New Issue: Moody's assigns Aa3 to Baylor Scott & White Health's (TX) Ser taxable bonds; outlook stable

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1 New Issue: Moody's assigns Aa3 to Baylor Scott & White Health's (TX) Ser taxable bonds; outlook stable Global Credit Research - 02 Apr 2015 System to have $1.8B rated debt BAYLOR SCOTT & WHITE HEALTH, TX Hospitals & Health Service Providers TX Moody's Rating ISSUE RATING Taxable Bonds, Series 2015 Aa3 Sale Amount $554,280,000 Expected Sale Date 04/13/15 Rating Description Revenue: Other Moody's Outlook STA NEW YORK, April 02, Moody's Investors Service assigns a Aa3 to Baylor Scott & White Health's (BSWH) proposed $554.28M Series 2015 taxable bonds to be issued by Baylor Scott & White Holdings. The bonds are expected to mature in 2045, though BSWH is evaluating the inclusion of 5, 10 and 40-year maturities as well. The outlook is stable. We are affirming the Aa3 and Aa3/P-1 ratings on outstanding debt. The outstanding bonds were issued under the legacy names of Baylor Health Care System (Baylor) and Scott & White Healthcare (Scott & White). SUMMARY RATING RATIONALE The Aa3 rating is attributable to BSWH's status as the largest not-for-profit health system in Texas, geographic diversity with strong market positions in Dallas and Temple, favorable demographics driving very good revenue growth, good liquidity, and a strong and experienced management team with proven track record. The system has made good progress on rapidly executing integration initiatives while maintaining solid operating margins. The proposed Series 2015 new money issuance was considered in our credit assessment in January Challenges include a moderately leveraged operating and balance sheet position, highly competitive markets in the North Texas region with no Certificate of Need regulations and likely increased capital needs to fund growth strategies. OUTLOOK The stable outlook reflects our expectation that the system will achieve its fiscal year 2015 operating budget, which represents stability to 2014 and further progress on integration initiatives, maintenance of unrestricted investments, and no material new debt issuance beyond the proposed offering. WHAT COULD MAKE THE RATING GO UP - Sustained improvement in operating margins - Deleveraging of balance sheet and operations - Significant reduction in competition or increase in market share WHAT COULD MAKE THE RATING GO DOWN - Material amount of new debt

2 - Material amount of new debt - Multi-year decline in operating margins - Contraction in liquidity - Dilution of key measures from acquisition or merger STRENGTHS - Status as the largest not-for-profit health system in Texas with about $7.3 billion in annualized total operating revenue (based on the 6-month period ended December 31, 2014), supported by 43 hospitals, over 6,000 affiliated physicians and a large health plan, and geographic diversification with flagship hospitals in Dallas and Temple - Dominant market position in the Central Texas region with the only stand-alone children's hospital between Austin and Dallas - Location in a favorable and expansive service area with a well-diversified economy and continued population growth, driving very strong annual revenue growth as evidenced by a 3-year operating revenue CAGR approximating 8% - Operating cashflow margins of 12% for the nine months ended June 30, 2014 and 15% for six months ended December 31, 2014 are very good, especially given the short timeframe operating as an integrated system - Over $3 billion in unrestricted cash and investments, equating to an adequate 184 days cash on hand, and monthly liquidity provides a strong 412% coverage of demand debt - Primarily defined contribution pension plans, providing predictability in funding requirements CHALLENGES - Dallas-Fort Worth metroplex is highly competitive with two other well-funded regional systems and the absence of Certificate of Need (CON) regulation; while the legacy Scott and White hospitals have a leading market share, competition is higher in the system's Waco and Austin markets - Somewhat leveraged relative to medians, including debt-to-cashflow of 4.0 times and cash-to-debt 110% based on proforma annualized nine-month fiscal year 2014 performance - High degree of competition will likely require greater levels of capital investments than in the past - The system is still on the path of executing major operational improvements and synergies, but has made good progress to date RECENT DEVELOPMENTS BSWH recently announced two joint ventures with an affiliate of Tenet Healthcare Corporation. We will evaluate these transactions when further details are available. DETAILED RATING RATIONALE MARKET POSITION: GOOD MARKET SHARE IN COMPETITIVE MARKETS Since the merger effective October 1, 2013, BSWH has made good progress on integrating the legacy Baylor (referred to herein as the "North Texas Division") and Scott and White (referred to herein as the "Central Texas Division") systems. Relatively rapid execution of initial integration strategies and transition to centralized control has allowed the system to maintain solid operating performance, even with a moderate shortfall to budget primarily due to weaker than expected operating performance in the Central Texas Division. In FY 2014 and year-to-date FY 2015, while BSWH is still integrating many aspects of operations, we believe progress to date and a strong and tenured leadership team will result in further significant savings and efficiencies from integration strategies. The Central Texas Division has historically enjoyed a dominant market position, but the system faces higher competition in the North Texas market and is investing in new Central Texas markets (over five years) that are increasingly competitive. The system benefits from high 7-8% population growth (over a five-year period) in many markets, but the absence of CON regulations attracts well-funded competitors. Based on management-provided data, BSWH holds an approximate 22% total market share across the North Texas region with Texas Health

3 Resources holding equivalent share. BSWH is the market leader with approximate 28.5% total market share across the Central Texas region. BSWH also faces significant competition from physician groups that own hospitals and surgery centers. A significant strategy for BSWH involves joint ventures, which allow alignment with physicians and organizations with clinical expertise in particular specialties but require the system to share income for these services. All of the system's ambulatory surgery centers (28) and seven short-stay surgical hospitals are part of a joint venture with USPI. Other joint ventures include rehabilitation services, free-standing emergency hospitals and imaging centers. OPERATING PERFORMANCE, BALANCE SHEET AND CAPITAL PLANS: IMPROVED OPERATING PERFORMANCE SUPPORTS INCREMENTAL DEBT Since the merger, through nine months ended June 30, 2014, BSWH produced good operating margins, even with the moderate shortfall to budget. For this period, the operating and operating cashflow margins were 5.4% and 11.9% respectively, including $28 million of merger-related costs in operating expenses. Operating cashflow was below budget by about 1.1% primarily due to revenue cycle issues and modest volume shortfalls to budget in the Central Texas Division. The North Texas Division outperformed budgeted performance, driven by operating improvements and increased Medicaid waiver funds. (The audit reports noncontrolling interests as a change in net assets; Moody's includes noncontrolling interests as a non-operating deduction, affecting debt-to-cashflow and debt service coverage ratios.) Through six months ended December 31, 2014, results are strong and significantly exceeded budget with operating and operating cashflow margins of 8.9% and 14.7%, respectively. Year-to-date FY 2015 performance benefited from operating improvements and synergy benefits, increased volume, better payer mix with less selfpay than expected, and improved performance in the Central and North Texas Divisions. The system is targeting around $600 million in total operating improvements and synergy benefits for fiscal years 2014 through 2016, representing strategies to offset Medicare and federal reimbursement cuts and realization of merger benefits. Through nine months ended June 30, 2014 BSWH achieved close to $140 million in total improvements and is targeting over $200 million for fiscal years 2015 and 2016, respectively. The system is ahead of targets for The largest initiatives involve centralization of and/or improvements in revenue cycle, supply costs including pharmaceutical costs, and retail pharmacy. The system has already re-negotiated and centralized managed care contracting. Growth strategies and competition will result in increased capital spending. BSWH is constructing a new hospital in Marble Falls and may consider acquisitions of existing providers. The system has begun to grow the health plan beyond the Central Texas market and increase the number of physicians aligned through the Baylor Scott & White Quality Alliance. The health plan is already large with over $760 million in revenue projected for fiscal year Liquidity BSWH has over $3 billion in unrestricted cash and investments, equating to an adequate 184 days cash on hand. Investments are fairly liquidity with almost 50% cash and fixed income securities. Monthly liquidity provides a strong 412% coverage of demand debt. The system has manageable and predictable liquidity risks with minimal swap collateral and defined contribution pension plans. DEBT STRUCTURE AND LEGAL COVENANTS: LEVERAGE HIGHER THAN PEERS The proposed issuance was incorporated into our prior assessment. The proposed new debt of $250 million represents a moderate 10% increase in debt. On a proforma basis, the system is leveraged with debt-to-cashflow somewhat high at 4.0 times and cash-to-debt modest at 110%. Given the system's leveraged position relative to the rating category, issuance of a meaningful amount of new debt could drive a downward revision to outlook or underlying rating. The system also plans on issuing $181 million of tax-exempt fixed rate refunding debt to be directly placed with TD Bank to fully or partially defease the S&W Series 2008A and Series 2010 bonds and the BHCS Series 2009 bonds. The bonds are fully amortizing and are expected to have the same covenants as noted below. Debt Structure Debt structure risks are manageable with diversified bank counterparties and facility expiration dates for bank agreements supporting variable rate debt. BSWH has ample headroom under covenants. MTI and bank agreement covenants include a debt service coverage ratio of at least 1.10 times; if less than 1.10 times, a

4 consultant will be hired. An event of default occurs if, under the MTI, the debt service coverage ratio for two consecutive fiscal years is less than 1.00 times. Bank agreements also include a days cash on hand covenant of 75 days or greater. The Aa3/P-1 rating on the 2011B and 2013B bonds reflects the system's ability to access the market or liquidate assets should the bonds fail to be remarketed and the structure that allows a lengthy period of time to get funds to meet the mandatory tender. Debt-Related Derivatives BSWH's combined swap program includes $813 million of fixed payer swaps and $80 million of fixed receiver swaps. Counterparty risk is diversified among five counterparties. The total mark to market (MTM) was a negative $292 million as of December 31, 2014 and excludes the impact of any counterparty credit value adjustment (CVA) to the MTM. The CVA adjustment at June 30, 2014 resulted in a favorable $16.2 million reduction in BSWH's MTM swap liability. The system's collateral posting requirements are modest for the size of the program, resulting in minimal liquidity pressure. Collateral thresholds are high for most swaps. Pensions and OPEB BSWH's pension plan is largely defined contribution. GOVERNANCE AND MANAGEMENT The legacy Baylor system ("North Texas Division"), whose tenured management team holds a majority of the senior leadership positions of BSWH, has a long track record of producing very strong and consistent margins. BSWH has control and substantial reserved powers over the system's affiliates, which supports tight integration and centralization of operations. BSWH's budgets and financial plans are very well detailed and appropriately conservative. The system typically underspends its capital budget. Quarterly disclosure is very good. KEY STATISTICS Assumptions & Adjustments: - Based on financial statements for Baylor Scott & White Health - First number reflects 9 months ended June 30, 2014, annualized if applicable - Second number reflects 9 months ended June 30, 2014, annualized if applicable and proforma with $250 million additional debt - Investment returns normalized at 6% unless otherwise noted - Comprehensive debt includes direct debt, operating leases, and pension obligation, if applicable - Monthly liquidity to demand debt ratio is not included if demand debt is de minimis - Non-recurring items or adjustments: None - Inpatient admissions: 185,008 - Observation stays: N/A - Medicare % of gross revenues: 41.9% - Medicaid % of gross revenues: 9.3% - Total operating revenues ($): $6.8 billion - Revenue growth rate (%) (3 yr CAGR): 8% est. - Operating margin (%): 5.4% - Operating cash flow margin (%): 11.9% - Debt to cash flow (x): 3.7 times; 4.0 times proforma

5 - Days cash on hand: 184 days - Maximum annual debt service (MADS): $161 million; $162 million proforma - Moody's-adjusted MADS Coverage with normalized investment income (x): 4.9 times; 4.8 times proforma - Direct debt ($): $2.5 billion; $2.8 billion proforma - Cash to direct debt (%): 121%; 110% proforma - Comprehensive debt: $3.2 billion - Cash to comprehensive debt (%): 97% - Monthly liquidity to demand debt (%): 412% OBLIGOR PROFILE Effective October 1, 2013, Baylor and Scott & White combined to form a new organization called Baylor Scott & White Health (BSWH). Effective February 21, 2014, Baylor and Scott & White completed the substitution of each of their existing master trust indentures and established a single new BSWH Master Trust Indenture (MTI) that combined the two previously separate obligated groups. As such, previous debt issued by Baylor and Scott & White is now secured with the security interest provided under the new MTI. BSWH is the largest not-for-profit healthcare system in Texas with 43 hospitals in northern and central Texas, 6,000 affiliated physicians, the large Scott & White Health Plan with over 210,000 members and the Baylor Scott & White Quality Alliance with over 130,000 members. LEGAL SECURITY The bond payments are secured by the Obligated Affiliates. Obligated Affiliates include Baylor Scott & White Holdings, Baylor Health Care System, Baylor University Medical Center, Baylor All Saints Medical Center, Baylor Regional Medical Center at Grapevine, Baylor Medical Center at Waxahachie, Baylor Regional Medical Center at Plano, Scott & White Memorial Hospital, Scott & White Healthcare, Scott & White Clinic, Scott & White Hospital- Round Rock, Scott & White Continuing Care Hospital, and Hillcrest Baptist Medical Center. Not included in the Obligated Affiliates are Baylor Medical Centers at Garland and McKinney and Scott & White Healthcare Foundation, which were previously members of the respective obligated groups. The bonds are secured by a security interest in (1) all accounts receivable and Receipts of the Obligated Affiliates, (2) all right, title, and interest of the Obligated Affiliates in and to all money and investments deposited or required to be deposited with the master trustee, (3) any and all property that may be subjected to the lien and security interest of the MTI, and (4) all Accounts, Bank Accounts, General Intangibles, Contract Rights, and Related Rights of the Obligated Affiliates. However, at such time that Scott & White's Series 2008A and 2010 bonds are no longer outstanding, then the bonds will be secured only by (1) all right, title, and interest of the Obligated Affiliates in and to all money and investments deposited or required to be deposited with the master trustee and (2) any and all property that may be subjected to the lien and security interest of the MTI. There are no limitations on the issuance of debt and no limitations on the disposition of assets in the MTI. USE OF PROCEEDS Proceeds from the Series 2015 taxable and tax-exempt bonds will be used to fully refinance the Series 2008A and 2009 bonds and partially refinance the Series 2010 bonds, as well as provide funds for capital projects and strategic initiatives. RATING METHODOLOGIES The principal methodology used in this rating was Not-for-Profit Healthcare Rating Methodology published in March The additional methodology used in the short-term rating was Rating Methodology for Municipal Bonds and Commercial Paper Supported by a Borrower's Self-Liquidity published in January Please see the Credit Policy page on for a copy of these methodologies. REGULATORY DISCLOSURES

6 For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review. Please see for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating. Please see the ratings tab on the issuer/entity page on for additional regulatory disclosures for each credit rating. Analysts Lisa Martin Lead Analyst Public Finance Group Moody's Investors Service Lisa Goldstein Backup Analyst Public Finance Group Moody's Investors Service Contacts Journalists: (212) Research Clients: (212) Moody's Investors Service, Inc. 250 Greenwich Street New York, NY USA 2015 Moody s Corporation, Moody s Investors Service, Inc., Moody s Analytics, Inc. and/or their licensors and affiliates (collectively, MOODY S ). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES ( MIS ) ARE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY S ( MOODY S PUBLICATIONS ) MAY INCLUDE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY S OPINIONS INCLUDED IN MOODY S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR

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