Fitch Rates Bon Secours Health System's (MD) 2010 Revs 'A-' & Affirms Outstanding; Outlook Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an underlying rating of 'A-' to the following Bon Secours Health System, Inc. (BSHSI) revenue bonds:

--$39,995,000 Virginia Small Business Financing Authority revenue bonds, series 2010.

Fitch also affirms its 'A-' rating on approximately $1 billion of outstanding bonds issued on behalf of BSHSI.

The Rating Outlook is Stable.

The affirmation applies to the underlying ratings on various issues including the following which will convert to a fixed rate mode on Sept. 29, 2010:

--$40,345,000 Economic Development Authority of Henrico County (Virginia) revenue bonds, series 2008B-1;

--$40,350,000 Economic Development Authority of Henrico County (Virginia) revenue bonds, series 2008B-2;

--$46,440,000 Economic Development Authority of the County of Chesterfield (Virginia) revenue bonds, series 2008C-1;

--$46,220,000 Series Economic Development Authority of the County of Chesterfield (Virginia) revenue bonds, series

2008C-2.

Rating Rationale:

--BSHSI is a large system with significant geographic dispersion, a manageable debt load, stable operating profitability, and a strong management team, all of which help compensate for a relatively light liquidity position at this rating level.

--With liquidity now stabilized after substantial investment losses, Fitch expects a moderate and gradual improvement in liquidity metrics, as healthy operating cashflow is reinvested in ambulatory facilities and information technology. Cash and unrestricted investments of $810.8 million through the interim period translate to 112.3 days cash on hand (DCOH), 11.1 times (x) cushion ratio and 78% cash to debt, lagging the 'A' category medians of 183.8 DCOH, 14.4x and 105.5%, respectively.

--Operating performance improved in fiscal 2009 and has been maintained for the 11-month interim period ended July 31, 2010, with operating and operating EBITDA margins of 3.1% and 8.5%, consistent with 'A' category medians of 3% and 10%, respectively.

--Historically BSHSI has maintained a high reliance on variable rate debt (totaling 53% of all outstanding) and swaps, but this is mitigated by the planned 2010 debt restructuring which will reduce the percentage of variable rate debt to 39% and terminate four swaps.

Key Rating Drivers:

--The sustainability of operating improvements recently undertaken in underperforming markets;

--Full implementation of a comprehensive clinical information system at all divisions and realization of attendant benefits;

--Ability to make capital investments in growth markets without negatively impacting debt ratios.

Security:

Pledge of unrestricted receivables of all obligated group members.

New Issue Detail:

The series 2010 bonds are expected to be issued as either daily or weekly variable interest rate bonds with a 2042 final maturity and liquidity will be provided via a JP Morgan Letter of Credit. However, issuance is dependent upon favorable market rates at the time of the proposed transaction. Ratings based on bank support would be assigned at a later date. Regardless of the issuance of the series 2010 bonds, BSHSI will be converting the series 2008B-1, 2008B-2, 2008C-1 and 2008C-2 series bonds to a fixed rate on or about Sept. 29, 2010. The proceeds of the 2010 bond issuance would be used to fund the swap termination payments relating to the 2008B-1, 2008B-2, 2008C-1 and 2008C-2 series.

Credit Summary:

The proposed debt restructuring is intended to address BSHSI's high reliance on variable rate debt, which had been noted by Fitch as a credit weakness, particularly in light of the system's relatively light liquidity. The conversion of the four 2008 series to fixed rate will somewhat mitigate this risk by reducing the percentage of variable rate debt to a more manageable 39% of outstanding debt and will also potentially eliminate exposure to four swaps with notional par of $173 million. The total notional amount of swaps outstanding post transaction would be $1.2 billion, well diversified among several counterparties, and no collateral posting required on approximately $718 million of notional par.

The improvement in the system's financial operations, which began to take hold during mid-fiscal 2009 after a somewhat weaker fiscal 2008, has been maintained in the current fiscal year, as demonstrated by the operating margin and operating EBITDA margin through the 11-month 2010 interim period ended July 31, of 3.1% ($87.4 million operating income) and 8.5%, respectively. BSHSI ended fiscal 2009 with operating income of $77.7 million, for an operating margin of 2.7% and an operating EBITDA margin of 8.6%, an improvement over the prior year's 1.8% operating and 8.1% operating EBITDA margins. The interim period operating performance was achieved as a result of a continuation of a turnaround in Baltimore, a market which has presented a continuing challenge for the system, which is now operating at a slightly positive margin, as well as a return to solid profitability of the Hampton Roads division. However, the turnaround at New York Charity was not sustained, and a $13.6 million operating loss was reported through the 11-month interim period, following what was essentially breakeven performance in the last fiscal year. The system's management attributes the loss to leadership issues at the division and has responded by making several management changes, including the CEO and CFO positions. The focus at the New York Charity division is on rebuilding physician loyalty, with volumes slowly being restored and losses stemmed in the fourth quarter.

The additional approximately $40 million of new debt planned as part of the 2010 transaction will not materially impact BSHSI's debt metrics. The system's debt to capitalization is high at 65%, but pro forma maximum annual debt service (MADS) coverage at 3.1x through the 11-month interim period is close to the 'A' category median of 3.3x. MADS coverage by operating EBITDA is a stronger 3.6x, exceeding the 3.3x category median and MADS as a percentage of revenues is a manageable 2.4%.

BSHSI has made significant investments in clinical transformation and information technology and its ConnectCare system, where already implemented, has produced tangible results in reduced length of stay, improved revenue capture, reduced costs per care as well as better clinical outcomes. BSHSI has to date spent $124 million of the $200 million projected ConnectCare cost and expects full system-wide implementation by 2013, with between $75-90 million potentially recaptured through the health care stimulus IT funding.

Fitch's main credit concern continues to be BSHSI's light liquidity. While management took steps to scale back capital spending and focused on operating profitability, which halted the liquidity decline, liquidity metrics remain below the category medians. BSHSI's management is cognizant of the need to generate stronger operating results in order to generate funds for needed capital investment over the medium term. This is particularly critical given the presence of several of the system assets in areas with solid population growth, coupled with competitive pressures, such as the Richmond and Hampton Roads market.

An additional concern is the growing pension liability, which will likely cause the system for fiscal 2010 to again violate the 65% debt to capitalization covenant in certain of its insurer covenants. Management is in the process of securing waivers from these parties. Although BSHSI's pension funding expectations are an additional expected draw on liquidity, the status of most of the plans as church plans reduces the level of concern.

The Stable Outlook reflects Fitch's expectation that BSHSI's strong management practices, favorable markets, and substantial investment in facilities, clinical programs, and informational technology will translate into higher operating profitability. Over time, BSHSI should be able to build the liquidity necessary to continue to invest in the enterprise.

BSHSI, headquartered in Marriottsville, MD, with facilities in seven eastern states, consists of 18 owned and joint-ventured hospitals, as well as several other non-acute entities. BSHSI reported total revenues of $2.9 billion in fiscal 2009. BSHSI covenants to supply both audited annual and unaudited quarterly financial data to bondholders through the nationally recognized municipal securities information repositories. BSHSI has been disclosing annual and quarterly financial statements through Digital Assurance Certification LLC (DAC) at 'www.dacbond.com'. Financial disclosure to bondholders has been excellent in terms of content and timeliness and includes detailed management discussion and analysis, a balance sheet, an income statement, utilization statistics, and consolidating statements.

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

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', dated Aug. 16, 2010;

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated Dec. 29, 2009.

For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.

Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548606

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493186

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