Rating Update: Moody's downgrades Reading Hospital and Medical Center (PA) to A2; outlook stable

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1 Rating Update: Moody's downgrades Reading Hospital and Medical Center (PA) to A2; outlook stable Global Credit Research - 06 Oct 2015 Approximately $364M affected BERKS COUNTY MUNICIPAL AUTHORITY, PA Hospitals & Health Service Providers PA NEW YORK, October 06, Moody's Investors Service downgrades to A2 from A1 the ratings assigned to Reading Hospital and Medical Center's PA (Reading) bonds issued through the Berks County Municipal Authority. The rating outlook is stable at the lower rating level. Our rating action affects approximately $364 million of outstanding debt. SUMMARY RATING RATIONALE The downgrade to A2 follows a severe downturn in operating performance in FY 2015 following very weak performance in FY 2014, our expectation for suppressed results (as compared with historic levels of performance) and debt service coverage and a likely moderation of the balance sheet cushion in the near term. The A2 rating is supported by TRHMC's leading market position, solid clinical demand trends, and a still healthy absolute unrestricted investment position. In addition, we retain our prevailing concerns about materially higher leverage than typical for an organization of this size, exacerbated by indirect debt, extensive capital spending which may temper cash, and a heightened competitive landscape. OUTLOOK The stable rating outlook reflects Reading's strong fundamentals, which provide some tolerance for operational weakness as management's initiatives to improve operations are implemented. The stable rating outlook also reflects our expectation that operating performance for full FY 2016 will be break-even. Failure to demonstrate significant improvement in operating margins in FY 2016 could pressure the outlook or rating. WHAT COULD MAKE THE RATING GO UP -Material and sustained improvement in financial margins to levels in line with A1 medians -Marked deleveraging and cash-flow growth which translates to significantly stronger leverage metrics WHAT COULD MAKE THE RATING GO DOWN -Inability to demonstrate substantial improvement in operations in FY Decline in liquidity and debt coverage ratios -Increase in debt without commensurate growth in cash flow and liquidity -Measurable market share loss for inpatient and outpatient services STRENGTHS -Leading healthcare provider within Berks County with wide geographic draw and extensive array of high end clinical services, contributing to favorable managed care contract terms; dominant and growing 62% market share of primary service area which accounts for 85% of admissions. -Still ample absolute unrestricted cash balance of nearly $1.0 billion which, while showing tempering, provides a substantial 419 days cash on hand and a solid 161% cash-to-debt. -Investment allocation remains relatively conservative (approximately 75% cash and fixed income allocation).

2 -Despite recent challenges arising from a system conversion and installation, management has brought financial rigor and good focus on strategic development to Reading. There are numerous initiatives being undertaken to restore operating stability. CHALLENGES -Reported losses escalated to very weak levels with a -5.3% operating margin and 5.6% operating cash flow margin in FY 2015; performance reflects a material miss to budget -As we have noted historically, Reading's leverage is high as measured by revenue (68% debt to revenue and 6.4 times debt to cash-flow as compared with A2 medians of 37.2% and 2.7 times, respectively) -Sizable amount of indirect debt, including non-cancelable operating leases and an unfunded pension liability, elevate already outsized measures of leverage further -Large capital investments already underway to address capacity and some aged facilities, expected to aggregate to $270 million through FY 2017, will likely temper the balance sheet cushion in the near term; management reports no new debt. -Broader market developments and new alliances in eastern and central Pennsylvania have heightened the competitive landscape for all providers. RECENT DEVELOPMENTS Recent developments are incorporated in the Detailed Rating Rationale section. DETAILED RATING RATIONALE MARKET POSITION: STRONG MARKET SHARE BUT COMPETITIVE LANDSCAPE IS CHANGING Reading's primary credit strength remains its leading market position. Reading Hospital captures a commanding 62% market share of its primary service area, which encompasses the city of Reading and the majority of Berks County, and over 31,000 admissions annually. Expanding clinical access, largely through ambulatory sites and physician alignment has been a key focus of the management team. This strategy has helped to secure its patient referral base and market position as evidenced by stable market share. However, the broader competitive landscape is a heightened risk. St. Joseph Medical Center, the only other acute care provider in Reading's service area, has benefitted from its move to its replacement facility, leaving downtown Reading and enjoying a reduction of Medicaid volume which has shifted to Reading (Medicaid has risen to 17% of gross patient revenue in from 12% in FY 2008). Most recently, St. Joseph's has become a member of Pennsylvania State University's (Penn State) health network, Penn State Health, which will align its strategy and potentially referral patterns with a quaternary provider outside of the local market. Similarly, larger providers in contiguous markets have aligned clinically with smaller facilities throughout the eastern and central Pennsylvania market, with a goal of shifting high end referral volumes. Reading currently holds approximately 33% inpatient market share in the total service area. With major competitors in the broader area, including Lehigh Valley Health Network, St. Luke's University Health Network, Penn State's Hershey Hospital, Schuylkill Health System, and Lancaster General, aligning with independent hospitals and regional systems we expect to see more fluidity in patient flow across the market. Participating in an ACO with several of the providers in the broader market should allow for efficiencies that translate into savings, and possibly thwart competitive overtures in the marketplace. OPERATING PERFORMANCE, BALANCE SHEET, AND CAPITAL PLANS: SUBSTAINTIAL ABSOLUTE LIQUIDITY PROVIDES SOLID CUSHION OF HIGH LEVERAGE BUT MAY BE TEMPERED BY POOR PERFORMANCE The downgrade to A2 reflects the severe downturn in Reading's financial profile for the last two fiscal years, with Reading's exceptionally strong balance sheet showing some modest tempering. Both years reflect management's strategic decision to install its electronic medical record system and a decline in utilization trends in FY 2015, including inpatient admissions and inpatient surgeries as demand shifted to outpatient settings. Operationally, FY's 2014 and 2015 were challenging years, with a system conversion and installation stressing financial controls. Through June 30, 2015, Reading reported a $47.3 million operating loss (-5.3% margin) and operating cash flow of just $50.2 million (5.6% margin), which reflects a level that is less than half of the historic levels of operating cashflow. Management reports that the final integration of the accounts receivable post-epic conversion in FY 2014

3 occurred during FY 2015, which resulted in an $18 million one-time decrease in operating income. Notwithstanding, this poor financial performance follows the very weak performance in FY 2014 (-3.4% operating margin and 8.3% operating cash-flow margin). A performance improvement plan translated into slightly better than break even adjusted performance in the last quarter of FY 2015, and management reports that July and August 2015 (FY 2016) were both profitable months and ahead of budget. Management is projecting slightly better than break-even performance for full FY 2016, with a 0.7% operating margin and 10.8% operating cash flow margin. We note that management has engaged in a revenue capture/expense reduction strategy that is expected to result in an aggregate $35.0 million in revenue improvements and expense savings in FY 2016, following approximately $28.9 million of improvements achieved in FY With outsized leverage, we see restoring margins to support the fixed requirements of debt as Reading's greatest challenge. Liquidity Reading's unrestricted cash and investment position remains substantial. At June 30, 2015, unrestricted cash and investments totaled $991 million, or an ample 419 days cash. Cash-to direct debt remains a solid 161%. However, both measures have declined in the last year and with capital spend expected to remain high through 2017, budgeted cash-flow will fall short of planned capital spend by approximately $100 million in the next year. The downgrade to A2 incorporates the expectation that balance sheet measures will temper over the next fiscal year. DEBT STRUCTURE AND LEGAL COVENANTS: Weak operations have translated into adequate but thinning cushion of a high debt position as measured by 68% debt to revenue (A2 median is 37.2%). Maximum annual debt service coverage of 3.2 times and debt to cash-flow of 6.4 times in FY 2015, are measures far weaker than the A2 medians of 5.4 times and 2.7 times, respectively. Debt Structure Of nearly $610 million of direct debt, approximately $364 million carries an A2 rating. Approximately 52% of Reading's debt is variable rate, supported by various private placement bank agreements which are long dated. While the majority of covenants are fairly consistent with the MTI (1.1 ties coverage of MADS), some additional covenants are included. There is an 80 days cash test in the Royal Bank of Canada (RBC) 2012D private placement loan, to which there is significant headroom. However, the 2012D private placement with RBC also contains a 30-day redemption if the rating on Reading should fall below an A2. Debt-Related Derivatives Reading has a total of nine floating to fixed rate swaps with an outstanding notional amount of $256 million, where the primary counterparty is JPMorgan Securities Inc. Reading also has two basis swaps with a total notional amount of $167 million, with RBC as counterparty. Pensions and OPEB Sizable amount of indirect debt, including non-cancelable operating leases equivalent to $48 million (calculated as six times current lease expense) and an unfunded pension liability of approximately $169 million, tempers already modest measures of leverage further. GOVERNANCE AND MANAGEMENT: Management has brought financial rigor and good focus on strategic development to Reading. There are numerous initiatives being undertaken to restore operating stability. A new CFO joined Reading in the summer of 2015, at a time when the System is challenged by weaker financial performance, an increasingly competitive service area, and changes to the Medicaid program, however, he brings experience with managing revenue cycle issues and managing in more competitive markets. KEY STATISTICS Based on financial statements for Reading Hospital and Controlled Entities First number reflects audit year ended June 30, 2014 Second number reflects management prepared year end June 30, 2015

4 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 -Inpatient admissions: 31,830; 31,125 -Observation stays: 6,310; 9,432 -Medicare % of gross revenues: 48.0%; 47.0% -Medicaid % of gross revenues: 17.0%; 17.0% -Total operating revenues ($): $901.1 million; $899.7 million -Revenue growth rate (%) (3 yr CAGR): 2.4%; 2.4% -Operating margin (%): -3.4%; -5.3% -Operating cash flow margin (%): 8.3%; 5.6% -Debt to cash flow (x): 4.8 times; 6.4 times -Days cash on hand: 463 days; 419 days -Maximum annual debt service (MADS) ($): $34.4 million; $34.4 million -MADS coverage with reported investment income (x): 4.0 times; 2.5 times -Moody's-adjusted MADS Coverage with normalized investment income (x): 4.1 times; 3.2 times -Direct debt ($): $610 million; $610 million -Cash to direct debt (%): 175%; 161% -Comprehensive debt: $794 million; $831 million -Cash to comprehensive debt (%): 134%; 119% -Monthly liquidity to demand debt (%): 268%; 268% OBLIGOR PROFILE Reading Health System ("RHS") is a regional tertiary provider, anchored by the Reading Hospital located in Reading Pennsylvania. Reading captures leading market share in its primary service area and many core service lines. LEGAL SECURITY The Obligated Group includes The Reading Hospital and Medical Center and the parent holding company, The Reading Hospital. The bonds are secured by a general obligation of the Obligated Group. A first-priority security interest in the gross revenues of the Obligated Group has been granted to secure all priority debt and other obligations. USE OF PROCEEDS Not applicable. PRINCIPAL METHODOLOGY The methodology used in this rating was Not-for-Profit Healthcare Rating Methodology published in March Please see the Credit Policy page on for a copy of this methodology. REGULATORY DISCLOSURES

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