit Acute Health Care Sector Rating Actions # of rating actions Source: Standard & Poor’s Ratings Services.

19. Outlook Changes – U.S. Not-For-Profit Healthcare Outlook changes unaccompanied by a rating change. Source: Standard & Poor’s Ratings Services.

20. More Negative Outlooks = Future Rating Pressure 2012 2011 Excludes developing and not meaningful outlooks. Source: Standard & Poor’s Ratings Services.

21. *Through July 26, 2013.

22. Pennsylvania Acute Care Hospital Ratings

23. Acute Care Rating Distribution – PA vs US

24. Not-For-Profit Health Care: Our View Of Sector Outlook – 2014 and Beyond • Many substance and implementation issues surrounding reform • Substance issues: • Uncertainties around the growth or decline of private health insurance • Who will populate the insurance exchanges? • Will the surge of people with insurance in 2014 “flood” providers and boost labor markets? Will this be a temporary issue? • Longer-term, will inpatient volume plummet due to more effective prevention measures and the advent of evidence-based medicine? • Impact of local payor mixes will continue to influence view of reform – either positive or negative • Implementation issues: • Political opposition to the legislation • Which states will participate in Medicaid expansion • Specifics of rules and regulations yet to be published; and • Uncertainty about how health care exchanges will function • We believe implications of initial implementation of individual mandate likely to take a year or two to settle in; longer-term impact from reform may not be apparent until 2016 or 2017 • We believe that many hospitals and health systems will manage under reform effectively, but even the strongest hospitals are, at best, only likely to hold existing margin and liquidity levels, while weaker providers will likely see ongoing margin and balance sheet pressure leading to rating deterioration

25. Medicaid expansion map as of July 1, 2013 Source: Kaiser Family Foundation http://kff.org/medicaid/state-indicator/state-activity-around-expanding-medicaid-under-the-affordable-care-act/#

26. Common reasons for not expanding Medicaid • Reluctance to initially commit to the expansion • Concerns that funding will not flow to the states as anticipated • Are there other “strings attached”? • Don’t make a broken system a bigger system, a bigger system will cost the state more overall • Expansion could also attract more high utilization individuals “out of the woodwork” and add even more costs to the healthcare system (at traditional FMAP levels) • We can/will design our own system • We can/will expand later • It won’t solve our problem with illegal immigration utilization • Etc.,

27. What it means for healthcare ratings • High levels of Medicaid and Self Pay have always been rating factors, this is no different • It is just another Medicaid program (if expanding) or not (if not expanding) that we will evaluate it as a credit’s overall payor mix and impact on their credit profile • Minimal impact expected (at least initially) • Not withholding upgrades or positive outlooks on credits in non-expansion states • Not putting negative outlooks or downgrading credits in non-expansion states • Not putting positive outlooks or upgrading credits in expansion states • Over time, this will, like most things, impact the smaller and weaker credits first, less so on the larger and stronger credits • Still in a watch and wait mode • More to be determined and decided on this issue • A lot more politics to be played out

28. Rating Process • Request an S&P rating through phone call, email or online submission • www.standardandpoors.com • Assigned analysts will contact you regarding information needed, scheduling call/meeting, and timing • We have a conference call or meeting in person; it is your preference • We can also have a “site visit/tour” if you would like us to visit your location in person • Analysts cannot discuss fees • Once a rating is requested, it will be released to public unless you request “confidential rating” from the beginning

29. Information Needed Before Call/Meeting • Three years of audited financial statements • Preliminary official statement or term sheet • Debt service schedule • Any legal docs (MTI, LA, etc.) ***S&P analyst will provide a list of discussion topics/questions in advance of the call to guide you on what other specific information is needed

30. Rating Meeting: TypicalLogistics • Meeting participants: • Two S&P Analysts; • Financial Advisor; • Underwriter(s); • Senior leadership team (CFO, CEO, Treasurer, Etc.) • Duration: 2-4 hours, tour if applicable • Location: on site at client location, sometimes S&P offices • Time: as early in the process as you can (but still have good data) • Topics: • Purpose of the bond issue (what type of capital project, nature of refunding, etc.) • Criteria factors used to determine the rating

31. What TypicallyHappens in an S&P Rating Committee? • Committee Members: • Includes two analysts at the rating meeting (or on the rating call) • Typically at least four senior analysts • From any S&P office: Chicago; Dallas; San Francisco; Boston; New York • Duration: typically 1-2 hours • Location: Conference call • Time: as early as needed, typically 2-3 weeks after rating meeting • Agenda • Committee Members read draft rating report • Primary analyst explains their analysis of major credit factors • Focus on trends and projections • Question and answer • Primary analyst makes final rating and outlook recommendation • Committee members vote (only senior analyst votes are counted); majority rules

32. What Happens After the Rating Committee? • Financial advisor and/or client and/or underwriter notified of rating • Financial advisor and/or client and/or underwriter receives rating report • Fact check/confidentiality check ONLY • Describes why the particular rating and outlook were assigned • Rating released to public on the S&P website (www.globalcreditportal.com) • Client distributes rating/report as desired • Typically, regular surveillance • Annual receipt of audit • Event-driven rating review (requires client input, although we screen various public web sites)

33. Contact Us Additional Questions?

34. Contact Us Kenneth T. Gacka, Associate Director Phone: 415-371-5036 Email: kenneth.gacka@sandp.com