University of Pittsburgh Medical Center, PA

U.S. PUBLIC FINANCE

CREDIT OPINION15 September 2016

New Issue

Analyst Contacts

Beth I. Wexler 212-553-1384VP-Sr Credit [email protected]

Lisa Goldstein 212-553-4431Associate [email protected]

Rita Sverdlik 212-553-3908Associate [email protected]

CLIENT SERVICES

Americas 1-212-553-1653

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University of Pittsburgh Medical Center, PANew Issue - Moody’s assigns Aa3 to University of PittsburghMedical Center (PA) $239.2M Ser. 2016; Outlook Negative

Summary Rating RationaleMoody's Investors Service assigns a Aa3 to the University of Pittsburgh Medical Center’s(UPMC) proposed $239.2 million of Revenue Bonds, Series 2016 through the PennsylvaniaEconomic Development Financing Authority. The bonds are expected to be issued as fixedrate securities and are scheduled to mature in 2041. Concurrently, we are affirming theAa3 on UPMC's outstanding bonds as well as the bonds of UPMC-Hamot, which are parityobligations under UPMC’s indenture. The rating outlook remains negative. Our action affectsapproximately $3.1 billion of debt.

The assignment and affirmation of the Aa3 reflects several key credit strengths, includingthe system’s large absolute size, strong market position in western Pennsylvania, anchoredby a highly regarded academic medical center with international draw, adequate balancesheet measures, effective management of debt structure risks, and relatively stablefinancial performance at the clinical enterprise. The tangible benefits of UPMC’s operatingmodel mitigates our continuing concerns about the weak regional economy, an unusuallyacrimonious business environment, historically modest margins and higher total adjustedleverage than is typical for the rating category.

Exhibit 1

Unrestricted Cash and Investments Provides for Improving, Though Still Modest, Coverage ofDebt

Source: Moody's Investors Service

http://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=PBM_1041929

MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 15 September 2016 University of Pittsburgh Medical Center, PA: New Issue - Moody’s assigns Aa3 to University of Pittsburgh Medical Center (PA) $239.2M Ser. 2016;Outlook Negative

Credit Strengths

» Solid brand recognition anchored by highly regarded academic medical center with an international draw; favorable relationshipwith the University of Pittsburgh, PA (rated Aa1)

» FY 2016 performance improved over normalized FY 2015, though margins remain thin to comparably rated peers

» Wide patient draw regionally and nationally, supporting future growth and compensating for stagnant population trends in thePittsburgh area; unrivaled business platform in 29-county service area

» Strong leadership team carefully navigating a highly fluid business environment and multiple growth strategies

» Absolute growth of wealth has translated to improved coverage of leverage since FY 2012; manageable debt structure risks

» Highly integrated medical staff through 3,600 employed physicians

» Long history operating insurance business

Credit Challenges

» Insurance division perennially pressures margins, though is a key component of the System's integrated delivery model

» Multi-year trend of thin consolidated margins as compared with comparably rated peers

» Acrimonious operating environment that has been unusually litigious, divisive and distracting; 10% of business remains at risk forleaving system

» Higher than average leverage as compared with unrestricted resources as illustrated by just 132% pro-forma unrestricted cash tototal debt

» Total adjusted debt (pension and operating leases) is material adding an additional $885 million of comprehensive liabilities,diluting all cushions for leverage

» Long standing concern that UPMC's investments are riskier and relatively less liquid than optimal given balance sheet leverage andthinner than average margins

» Weak demographics in Pittsburgh and the majority of the Western portion of Pennsylvania

Rating OutlookThe negative outlook reflects our concern with the continued evolution of the marketplace with the wind down of the businessrelationship between UPMC and Highmark. The outlook also incorporates the challenge to continue to strengthen margins and buildliquidity while concurrently absorbing the System’s acquisitive growth strategies.

Factors that Could Lead to an Upgrade

» Material improvement in operating margins for a sustained period

» Notable strengthening of all liquidity and leverage ratios

Factors that Could Lead to a Downgrade

» Deterioration of operating performance

» Contraction of unrestricted cash and investments

https://www.moodys.com/credit-ratings/University-of-Pittsburgh-PA-credit-rating-600028453



» Sizable acquisition that dilutes system margins or balance sheet measures

» Material increase in debt without commensurate increase in cash and cash flow

Key Indicators

Exhibit 3

University of Pittsburgh Medical Center, PA

Based on financial statements for University of Pittsburgh Medical Center (FYE June 30)Investment returns normalized at 6% prior to FY 2015 and 5% in FY 2015 and beyondSource: Moody's Investors Service

Recent DevelopmentsOn May 1, 2016, UPMC and Jameson executed an Integration and Affiliation Agreement providing for an affiliation between UPMC andJameson Health System in New Castle, Pa. During the fiscal year ended 2016, UPMC recognized revenues for two months as well asassets and liabilities (which included approximately $22,000 of pension liability and $38,000 of long-term debt obligations).

UPMC and Susquehanna Health System (SHS), based in Williamsport, Pa., entered into an integration and affiliation agreement datedAugust 26, 2016 pursuant to which, among other things, UPMC will become the sole corporate member of SHS. Both parties currentlyexpect an effective date of the affiliation on or about October 1, 2016, contingent on meeting all closing conditions and obtainingall necessary regulatory approvals. No assurances can be given as to when the regulatory approvals will be obtained or what theconditions of any such approvals will be at this time.

In December 2015, UPMC and WCA Hospital in Jamestown, NY, announced a formal affiliation agreement to integrate WCA Hospitalinto the UPMC network. The affiliation agreement is contingent upon the completion of regulatory approvals, including final New YorkState Certificate of Need approval. UPMC and WCA anticipate finalizing the transaction before the end of CY 2016.

Detailed Rating ConsiderationsMarket Position: Distinctly Leading Market Share But Environment Presents Chronic ChallengesUPMC's fundamental credit strength continues to be its preeminent national clinical reputation and strong local and regional marketpositions (60% market share in Allegheny County and 41% market share of a 29-county region), which has been notably enhanced bythe system's well executed growth. UPMC's wide patient draw has supported demand growth, compensating for stagnant populationtrends in the Pittsburgh area.

System growth has followed both greenfield build and acquisitive growth. Most recently, UPMC assumed the operations ofJameson Health System and has intentions to add two organizations before CYE (see Recent Developments). Each of the respectiveorganizations to be acquired is relatively modest in size as compared with UPMC’s consolidated organization and collectively will havean immaterial impact on UPMC’s financial profile. However, absorption and integration of the differing cultures at this accelerated



pace can prove challenging, particularly as the System endeavors to sustain operational traction while managing the wind down of theHighmark relationship.

This region’s healthcare marketplace, an unusually acrimonious operating environment, poses a degree of uncertainty to UPMC.Highmark’s development of a provider network, precipitated the fractured dynamic that now exists in the greater Pittsburghmarketplace with UPMC and Highmark having executed consent decrees that provided for a multi-year wind-down of their relationshipthrough mid-2019. We continue to see Highmark’s provider services as bearing some risk for UPMC as Highmark now competesdirectly with UPMC as an integrated delivery and financing system. Though, under the transition agreement, Highmark subscribers cancontinue to access UPMC providers if they are in the midst of a course of treatment, as if they were in network, or in a market whereaccess becomes an issue, the potential for fluidity of demand and general subscriber confusion is high, rendering UPMC vulnerable toa higher degree of market risk than historically present given its formidable clinical footprint. UPMC’s business platform somewhatinsulates it from this variability with growing volumes from national insurers and its employment of approximately 3,600 physicianswho are responsible for more than two-thirds of its admissions. In general, UPMC’s market share in each of its three defined serviceareas, Allegheny County, Southwestern PA, and Western PA, has grown in spite of the market-wide volume declines and Highmark’sdevelopment of a provider network.

Finally, potential reductions in Medicare and Medicaid reimbursement, which comprise over 60% of gross patient revenue, maychallenge margins in the future, though the Commonwealth’s expansion of Medicaid and UPMC’s continuous focus on cost reductionshould mitigate this risk.

Operating Performance, Balance Sheet and Capital Plans: Solid Clinical Enterprise Performance, But Insurance DivisionSuppresses MarginsConsolidated operating performance improved in FY 2016, but remains weak relative to comparably rated peers and historical levelsdue to the lower margin insurance division. The consolidated operating cash flow margin improved to 5.8% in FY 2016 from 4.9% inFY 2015, after reclassifying $233 million of gains from Evolent Health's IPO to non-operating revenue. Operating results at the coreclinical enterprise are more stable and robust than consolidated results, as illustrated by an 8.0% operating cash-flow margin in FY2016. The System’s ability to continue to generate operating performance at FY 2016 levels will be challenged by the high likelihoodthat volume will be fluid with the Highmark transition agreement as well as the integration of several growth strategies simultaneously.

Financial performance at the clinical enterprise reflects relatively flat demand as the System compensates for multi-year same storedeclines with growth of inpatient and outpatient access points. The addition of Jameson, and potentially SHS and Jamestown shouldafford the System the ability to continue to grow its platform and rationalize services across the broader market efficiently.

LIQUIDITY

UPMC's total absolute cash and investments increased to over $4.3 billion at FYE 2016, equating to a very stable 131 days and providesfor 132% pro-forma unrestricted cash to total debt. With the marked System growth, the relatively stable cushion for leverage andbalance sheet metrics over a five year span reflects profitable operations, borrowings for capital investments, good equity marketperformance and management’s financial rigor. Notwithstanding, UPMC remains highly leveraged both relative to operations andbalance sheet measures, emphasizing the concern we hold regarding thinner operations. All measures of leverage compare unfavorablyto Aa3 medians, as illustrated by the Aa3 median for unrestricted cash-to-total debt of 201%. We also note, with some concern givenmodest margins, that while UPMC's wealth is highly diversified across asset classes and managers, just 59% of the investment balanceis available on a monthly basis. More recent changes in target asset allocation were designed to address this issue, with monthlyliquidity of wealth improving from just 50%.

Debt Structure and Legal CovenantsWhen normalizing investment returns at 5%, pro-forma maximum annual debt service coverage of 3.4 times based on FY 2016performance, is very modest compared with Aa3 median of 6.8 times. While the current offering includes new money for capitalexpenditures, management has institutionalized rigor around the absolute level of leverage of the System, maintaining approximately$3.2 billion of debt, absent liabilities from newly acquired entities.



DEBT STRUCTURE

Of UPMC’s pro-forma $3.3 billion of debt to be outstanding, approximately 77% is fixed rate. All demand debt obligations are placedprivately with a mix of banks and carry staggered tender dates. Approximately $3.1 billion of UPMC’s debt obligations carry a Aa3rating.

DEBT-RELATED DERIVATIVES

UPMC has three remaining debt-related derivative contracts with a total notional amount of approximately $204 million and fourequity-related derivative instruments with a total notional amount of approximately $175 million. UPMC's payment obligations onthese debt with UPMC’s rated debt. As of June 30, 2016 UPMC had posted no collateral.

PENSIONS AND OPEB

UPMC’s comprehensive debt equivalents exacerbate our concerns regarding stressed measures of leverage. The system has a cashbalance defined benefit pension plan, which was 81% funded ($397.7 million liability) compared to a projected benefit obligation of$2.1 billion at FYE 2016. The debt equivalent of operating leases was $487 million at FYE 2016 (based on a four times lease expensemultiplier method). Pro forma cash-to-total adjusted debt is 104% (Aa3 median is 149%).

Management and GovernanceUPMC has a seasoned and deep management team. The team has demonstrated strong management capabilities evidenced by thesystem's ability to absorb operating challenges and execute strategies effectively, including integrating newly acquired hospitals.Additionally, there is a long history of commitment to very good disclosure practices. UPMC has voluntarily complied with all relevantprovisions of the Sarbanes-Oxley Act since 2006.

Legal SecurityUPMC’s parity debt enjoys a joint and several commitment of the obligated group secured by a lien on gross revenues. The ObligatedGroup under the 2007 Master Trust Indenture consists of the Parent Corporation, UPMC Presbyterian Shadyside Hospital, Magee-Womens Hospital of UPMC, UPMC Passavant and UPMC St. Margaret. The system also includes several additional hospitalsthroughout western Pennsylvania, international operations and a variety of insurance subsidiaries as part of its integrated delivery andfinancing system.

Use of ProceedsProceeds from the Series 2016 bonds will be used to current refund the Series 2006 bonds (issued on behalf of UPMC-Hamot) andfor the payment of the costs of the construction, acquisition and installation of various capital improvements to be located at thehealthcare and related facilities owned and/or operated by UPMC.

Obligor ProfileUPMC is an integrated delivery and financing system (IDFS) based in Pittsburgh, Pennsylvania, primarily serves residents of westernPennsylvania. It also draws patients for highly specialized services nationally and internationally. UPMC’s more than 20 hospitals andmore than 500 clinical locations comprise the largest health care delivery system in Pennsylvania. UPMC is the largest nongovernmentemployer in the Commonwealth. Approximately 5,700 physicians are affiliated with UPMC, including more than 3,600 who areemployed by UPMC. UPMC also offers a variety of insurance products that cover more than 2.9 million lives.

MethodologyThe principal methodology used in this rating was Not-for-Profit Healthcare Rating Methodology published in November 2015. Theadditional methodology used in this rating was U.S. Health Insurance Companies published in May 2016. Please see the RatingsMethodologies page on www.moodys.com for a copy of these methodologies.



Ratings

Exhibit 4

University of Pittsburgh Medical Center, PAIssue RatingRevenue Bonds, Series 2016 Aa3

Rating Type Underlying LTSale Amount $239,210,000Expected Sale Date 09/20/2016Rating Description Revenue: Other

Source: Moody's Investors Service



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University of Pittsburgh Medical Center, PA

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